Fidus Investment Corporation (NASDAQ:FDUS)
Q4 2013 Earnings Conference Call
March 7, 2014 9:00 AM ET
Stephanie Prince – IR
Edward Ross – CEO and President
Cary Schaefer – CFO and Chief Compliance Officer
Chris Kotowski – Oppenheimer & Co.
Robert Dodd – Raymond James
Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation Fourth Quarter and Year-End 2013 Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the call over to your host for today Ms. Stephanie Prince of LHA. Ma’am, you may begin.
Thank you, Ben and good morning everyone. Thank you for joining us for Fidus Investment Corporation’s Fourth Quarter and Year-End 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 and annual 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 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 flow of Fidus Investment Corporation.
Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, March 7, 2014 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?
Thank you, Stephanie and good morning everyone. Welcome to our fourth quarter year-end 2013 earnings call. Today I’ll begin with highlights of our results for the full year before discussing quarterly results and investment activity, the performance of our investment portfolio and current market conditions. I’ll then turn the call over to Cary who will go into more detail about our financial results and liquidity position before we open up the call for questions.
Fidus had an outstanding 2013. We met our key strategic goals during the year, including covering shareholder distributions from adjusted net investment income, further increasing the diversification of our portfolio and generating attractive risk adjusted returns for our shareholders. Our portfolio grew by 12% to $307 million and we ended the year with 37 portfolio companies, up from 30 at the end of 2012.
In addition our portfolio generated attractive risk-adjusted returns for our shareholders in 2013 including an increase in adjusted net investment income of 27% to $20.9 million or $1.54 per share plus realized net capital gains of $30.2 million or $2.24 per share. We ended the year with a net increase in net assets from operations of $27.2 million or $2.01 per share, a 40% increase.
We also received approval for our second SBIC license which gives us access to an additional $75 million in attractive low cost long-term SBA debentures. And we raised $29 million in net proceeds from a follow on equity offering at a price accretive to net asset value. As a result we paid cash dividend of $1.94 per share comprised of two special dividends totaling $0.42 per share and our regular quarterly dividend totaling $1.52 per share. We also retained a portion of the realized capital gains for future growth by declaring a deemed distribution for stockholders of record as of December 31, 2013 of $8.3 million or $0.60 per share.
We ended 2013 with approximately $15.6 million or $1.14 per share of spillover taxable income. This spillover income gives us capital allocation flexibility to declare additional special dividends over time or to fund other corporate needs including additional investments. This reflects our Board’s balancing of several primary objectives, including delivering long term value for shareholders in the form of stable and growing dividends, managing the business with a high margin of safety and growing our Net Asset Value or NAV on a per share basis over time. Going forward, the Board intends to consider our spillover position and how it is utilized on an ongoing basis.
Given the active financing market and the natural maturation of our portfolio we expected a higher level of refinancing and realization activity in 2013 versus 2012. Inclusive of $30.2 million of realized net capital gains Fidus received repayments and realizations totaling $131.2 million on investments in fifteen portfolio companies. As we look forward to 2014 we expect repayments and realizations to continue to be part of our business but we currently do not foresee the same levels that we saw in 2013.
During the year we invested $149.1 million in nine new and twelve existing portfolio companies and notably despite the high level of repayments we increased our portfolio on a cost basis by approximately $55 million or 21%.
Moving to our fourth quarter we generated net investment income of $5.9 million, or $0.43 per share. Our adjusted NII which we define as net investment income excluding any capital gains incentive fee attributable to realized and unrealized gains and losses was $5.7 million or $0.41 per share. As of December 31, 2013 net asset value was $15.35 per share compared to $15.32 per share as of December 31, 2012.
Fourth quarter was extremely active. We invested $69.5 million in five new and seven existing portfolio companies, including recapitalizations of Connect-Air and FutureTech further illustrating our portfolio growth and diversification strategy. As many of you know our investment strategy is based on building 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.
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 investment and have positive outlooks. And from a debt structuring perspective we look to maintain significant cushions through our VARs enterprise value in support of our capital preservation and income goals.
Since our IPO we are pleased to have made great strides in our portfolio growth and diversification almost doubling the number of companies in our portfolio from 19 as of June of 2011 to 37 as of December 2013.
The new portfolio of companies that we added during the fourth quarter include a leading provider of highly engineered custom plastic processing solutions that serves the global healthcare market; manufacturer of piezoelectric, ceramics and crystals, transducers and complex sonar navigation and ultrasound systems used in the defense medical and energy industries; a developer, manufacturer and global distributor of unique, high purity detergents and synthetic lipids for use in cell membrane protein studies; a leading manufacturer of safety gates and passive fall protection guardrail systems used in the chemical, oil and gas, mining and construction, and other industrial end markets; and a holding company for original full service, casual dining concepts primarily under the Blackfinn trade name.
