Fidus Investment (NASDAQ:FDUS) Q1 2018 Earnings Conference Call May 4, 2018 9:00 AM ET
John Heilshorn - IR, LHA
Ed Ross - Chairman & CEO
Shelby Sherard - CFO
Robert Dodd - Raymond James
Chris Kotowski - Oppenheimer
Ryan Lynch - KBW
Mickey Schleien - Ladenburg
Good day, ladies and gentlemen and welcome to Fidus Investment Corporation First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Mr. John Heilshorn from LHA. Sir, you may begin.
Thank you, Jimmy and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's first quarter 2018 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, our 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 would 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 call.
I would 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 upon estimates, assumptions and projections as of today, May 4, 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, uncertainties and other factors including, but not limited to the factors set forth in the Company's filings with the Securities and Exchange Commission. Fidus undertakes no obligation to update or revise any of these forward-looking statements.
With that I'd like to now turn the call over to Ed Ross. Ed, good morning.
Good morning, and thank you, John, and good morning, everyone. Welcome to our first quarter 2018 earnings call. I will start our call by highlighting our results for the first quarter, followed by comments about investment activity and the performance of our investment portfolio and then offer our views about deal activity. Shelby will go into more detail about our first quarter financial results and liquidity position. After that, we will open the call for questions.
We had a good start to 2018 with our first quarter adjusted net investment income which we define as net investment income excluding any capital gains incentive fee attributable to realized our unrealized gains and losses increasing 8.8% to 8.7% year-over-year to $8.9 million or $0.36 per share. Our debt and equity investments continued to perform well in the first quarter, affirming our diversified portfolio approach to include prioritizing quality over quantity, focusing on capital preservation and investing with a long-term view. In the first quarter we realized net gains of $5.5 million related to our equity investments.
As of March 31, 2018 our net asset value or NAV was $398.2 million or $16.28 per share. And asset value per share grew with respect to 1.4% from our 2017 year-end level. I'm pleased to announce that we have received a green light letter from the SBA and earlier this week submitted our application for a third SBIC license. On March 23, 2018 Fidus paid a regular quarterly dividend of $0.39 per share; at March 31, estimated spillover income or taxable income in excess of distributions was $10.2 million or $0.42 per share. For the second quarter of 2018, Board of Directors has declared a regular quarterly dividend of $0.39 per share which is payable on June 22, 2018 to stakeholders of record on June 2018.
In the first quarter of 2018, we invested $60.9 million in debt and equity securities. Of this amount, $56.9 million was channeled to five new portfolio company investments. In each case, these businesses meet our investment criteria including companies that have positive long-term outlooks, strong yet defensible market positions, operating industries we know well and generate excess free cash flow for debt service and growth.
Let me briefly recap each of our new portfolio company investments. We invested $19.5 million in second lien debt in common equity of AVC Investors, LLC doing business as Auveco, a provider of fasteners and autobody hardware to the automotive aftermarket and general industrial markets. $10.5 million in second lien debt and common equity and made a commitment for up to $0.1 million of additional common equity of B&B Roadway and Security Solutions, LLC, a leading manufacturer of traffic control and perimeter security solutions. $9.8 million in second lien debt and common equity of CRS Solutions Holdings, LLC doing business as CRS Texas, a technology-enabled provider of comprehensive point-of-sale solutions to the hospitality end market. $11 million in second lien debt and common equity of SpendMend LLC, a leading provider of spend visibility and audit recovery services to the healthcare industry. And $6.1 million in subordinated debt, preferred equity and common equity of the Tranzonic Companies, a value-added supplier of disposable maintenance, cleaning, personal care and safety products to the away-from-home marketplace.
In addition, we invested $3.5 million in second lien debt of Thermoforming Technology Group LLC in support of an acquisition and $0.5 million in common equity of Vanguard Dealer Services LLC in support of an acquisition. From a repayments and realizations perspective, we also had an active first quarter. Proceeds totaled $36.1 million including we received payment in full on our second lien debt investment in United Biologics. We exited our debt investment in Comprehensive Logistics and received payment in full on subordinated debt including a prepayment penalty of approximately $0.5 million. And we exited our equity investment in worldwide packaging and realized a gain net of estimated taxes of approximately $5.2 million.
