Fidus Investment Corporation
Q1 2013 Earnings Call Transcript

Published: 3 May 2013

[Operator:]

Good day, ladies and gentlemen. And welcome to the Fidus Investment Corporation’s First Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions to be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host today, Ms. Stephanie Prince. Ma’am, you may begin.

[Stephanie Prince:]

Thank you, Dan, and good morning, everyone. This is Stephanie Prince from LHA. Thank you for joining us for Fidus Investment Corporation’s first quarter 2013 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation’s Chairman and Chief Executive Officer; and Cary Schaefer, Chief Financial Officer and Chief Compliance Officer. Fidus Investment Corporation issued a press release yesterday afternoon with details of the company’s quarterly financial and operating results. A copy of the press release is available on the Investor Relations page of the company’s website at fidus, excuse me, 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 in the earnings release. The conference call today will contain certain 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, May 3, 2013, 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, 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. I’d now like to turn the call over to Ed Ross. Ed?

[Ed Ross:]

Thank you, Stephanie. Good morning, everyone. And welcome to our first quarter 2013 earnings call. I’ll begin our discussion with a brief summary of our strategy and follow with highlights of the first quarter before discussing the investment activity and performance of our investment portfolio. I’ll close my comments with a brief market update and before opening the call up to questions, I'll turn the call over to Cary who will go into more detail about our financial results and liquidity position. For those of you who are new to Fidus, I’ll briefly review our strategy. Primary goal of Fidus Investment Corporation is to deliver stable and growing dividends to our stockholders. Our strategy is to build a well diversified portfolio of debt and to a lesser extent equity investments in high quality lower middle-market companies that are market leaders in their respective niches. In executing this strategy we focus on capital preservation while generating attractive risk-adjusted returns. We seek to invest in businesses that we believe will perform well over the long-term with an emphasis on companies that operate in industries we know well, that generate excess free cash flow for debt service and investments, and have positive outlooks. Also from a debt structuring perspective, we look to maintain significant cushions to a borrower’s enterprise value in support of our capital preservation and income goals. Some of the industries we know well and focus on include aerospace and defense, consumer products and services, retail and restaurants, business services, industrial products and services, transportation and logistics, healthcare products and services, and niche manufacturing. Notably, our senior investment professionals, most of whom have worked together for over 14 years, have an average of more than 20 years experience investing and advising in these broad sectors of the economy. Turning now to the first quarter, 2013 has started off well with a solid first quarter. We generated net investment income or NII of $4.9 million or $0.38 per share. Net asset value or NAV increased to $15.46 per share as of March 31st from $15.32 per share as of December 31, 2012. This increase was primarily due to the equity capital raise that we completed in February, which was accretive to net asset value. We ended the first quarter with approximately $59 million of cash. We also have an additional $5.5 million of debt availability from the SBA for additional investments and operations. This liquidity positions us well to continue to grow the investment portfolio and it also provides the required capital to fund a second SBIC license, which we have -- which we applied for last October. This second license if approved will result in excess to an additional $75 million of attractive low-cost long-term debt capital. Our Board of Directors had declared a dividend of $0.38 per share for the second quarter of 2013. This is 5.6% above the second quarter of last year. The company’s dividend will be paid on June 26, 2013 to stockholders of record as of June 12, 2013. And as we said before an important goal of ours is to cover our dividends from earnings on a long-term basis. Furthering, our