Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation’s Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Jody Burfening. You may begin.

Thank you, Gigi, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation’s Third Quarter 2018 Earnings Conference call. With me this morning are Ed Ross, Fidus Investment Corporation’s Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial Officer. Fidus Investment Corporation issued a press release yesterday afternoon with details of the company’s quarterly financial results. A copy of the press release is available on the Investor Relations page of the company’s website at fdus.com. I’d like to remind everyone that today’s call is being recorded. A replay of today’s call will be available by using the telephone numbers and conference ID provided in the earnings press release. In addition, an archived webcast replay will be available on the Investor Relations page of the company’s website at fdus.com following the conclusion of this conference call. I’d also like to call your attention to the customary safe harbor disclosure regarding forward-looking information included on today’s call. The conference call today will contain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results and cash flows of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, November 2, 2018, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of any telephonic or webcast replay. Actual results may differ materially as a result of risks and uncertainties and other factors, including, but not limited to, the factors set forth in the company’s filings with the SEC. Fidus undertakes no obligation to update or revise any of these forward-looking statements. With that, I would now like to turn the call over to Ed. Good morning, Ed.

Good morning, Jody and thank you and good morning, everyone and welcome to Fidus’ third quarter 2018 earnings call. I’ll start today’s call with a high-level perspective on our third quarter results and then I’ll cover our investment portfolio performance and conclude with comments and our view of the market and Q4 activity levels. Shelby, will go into more detail about the third quarter financial results and liquidity. Once we have completed our prepared remarks, we’d be happy to take your questions. Throughout 2018, we have stayed the course, executing our strategy of building a well diversified portfolio of debt and equity investments and lower middle market businesses that we believe will perform well over the long-term with an emphasis on companies that operate in industries we know well, generate excess cash flow for debt service and have positive long-term outlooks. By adhering to our underwriting discipline focused on capital preservation and generating attractive risk adjusted returns, we emphasize quality over quantity in the long-term over the short-term. Our investment strategy and underwriting principles ensure that we stay focused on our primary goal of delivering stable dividends and growing net asset value per share over time. The third quarter was no exception. Our operating results for the third quarter were in line with our expectations. Adjusted net investment income, which we defined as net investment income, excluding any capital gains and incentive fees attributable to realized or unrealized gains and losses was $8.9 million or $0.37 per share reflecting a high-level of current and recurring income from debt investments. We realized net losses of $7.2 million primarily related to the anticipated exited at one portfolio company that was outweighed by further unrealized appreciation in our equity portfolio. As of September 30, 2018 our net asset value or NAV was $401.5…

Thank you, Ed, and good morning everyone. I’ll review our third quarter results in more detail and close with comments on our liquidity position. Please note I will be providing comparative commentary versus the prior quarter Q2 2018. Total investment income was $17.9 million for the three months ended September 30, 2018, a $0.2 million decrease from Q2. Interest and PIK income decreased by $0.1 million related to incremental assets under management offset by placing our debt investment in K2 Industrial Services are non-accrual. Fee income decreased by $0.2 million primarily due to more prepayment and structuring fees in Q2. Dividend income in Q3 was $0.4 million, a $0.1 million increase versus Q2. Total expenses including income tax provision, were $10.4 million for the third quarter, approximately $1.2 million higher than the prior quarter, primarily related to the capital gains fee accrual. Total G&A expenses decreased by $0.5 million, due to the acceleration of non-cash expenses related to an expired registration statements and annual shareholder meeting costs incurred in Q2. Base management and income incentive fees increased by $0.2 million, and accrued capital gains incentive fees decreased by $1.7 million. Interest expense was $0.1 million higher in Q3. Interest expense includes interest as well as any commitment and unused line fees. As of September 30, 2018, the weighted average interest rate on our outstanding debt was 4.1%. As of September 30, we had $301.5 million of debt outstanding, comprised of $214.5 million of SBA debentures, $50 million of public notes and $37 million outstanding on our line of credit. Our debt-to-equity ratio was 0.75 times or 0.22 times regulatory leverage, excluding exempt SBA debentures. Net investment income or NII for the three months ended September 30, 2018, was $7.5 million or $0.31 per share versus $0.37 per share in Q2.…

Thanks, Shelby. As always, I’d like to thank our team and the Board of Directors at Fidus for their dedication and hard work and our shareholders for their continued support. I’ll now turn the call back over to Gigi for Q&A. Gigi?

[Operator Instructions] Our first question is from Robert Dodd from Raymond James. Your line is now open.