As reported in the first quarter press release, subsequent to quarter end on April 3, 2018 we invested $7.8 million in subordinated debt and common equity of UBEO, LLC, a premier provider of printer, copier, and related office equipment sales and services. On April 12, 2018, we invested $12 million in second lien debt, preferred equity and common equity of Power Grid Components, Inc., a supplier of high quality, mission critical products used in the North American electric power grid. On April 19, 2018, we exited our debt investment in Allied 100 Group, Inc. We received payment in full of $13 million on our subordinated debt.
The portfolio [ph] in March 31, 2018 was approximately $632.2 million, equal to approximately 103% of cost. We ended the quarter with debt and equity investments and 63 active portfolio companies plus three portfolio companies that have sold their underline operations. The breakdown on a fair value basis between debt and equity remained fairly stable with 82% in debt and 18% in equity investments providing us with high levels of current and recurring income from dent investments and the continued opportunity to realize capital gains from our equity related investments.
In terms of portfolio 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 first quarter, these metrics remain 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 March 31, the weighted average investment rating for the portfolio was 2 on a fair value basis in line with prior periods.
Another metric we track is the credit performance of the portfolio which is measured by our portfolio companies combined ratio of total net debt to Fidus's debt investments to total EBITDA. For the first quarter this ratio was 3.8x compared to 3.5x for the same quarter last year. The third measure we track is a combined ratio of our portfolio companies total EBITDA 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 first quarter, this metric was 3.4x compared to 3.5x for the same quarter last year. The soundness of these metrics reflects our philosophy of maintaining significant cushions to our borrower's enterprise value and support of our capital preservation and income goals.
Two of our investments, Restaurant Finance Co, LLC and Six Month Smiles Holdings Inc. [ph] remain on non-accrual status as of March 31, 2018. With respect to Six Month Smiles, it's an extremely fluid situation and as a result of both events and company performance, the risk level has increased substantially. As a result, we wrote down the value of Six Month Smiles Holdings investment to zero this quarter. We remain in active discussions with both of these companies.
Joining the business conditions in our target market; while M&A activity continues at a reasonably healthy level and deal flow remains stable, the quality of deals that we are seeing in the pipeline has been more radic over the past month. The first quarter was relatively unchanged for us from 2017 and as of today, we currently don't see any issues that would cause a dramatic expansion or contraction in our deal flow. Notwithstanding an uptick in interest rates and energy prices, the overall economy continues to grow at a slow but steady rate, repayments and realizations of course are always a wildcard in our business, but we have been successful in redeploying our exit proceeds.
We will, as we always do, focus on industries we know well, leveraging our knowledge and relationships and be highly selective with our cautious and deliberate approach to investing in businesses that we believe will perform well over the long-term. By hearing to our proven investment strategy to grow and further diversify our investment portfolio, we remained well positioned relative to our goals of preserving capital and generating attractive risk adjusted returns.
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 will review our first 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 Q4, 2017.
Total investment income was $18.2 million for the three months ended March 31, 2018, a $1.2 million increase from Q4 2017. Interest and pick income decreased by $0.6 million related to incremental assets under management and investment timing as the majority of our new Q4 investments took place late in the quarter. Fee income increased by $0.4 million due to a $0.5 million prepayment fees from the repayment of our debt investment and comprehensive logistics. Dividend income in Q1 was $0.3 million versus $0.2 million in Q4.
Total expenses, including income tax provision were $10.9 million for the first quarter, approximately $1.5 million higher than the prior quarter primarily due to an increase in interest expense related to an increase in debt outstanding, a modest increase in the weighted average interest rate related to our public debt offering, and interest on SBA debentures that were repaid in late February, as well as a higher accrued capital gains incentive fees.
Interest expense increased by $0.7 million, approximately $0.2 million of the increase was related to the acceleration of non-cash amortization expense on the SBA debt repaid in Q1. G&A expenses increased by $0.1 million. Base management and income incentive fees increased by a total of roughly $0.2 million and accrued capital gains incentive fees increased by $0.6 million. Interest expense includes the interest paid on Fidus' SBA debentures, public notes and line of credit, as well as any commitment and unused warranties and amortization of deferred financing cost. As of March 31, 2018, the weighted average interest rate on our outstanding debt was 3.8% versus 3.6% at year-end. As of March 31, we had $264.5 million of debt outstanding including our $50 million public debt offering of 5.87% notes to 2023 completed in the first quarter.