portfolio growth and diversification goals, we started to put the capital we raised to work by investing a total of $22 million in two new and two existing portfolio companies during the quarter. The quarter’s new portfolio companies fit well within our investment strategy, which are reviewed a few minutes ago. One of these new portfolio companies is the leading global provider of live video transmission, analysis and archive solutions for the qualitative market research industry. The other one is a leading niche provider of critical ingredients used to formulate, develop and manufacture biologic drugs, vaccines and highly potent cancer treatments As of March 31, 2013, we had debt and equity investments in 32 portfolio companies with a total fair value of $294.2 million. This is up from 25 portfolio companies with a fair value of $217 million a year ago. As of the end of the first quarter the fair value to cost ratio of the portfolio was 105%. Repayments during the quarter totaled $3.2 million, representing partial realizations and one special dividend from two portfolio companies. We currently expect to see a higher level of refinancing and realization activity in 2013, then we did in 2012. As an example, in early April we received full repayment of our subordinated loan to Westminster Cracker Company in the amount of $7.5 million. This loan repayment was driven by improved company performance, which enabled them to lower their cost of debt capital. Fortunately, we still hold an equity position in the company. Looking forward a higher level of realizations will result in increased cash balances and potential capital gains, longer term of course this would enhance our liquidity position to help support future investment activity. With regard to our investment portfolio, we continue to be to be pleased with its stability and overall quality. As those of you who have been following us know, we track several measures of quality One of those metrics is the portfolios weighted average investment rating based on our internal system under our methodology one is outperformed and five is in expected loss. As of March 31, 2013, the weighted average investment rating for the portfolio was 2 in line with prior periods. We continue to have no investments on non-accrual status. Our portfolio credit performances’ remained strong, at March 31, 2013, our portfolio of companies had a combined ratio of total net debt to Fidus’ debt investments to total EBITDA of 3.6 times, a modest change from 3.4 times last quarter. Which we believe still reflects a prudent level of risk for our portfolio. And last, our portfolio companies have a combined ratio of total EBITDA to total cash interest expense of 2.8 times, which we believe provides a significant cushion for them to meet their debt service obligations to us. I like to close with some comments on our current market conditions in our target lower middle market. Deal flow has picked up from the initial slower pace of early 2013, which occurred after the pending tax law changes at year-end cause a rush close deals in the fourth quarter. We are hearing and seeing to the certain the extent that M&A and another bankers have been getting busier, so we’re hopeful that all else being equal the second half of this year will reflect that activity. Broadly speaking, the market remains competitive within our target lower middle market, which is quite large and fragmented there are generally less than 10 competitive conditions. In this segment of the market, relationships, industry knowledge and the ability to offer flexible capital solutions are critical to our success. Given our team’s experience in the industry and our relationships are based across multiple origination channels, we believe will continue to see a steady flow of attractive investment opportunities As I said at the outset, our investment approach remains selective and delivered with an acute focus on capital preservation and generating attractive risk-adjusted returns over the long-term. We emphasize quality over quantity in search of high quality business with strong market positions that perform relatively well during the last downturn and have positive long-term outlooks This is always been our strategy we believe that will continue to result in attractive risk-adjusted returns as we deploy our available capital and pursue our diversification and portfolio growth goals I’ll now turn the call over to Cary to provide some details on our financial and operating results. Cary?