During the fourth quarter proceeds from repayments, sales and recapitalization totaled approximately $40.9 million from six portfolio companies, including net realized capital gains of approximately $4.6 million from five of those companies. Approximately $3.9 million or 85% of the quarter’s net realized gains came from the sale of our debt and equity investments in Tulsa Inspection Resources. This successful investment speaks to our strategy of investing in the debt and equity of high-quality companies that operate in industries we know well which in this case was the energy service industry. Other repayment activities included the full repayment of our subordinated notes from Goodrich Quality Theaters and a partial repayment of our subordinated notes from FocusVision Worldwide.
As of December 31, 2013 we had debt and equity investments in 37 portfolio companies with a total fair value of $307 million which represented approximately 97% of cost. We put one loan on non-accrual status, that’s the restaurant company reflecting the meaningful increase in the risk of our investment. While the broader slow growth economy continues to face certain headwinds and uncertainty we continue to be pleased with the overall stability, quality and performance of our investment portfolio. We track several quality measures including the portfolios weighted average investment rating based on our internal system.
Under our methodology one is outperform and five is an expected loss. As of December 31 the weighted average investment rating for the portfolio was two on a fair value basis in-line with prior periods. The credit performance of the portfolio remained solid as well with our portfolio of companies combined ratio of total net debt-to-Fidus’ debt investments to total EBITDA of four times which we believe is a prudent level of risk for our portfolio.
The third measure we track is the combined ratio of our portfolio companies’ total EBITDA-to-total cash interest expense which was 2.9 times and an indicator that our portfolio of companies as a whole currently have significant cushion to meet their debt service obligations to us. Overall these metrics reflect our cautious and deliberate investment approach which remains intensely focused on capital preservation.
Turning to market conditions, broadly speaking market conditions remain healthy and active. For Fidus we continue to see a strong level of deal flow and as we sit here today we expect the current economic environment which we would characterize as stable to slow growth to continue in 2014 which should bode well for continued strong deal flow levels for Fidus.
Despite the intensively competitive nature of the broader market we believe the sheer size and fragmentation of our target lower-middle market makes this end of the market attractive and generally less competitive than the broader markets. In this segment of the market relationships, industry knowledge and the ability to offer flexible capital solutions are key drivers of our success.
Looking ahead we believe that Fidus is well positioned from a capital perspective to continue to grow and diversify our portfolio. Our approach remains cautious and deliberate with an intense focus on capital preservation and generating attractive risk-adjusted returns. As we move forward we will continue to maintain our highly selective investment approach to our target lower middle-market emphasizing quality over quantity. We believe that our strategy of investing in high-quality businesses with strong market position and positive long-term outlook will continue to invest in the – to result in the generation of attractive risk-adjusted returns that work well for our stockholders.
Before turning the call over to Cary I’d like to remind everyone that on February 18 our Board of Directors declared a regular quarterly dividend for the first quarter of $0.38 per share. The dividend is payable on March 31, 2014 to stockholders of record on March 21, 2014.
I’ll now turn the call over to Cary to provide some details on our financial and operating results. Cary?
Thank you Ed and good morning everyone. I’ll now review our fourth quarter and full year 2013 results in more detail and close with comments on our liquidity position. Total investment income was $11.2 million for the three months ended December 31, 2013, an increase of $1.6 million or 16.5% over the $9.6 million of total investment income for the three months ended December 2012. This increase was primarily attributable to an increase in investment activity and average outstanding debt investments during the fourth quarter 2013 compared to the fourth quarter of 2012.
Interest income increased 13% to $9.8 million compared to $8.7 million in the prior year quarter. Dividend income increased $0.1 million primarily due to a higher amount of income producing preferred equity investment as well as distributions from portfolio companies.
Fee income which fluctuates from quarter-to-quarter depending on the level of new investment or prepayment activity was $927,000 for the fourth quarter of 2013 compared to $512,000 in last year’s fourth quarter. This reflects the high level of portfolio activity from our investments in five new companies that closed during the quarter, first fees related to the repayment realization activity in six portfolio companies that Ed mentioned earlier.
Total expenses, including income tax provision were $5.3 million for the fourth quarter, an increase of $0.4 million or 7.6% over the $4.9 million of total expenses for the same period last year. Interest expense on our SBA debentures was approximately $1.8 million for the fourth quarter of 2013 consistent with the fourth quarter of 2012.