Net investment income or NII for the three months ended March 31, 2018, was $7.4 million or $0.30 per share versus $0.31 per share in Q4 2017. Adjusted NII was $0.36 per share in Q1 versus $0.35 per share in Q4. Adjusted NII is defined as net investment income excluding any capital gains incentive fee expense or 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 the Investor Relations page of our website.
For the three months ended March 31, 2018, Fidus had $5.5 million of net realized gains, primarily related to $6.8 million realized gain from the exit of our equity investment in worldwide packaging offset by $1.7 million in estimated tax expenses related to realized gains on equity investments held on taxable subsidiary. Our net asset value at March 31, 2018 was $16.28 per share, which reflects payment of the $0.39 per share regular dividend in March.
Turning now to portfolio statistics as of March 31; our total investment portfolio had fair value of $632.2 million consistent with our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 5% first lien debt, 65% second lien debt, 19% subordinated debt, and 11% equity securities. Our average portfolio company investment on a cost basis was $9.7 million at the end of the first quarter, which includes three investments in portfolio companies that sold their operations and are in the process of winding down. We have equity investments in approximately 89.4% of our portfolio companies with an average fully diluted equity ownership of 7.1%.
Weighted average effective yield on debt investments was 12.7% as of March 31. The weighted average yield is computed using the effective interest rate for debt investments at costs, including the accretion of original issue discounts and loan origination fees, but excluding investments on non-accrual, if any. Under our share repurchase program we purchased approximately 45,000 Fidus shares at an average price of $12.94 or total purchase of approximately $582,000 in Q1.
Now, I would like to briefly discuss our available liquidity. As of March 31, our liquidity and capital resources included cash of $32.8 million, and $50 million of availability on our line of credit resulting in total liquidity of $82.8 million. As discussed in our year-end earnings call, we prepaid $43.8 million of SBA debentures in advance of scheduled maturity date at the end of February. These debentures had an average interest rate of 4.9%. As a result, we currently have $64.5 million of remaining debentures at FMC with maturity dates ranging from September 2020 to March 2025.
In Q1, we borrowed $27 million of SBA debentures under our second SBIC fund FMC2 and as of March 31 have $150 million in outstanding under FMC2. In aggregate, we $214.5 million of SBA debentures and $50 million of public notes totaling $264.5 million of debt outstanding for a total debt-to-equity ratio of 0.66 versus approximately 0.62 as of year-end 2017. As Ed mentioned, subsequent to quarter end, we invested in two new portfolio companies and received repayments. Taking into account subsequent events, we currently have total liquidity of $76 million which includes cash of $26 million and $50 million of availability on our line of credit.
One final comment regarding Q2 before I turn the call back to Ed; as our existing registration statement has expired, we filed a new registration statement that was declared effective earlier this week. In conjunction with the exploration of our prior registration statement, we will incur approximately $250,000 of non-cash expense in Q2 related to unamortized expenses, roughly $0.01 per share of incremental expense.
Now I will 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 over to Jimmy for Q&A. Jimmy?
Thank you. [Operator Instructions] Our first question comes from Robert Dodd of Raymond James. Your line is now open.
First question I'll ask about, prospect for double leverage, obviously you guys have never been over one-to-one, all-in even when you've been allowed to the SBIC vehicle. So I mean, is there any intent to either ask board or shareholder approval to change the asset coverage ratio cap for you guys?
I think -- I guess, just talking about [indiscernible]. Again, I think if the margin we think it's a positive for the industry and thus I think it's good for us as well and we think offering reform is a positive, leverage as we know is a double-edged sword but can be a positive. But whether we sit here today, we don't need to utilize the increase in the leverage opportunity to perform well for our shareholders given our investment strategy; so for us at this point we don't think there is a need to do anything, so we're very much taken -- kind of a wait, watch and see approach at this point in time.
Another one that I think just changed; the SBIC limit per license I think just ticked up to -- obviously, the -- you've got $150 million on your SBIC2 right now which was the previous cap, correct me if I'm wrong, has that just gone upto $175 million so you can tap a little bit more in that one while -- and then tied to that, last quarter you sounded a little bit more cautious, I heard that how long it takes except for the potential third license process but a green light led already. I mean, are things moving faster than you expected? And is there anything you can point out as to why?
