Alphabet Q4 2023 Earnings Call Transcript

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Provided by Quartr
March 1, 2024

There are 8 speakers on the call.

Operator

Good morning, and welcome to the Fidus 4th Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Jody Berfening. Please go ahead.

Speaker 1

Thank you, Drew, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's Q4 2023 earnings conference call. With me this morning are Ed Ross, Baidus Investment Corporation's Chairman and Chief Executive Officer and Shelby Sherrod, Chief Financial Officer. Baidus Investment Corporation issued a press release yesterday afternoon with the 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 atfdus.com. I'd also like to call your attention to the customary Safe Harbor disclosure regarding forward looking information included on today's call.

Speaker 1

The conference call today will contain forward looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results and cash flows of Binance Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, March 1, 2024, these statements are not guarantees of future performance. Time sensitive information may no longer be accurate at the time of any telephonic or web 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.

Speaker 1

With that, I would now like to turn the call over to Ed. Good morning, Ed.

Speaker 2

Good morning, Jody, and good morning, everyone. Welcome to our Q4 2023 earnings conference call. Today's call, I'll start with a review of our 4th quarter performance and our portfolio at quarter end and then share with you our outlook for 2020 4. Shelby will cover the Q4 financial results and our liquidity position. After we have completed our prepared remarks, we'll be happy to take your questions.

Speaker 2

Our strong 4th quarter performance reflects the benefits to Fidus of our strategy of both serving the lower middle market, which has remained reasonably active in a less robust environment, and selectively investing in companies that possess resilient and strong cash flow generating business models and positive long term outlooks. Our patience during the year has paid off with the typical year end push and deal activity, originations totaled 132 point $7,000,000 and proceeds from repayments and realizations totaled $112,500,000 for a net origination of $20,200,000 and we grew the total portfolio to $957,900,000 on a fair value basis. Adjusted net investment income increased 49% to $18,800,000 in Q4 compared to $12,600,000 last year. As was the case for each quarter in 2023, interest income growth drove this year over year increase, reflecting both higher average debt balances and higher weighted average yields. Taking into account the higher average share count resulting from the equity raises we completed during the year, adjusted net investment income on a per share basis increased 27.5 percent to $0.65 from $0.51 We paid dividends totaling $0.80 per share, including a base dividend of $0.43 per share.

Speaker 2

For the year, we distributed a total of $2.88 per share to shareholders consisting of regular dividends of 1.66 dollars per share, supplemental dividends of $0.82 per share and special dividends of $0.40 per share. Adjusted NII of $2.56 per share comfortably covered base dividends. As a reminder, we distributed a special cash dividend of $0.10 per share each quarter of 2023 to satisfy RIC requirements and to bring our spillover income in line with our target level, which is roughly the equivalent of the base dividend for 3 quarters. For the Q1 of 2024, the Board of Directors declared dividends totaling $0.65 per share, consisting of a base dividend of $0.43 per share and a supplemental dividend of $0.22 per share equal to 100% of the surplus and adjusted NII over the base dividend from the prior quarter, which will be payable on March 27, 2024 to stockholders of record as of March 20, 2024. Net asset value at quarter end was 589 $500,000 or $19.37 per share, a meaningful increase as compared to 548 point $6,000,000 or $19.28 per share as of September 30, 2023.

Speaker 2

During the quarter, we grew our portfolio, investing as always in high quality companies that generate excess levels of cash flow to service debt and structuring our investments with a high level of equity cushion to give us an added margin of safety. Originations totaled $132,700,000 consisting of $123,500,000 in debt and $9,200,000 in equity. 1st lien investments accounted for $110,500,000 or approximately 90% of the additions to the debt portfolio. We invested 94 point $6,000,000 or about 3 quarters of total originations in 6 new portfolio companies, which were added to the portfolio through financing of $38,100,000 was invested in add ons in support of existing portfolio companies, almost all of which was M and A driven. Proceeds from repayments and realizations totaled 112 $500,000 for the 4th quarter, reflecting exits and some strategic pruning of the portfolio on our part.