[Cary Schaefer:]

Thanks, Ed, and good morning, everyone. I’ll now review our first quarter results in more detail and close by commenting on our liquidity position. Total investment income was $9.8 million for the first quarter of 2013, an increase of $2.2 million or approximately 29% over the $7.6 million recorded during the first quarter of 2012. This increase was primarily driven by the increase in average outstanding debt investments in the first quarter of 2013 compared to last year. In addition, dividend income in Q1 2013 increased to $359,000 from $151,000 in last years first quarter. Driven by dividend from our portfolio equity investment. The total amount of this portfolio distribution was approximately $600,000 of which $165,000 has been estimated to be dividend income with the remaining $435,000 deemed return of capital. Fee income which may fluctuate from quarter to quarter, depending on the level of new investment activity as well as prepayment activity was $406,000 for the first quarter of 2013, was consistent with $425,000 for last year’s first quarter. Total expenses for the first quarter 2013 were $4.9 million compared to $4 million for the first quarter of 2012. Base management and incentive fees totaled $2.4 million for the first quarter 2013, including both income and capital gains incentive fees. In the first quarter 2013, incentive fees were partially offset by $57,000 reversal of previously accrued capital gains incentive fee due to modest net unrealized depreciation on investments for the quarter. Keep in mind that the capital gains incentive fees are only payable when net realized capital gains are in excess of gross unrealized depreciation. Administrative service expenses, professional fees and other general and administrative expenses totaled approximately $699,000, essentially flat with the first quarter of 2012, which totaled approximately $702,000. Interest expense on our SBA debentures was approximately $1.7 million for the first quarter of 2013 compared to $1.4 million for the first quarter 2012 due to a higher average level of outstanding debentures. As of March 31, 2013, the weighted average fixed interest rate on our SBA debentures was 4.6% before fees. As a result of these operating activities, net investment income for the three months ended March 31, 2013 was $4.9 million, a 36% increase compared to $3.6 million reported in the first quarter of 2012. On a per share basis, NII was $0.38 for the Q1 2013 and 2012 as a result of the 37% increase in the weighted average shares outstanding year-over-year. During the first quarter 2013, we recorded net unrealized depreciation on investments of approximately $286,000 or about $0.02 per share. This was comprised of net unrealized depreciation of $800,000 on debt investments, partially offset by net unrealized appreciation on equity investments of $500,000. This activity resulted in a net increase in net assets from operation of $4.6 million or $0.36 per share for Q1 2013, including our first quarter dividend payment of $0.38 per share, net asset value as of March 31, 2013 was $15.46 per share. This compares to a net asset value of $15.32 per share at December 31, 2012. NAV per share is based on 13.7 million fully diluted shares outstanding as of March 31, 2013 compared to 12 million fully diluted shares outstanding on December 31, 2012. As referenced earlier, the first quarter 2013 income statement per share results are based on weighted average shares outstanding of 12.9 million shares, up from 9.4 million weighted average shares outstanding in the first quarter of 2012. This increase in weighted average shares year-over-year reflects the equity offerings, we completed in September 2012 plus a portion of the shares that were issued in February 2013. Both offerings were completed at prices above 10 times NAV per share and were therefore accretive to net asset value. Turning now to portfolio statistics as of March 31, 2013, our total investment portfolio had a market -- a fair market value of $294.2 million on March 31 or 105% of cost. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 75% subordinated debt, 12% senior secured loans and 13% equity and warrant securities. Our average portfolio company investment on a cost basis was $8.8 million at the end of the first quarter. We held equity investments in approximately 91% of our portfolio companies with an average fully diluted equity ownership of 8.8%. The weighted average effective yield on debt investments was 15.2% as of March 31, 2013. We continue to have no investments on non-accrual status. And now, I’d like to comment on our liquidity position and capital resources. As of March 31, 2013, total cash was approximately $59 million. We also have remaining unfunded SBA commitments of $5.5 million, which taken together results in approximately $64.5 million of capital available for additional investments and operations as of March 31, 2013. Lastly, our application for second SBIC license continues to be in the review process at the SBA. As a reminder, we filed a second application on October 15 after receiving a green light letter from the SBA. If approved, the second license will provide us with access to an additional $75 million of long-term, low-cost SBA debentures. Now, I’ll turn the call back to Ed for concluding comments. Ed?

[Ed Ross:]

Thanks, Cary. In closing, as always, I’d like to acknowledge and thank the outstanding team at Fidus for their commitment and great work. I’d also like to thank our shareholders for their continued confidence and support. And thank you all for joining us today. I will now turn the call back over to Dan for Q&A?

[Operator:]

(Operator Instructions) Our first question comes from the line of Robert Dodd of Raymond James. Your line is open. Please go ahead.

[Robert Dodd:]

Hello, everybody. Good morning. Couple of questions. Obviously on the SBA, we will have to push you for some more clarify on that. First, not even your licensees are positioned really. But what’s the latest that you’ve heard from the industry policy talking about the potential for, obviously to be able to expand the total to 350 for a management company?