I think from our perspective, the SBIC license is obviously a very good thing. I think we are planning at the moment on utilizing $150 million of debentures with regard to that license. And if we can go to $175 million, I don't think that's clear at this point, then we will consider that clearly but I think the expectation is to hopefully get the license and utilize $150 million of debentures. From a timing standpoint, I think things have been moving slowly; I think really in 2017 at the SBA -- that would be my perspective, but I do think things have picked up a little bit here in 2018. That doesn't mean that we just put the $4 million application, in this week we expect that to test sometime. So our hope is -- and hopefully by year end we hear something and can accomplish full receipt of the license, so it's going to take some time.
Another question just on the debt; I mean, it looks like another dividend reversal this quarter, $106,000 in the non-control effects. Obviously, there was one last quarter as well; any color on that -- I mean, is there anything we should read into that in terms of the quality of information you're getting from portfolio companies about what the character of dividend is versus capital repayments? I mean, two in a row.
No, that has to do with re-record dividend income and we have to do estimates based on the character of that dividend. We don't actually receive the K1s associated with that until subsequent period, and so that has to do with kind of a one-time true-up related to dividend income that we had recognized in 2017 but didn't receive the K1 information until the first quarter of 2018.
I guess, I mean that's kind of the place -- I don't think dividend reversals at -- it's a minor collection, it never had before for the last couple of quarters. So I mean the question is, if those depend on the character, depends on what the company has told you overtime, etcetera, etcetera but has that information quality changed to the point -- are your estimates getting less reliable I guess is the question.
No, I don't think it has. I think what you're probably seeing is because now dividend income is broken out by control versus affiliate versus non-controls, focusing a little bit of more detailed information as opposed to in prior quarters it would prefer a one line item; so things kind of netted out.
Last one for me; can you give us a current estimate of what your spillover income is because obviously you've had some additional realized gains and you've already had a decent [indiscernible]. But where do you stand today on that front?
At $0.42 per share.
And our next question comes from Chris Kotowski with Oppenheimer. Your line is now open.
I know normally you can't say much about individual companies and their investments but I just -- I noticed the mark on energy [ph] $3 million cost investment equity went from $15.6 million to $23.6 million, and just seems like a big move and I was wondering is there an event that is triggering that or -- well, let me leave it there and see what you can say.
You know, this is a business that was performing very well. Obviously, we went through the cycle, we went through a restructuring, we retained some of our debt and obviously are very meaningful equity holder in this business now, and quite frankly, the valuation is based on just performance, its performance based. The company is performing both operationally and from a financial perspective extremely well. So that's the driver.
I'm curious I guess -- I don't remember you ever having an equity investment quite this big, what's your desire, willingness, capacity; however you want to phrase it to hold this for the longer term? And do you have any control over the exits?
As I'm sure you've seen, our equity portfolio now is over $110 million or about $100 million on a fair value basis which is substantial and it is something that we would like to monetize some of these investments and rotate them into more yielding investments if you will or debt investments. But at the same time they are performing well and we're obviously pleased with the outcome of where we are. So what I would say is, we do not have control over -- really, we only have control over one company; so we don't have control of these exits. But some of them are getting to a more mature point if you will, and so our hope is to over the next -- you call it 12 to 18 months to monetize some of these equity investments and that would obviously be a good thing for Fidus, and so that is one of our goals to the extent we can influence it. Hopefully that's helpful but we really don't have a controlling stake if you will to drive these but we definitely can give our opinions and try to do the best we can with regard to exits.
And I noticed the Six Month Smiles, you obviously marked to zero. Is that loss and crystallized and there to offset any realized gains or is that still to be done?
That loss is not crystallized at this point, that write-down as the right definition if you will. It is a situation that -- and I think I commented on this last call but over the last 24 months not much has gone according to plan with regard to this company. It's been both, company performance, as well as other events that I need to keep confidential that have been big negatives to our investments here recently and so it's extremely fluid, I do hope to be able to provide some clarity on our next call. We're working hard and in active discussions but obviously the risk profile is reflected in evaluation at this point.
And our next question comes from Ryan Lynch with KBW. Your line is now open.