Speaker 2

We received $87,200,000 in debt repayments, primarily due to M and A activity and received proceeds of $25,300,000 from the sale of equity investments, resulting in net realized gains of $19,800,000 Our portfolio of debt investments was $832,800,000 or 87 percent of the total portfolio at quarter end. 1st lien investments continue to account for the largest portion of the debt portfolio, now at 69%. Including the fair value of our equity portfolio of $125,100,000 the fair value of the total portfolio at quarter end stood at $957,900,000 equal to 102.3 percent of cost. We ended the 4th quarter with 81 active portfolio companies. Subsequent to quarter end, we invested $17,000,000 in 1st lien debt and equity in 2 new portfolio companies, and we had a debt repayment and equity realization in 1 company, generating net proceeds of approximately $24,300,000 and a realized gain of $1,500,000 Overall, our portfolio from a credit quality perspective remains solid.

Speaker 2

As of December 31, we had 2 operating companies on nonaccrual, unchanged from the 3rd quarter. Nonaccruals represented approximately 1% of the total portfolio on a fair value basis. The vast majority of our portfolio companies continue to capture growth opportunities and sustain profitability, supported by resilient business models. We do, of course, have a few companies that are experiencing difficulties for a variety of reasons, that there is no one market condition that is weighing on their operations. Looking ahead, we are well positioned to build on our successes in 2023.

Speaker 2

During 2023, we expanded our portfolio of debt and equity investments on a fair value basis by nearly $100,000,000 to $957,900,000 despite subdued levels of M and A activity in the lower middle market. This performance speaks to our experience, our relationships with financial sponsors and industry knowledge that together enable us to remain highly selective investing in high quality companies that meet our investment criteria. By building our portfolio of income producing assets and with an assist from widened spreads, we enhanced the earnings power of our healthy and high performing portfolio, generating a 46.4% increase year over year and adjusted NII to $67,500,000 Our strategy of co investing investments continue to work well for us, producing approximately $22,400,000 in net realizable gains for the year. Finally, we continue to deliver value to our shareholders, distributing 100% of our earnings and demonstrating our ability to generate gains in excess of losses while maintaining an overall healthy portfolio, thanks to our rigorous underwriting standards. While we are positioned to build on our successes of 2023, we remain committed to managing the business for the long term to our underwriting disciplines in selecting investments into our long term goals of growing net asset value over time, preserving capital and generating attractive risk adjusted returns for our shareholders.

Speaker 2

Now, I'll turn the call over to Shelby to provide some details on our financial and operating results. Shelby?

Speaker 3

Thank you, Ed, and good morning, everyone. I'll review our 4th 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 Q3 2023. Total investment income was $36,300,000 for the 3 months ended December 31, a $2,100,000 increase from Q3, primarily due to a $400,000 increase in interest income, including PIK, a $1,300,000 increase in fee income due to higher levels of investment activity and a $500,000 increase in interest income on excess cash. The increase in interest income was driven by an increase debt investment balances outstanding, partially offset by a decrease in yield on new debt investments and the repayment of 2 higher yielding debt investments.

Speaker 3

Total expenses including income tax provision were $19,400,000 for the 4th quarter, dollars 1,800,000 higher than Q3, driven primarily by a $1,000,000 increase in income taxes related to the annual excise tax accrual, dollars 3,000,000 increase in professional fees and a $400,000 increase in the capital gains fee accrual. We ended the quarter with $475,900,000 of debt outstanding comprised of $210,000,000 of SBA debentures, dollars 250,000,000 of unsecured notes and $15,900,000 of secured borrowings. Our debt to equity ratio as of December 31 was 0.8x or 0.5x statutory leverage excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 4.3% as of December 31, 2023. Net investment income or NII for the 3 months ended December 31 was $0.58 per share versus $0.63 per share in Q3.