As at December 31, 2013 the weighted average fixed interest rate on our SBA debentures remained at 4.6% before fees. The base management fee increased $0.1 million due to higher average outstanding total assets less cash during the fourth quarter 2013. The income incentive fee increased $0.2 million to $1.4 million for the three months ended December 31, 2013 compared to $1.2 million in the prior year period.
The capital gains incentive fee decreased $0.3 million due to a reversal of capital gains incentive fee expense as a result of a net loss on investment for the three months ended December 31, 2013 compared to $0.1 million capital gain incentive fee expense in the prior year period.
Administrative service expenses, professional fees and other general and administrative expenses totaled approximately $852,000 for the quarter, 19% higher than the fourth quarter of 2012 which totaled approximately $716,000. This increase was primarily due to an increase in administrative fees and other G&A expenses associated with our growing portfolio and addition for the finance and accounting team in July 2013.
Net investment income or NII for the three months ended December 31, 2013 increased by 25.9% to $5.9 million or $0.43 per share compared to $4.7 million or $0.40 per share for the fourth quarter of 2012. Adjusted NII was $5.7 million or $0.41 per share for the last three months of 2013 compared to $4.8 million or $0.40 per share for the fourth quarter 2012.
Adjusted NII is defined as net investment income, excluding any capital gains incentives fee attributable to realized and unrealized gains and losses on investments. A reconciliation of NII to adjusted NII can be found in our earnings press release that was issued yesterday afternoon and is also posted on the investor relations page of our website.
For the three months ended December 31, 2013 Fidus realized capital gains on investments net of applicable taxes of $4.6 million resulting from exits of investments in five portfolio companies. We recorded net unrealized depreciation on investments $5.7 million for the fourth quarter of 2013 which is comprised of unrealized depreciation of $1.9 million related to reversal of unrealized appreciation upon the exit of investments during the quarter, net unrealized depreciation of $4.7 million on dead investments and net unrealized appreciation of $0.9 on equity investments.
Taken together these activities resulted in a net increase in net assets resulting from operations for fourth quarter 2013 of $4.6 million or $0.34 per share compared to a net increase in net assets resulting from operations of $5.1 million or $0.43 per share for the fourth quarter 2012.
Per share income results for the quarter ended December 31, 2013 are based on weighted average shares outstanding of $13.7 million compared to $11.9 million weighted average shares outstanding for the fourth quarter of 2012. This increase reflects the common equity offering Fidus completed in February 2013 which is completed at a price accretive to net asset value.
Our net asset value as of December 31, 2013 was $15.35 per share, which reflects payment of both the $0.38 per share special dividend plus the $0.38 per share regular dividend in December as well as the $0.21 per share of tax expense related to the deemed distribution which is considered paid on behalf of the shareholders of record as of December 31, 2013.
For the full year ended December 31, 2013 total investment income was $41.8 million, an increase of $7.9 million, or 23.5%, over the $33.8 million of total investment income for year ended December 31, 2012. The increase was primarily attributable to a $6.5 million increase in interest income, a $0.7 million increase in fee income from investments and a $0.7 million increase in dividend income, all primarily driven by higher investment activity, average levels of portfolio debt investments and dividend producing equity investments outstanding during the year as well as an increase in distributions from our portfolio companies in 2013 compared to 2012.
Total expenses, including income tax provision, were $22.5 million for the full year 2013, an increase of $4.3 million, or 23.9%, over the $18.2 million of total expenses for the year ended December 31, 2012. Management and incentive fees increased $3 million to $12.1 million due to higher average total assets less cash outstanding and resulting increase in net investment income generated during the full year 2013 compared to 2012. This includes an increase of $0.8 million in capital gains incentive fee expensed to $1.6 million for 2013 due to a $4.2 million increase in net realized and unrealized gains on investments during the year.
As a reminder the capital gains incentive fee is payable annually only to the extent that on cumulative basis since inception Net realized capital gains are in excess of gross unrealized depreciation. As of December 31, 2013 the capital gains incentive fee payable was $348,000.
Interest expense increased $0.7 million due to higher average balances of SBA debentures outstanding during the year compared to 2012.
Administrative service expenses, professional fees and other general and administrative expenses totaled approximately $3.1 million for the full year, $17.3% higher than 2012 which totaled approximately $2.7 million. The increase was primarily due to the increase in staff mentioned earlier and overall portfolio growth. The income tax provision increased $0.2 million due to higher levels of excise tax recorded for the year ended December 31, 2013 compared to the year ended December 31, 2012.
