Fidus Investment Corp. (NASDAQ:FDUS) Q2 2016 Earnings Conference Call August 5, 2016 9:00 AM ET
Jody Burfening – LHA
Ed Ross – Chairman and Chief Executive Officer
Shelby Sherard – Chief Financial Officer
Bryce Rowe – Baird
Robert Dodd – Raymond James
Chris Kotowski – Oppenheimer
Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the call over to Ms. Jody Burfening of LHA. Ma’am, you may begin.
Thank you, Takia, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation’s second quarter 2016 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 at 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 press 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, August 5, 2016, 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.
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. Welcome to our second quarter 2016 earnings call. On today’s call I’ll be commenting on our recent common stock offering and reviewing our second quarter results, the performance of our investment portfolio, and our views about deal flow for the rest of 2016. Then Shelby will go into more detail about our financial results and liquidity position. After that, we will open up the call for questions.
As announced during the quarter, Fidus completed a common stock offering that raised net proceeds of $43.7 million for the company at an offering price of $15.27 per share. This offering was a strategically positive move for us, we plan to use these proceeds to make investments in lower middle market companies in accordance with our investment objectives and strategies to repay outstanding indebtedness under our credit facility and to take advantage of the increase in allowable borrowing capacity under the small business investment company or SBIC debenture program subject to SBA approval.
Our second quarter results were generally solid. Total investment income grows 8.1% year-over-year to $13.8 million and was largely supported by a 5.6% increase in total interest income. Adjusted net investment income, which we defined as net investment income excluding any capital gains incentive fee attributable to realized and unrealized gains and losses increased 7.1% to $6.5 million or $0.38 per share.
As of June 30, 2016, our net asset value was $298 million or $15.52 per share. On June 24, 2016, Fidus paid a regular quarterly dividend of $0.39 per share. As of June 30, 2016, estimated spillover income or taxable income in excess of distributions was $15 million or $0.78 per share. For the third quarter of 2016, our Board of Directors has declared regular a quarterly dividend of $0.39 per share which is payable on September 23, 2016, to stockholders of record on September 9, 2016.
From an investment perspective, our second quarter came in quite light as you may recall from our last earnings call market turmoil at the begin of the year brought the M&A market nearly to a standstill. With the deal pipeline short of high quality opportunities, we invested a total of $2.1 million in debt and equity securities and existing portfolio companies. As expected this was one of our slower investment periods. Comparatively we had a more active quarter in terms of repayments and realizations receiving proceeds of $14.5 million in the period, which included a realized gain of $0.5 million, which primarily resulted from the exit of our debt and equity investments and Safety Products Group, LLC.
Investment activity has picked up as expected. As reported in our second quarter press release subsequent to quarter end we invested $17.25 million in debt and equity investments and Rohrer Corporation a manufacturer of high visibility graphically intensive packaging for consumer products. Furthermore we exited three investments. First, Carlson Systems Holdings, Inc, we exited our debt investment receiving payment in full and received a distribution from our equity investment recognizing a gain of approximately $4 million.
Second, National Truck Protection Company, we exited our debt and equity investments receiving payment in full on our senior secured loan and recognizing a gain of approximately $1 million on our equity investment. And third, Paramount Building Solutions, we realized a loss of approximately $12 million on our debt and equity investments. Paramount had been on non-accrual status for the past year and fully written down before the second quarter.
Turning to our portfolio of construction in metrics, the fair market value of our investment portfolio at June 30, 2016, was approximately $453 million equal to 101% of cost. We ended the second quarter with debt and equity investments in 53 portfolio companies and with equity positions in roughly 85% of them. The breakdown on a fair value basis between debt and equity remain fairly stable with 85% in debt and 15% in equity investments, providing us with high levels of current income from our debt investments and the continued opportunity for capital gains from our equity related investments.
In terms of portfolio of performance, we track several quality measures on a quarterly basis to help us monitor the overall stability, quality, and performance of our investment portfolio. In the second quarter, these metrics remained strong and in line with prior periods. First, we track the portfolios weighted average investment rating based on our internal system. Under our methodology a rating of 1 is outperformed and a rating of 5 is an expected loss. As of June 30, the weighted average investment rating for the portfolio was 2 on a fair value basis unchanged compared to prior year’s period.