Speaker 3

Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments was $0.65 per share in Q4, which includes a $0.03 per share excise tax accrual versus $0.68 in Q3. For the 3 months ended December 31, we recognized approximately $19,800,000 of net realized gains related to the sale of our equity equity investments in Power Grid Components, Aeronics, Road Safety Services and Comply 365, offset by realized losses on the exit of our debt investment in K2 and equity investment in Technics Industries. As Ed mentioned, in 2023, we paid total cash dividends of $2.88 per share versus $2 in cash dividends in 2022. Turning now to portfolio statistics. As of December 31, our total investment portfolio had fair value of $957,900,000 Our average portfolio company investment on a cost basis was 11,600,000 dollars which excludes investments in 1 portfolio company that sold its operations and in this process of winding down.

Speaker 3

We have equity investments in approximately 79.3 percent of our portfolio companies with an average fully diluted equity ownership of 3%. Weighted average yield on debt investments was 14.2% as of December versus 14.6% at September 30. The weighted average yield is computed using effective interest rates for debt investments at 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. In Q4, we issued approximately 2,000,000 shares under our ATM program at an average share price of $19.79 raising net proceeds of approximately $38,700,000 As of December 31, our liquidity and capital resources included cash of $119,100,000 $100,000,000 of availability on our line of credit, resulting in total liquidity of approximately 219,100,000 dollars Subsequent to year end, we repaid the remaining $35,000,000 of outstanding SBA debentures and our second SBIC fund.

Speaker 3

We have submitted a new license application to the SBA for a 4th SBIC license, which subject to SBA approval will provide us with access to $175,000,000 of additional SBA debentures. Now I will turn the call back to Ed for concluding comments.

Speaker 2

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 over to Drew for Q and A. Drew?

Operator

We will now begin the question and answer The first question comes from Robert Dodd with Raymond James. Please go ahead.

Speaker 4

Good morning and congratulations on another very good quarter. Couple of questions. On the Ed, you mentioned strategic pruning of the portfolio during the opening remarks. Could you give us any more color on that? I mean, a decent chunk of that sounds like it was equity.

Speaker 4

Was it people requesting different recaps you weren't comfortable with that drove you to prune it? Or can you give us any color on the reasons that you decided to do that?

Speaker 2

Sure. There was one equity investment that was you could argue was strategic pruning in an equity investment that we did very well on. I think we made 8 times our money or something like that. So we had an opportunity to stay in and we chose to go ahead and exit and saw risk greater than the opportunity, quite frankly. But really what that was kind of meaning to talk about was a couple of debt investments.

Speaker 2

They weren't huge, but they were ones that risk levels were higher than we were comfortable with. And so we made kind of the strategic decision to work to exit those investments. And in both cases, we were able to accomplish it in Q4. So it was more debt oriented than equity, but there was one equity investment. We did make that decision.

Speaker 2

Got it. Got it.

Speaker 4

Thank you. On the credit situation, it seems I mean, obviously, there's clearly no broad based problems, so you wouldn't be lighting up anything. And you said the vast majority of portfolio companies are performing fine. No single reason for the maybe handful that aren't. Are those idiosyncratic issues for the company?

Speaker 4

Or is it delayed the market or anything? Could you give us more color? And how comfortable you are that those problems are being managed and aren't showing material lapping size of the deterioration maybe or something like that?

Speaker 2

Sure. And the one, Dom, was really kind of generally referencing are the non accruals, which have been there for a few quarters. And those are companies that are both supported by private equity groups. They are going through idiosyncratic type situations and in both cases improving, but we got a ways to go. So that's really what we're referencing primarily.

Speaker 2

In terms of other companies that are underperforming, again, kind of one off type reasons for it. And we feel very good about our portfolio. There's always a chance for another non accrual, but that's not our expectation. And we clearly hope that we can keep managing the rest of the businesses in the way that we have in the past.

Speaker 4

Okay. I appreciate it. And again, congrats on the quarter. Thank you.

Speaker 2

Thanks, Rob. Appreciate it. Good talking to you.

Operator

The next question comes from Bryce Roe with B. Riley. Please go ahead. Thanks.