Net investment income for the year ended December 31, 2013 was $19.3 million, an increase of $3.6 million or 23% compared to $15.7 million for the same period in 2012. NII per share was $1.43 per share compared to $1.54 per share for the same period in 2012. Adjusted NII was $20.9 million or $1.54 per share for the full year ended 2013 compared to $16.4 million or $1.61 per share for the full year 2012. Adjusted NII is defined as net investment income excluding any capital gains incentive fee attributable to accumulative realized and unrealized gains and losses on investments and is we believe a better reflection of Fidus’ core level of earnings.
For the full year 2013 Fidus realized capital gains on investments net of applicable taxes of $30.2 million or $2.24 per share consisting of realized gains on investments in six portfolio companies. Net unrealized depreciation on investments for the year-ended December 31, 2013 totaled $22.2 million which was comprised of unrealized depreciation $14.6 million related to the reversal of unrealized appreciation of the exit of investments during the year, net unrealized depreciation of $6.8 million on debt investments and net unrealized depreciation of $0.8 million on equity investment.
This activity led to a net increase in net assets resulting from operation of $27.2 million for the year-ended December 31, 2013, a 40.2% increase over the $19.4 million that we reported for 2012. On a per share basis this equates to $2.01 per share for 2013 compared to $1.91 per share in 2012. Per share figures for the year-ended December 31, 2013 are based on weighted average shares outstanding of 13.5 million shares compared to 10.2 million shares for the full year 2012. This increase reflects the common equity offering Fidus completed in September 2012 as well as February 2013, both of which were completed at prices accretive to net asset value.
Turning now to portfolio statistics, as at December 31, 2013 our total investment portfolio had a fair value of $307 million, approximately 97% of cost and consistent of our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 70% subordinated debt, 17% senior secured loans and 13% equity and warrant securities.
Our average portfolio company investment on a cost basis was $8.5 million at the end of the fourth quarter and we had equity investment in approximately 92% of our portfolio companies with an average fully diluted equity ownership of 7.3%. Weighted average effective yield on debt investments was 14.5% as at December 31, 2013 and as Ed mentioned we placed one investment on non-accrual status which is excluded from our weighed average effective yield on debt calculation.
As at December 31, 2013 our liquidity and capital resources included cash and equivalents of approximately $53 million and unfunded SBA commitments of $30.5 million. In addition we have access to an additional $15 million of SBA leverage. We believe that this combination provides Fidus with ample capital to support its growth and diversification goals.
Now I’ll turn the call back to Ed for concluding comments. Ed?
Thanks Cary. I would like to thank the outstanding team at Fidus for their hard work over the past year and our shareholders for their continued support. I’ll now turn the call back over to Ben for Q&A. Ben?
(Operator Instructions). Our first question today comes from the line of Chris Kotowski from Oppenheimer. Your line is open. Please go head.
Chris Kotowski – Oppenheimer & Co.
Yeah I am just curious, as to credit quality has been too good to be true for quite a long time and this is the first non-accrual we’ve seen in a long time. And now I am wondering do you see this just as part of a trend of normalizing or is this is a one-off situation or how would you characterize it?
Sure Chris, great question. I think let me just touch on the overall portfolio which I think will be helpful. We feel as I stated very good about the overall health of our portfolio. It is a situation and we’ve talked about this is in the past that we’ve many companies that are exceeding expectations and then we have a few companies that are not meeting expectations.
And at the end of the day we would expect to have – we are taking real risk, earning the returns that we are getting and so we would expect to have a certain number of companies in our portfolio to not be meeting expectation, and in this case it’s non-accrual, it is a company that has been impacted by some of the headwinds that are impacting certain companies in the casual dining sectors and it’s also operating in certain geographic regions that have higher unemployment rates that the national average.
So it’s kind of had a full set of headwinds, if you will. So I view this more as a one-off situation. I don’t think it’s indicative of our portfolio at all. And I think as I said in our prepared remarks I think we feel very good about the construction and overall health of our portfolio. But again having said that we are always going to have a few that are not meeting expectations and that we are managing very closely which is the case for sure.
Chris Kotowski – Oppenheimer & Co.
Okay. Fair enough. And then also I am wondering just how much – being an SBA funded BDC you have access to more leverage than the average BDC and you highlight the dry powder that you have with $53 million of cash and $80.5 million in the SBA. And how – philosophically speaking, how much leverage do you – how do you look at the leverage and how much would you tolerate on the balance sheet of the BDC?
Sure, that’s a great question Chris. And I think we feel fortunate that the SBA and benefit of – the SBIC funds that we have and the benefits that come with that from a regulatory perspective and then we to the extent we want to or even need to we can run a little bit more leveraged than the average BDC. Having said that I don’t think we want to be in too leveraged position or an outlier in the industry I am not sure that’s overly healthy as well.
So I think we feel at comfortable positions today from a leverage perspective. We could go up in leverage a little bit but I don’t think we intend on trying to just absolutely maximize and go outside of the norm from a BDC perspective. So I think we like the flexibility of it and the position that we have especially related to the benefits of the SBA programs. But I don’t think we are going to be an outlier either.
Chris Kotowski – Oppenheimer & Co.
Okay. Thank you. That’s it from me.
Okay. Thank, Chris.
Thank you. (Operator Instructions). Our next question comes from the line of Robert Dodd of Raymond James. Your line is open. Please go ahead.
Robert Dodd – Raymond James
Hi guys. Just a question on kind of the outlook as I always kind of hop on about, you mentioned that on the call you don’t expect repayment realization activity to be as high in 2014 as it was 2013 and you have talked before about having a pipeline with ramping up and excuse me if I have missed some of your comments on the call. Can you give us a bit more color on what you expect maybe in mix of activity in 2014 if you are seeing anything more from your pipeline in terms of like is it going to be brand new LBOs, do you expect more recaps but expect to participate in them [inaudible] out I mean can you give us anymore color?
Sure. I am going to try to take that question in a couple facets, one, just talking about repayments for a second. Clearly repayments were at what I would consider a pretty high level in 2013 and I would say that was probably a one in the [inaudible] you go back to 2012 you know I think the number was more in the $25 million to $30 million range versus $131 million so what our expectation would be in 2014 is it would be somewhere in between those two numbers. As we sit here today and this is obviously today’s point in time we don’t see getting anywhere near to $131 million and so we don’t see kind of refinancing activity coming our way.
We do see some M&A driven repayments sometime during 2014 meaning there are discussions going on with some of our portfolio companies but as you know it’s impossible to predict but we do and we are just a bigger company today so going back to 2012 that’s probably 20 but we also think $131 million is pretty high. So hopefully that is helpful from a repayments perspective.
On the origination side you know I think we feel very fortunate that over the past year our deal flow has been strong and it’s been meaningfully up for us as we calculate which is just deal flow coming into that, into the shop and that’s driven by a very concerted effort on the part of our company and our partners of trying to drive deal flow and originations. It doesn’t mean that it’s not harder to get deals done today, it doesn’t mean that we are not being extremely judicious and deliberate and thoughtful in terms of the assets that we are ultimately putting on our books.
So we feel good about the opportunities we are seeing. We think a majority of our investments will come about as a result of M&A activity and we think M&A activity at this point in time looks pretty good for 2014 relative to maybe 2012 and 2013 and that’s driven by couple of things that you probably are very much aware. Obviously there’s ample debt capital out there that makes financing buyouts very possible.
There’s ample equity capital and there is also pent-up demand from the private equity community and that the average age of those portfolio companies with that portfolio, group of portfolio companies has gotten extended and it’s at a level that I don’t know if it’s never been seen but it’s pretty high. And so all those factors I think hopefully bodes well for an active 2014.
Robert Dodd – Raymond James
Okay, great. Thank you. Just kind of following on with that with the ample capital question and the issue obviously with the rules on banks on high leverage loans, the limits on how high they could go. Do you think that creates more of an opportunity for you in terms of making this more attractive in this space versus potentially a bank maybe in the past being willing to do a unit tranche but now being capped on how high they could go on the leverage multiple?
It’s a great question. I think pontificating here a little bit but I think over time I think that does help us. I do think there will be an increase in opportunities over time and I do think it’s going to be more difficult for banks to deploy highly leverage loans on their balance sheet. Having said that over the past 18 to 24 months as you all know there has been an increase in appetite by banks to do cash flow lending, not at crazy leverage levels but they have been more active.
At the same time we don’t view that as a negative. We view that as a potential source of capital that we can ultimately partner with to effect transactions. You know I do think they are more active. They are one of the groups of competitors out there that are getting more active in the market but I do going back to your initial question believe long term is a fundamental positive for non-bank lenders and particular BDCs.
Robert Dodd – Raymond James
Okay, great. Thank you.
Yeah, absolutely good talking to you, Robert.
Thank you. And with no further questions in queue I would like to turn the conference back over to Mr. Ed Ross for any final remarks.
Well, thank you Ben and thank you everyone for joining us this morning. We look forward to speaking with you on our first quarter call in early May. Hope everyone has a great day and a great weekend and thank you again.
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 your day.
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