Another metric we track is the credit performance of the portfolio, which is measured by portfolio companies combined ratio total net debt through Fidus' debt investments to total EBITDA. For the second quarter, this ratio is 3.1 times compared to 3 times for the same quarter last year. The third measure we track is the combined ratio of our portfolio companies total EBTIDA to total cash interest expense, which is indicative of the cushion our portfolio companies have in aggregate to meet their debt service obligations to us. In the second quarter this metric was 3.6 times compared to 3.5 times for the same quarter last year.
The strength and stability of these metrics reflect our philosophy of maintaining significant cushion to our borrowers' enterprise value a critical determinant of our capital preservation and income goals. As of June 30, our debt investments in two portfolio companies were on non-accrual status, which represented approximately 6% at the current portfolio cost. As I mentioned on our last call, we have decided to place Pinnergy on non-accrual status at the beginning of Q2 to reflect the increased risks of this investment from persistent difficult industry conditions in the energy sector.
We are currently continuing to work with all stakeholders on this situation. Paramount Building Solutions, LLC, was the other portfolio company on non-accrual at the end of Q2 an investment, we've now exited.
All things considered our debt portfolio performed reasonable well. Our equity portfolio is also doing quite well with the value of a number of our investments written-up as a result of both solid specific company performance and selective aggressive M&A activity. These write-ups drove meaningful NAV growth for the quarter.
Turning to our outlook, market dynamics thus far in 2016 have painted a mixed picture while the overall economy has remained in a slow but steady growth state. M&A activity that matters to us essentially ground to a halt in the first quarter of the year. Our concerns ranging from a troubled oil and gas market to economic uncertainty to the geopolitical unrest. This slow start for M&A activity is reversed however and activity has picked up as fears of a near-term recession have receded.
As a result we're looking at greater number of quality opportunities presently. Deal competition is not insignificant for these companies in the private debt and equity markets however and it is important that we wait for the right deals to come along sticking to our discipline of choosing quality over quantity and managing for the long-term. Our goal in this process is to grow and further diversify our investment portfolio in a very deliberate manner with an overriding focus on generating attractive risk adjusted returns and capital preservation.
Fortunately, we have a time tested strategies and disciplines in place, once we are confident we’ll support our long-term capital preservation and income goals. And at the end of day I think we'll get our fair share of these deals. Of course a more active M&A market may also give rise to a greater level of repayments and realizations, which may dampen portfolio growth for the year.
Now I’ll turn the call over to Shelby to provide some details on our financial and operating results. Shelby?
Thank you, Ed, and good morning, everyone. I’ll review our second 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 Q1 2016. Total investment income was $13.8 million for the three months ended June 30, 2016, a $0.9 million decrease from Q1 2016. Interest income decreased by $0.7 million primarily related to placing Pinnergy on non-accrual status. A $0.7 million decrease in fee income due to more investment activity and prepayment fees in Q1 was offset by a $0.5 million increase in dividend income primarily related to distributions from equity investments received in Q2.
We also recognized $0.3 million in fee income from amendment fees. Total expenses including income tax provision were $8.9 million for the second quarter approximately $1.3 million higher than the prior quarter due to an increase and accrued capital gains incentive fees. Interest expense was in line with the prior quarter, G&A expenses decreased by $0.1 million, and base management and income incentive fees decreased by a total of roughly $0.1 million, which were offset by $1.5 million increase in capital gains incentive fees. Interest expense includes the interest paid on Fidus' SBA debentures and the line of credit as well as any commitment in unused line fees.
As of June 30, 2016, the weighted average interest rate on our outstanding debt was 4.2%. As of June 30, we had $214 million of debt outstanding as summarized on footnote 6 to our financial statements. Net investment income or NII for the three months ended June 30 was $4.9 million or $0.29 per share versus $0.43 per share in Q1. Adjusted NII was $0.38 per share in Q2 versus $0.44 per share in Q1. Adjusted NII is defined as net investment income excluding any capital gains incentive fee expense a reversal 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 our Investor Relations page of our website.
For the three months ended June 30, 2016, Fidus had $0.4 million of net realized gains primarily related to the sale of the operations of Safety Products Group. We also recorded $7.5 million of net unrealized depreciation on investments, primarily related to a write-up of three equity investments including Carlson Systems Holdings, which was sold subsequent to quarter end. Our net asset value at June 30 2016, was $15.52 per share, which reflects payment of the $0.39 per share regular dividend in June as well as the equity offerings.