Hi, everybody. Congratulations on the quarter. Edward, can I ask you about your comments about improved quality of deal flow versus the first half of the year, I mean, Q3, Q4 and how the outlook for that. I mean, can you give us any color on what’s improving? Is it – I mean, obviously, the deals you did in the third quarter, two of the three were first lien. So is it, kind of spreads on first lien, is it better structures? I mean, what exactly would you quantify if you could, as the year improve?

Sure. Well, Robert, it’s a great question. It’s also a difficult question to answer other than, I would say, during the first six months of the year, I mean, the market was open, but just the quality of the opportunities we were seeing were kind of okay, at best. We obviously lost a couple deals to from – due to competition, but it really wasn’t that good in the second quarter in particular. And I would say we saw a significant improvement really starting in July. And I think, I commented on that in the last conference call as well. And so since that point in time, we’re just seeing much better opportunities in terms of what we want to invest in. And so what do I mean by that? I mean, recurring revenue businesses, high free cash flow businesses, things that we think will withstand any potential recessions that could happen in the not too distant future. So those types of businesses, it just – there’s a difference in terms of the quality of the opportunities that we’re seeing today and have been seeing really since July relative to Q2 in particular with relative to the first six months of the year.

Got it. So it’s really is the quality of the companies, not the quality of the structures.

That’s correct. That’s very much correct.

Got it. Perfect. Thank you. And then on robust realizations, I mean, if I look at just the affiliate segment of your schedule and investments, I mean between Fansteel, where the equity is obviously up, way up, Pinnergy, the A2s at 10x cost. I mean those, some of the ones, I mean without, I’m not trying to pin you down on specific names, but is it those kind of businesses that you’re seeing – really see high levels of interest from acquirers? Or is it just more broad based or...

Well, I think – what I would say is, we’re not at first and foremost, we are in almost all of the situations. We’re not in control of the decisions to sell a company, if you will. But what I would say, having said that is there are numerous portfolio companies in our portfolio that are undergoing strategic alternative evaluations or in sales processes. And so we’ve seen several events that take place in the last three months or so. But it’s our anticipation that more will come. And we do have a more than a few portfolio companies that are – I would say, right for sale, if you will. But I don’t know that I want to comment any more than that. At the same time, these are processes that are unpredictable, meaning, someone is engaged and they may sign up an LOI and do all their diligence and then people fight about the working capital adjustment and the deal doesn’t happen. And so they’re unpredictable and it’s hard – so it’s hard for me to say anymore that I just said. But what I would say is, we’ve got numerous portfolio companies that are undergoing strategic alternatives, and we’re evaluating them. And that’s – we’re optimistic that hopefully several of our portfolio companies that are right for monetization. Those transactions will take place.

Got it. I appreciate that color. And one more if I can kind of on just the arithmetic. Given what you’ve had in terms of realization and exits so far in October. Your earning assets down sequentially right now. You’ll probably say, you could have a very active backend to Q4 potentially more realizations below the line, but potentially more repayments may be, but more of the originations as well. Would it be fair to say though that given where you are today, which is down sequentially versus Q2, if these originations happen, they’re likely to happen late. And so Q4 maybe weighted average interest generating assets probably going to be down versus Q3, but potentially and then obviously you pick up the bump in Q1, but would that be fair to say right now based on what you think you’re going to see the rest of the year?

Yes, Robert, I think that’s actually a good way to look at it. We do anticipate this quarter to have more repayments and realizations than we do originations. It’s early. There’s still a lot being worked on, but that would be – and there’s a lot of uncertainty in that statement both from an originations and on repayments perspective. But as I look at it today, I would say that is an accurate statement and that’s what our expectation is at this point.

Thank you. Got it. Got it. I appreciate it. Thank you.

Yes. Absolutely. Good talking to you, Robert.

Thank you. Our next question is from Mickey Schleien from Ladenburg. Your line is now open. Mickey, your line is now open. Mickey, please check to see if your line is muted.

Yes, I’m here. Can you hear me?

We can now. Yes, we can now Mick. But we couldn’t before, but we can now.

Yes. I’m not sure what happened there. Good morning, everyone. Look at none of us obviously has a crystal ball, but the equity portfolios mark has expanded sharply this year. And I’m trying to understand when you look at valuation, how that’s been driven in terms of – can you give us a sense of how much of the increase in valuation was driven by operating performance and the tax cut and higher market multiples?

Sure. I’ll do my best. So I think, to generalize or just the only way to do it, I think at this point. I would say, a large, large majority of it has been driven by operating performance of the portfolio companies. There are a couple in the list of where we have appreciation that, we did increase the multiples and some of that was due to interest in the company from a potential acquisition. And so we – obviously, when we get that kind of information, we update our valuations. But I would say a large, large majority of it has been driven by operating performance of the underlying portfolio companies. Tax code really has had nothing to do with it generally speaking.