Speaker 5

Good morning, Ed and Shelby.

Speaker 2

Good morning, Bryce.

Speaker 5

I'm good. Thank you. Maybe I'll start on the capital structure. And Shelby, you appreciate the commentary around SBA license number 2 and kind of trying to re up with a 4th license. How do you think about kind of timing of that 4th license and maybe access to that additional capital kind of relative to where the balance sheet how the balance sheet looks today.

Speaker 5

You're sitting on a lot of cash. And so just trying to think about how you work through that cash with the pipeline that you see in front of you.

Speaker 2

Sure. Great question, Bryce. As we think about the SBIC fund that we applied for, as you know, that takes some time. And I think about it in terms of kind of a 6 month window or so. So that's what our expectation is.

Speaker 2

Our hope is that in 2024, we'll be able to start utilizing that license. But obviously, we're still in the application mode. With regard to the cash, obviously, we did prepay debentures and fund too. But the other piece of the puzzle is, we this quarter is actually shaping up from our perspective, assume things go as we expect to be a very active investment quarter, but it is going to primarily be in March. And so, we're currently in the execution phase, diligence and final execution phase of numerous investment opportunities.

Speaker 2

And I would also say our portfolio continues to exhibit acquisition type activity as well. So it's shaping up to be a pretty active new investment quarter. And then from a repayment perspective, we actually think it's probably going to shape up to be a lighter quarter. We've obviously had one sizable realization, I mean, almost $25,000,000 But it doesn't appear that the calendar is very robust, the rest of the quarter. We do have a few companies that are evaluating strategic alternatives.

Speaker 2

At the moment, we view those investments as probably more Q2 realizations. And they also aren't the ones that we're aware of, they aren't very large investments at the same time. So we think a fair bit of the cash that we have on the balance sheet today will actually go to new investments here as we move forward here over the next 4 to 8 weeks.

Speaker 5

Okay. That's helpful. And Ed, beyond, I guess, we've heard M and A activity picking up from many of your peers in the lower middle market. Does that M and A trend that you're seeing and experiencing, does that continue beyond this March period? Are we going to continue to see it in the second, Q3 just based on kind of what you're hearing at this point?

Speaker 2

It's a really good question, Bryce. I think it's a little unclear. I mean, look, in the lower middle market, one of the reasons we like it, there's more activity than the broader market in terms of number of deals. It's fragmented, which we like, gives us a chance to kind of choose what we really are interested in. But activity levels are still well below 2021 and I'd say below normal activity levels.

Speaker 2

But there has been a little bit of an uptick here in Q4 and Q1 as well. In January, we obviously had some pretty robust deal flow in some high quality situations. I think it's unclear on how long, how sustainable that is, but the expectation, so more of a market expectation is for continued M and A activity at reasonable levels and above last year. And so that's our hope. And so that's what we're planning for, but there's no guarantee of that, obviously.

Speaker 5

Got it. All right. Last one for me, Ed. It looks like the new activity in the 4th quarter from a, I guess, pricing perspective, it looked like most of those debt investments were straight up first lien, no last out structure to them. I might be wrong there, but that's the way I read the schedule of investments.

Speaker 5

Anything to kind of read into that? Or is that more just kind of flow of what happened in the quarter relative to kind of what we've seen over the last couple of years in terms of structuring those debt investments?

Speaker 2

Sure. No, nothing strategic. It's more we start with, I think, as you know, just what's the quality of the underlying business and then try to figure out what the opportunity is. And in this case, it was more just a mix towards dollar 1 type investments. The only thing I would say, we are very focused on quality, right?

Speaker 2

And so we're willing to sacrifice a little yield if we find the right quality investment, if you will. And so I'd say there's a little bit of both of those that go into the decision making, but it starts with trying to find very high quality businesses to invest in and then we figure out how we can do it. And so hopefully that's helpful.

Speaker 5

That is it. Thanks for the time.

Speaker 2

Yes. Thank you. Appreciate it. Good talking to you, Bryce. You too.