Turning now to portfolio statistics. As of June 30, our total investment portfolio had a fair value of $452.7 million. Consistent with our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 74% subordinated debt, 15% senior secured loans, and 11% equity securities. Our average portfolio company investment on a cost basis was $9.2 million at the end of the second quarter. This excludes four investments in portfolio companies that sold their operations are in the process of winding down. We have equity investments in approximately 85% of our portfolio companies with an average fully diluted equity ownership of 7.6%.
Weighted average effective yield on debt investments was 13.3% as of June 30. The weighted average yield is computed using the effective interest rates for debt investments to cost, including the accretion of original issue discount and loan origination fees, but excluding investments on non-accrual if any.
Now I’d like to briefly discuss our available liquidity. On May 27, we issued 2.5 million shares above NAV and a follow on offering with an additional 375,000 shares from the over-allotment option issued on June 10 raising net proceeds of $43.7 million. As of June 30, our liquidity and capital resources included cash and cash equivalents of $59.1 million, unfunded SBA commitments of $11 million, and $50 million of availability on our line of credit resulting in a total of $120.1 million. Taking into account investment activity subsequent to quarter end, our liquidity is currently around $142.5 five million.
Furthermore, we have submitted a commitment application requesting SBA approval for an additional $15 million of SBA debentures for Fidus Mezzanine Capital too.
Now, I’ll turn the call back to Ed for concluding comments. Ed?
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 will now turn the call back to Takia for Q&A. Takia.
Thank you. Thank you. [Operator Instructions] And our first question will come from Bryce Rowe at Baird. Your line is now open.
Thanks. Good morning, guys.
Good morning, Bryce.
Just a question on some of the activity here subsequent to quarter end, Shelby, you guys mentioned prepayment fees that were associated with two of the three exits here in the third quarter – early in the third quarter. Can you help us from a modeling perspective in terms of what this might be in the third quarter?
Absolutely. On Carlson, we received 260,000 and on National Truck, we got 45. So again some healthy prepayment fees to kick start the third quarter.
Right. That's great. And then one, I guess follow-up to the prepared remarks about the SBA or applying for additional SBA commitment to $50 million dollars. Have you guys I guess committed additional capital to SBIC too, yes?
Yes, we did. So with our $50 million additional debentures that we’ve requested approval for, we committed $25 million to Fidus Mezzanine Capital too. And that was partly use of our equity offering proceeds.
That's great. Thank you, guys. That’s it for me for now.
Okay, great. Thanks, Bryce, good talking to you.
Thank you. And our next question will come from Robert Dodd at Raymond James. Your line is now open.
Hi. Just a simple one first list to it kind of less order of complexity, on the gains and the realized loss obviously in subsequent to the quarter end. Are those all including the equity on call for the National Truck, which is obviously marked up. So were those all in line with the mark, so basically we could have realized – net realized loss, but that's going to be precisely offset by – on the unrealized line. Is that going to be a material mismatch?
I think your statement is correct. So they were kind of marked appropriately – that’s the right way to think about it.
Perfect. Thank you. On Pinnergy you gave some comments I mean the last quarter you think, I got kind of the impression you hoped to be sorted out by the end of the year. Any additional color you can give us on kind of timeline you expect.
I do think a time line would be during this quarter we will have some kind of restructuring. But I don't really have much of an update that I can give you at this point. We have multiple constituents in the capital structure. We are all in deep discussions is what I would say and I would characterize the situation as fluid at this point, so.
Great. Thanks. And then on the activity rebound, obviously it's relatively early stages I presume you haven't gotten – got a lot of signed LOI’s out yet. So I mean what’s the kind of your confidence level that those are really going to turn into whether you win the more marks obviously you mentioned competition obviously. But the confidence level that’s actually going to turn into real closings on M&A front versus it's kind of an activity blip because everybody has gotten bored, but maybe they aren’t actually going to close the deals.
Sure, sure. It's a great question, Robert. I think as you know with M&A activity and originations they're erratic, they are very hard to predict. I will tell you we are very busy. So my confidence in getting some new investments made incremental new investments made here in the third quarter is I'd say high, but to what degree I think is there's no way for me to say that. But I would also say I mean the good news is we've got a I would consider a strong portfolio and a healthy portfolio. What that gives raise to is repayments as well and I mentioned that in the prepared remarks.