I just have one; yes, we look at the debt capital structure with your SBIC1 kind of winding down, I know you guys are kind of [indiscernible] on SBIC2 and looking to get us there SBIC but obviously that's always uncertain with -- I think it's full to the SBA. When I look at increment growth on your balance sheet, it looks like data would probably come from cash on the balance sheet and next would be the credit facility. Having you guys continue to grow nicely as you did this quarter; do you guys foresee issuing anymore unsecured debt or would you guys want to draw down more leverage on the current facility assuming the growth continues to go?
The one reason that I asked is because the way your investment portfolio is set up, you guys I believe have about $25 million or so of floating rate investments but predominantly your investment structure -- your investments are fixed rate and so I was just wondering if you draw too much on the credit facility or interest rate, you know, fixed versus floating mismatch. So what are your thoughts about the debt capital structure going forward given the uncertainty of SBIC3?
I think first and foremost, I mean, you mentioned most of them. I did think -- we like having diverse sources if you will of debt. So like the fact that we obviously issued some public bonds last quarter and so that is an option to increase those a little bit, that's one. Secondly, we obviously have a line of credit, it is unfunded as we sit here today. So we've got a good availability there but we also have the ability to increase that. And I think that is an option for us in something that we are considering quite frankly. I don't think that's going to be a majority of our debt but I do think it's an option for growth capital. So I think we should utilize that.
And then you have the SBIC debentures that we're hopeful to get that approval and utilize those proceeds as well. So from a debt perspective, those are -- we like the diversity and we'll plan to access probably all three overtime but the timing; there is no need at the moment but I think it makes sense to act all three as we grow.
And the only other thing I would add just from a liquidity perspective, as you noted, we're on the process of winding down our first SBIC fund and we made a sizeable debt prepayment here in the first quarter. So with that debt prepayment, we have the ability to upstream cash to create additional liquidity at the holding company as we receive repayments on the debt fund. So we can do return of capital distributions that provide additional source of cash liquidity later this year.
And our last question for today comes from Mickey Schleien with Ladenburg. Your line is now open.
Well, all the good questions I think have been reviewed; I do have a couple that hopefully will shed a little more light on the quarter. Ed, I did see the portfolio the way declined from the fourth quarter little bit; I was trying to understand that a little bit better in terms of what was the yield on the new investments you've made versus your exits? Or another way of looking at how much prepayment risk is there still existing in the portfolio?
I guess just to answer your question very directly, the average yields was about under 12% to 11.8% in Q1. And then from a repayment perspective, in particular, comprehensive logistics driving it, that was -- 15% was the yields on the debt that was repaid. And so those moves were the primary drivers of the change. What I would say is a couple of things as we move forward; we're continuing to invest in companies that we believe want to have very enduring characteristics as well as defensive qualities. And in particular, with past couple of years we've been -- we've continue to strategically focus on what I would say a little bit larger companies within our core market; so few works of $5 million EBITDA businesses and more -- between $5 million and $10 million or even over $10 million, and quite a few over $10 million in EBITDA.
And with that focus, our overall yields could drop a little from where we are today, so -- but I don't think it would a material drop at this point. That has been a strategic move that we've kind of made over the last two to three years and that continues.
And my last question; I think Shelby said something about non-recurring amortization of expenses for the SBA prepayment; could you just repeat that information?
Yes, so towards the end of my commentary I was talking about in -- whether it's two thoughts there. There is one, that -- in Q2, we'll have about an additional $0.01 of incremental expense, that's non-cash amortization related to cost on our registration statement that has now expired since -- and we've put in a new one. So in the first quarter, as I mentioned, we repaid $43.8 million of SBA debentures and so with that repayment we had to accelerate the deferred financing fees associated with those debentures and that was about $200,000 of accelerated non-cash expenses in Q1.
And lastly, Shelby can you tell us how much of your cash is in the SBIC subsidiaries?
Sure. At this point I'd say it's about half and half in terms of half being as the holding company and then the half -- the remaining half of the $26 million being in the SBIC subsidiary.
And most of that would be in the first license, right because if I'm not mistaken, you're good. I'm sorry…
So in the first license it's about $3.5 million, and then the residual is in the second license.
Thank you. And there are no further questions in the queue. I'd like to turn the call back over to Ed Ross for any closing remarks.
Thank you, Jimmy and thank you everyone for joining us this morning. We look forward to speaking with you on our second quarter call in early August. Have a great day and a great weekend.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program, and you may now disconnect. Everyone have a great day.