Speaker 2

Thanks.

Operator

The next question comes from Mickey Schleien with Ladenburg. Please go ahead.

Speaker 6

Yes. Good morning, everyone. Ed, it sounds like some of the repayment activity in the Q4 was due to refinancings, which certainly is in line with what we're seeing broadly. So I'd like to get your take on how much more prepayment risk you see in the portfolio?

Speaker 2

Sure. It's a great question, Mickey. I think in terms of repayments, we haven't seen a lot of repayments that are just trying to get a lower price. In fact, I look at the 3 companies that were repayments for us, 2 of them were strategic in nature by us. And then one of them was a very large acquisition and we just chose to exit that situation from a debt and equity perspective.

Speaker 2

So we haven't seen a lot of just getting taken out, if you will, of our debt investments. Having said that, I think we're in an environment where competition has increased over the last 12 months. Yields have come down a little bit. And are so I would expect that piece of the puzzle to show its face a little bit here in 2024 more so than the last couple of years. That's how we currently think about it.

Speaker 6

I understand. Thanks for that. I just wanted to follow-up on the 4th SBIC license. I'm not clear on exactly what's going on because Fund 3 already has regulatory capital of $175,000,000 So what debt commitments has the SBA made to Fund 3? And why does that necessitate a Fund 4?

Speaker 2

Sure. Shelby, do you want to take that one?

Speaker 3

Sure. So let me just start, let's talk about Fund II. And so I made the comment that we repaid $35,000,000 of SBA debentures. And that was really just to avoid a situation where we would end up with trapped cash. And so given some of the repayments that we had in 2023 and quite frankly a subsequent event in 2024, our second SBIC license had a fair amount of excess cash.

Speaker 3

And so the best way to utilize that cash was just to repay $35,000,000 that completes the wind down of fund 2. Any further repayments in that fund, we can fully redeploy cash on a go forward basis, whether it be making investments out of the BDC or using some equity capital to contribute to a new 4th SBIC license once it's approved by the SBA. So that really with that repayment that leaves us with 1 SBIC license, Fund 3, that has been fully deployed, meaning we fully borrowed and invested 175,000,000 cap per SBIC license for Fund 3. So that necessitated the need to go ahead and get another SBIC license. So we submitted that application at the end of December.

Speaker 3

And as Ed mentioned, we'd kind of like to think that hopefully that'll definitely be in 2024. My hope would be first half, if not shortly thereafter of 2024. So we can start deploying new capital into that 4th SBIC license, because of the attractive rates on SBA debentures given other alternatives in this market environment. So it's really just more

Speaker 6

Yes. No, I agree that the rates are attractive. So Fund 3 is limited to debt to equity of only one times rather than two times?

Speaker 3

No, it's two times. So we have the two times fully deployed. The $175,000,000 is the two times.

Speaker 6

Okay. Thanks for that Shelby. And how has the increased allocation to 1st lien and unitranche over time impacted your target debt to equity number?

Speaker 2

Great question, Maggie. At the moment, we're kind of sticking with our 1 to 1 target leverage from a GAAP perspective. We are okay if from time to time we go above that. But generally, the target would be 1 to 1. And so it really hasn't changed our focus.

Speaker 2

Clearly, we have the ability and as you know, the SBIC funds are as dropdowns are levered more 2 to 1. We feel very comfortable with higher leverage. But from a just a strategy perspective and how we think about it, I think being kind of more conservative and just thinking about 1 to 1 makes more sense to us at this juncture.

Speaker 6

And Ed, does that reflect some concern you have about the economy and you still have a meaningful allocation to second lien subordinated debt or is it something else that's on your mind?

Speaker 2

No. I think we prefer to operate in a kind of less than market leverage. We don't think we need to use leverage to perform well. And so it's we kind of like a little bit less than market leverage just overall. But it does it's not a reflection of concerns in the portfolio or recession or what have you.

Speaker 2

It's more just kind of how we've operated in the past and we don't see a need to change that at this point.

Speaker 6

Okay. Appreciate that. Those are all my questions. Thanks for your time.

Speaker 2

Thank you, Mickey. Good talking to you.

Operator

The next question comes from Eric Zwick with Hovde Group. Please go ahead.

Speaker 7

Good morning. Wanted to start first with just a question on the PIK income. It looks like it was down quarter over quarter in Q4. So wondering if it's just maybe some positive development with a company or 2 that had been paying PIK income before and return to cash payer or kind of maybe what moved that quarter over quarter?

Speaker 2

Sure. Great question. I think the primary driver there was exactly what you just said. 1 of our strategic pruning situations was a company that had moved to pick during the Q3. And we obviously work to try to exit that credit and we're successful in doing so.

Speaker 2

So that's the biggest driver. I don't I'm not sure there are other big drivers in there. I think that's the main one.

Speaker 7

Got it. That makes sense. Thanks, Ed. And then just turning to kind of the pipeline and the opportunities you're seeing today, we've heard from other BDCs that operate further upmarket, the upper middle market and middle market that competition has become a little bit more intense. Curious what you're seeing kind of in your lower middle market focus in terms of spread, leverage covenants relative to maybe 6 or 12 months ago, if you noticed a market change there?

Speaker 2

I do think relative to 12 months ago, I mean, it's a different environment. There was 12 months ago, there were a lot of folks that were think about banks, quite frankly, a fair number of private lenders that were not far from just being on the sidelines. That situation has changed. And I think most people other than certain banks that have retracted are in the market. And so there is an increased level of competition 12 months ago.

Speaker 2

And I think you are seeing that in spreads. And spreads, if I were to pick a number, it's probably 50 basis points. And it depends on what structure, right, for us, whether it's a $1 first lien investment or if it's a first out, last out structure. But generally speaking, there is an increase in the level of competition because I think people a year ago were very, very worried about what's next. And now just given the resiliency of the economy, I think folks are more both from an acquisition and M and A perspective on the equity side as well as the lending side.

Speaker 2

I think folks are more interested in transacting and kind of see the resiliency economy

Speaker 7

debt investments that are fixed. So I think debt investments that are fixed. So I think the market is still trying to figure out exactly when the shape of the kind of curve or the future kind of short rate interest rates go down, but it seems to be that that's more likely than going up. So wondering if you could just kind of remind me the sensitivity to earnings for maybe like each 25 basis point potential cut, how that would impact earnings?

Speaker 2

Shelby, do you want to take this one or you want me to do it either?

Speaker 3

Why don't you take a crack at it? And then the other thing, Eric, I would point, we do have a for more details, we do have a sensitivity chart disclosed in our 10 ks, where you kind of see some calibrations based off of various increases or decreases in underlying interest rates.

Speaker 2

So, Eric, just taking a shot at it. So, 25 basis points would probably create a reduction of, call it, dollars 1,000,000 in the quarter. These are estimates. Reduction in our NII, assuming no movements in the incentive fees. So if you double that to 50 basis points, it would be 2.5 100 basis points would be $5,000,000 So that's how I hopefully that's helpful.

Speaker 2

And I do think there's a sensitivity table in the 10 ks that hopefully will be helpful as well.

Speaker 7

Yes, that's great. Yes.

Speaker 3

And the only thing I to the table. The only thing I would add, Eric, is that it's not entirely linear just because we do have some floors on a variety of our debt investments.

Speaker 7

No, that's great color too. I'll check out the table. And I would like to ask too just because as we know those sensitivity analysis got to make some assumptions in terms of shock or more gradual and then if there's twists and occur things of that nature. So I appreciate the commentary. Thanks, Ed Ross.

Speaker 7

That's all

Speaker 2

for me today. Yes. Thank you, Eric. Good talking to you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Edward Ross for any closing comments.

Speaker 2

Thank you, Drew. Thank you everyone for joining us this morning. We look forward to speaking with you on our Q1 call in early May. Have a great day and a great weekend.

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