And so we took out some more repayments as well. And so I think there will be more investment activity on the originations side. But if I were a guessing man, repayments may outpace originations this quarter. That's quite possible. But again I think we think that's a healthy thing over time. So we're managing the business for the long-term. But that's kind of the state of play. We also think it will be an active fourth quarter just based on deal flow and pipelines. And so it's too early to tell how it all plays out, but we feel very good about the activity levels.
Okay. Perfect. You kind of preempted my next highlight question obviously I mean your $40 million in repayment so far at fair value $34 million at a cost between the National Truck and Carlson versus obviously 2017 in deployment. So you net down at the moment. That as you said that’s not necessarily a bad thing. You have gains on this, et cetera. So to that point and then also Shelby’s comments that the unrealized depreciation most of that was concentrated in fee assets one of those Carlson has already exited for gain.
Is that – should we read anything into the potential for those other two to be potential exits as well. And obviously that to your point will put some stress on portfolio growth and it’s not, that shouldn't be your target, right. That’s opportunistic, but I mean just from that perspective on that gain side I mean are you seeing particularly with those other not two non-Carlson assets went up in the quarter. Are those – is that going to give us some likelihood that those get repaid as well and that put additional repayments.
No. It's a great question. I wouldn't focus just on those. I mean the good news is the write-ups they were somewhere obviously much more material than others, but there was a lot more they were written-up than written-down. And that's a positive and a lot of that a little bit of that was what I would say selective M&A activity. I mean we've had three processes this year or three companies that have gotten it, they have not been in a process i.e. in a M&A process. But they've gotten serious interest from perspective buyers, so preempted a process if you will.
So that gives you a sense of the M&A market for high quality companies. I think the other part of the equation is there's been some pretty good performance in some of our portfolio companies and that’s driven value accretion. So I wouldn't pick on those two, but I do think we do have several companies that are in the middle of a process if you will a strategic alternatives process. And those very well could materialize into some gains, but I don't want to pick on those two, because I don't think that's appropriate.
Okay. I appreciate it. Thanks a lot.
Okay, absolutely. Good talking to you Robert.
Thank you. And our next question will come from Chris Kotowski of Oppenheimer. Your line is now open.
Yes. I guess staying on the theme of the day. In addition to BDCs, we cover some of the large cap private equity sponsors and one of them on their earnings call this quarter said, this is a much better time to reap than to sow and on balance there, they're realizing more capital than they're deploying. And I'm wondering do you find that attitude expressed among the middle market sponsors a lot.
Yes. I mean I think the sponsors actually I think absolutely. I think what we are seeing in the market today is that if people or firms or owners of company that are looking to find liquidity in the near to medium-term they're thinking very seriously about doing it right now. The equity markets are what I would say our private equity markets are aggressive and the debt markets are I think rational, but also aggressive. Specially from a structure and pricing perspective. It's not a big change to be honest it's been that way for a while other than in the first quarter when the concerns were out there and the public markets were kind of upside down. I think people backed up a little bit, but there really wasn't much activity, so that made some sense.
So we are I think if people are looking to get liquidity anytime soon. They're probably doing it right now or starting to process or in the middle of a process, because it's a pretty – it's a good time to be selling I guess no different than what you just said.
And then I guess just we've had higher energy prices now for a couple of months and I'm not sure of what you can say, but it does that. How does that flow through to Pinnergy’s business fundamentals. Does it or is it or is this kind of too little too late?
No, no. I think it does flow through to the fundamentals, what I’ll give you my perspective. And that is clearly prices are much higher than they were at the beginning of the year. They got towards 50, they're not there at the moment, but I think from a operations perspective, we've been bottoming out for the last couple of months. I think we expect an up tick in activity in the energy market, is it two months from now, is it four to six months from now, I don't know. But we do think that will happen. I think Pinnergy operates in some low cost basins, which is a good thing for the company. And so we are hopeful, but there's a lot of wood to chop. So it's a fluid situation from our perspective.
Okay, thanks. That's it for me.
Okay. Good talking to you Chris.
Thank you. And I'm showing no further questions at this time. I'd like to turn the call back over to Mr. Ross for closing remarks.
Thank you Takia and thank you, everyone for joining us this morning. We look forward to speaking with you in our third quarter call in early November of 2016. Have a great day and a great weekend.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.
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