[Ed Ross:]

Sure. Good morning, Robert. And obviously that’s a very good and relevant question. I don't know that I have a good update for you. We continue to believe in everything we hear though this isn’t overly updated information is that I think the probability or likelihood of it is generally pretty high. Having said that, there is not a lot going on right now in Washington, as we all know in terms of new laws, and so I think we are a little bit stemming from that perspective. But generally speaking, I think we feel good about that change occurring over the long-term, the timing of which I think is impossible to predict.

[Robert Dodd:]

Okay. Thanks. And then just to push you on your application. I mean, we’ve seen the SBA, there has been a long patch where they currently haven’t been doing much in terms of approvals, then we’ve seen recently a couple of other healthy BDCs starting to get their first licensee and sort of approval for second. But no movement from the information you are giving us regarding yours. No movement on yours right now. I mean, are you aware of any issues with regard to your license or is it…?

[Ed Ross:]

Just literally, obviously also a very good and fair question. And let me answer like this. We applied and I think Carry had mentioned specifically. We applied formally for the license in October, so it’s been over six months, just barely over six months which -- our expectation was it was going to take at least six months. So, I think the second point I will make is I think we’ve made a fair bit of progress on our application with the SBA over the last several months. And, so I think we are at a stage where we are hopeful that we will be hearing from them in the not-too-distant future. But we have worked very hard on it and we’ve made good progress. And so we're hopeful that it will continue to move forward in a good direction.

[Robert Dodd:]

Okay. Great. Thanks. Moving on just a couple other quick ones kind of on the market. I mean, one of Fidus’ focused vision, is that you did, is a bit larger than average for you, slightly lower yields than average in a 12 plus one set. Is that a conscious decision to move up market, when a lot of other players seem to be trying to move down market frankly, or is that just kind of an element of opportunistic events?

[Ed Ross:]

The short answer would be a little bit more opportunistic. I think the reality of it is from a strategy standpoint, we continue to go about things the way, we've kind of always have, which is we are looking for very good companies and underlying investments in those companies. And when we find those, that’s where we are trying to invest and the reality of that is the, facts of that company a very good one from our perspective, a little bit larger than maybe the average size of our portfolio company. And so with that comes kind of a need to drop the yields typically is also, I would call it moderately leverage. So, I think it fits squarely in our strategy of what we are trying to do today, which definitely is in the realm of the lower middle-market. I’ll call it $3 million to $20 million in EBITDA, somewhat larger size for us. But it was an investment, a company that we like very much. And so when we find those situations, we try to do what we need to do to invest in those companies as attractive risk adjusted just returns. And I think we feel very good about that.

[Robert Dodd:]

Okay. I appreciate. And one last one, if I can. Just on your comments about the overall market. It sounds like you are starting to see activity. Obviously, there is a pickup in activity. Obviously there is a lag between any pickup deals closing. So, I mean, we expect to -- it is reasonable expect originations activities expect in Q2 to be still pretty moderate and any pickup we would see would be Q2, Q3, Q4, et cetera? So with Q2, with one big repayment already with a pretty good yield from it, we would expect more of it in the portfolio as well, that would be realistic?

[Ed Ross:]

Sure. Yeah. It’s a very good question. As you know, it’s so hard to predict but we are obviously working on some things that could happen in the quarter. I think your assessment is a fair one and we are hopeful that M&A related activity picks up in the second half of the year. And to some degree I expect that but we’ll have to all see, but activity levels are picking up. I do think on the M&A side of things at the banker level, if you will. So, this quarter, we’re working on stuff just like we are every quarter. It’s hard to predict, but I don’t think your assessment is one that you should make, put it that way.

[Robert Dodd:]

Okay. Got it. Thank you.

[Operator:]

Thank you. (Operator Instructions). Our next question comes from the line of Bryce Rowe of Robert W. Baird. Your line is open. Please go ahead.

[Bryce Rowe:]

Thanks. Good morning. I have a couple of questions here and just to follow-up on the conversation about the SBA. I noticed that you guys commenced operations of Fund II on March 29th. Just logistically, can you help us with what happens there, did you fund that fund with some new capital and kind of, are just waiting now for that application to be approved?