Okay. And given what you just said and the concerns in the market about the outlook for growth, I don’t know, if it’s probably early days yet. I mean, you probably haven’t seen the numbers for October. But is your sense that at least in the middle market growth and therefore operating performance is stable this quarter? Or are you seeing pockets of weakness? I’m just looking into 2019 trying to get a sense of how things will shake out?

Sure. It’s a great question. I would say, overall we feel, first and foremost just about our portfolio, feel very good about the overall health and the quality of the portfolio. And I would characterize it as being in a slow growth mode from a – both a revenue and in EBITDA perspective. Within a portfolio, when you have 65 companies, we obviously have some that are exceeding expectations, and we also have some that are underperforming, but they’re not due – they’re really due to individual situations as opposed to broad industry problems, if you will. So we’re really not seeing from a pockets – or concern perspective, we’re not seeing any real concerns. There’s obviously little things that we are noticing tariffs, for instance, with regard to a couple of manufacturing companies we have. Steel prices are up, so people having to find ways to manage margins. Having said that, that is – it’s not overly alarming at this point and we believe, it’s pretty manageable. But there are things like that that were paying attention to. When I think about industries, we’re not very interested in investing in it at the moment, health care would be one on the services side where there’s reimbursement rate risk. The consumer, the consumer is – obviously, where they’re buying things is an ever-changing dynamic, if you will. And so we’re being very careful on the consumer side of things right now. But and then energy obviously is vulnerable by nature and it’s something that we’re obviously, being careful with as well as staying away from generally speaking. So hopefully, that’s helpful. But we’re not seeing anything today that is a concerning from a performance perspective, but there are clearly things to watch.

Okay. I appreciate. Then just a couple of questions about liquidity, one housekeeping question. Could you just give us a sense of how much of the cash that September was in SBIC I and II?

Sure. I’m going to let Shelby to answer that.

Yes. So as of the end of September about 50% of the cash that we had on the balance sheet was in the SBIC funds with the remainder at the parent company.

Okay. And was that more an SBIC? Forgive me if I’ve forgotten.

Yes. So the vast majority of that 50%, call it 43% was in the first SBIC funds, which is in the process of wind-down, which is probably where you’re going. So that is the fund – because we’re in wind-down, we cannot use that cash to reinvest in new portfolio company investments. However, there are some portions of that cash that we could use to upstream to the parent to use for other purposes. But there will be some trash cash, if you will in Q4 in that funds before we pay down SBA debentures.

Okay. That’s helpful. And just thinking about management of liquidity, Shelby, obviously the regulatory leverage is very low at your company. Could you give us an update on the progress toward SBIC III? You may have already mentioned it. And why wouldn’t the board approve higher leverage even if nothing else has an insurance policy against market volatility down the road?

So from an SBIC perspective, as everybody I believe knows we have submitted our request for a third license. We are continuing to progress in the SBA process for approval. And we’re optimistic that we’ll continue to make some headway in that front in Q4. At the specific timing there’s really nothing further I could say on that front.

And I’ll jump in here on the leverage opportunity. I guess, what I would say is, Mickey, we don’t really have a – what I would say, current need to utilize the increase in leverage opportunity that’s been afforded by the small business Credit Availability Act. We don’t think we need that leverage to perform well for our shareholders given our investment strategy and quite frankly the utilization of SBIC funds. However, it does make sense and we are continuing to evaluate it from a long-term flexibility perspective. Hopefully that’s helpful.

And Shelby, can you just remind us in SBIC I, what level of debentures need to be repaid in the near-term in that subsidiary?

Sure. We still have $64.5 million of SBA debentures that are left to repay before that fund is fully wind-down.

Okay. So the cash will go primarily toward that.

Correct.

Okay. Thank you. That’s it for me this morning. Appreciate it.

Great. Thank you. Good talking to you, Mickey.

Thank you. Our next question is from Ryan Lynch from KBW. Your line is now open.

Hey, good morning guys. First question has to do with Pinnergy. You guys had about a $6 million gain, which was the vast majority of your total gain recorded this quarter. So can you just comment on what is really driving the gain in your equity investments in Pinnergy? And then where do you guys really see the eventual outcome of this? I mean, it’s about a $40 million investment in your portfolio today. It’s a fairly large investment. It’s been a great performing investment. I know you mentioned that you’re not in control with most of the situations, or not you don’t have control of the equity ownership to decide for a lot of the companies that you own. I know this was a previously restructured investment just wanted to know how much influence you have on the eventual outcome of this as well as if you don’t have controlling ownership of Pinnergy, which I would assume you wouldn’t. Is there any thought to potentially sell off a piece of your investment to another strategic buyer versus just waiting for the controller of that equity to potentially sell? Or do you still have a name with that business?