[Ed Ross:]

I’ll let, Cary take that one.

[Cary Schaefer:]

Sure. Good morning, Bryce. Yeah, the answer is we did, we funded. We did just funded nice some equity down into that I think and maybe we are just mentioning the mechanics of how the SBA leverage works. They require you to fund the equity first in order to access any leverage at the subsidiary level. So we have begun funding that with the anticipation and a hope that we will be in a position to have a license and working on a commitment with the SBA in the not-too-distant future.

[Bryce Rowe:]

Okay. And then so, did any investments fit in that fund yet?

[Cary Schaefer:]

Yeah.

[Bryce Rowe:]

Yeah. Okay. All right, the second question you guys talked about where within a one to five rating scale your investments are rated and there was a bit of an uptake into the three rated investments. Just wanted to get maybe some detail around that or some color. Are you seeing some investments, or some of the financials within the investments to deteriorate a little bit or is that just company specific?

[Ed Ross:]

Sure. That’s a great question, Bryce. I think, as you know, we have 32 companies today at the end of the quarter. And we’re always going to have some that are over performing and some that are underperforming and so that is our expectation. So there’re no surprises from our perspective. I think the move you’re talking about is more company specific. And there was one move that we moved a company down into that category. For us, three assets doesn’t mean we’re in trouble. It means we’re watching some, there’s been an event or there is a trend that we’re paying attention to. It could get worse. It could be a situation where they quit paying at some point in time but that is not the situation. So we’re -- it’s kind of normal course is what I would say. And it’s -- when you have 32 companies, we expect to have a few that are moving around a little bit and ones that we’re working extra hard on, if you will, and so -- the one we’re talking about falls in that category.

[Bryce Rowe:]

Okay and last question. You talk about potential for accelerated or elevated refinancing in realization activity throughout the rest of the year. Beyond the Westminster, are you hearing anything specifically from your companies that would suggest some repayment or refinancing activity?

[Ed Ross:]

Sure. A great question. And the answer to that is, we are hearing to a certain degree and there’s really two things going on, right? There are some companies that are -- thankfully we’ve got a portfolio where there’s a fair number of companies performing very well. And so in certain situations just like the Westminster situation where there is an opportunity to reduce the company’s overall cost of debt capital, there are some companies looking at doing that over -- during this year. It’s very hard to predict when and if those things happen. But it’s clearly a situation, I guess, we’re fortunate we are in that situation where your company is performing that they can do that. I think the second piece of it is, we do have several companies that have hired advisors to evaluate strategic alternatives. And so I think thankfully we’ve got equity investments in over 90% of our portfolio companies. So I think overall that’s a good thing. In the short term, it can create a need to kind of reinvest those proceeds, but in the long term, we do expect to realize all these investments. And so we think it’s healthy generally speaking. But there -- so there’re two things going on. And I think overall, I think the statement I made we do think there is an increased probability that the repayments and realizations go up or above last year’s levels or that’s your size of portfolio as well.

[Cary Schaefer:]

NH.

[Ed Ross:]

NH portfolio.

[Cary Schaefer:]

Yeah.

[Bryce Rowe:]

Okay.

[Ed Ross:]

We don’t view it as negative it’s just kind of part of the business.

[Bryce Rowe:]

Yeah. I mean, it’s definitely going to get paid back, right?

[Ed Ross:]

Absolutely, absolutely. So our expectation will be there will be an increase this year from a probability standpoint.

[Bryce Rowe:]

Yeah. Okay. Thank you.

[Ed Ross:]

Good talking to you Bryce.

[Bryce Rowe:]

And me too. Thanks.

[Operator:]

Thank you. (Operator Instructions) And I’m showing no additional questions. I’d like to turn the conference back over to Mr. Ross for any closing remarks.

[Ed Ross:]

Okay. Thanks Ben. And thank you everyone for joining us this morning. We look forward to speaking with you on our second quarter call in early August. I hope everyone has a great day and a great weekend and thank you again for joining us. Good bye.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of the day.