Sure, Ryan, great question. And maybe I’ll just talk about Pinnergy for a second at a high-level. It’s an oilfield services company that’s focused on the Texas, the Oklahoma and Louisiana markets. So a large majority of its revenues are focused on the handling and disposal of fluids from producing wells. The balance of the business is drilling related. Fortunately the company is diversified by hydrocarbon, meaning it serves both the gas or the oil and the natural gas markets. And it’s also focused on some of the lowest cost basins in particular the Permian. Company has a great customer base, blue-chip and we are now a small second lien investor and what I would say very meaningful equity investor in the company, but having said that, we do not have a controlling position. So companies performing extraordinarily well, which is great and we are – yes, evaluating our opportunities for some form of liquidity. But that is – there are others that are involved in that equation and it’s a multipronged thing if you will. And so we are continuing to obviously work with the company as we did in the restructuring to figure out a long-term path forward. That’s what I would say.

Okay, that’s helpful. And then one other portfolio company, K2 Industrial, now with a new nonaccrual this quarter. I spent a long time portfolio company, had a pretty big markdown. Just any sort of commentary or color on that would be helpful.

Yes. I’ll give you a little bit of just an overview of the business. It’s a independent provider of outsource cleaning, coding and maintenance services. And what I would call, highly fragmented industrial cleaning and coating services market. So they are very much serving process industry. So think about chemical companies, steel companies, oil companies, refineries, that kind of thing. They offer what I would consider mission critical support programs ranging from regular comprehensive cleaning of production equipment and facility systems to scheduled shutdowns. The company serves over 500 customers in a variety of end markets as I discussed. The risk profile of our investments in K2 recently increased and that’s reflected in our evaluation. And I think the only thing I’d say is they are more one-time in nature stuff that has occurred and so that is reflected in our evaluation. I think I’d probably prefer to leave it there at this point.

That’s fair and that’s helpful. And then just one last one. You mentioned a couple aggregated portfolio statistics, debt to EBITDA in interest coverage. The debt to EBITDA year-over-year increased to 3.8% from 3.6%, which is a little bit of a downtrend. And then interest coverage increased to 3.8% from 3.7% year-over-year. So how you view those two metrics, they didn’t move a lot, so I don’t want to overstate this. But they did move in opposite directions. Do you view one more favorably than the other or is there one that you focus on more than the other?

Great question. Obviously, I focus more on the interest coverage quite frankly, and making sure that we have adequate cash flows at the portfolio company level to support obviously cash interest but also just get service requirements. So with interest rates overall being relatively low still, especially compared to long-term averages, we’re in a very good spot, which I think is a good thing for credit investors in general. When I look at leverage, yes, we’re up and I think that’s indicative of a couple things. One is I think the market is up from a leverage perspective a little bit over the last 24 months for sure. And so what we’re looking to do, and we’re fine actually increasing the leverage as long as the quality of those portfolio companies are intact. And so back to high free cash flow businesses, recurring revenue businesses where we believe the EBITDA is truly sustainable and/or growing. And so that’s how we’re looking at it. So it’s the quality of the underlying asset. And for instance, if someone’s going to buy a company that we think is very high caliber and they’re buying it for double digit EBITDA multiple, we leverage it to a market multiple. And the answer to that is yes, because we’ve done that for a long period of time where we’re comfortable going into the 5’s and even to 6 times for the right assets. So that’s part of the equation, but having said that, this last quarter I would tell you that two of the investments we invested in were more in the mid-3’s range leverage, and one of them was more in the mid 4’s. And so it really depends on the quality of the company and the type of situation. But back to your – which do you focus on the most. The first, I focus on the quality of the underlying company and then after that, the structure needs to work well and that’s where the interest coverage comes in.

That makes sense. That’s helpful. It’s not surprising to see whoever just take out just a little bit given where overall purchase price multiples are increasing and leverage levels just in the overall market. So, that’s all my questions for me. I appreciate the time today.

Thank you. Appreciate it, Ryan. Good talking to you.

[Operator Instructions] At this time I’m showing no further questions. I would like to turn the call back over to Mr. Ross for closing remarks.

Thank you, Gigi and thank you, everyone for joining us this morning. We look forward to speaking with you on our fourth quarter call in late February 2019. Have a great day and a great weekend.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect.