Fidus Investment Q1 2024 Earnings Call Transcript

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May 3, 2024

There are 9 speakers on the call.

Operator

Good day, and welcome to the Fidus First Quarter 20 24 Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ms.

Operator

Jody Berfening. Please go ahead, ma'am.

Speaker 1

Thank you, Chuck, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's Q1 2024 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer and Shelby Sherrod, Chief Financial Officer. Bias 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 at fbus.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

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, May 3, 2024, 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.

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 Q1 2024 earnings conference call. On today's call, I'll start with a review of our Q1 performance and our portfolio at quarter end and then share with you our outlook for the remainder of 2024. Shelby will cover the Q1 financial results and our liquidity position. After we have completed our prepared remarks, we'll be happy to take your questions.

Speaker 2

As expected, the Q1 shaped up to be a very active from a new investment perspective. While repayments were on the lighter side, we put a fair amount of capital to work redeploying proceeds from the 4th quarter With net originations totaling $85,700,000 the total portfolio on a fair value basis grew to over $1,000,000,000 To put our investment activity for the quarter in perspective, originations of $145,900,000 nearly equal the total amount invested in the first half of twenty twenty three. Consistent with our established practice, we grew the portfolio with a focus on capital preservation and the generation of attractive risk adjusted returns. We continue to invest in industries in the lower middle market we know well, leveraging our relationships with deal sponsors and carefully selecting businesses with defensive characteristics and sustainable business models and positive long term outlooks that generate cash to both service debt and support growth. Our debt portfolio generated adjusted net investment income of $18,100,000 an increase of 21.8% compared to $14,900,000 last year, primarily reflecting higher interest income and fee income for the quarter.

Speaker 2

Taking into account the higher average share count resulting from the equity raises over the past 12 months, adjusted net investment income on a per share basis was $0.59 per share compared to $0.60 per share for the same period last year. In Q1, we paid a base dividend of $0.43 per share plus a $0.22 per share supplemental dividend for a total distribution to shareholders of $0.65 per share. For the Q2 of 2024, the Board of Directors declared dividends totaling $0.59 per share consisting of a base dividend of $0.43 per share and a supplemental dividend of $0.16 per share equal to 100% of the surplus and adjusted NII over the base dividend from the prior quarter, which will be payable on June 26, 2024 to stockholders of record as of June 19, 2024. Net asset value grew 3.2 percent to $608,300,000 compared to $589,500,000 On a per share basis, net asset value was 19 point $3.6@quarterendcompared to $19.37 as of December 31, 2023. As I mentioned earlier, originations totaled $145,900,000 for the Q1.

Speaker 2

We stayed focused on investing in 1st lien investments, on structuring investments with a high percentage of equity cushion and on co investing in the equity of portfolio companies. Debt investments totaled $137,500,000 which first lien amounted to $96,100,000 or 70%. Equity investments totaled 8 point $4,000,000 Of the $145,900,000 total in originations, $94,600,000 was invested in 7 new portfolio companies, which were added to the portfolio primarily through M and A transactions. Proceeds from repayments and realizations totaled $60,200,000 for the Q1 consisting of debt repayments of $57,000,000 and proceeds from the sale of equity investments of $3,200,000 resulting in net realized gains of $1,700,000 primarily from the exit of Applied Data Corporation. Our portfolio of debt investments on a fair value basis was $916,400,000 or 87% of the total portfolio at quarter end.

Speaker 2

1st lien investments are still the largest portion of the debt portfolio at 69%. Including the fair value of our equity portfolio of $131,700,000 the fair value of the total portfolio at quarter end stood at $1,050,000,000 equal to 102.2 percent of cost and we ended the Q1 with 87 active portfolio companies. Our portfolio remains well structured, but is positioned to produce high levels of recurring income and the potential for enhanced returns from the sale of equity securities. Overall, our portfolio from a credit perspective remains solid with no change in the companies we have on non accrual from the 4th quarter. While the performance of the 2 operating companies on non accrual continue to improve, each of them remain higher risk situations.

Speaker 2

As a percentage of the total portfolio on a fair value basis, non accruals represented under 1% for the Q1. The health of our portfolio is attributable to our strict underwriting disciplines focused on carefully investing in businesses with strong and sustainable cash flow generating business models and positive long term growth prospects. With capital preservation in mind, we remain very deliberate in our investment selection process. As we look ahead to the remainder of 2024, we are positioned to continue to grow the portfolio. Deal flow and M and A activity is at reasonable levels and slowly improving relative to 2023.

Speaker 2

That said, quality is spotty at the present time. As a result, originations for the 2nd quarter are expected to be meaningfully lighter than the Q1. Nevertheless, our portfolio is healthy and positioned to continue to generate adjusted NII well in excess of our base dividend to generate attractive risk adjusted returns and grow net asset value over the long term. 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 Q1 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 2023. Total investment income was $34,700,000 for 3 months ended March 31, a $1,700,000 decrease from Q4 primarily due to a $1,300,000 decrease in interest income including PIK, a $1,200,000 decrease in fee income given higher prepayment fees in Q4. The decrease in interest and fee income was offset by a $100,000 increase in dividend income and a $700,000 increase in interest income on excess cash, which was due to the new investments in Q1 being back end loaded as approximately 72% of invested capital in Q1 closed in March.

Speaker 3

Total expenses including income tax provision were $17,000,000 for the Q1, dollars 2,300,000 lower than Q4 driven primarily by a 1 point $4,000,000 decrease in the capital gains fee accrual and a $1,000,000 decrease in income taxes related to the annual excise tax accrual in Q4. We ended the quarter with $463,100,000 of debt outstanding comprised of $175,000,000 of SBA debentures, $250,000,000 of unsecured notes, dollars 22,500,000 outstanding on the line of credit and $15,600,000 of secured borrowings. Our debt to equity ratio as of March 31 was 0.8x or 0.5x statutory leverage excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 4.6% as of March 31, 2024. Net investment income or NII for the 3 months ended March 31 was $0.57 per share versus $0.58 per share in Q4.

Speaker 3

Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investment, was $0.59 per share in Q1 versus $0.65 in Q4, which includes an increase in the weighted average shares outstanding and a decrease in the capital gains fee accrual in Q1. For the 3 months ended March 31, we recognized approximately $1,700,000 of net realized gains, primarily related to the sale of our equity investments in Applied Data Corporation. Turning now to portfolio statistics. As of March 31, our total investment portfolio had a fair value over 1,000,000,000 dollars Our average portfolio company on a cost basis was $11,800,000 which excludes investments in 4 portfolio companies that sold their operations are in the process of winding down. We have equity investments in approximately 81.3 percent of our portfolio companies with average fully diluted equity ownership of 3.5%.

Speaker 3

Weighted average effective yield on debt investments was 14% as of March versus 14.2% at year end 2023. 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 Q1, we repaid the remaining $35,000,000 of outstanding SBA debentures in our second SBIC fund, completing the wind down of this fund. As of March 31, our liquidity and capital resources included cash of 27,100,000 $77,500,000 of availability on our line of credit, resulting in total liquidity of approximately $104,600,000 Now I will turn the call back to Ed for concluding

Speaker 2

comments. 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 Chuck for Q and A. Chuck?

Speaker 2

Thank

Operator

And the first question will come from Robert Dodd with Raymond James. Please go

Speaker 4

ahead. Hi, and congratulations on the quarter. On several questions. On the deployment outlook, I mean, you flagged Q2 will be down versus Q1, which is a very large number. What are your expectations kind of for the year?

Speaker 4

And obviously, it's hard to predict the further you get out. But is it could 2024 be the first time you ever do $400,000,000 in originations for a year given the start you had this year? Or is that perhaps would that be a reach too far? Are we still looking in the 300s for this year? Just kind of ballpark.

Speaker 2

Sure. Great question. And as you know, originations and timing of deals are very hard to predict. I mean

Speaker 4

Yes. Understood.

Speaker 2

Yes. And what I would say, when you talk about Q1, we had a reasonable level of deal flow. We also had some holdover transaction opportunities from Q4, which helped the activity levels, if you will. So we were fortunate, right, to have a very strong quarter, which was great. Q2 deal flow has been solid.

Speaker 2

I would say, quality has been a bit spotty. We do have an expectation that deal flow will pick up here a little bit. M and A, there's just a lot of discussion around it. We think actually there is transaction activity that's starting to increase. For us, this quarter probably is going to it's going to be lighter than Q1 by a good bit.

Speaker 2

And that's okay. What I would say is our portfolio continues to be acquisitive. So that's part of our investments. And then new transaction activity, we're working on a couple of deals very seriously right now. Don't know if they'll close or not, but that's our hope.

Speaker 2

So we definitely are very busy, but it's not like Q1. So when I look out the rest of the year, I expect an increase in activity levels over Q2. Do we get to $400,000,000 like you asked? There's a possibility of that over the last 12 months. I think we've been near that number.

Speaker 2

But that's a pretty aggressive number at the same time. So I would guess something shy of that, but it's also a distinct possibility.

Speaker 4

Understood. Yes, yes, no, it's really hard to say. On the repayment side, I mean, you have deployed a lot of capital over the last 12 months or on. A lot of the portfolio is relatively young as a result. I mean, you said Q1 repayments were light and they were.

Speaker 4

But at the same time, should we expect that to continue for a while given how much the portfolio is relatively fresh? Or do you think there's a different dynamic that's going to play out in the payment level?

Speaker 2

Sure. Another great question. I wish I had a crystal ball. But what I would say is that we do have several companies, probably more than several that are evaluating strategic alternatives at the moment. It's unclear if any of those are Q2 or they kind of push into Q3 and which ones actually transact.

Speaker 2

The other piece of the puzzle is some of those portfolio companies are equity only investments and not the real large ones for instance. And so I'm not at the moment expecting a real high level of repayments here in Q2. The current expectation based on what we know today is probably it's less than Q1. Having said that, we do have an expectation that repayments will pick up in Q3 and Q4. As you know, the market is more aggressive and also we do see transactions from a realization perspective, company sale, M and A type stuff taking place in Q3, Q4 for us.

Speaker 4

Understood. That is very helpful. One comment, if I can. Shelby, your color on 72% capital was deployed in March. Very helpful for figuring out direction spreads, etcetera, etcetera.

Speaker 4

We're really helpful if color like that was in the press release. Thank you. And that's it for me. Thanks.

Speaker 2

Thank you. Appreciate it. Good talking to you, Robert.

Operator

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

Speaker 5

Yes. Good morning, everyone. Ed, LSEG is reporting that middle market spreads have declined about 50 basis points over the last year, but they're still above pre COVID levels. So when we think about how resilient the economy has remained and the fact that there's plenty of debt capital available out there, What's your outlook on spreads in sort of the in your bread and butter business?

Speaker 2

Sure. It's a great question. Spread, if you think about from a year ago, it's a bit of night and day, right? Banks were struggling. There was a banking crisis just 12 months ago.

Speaker 2

Today, banks are active, direct lenders are active, SBIC funds, BDCs, you name it. Everyone's pretty active today. And that's very different than it was 12 months ago. And with that comes a decline in spreads. Also, as you mentioned, the economy is showing a fair bit of resilience and people are getting pretty comfortable with where we are.

Speaker 2

So spreads have declined. We just given the uncertainty levels of focus very much and as we always do on quality. With that's been some first lien investments, dollars 1 with the if you do dollars 1 investments, your yields are a little bit lower. So that's been a bit of the puzzle for us. But we're focused on quality and attractive risk adjusted returns and not pushing the envelope obviously.

Speaker 2

I would expect yields today are depending on the deal 50 basis points to 100 basis points lower than they were a year ago. And in the larger markets, say the middle market and above, we're seeing spreads that are even narrower than that, I'd say even 150 basis points. And so it's much more aggressive in the upper market than it is where we are. But spreads have come in and you're seeing that in the originations of our investments. And if you think about last quarter and again it was weighted towards 1st lien, our originations repayments averaged more like 13 point 7%.

Speaker 2

So that gives you a little color on why our yields declined. But I would so I would expect going forward our yields to be stable to slightly declining just given what's going on in the marketplace today.

Speaker 5

That's really, really helpful, Ed. And if I could follow that up, you mentioned the I don't know what you want to call it frothiness in the upper middle market, but let's just say a very active upper middle market. I mean, part of your playbook is to invest in companies that will grow and succeed. And I imagine some of your portfolio companies have done that pretty well and could look to potentially refinance into the upper middle market. How concerned are you about that refinancing risk in your portfolio?

Speaker 2

Not terribly. I mean, those are investment. I think you're exactly right. We have some companies and we continue to support those companies that are performing extremely well. And could they get refinanced at lower rates at some point in time in the future and the next 12 months or what have you?

Speaker 2

And the answer to that is yes. I think at the same time, we add a lot of value to portfolio companies. We've got strong relationships, but they're built on trust and adding value. And so but your point is a good one. That is a part of the market today.

Speaker 2

And so it is our expectation that there'll be some of that activity whether it's Q3 or Q4 or into next year. That's a piece of the puzzle for sure. It's not alarming to us. It's just it's part of the equation.

Speaker 5

I understand. And my last question regarding balance sheet leverage, you're still below your target, which I believe is debt to equity of 0.8 to up to 1.1. I understand that that takes into account a lot of different moving parts. But with the discussion you just had about pressure on portfolio yields, are you open to increasing balance sheet leverage to continue to deliver financial performance at the BDC?

Speaker 2

Great question, Mickey. The answer to that is yes. We're trying to do what makes sense for our shareholders on a long term basis. As you know, there's been some turmoil in the debt markets here recently, in particular, the unsecured and the treasury markets, which impact those markets. We do have other ways to access capital, right?

Speaker 2

We have our revolver, which has a strong liquidity position. And then we also have the ability to increase the size of the revolver. I'd say if you look at our capital structure, the revolver is probably smallish in nature relative to most other BDCs. So and then we have the SBIC application that we obviously applied for that in December, and we knew it was going to take a while. We were told that and that continued we continue to be in the queue there, but that will be part of the equation for us as well.

Speaker 2

So the answer is yes, absolutely. But we're trying to do it in a methodical manner and do what's right for our shareholders over the long term, if that makes sense.

Speaker 5

Yes. I understand. Those are all my questions

Speaker 4

B. Riley. Please go ahead.

Operator

Good morning, Ed. B. Riley. Please go ahead.

Speaker 6

Good morning, Ed and Shelby.

Speaker 2

Good morning, Bryce.

Speaker 3

Good morning.

Speaker 6

Yes, I wanted to maybe follow-up just on those comments you made, Ed, about the SBA license and maybe expanding the credit facility. Any maybe any color around where you'd like to see the credit facility go in terms of commitment? And then I think last quarter you talked about the SBA license, the newer one, maybe being in place by the middle of this year. Is that still your expectation from a timing perspective?

Speaker 2

I think the SBA license is a tough one. I think there I think the SBA, they told us it was going to take a while and it's just hard to predict. I think June, if I sit here today where I don't have any real new information, I'd say that's a little aggressive. I do think things are moving along, but timing is very tough to predict and probably June is a little aggressive. I would assume Q3 or Q4 at this point.

Speaker 2

From a credit facility perspective, I don't know that we have a specific target, but I will say that we are looking to we're thinking about as we sit here today increasing the size of the facility. And I think that makes sense. And going back to strategy from a capital structure perspective, I think diversity is important. So having secured piece of the puzzle is important. Having unsecured being in a large piece of it and that includes SBIC debentures.

Speaker 2

I mean all of those are pieces to the puzzle that we like And I think we've got an ability to increase leverage in all three areas. It's just a matter of kind of picking the time, if you will.

Speaker 6

Yes. Okay. Okay. I wanted to maybe follow-up on that adjective you use, spotty, in terms of kind of quality that you're seeing in the market today. What does that mean in

Speaker 2

particular? For us, we're looking for pretty high quality, high free cash flow, generally high multiple, meaning EBITDA multiple transactions, so high value add businesses. And in terms of the stars aligning where the sponsor wins and we're well positioned, there's just less of those opportunities this quarter relative to last quarter. And so it's just it's a little bit of it's just mix. And I do think luck is not the right word, but sometimes it's just good fortune things fall in place and other times they don't as much.

Speaker 2

But we are being very, very careful. We're looking at the cream of the crop from a quality asset quality perspective and there are fewer of those companies out there. And then if we don't have the right equation, if you will, whether the sponsor doesn't win or we don't have the right financing facility, then maybe that transaction doesn't happen. And so that's just the quality for us has been a very important marker always, but we're sticking to our knitting of really focusing on those types of businesses. Hopefully that's helpful, but that's really what I'm getting at.

Speaker 6

Yes. And maybe one here on credit quality. Any way to kind of quantify where leverage in the portfolio is weighted average leverage and what you're seeing from a kind of a weighted average loan to value perspective at this point too?

Speaker 2

Sure. So leverage for our core lower middle market portfolio absent a couple of investments the larger world, if you will, BSL world. Our leverage is at 4.37 times, I think. So debt to EBITDA and then interest coverage was at 3.1%. And what was the last question?

Speaker 6

I think you've talked about kind of loan to value within portfolio in the past.

Speaker 2

Yes, loan to value is pretty stable. It's just under 40% in the quarter.

Speaker 5

Okay. All

Speaker 6

right. Appreciate your time. Good talking to you.

Speaker 2

Likewise. Good talking to you, Bryce.

Operator

The next question will come from Paul Johnson with KBW. Please go ahead.

Speaker 7

Yes, good morning. Thanks for taking my questions. Yes, Kevin, within the remarks on the equity portfolio, you mentioned the 1 gain this quarter. That was nice. But is there any other kind of significant notable movements or marks within the Ackley portfolio?

Speaker 2

I just want to make sure I heard you correctly. Were there notable mark changes? Is that the question, Paul?

Speaker 4

Yes.

Speaker 2

Yes. So nothing I mean overall the equity portfolio performed quite well. We did have a write down in fan steel, which is our largest position, and that company continues to kind of weather the pharma destocking trend. But that we're kind of at the end of that we believe and so we expect performance to start to improve. That continues to be a very high quality business with a very good outlook.

Speaker 2

It's just it's going through this inventory destocking trend in the pharma space and it's kind of at the tail end of that. The rest of the portfolio really is quite stable and performed well. I mean, I think the equity portfolio despite what I just mentioned with Fan Steel appreciated in the quarter as did the debt portfolio. So it was a good quarter, very stable and very solid performance.

Speaker 7

Thanks for that. And then just in terms of the deal flow you're seeing in the market, I'm just wondering, trying to get your thoughts on kind of what you think of the relative value of the 1st lien sort of structure opportunities that you've seen versus any kind of subordinated opportunities that are out there today and if that's something that you're even seeing and if that makes sense?

Speaker 2

Sure, sure. It's a great question and it's a tough one too. I think the market as you well know has moved very much to more of a first lien solution. Having said that, mezzanine investments are still a part of the market, a core part of the market. It's just from a market share perspective, it's lower.

Speaker 2

And in today's world, mezzanine continues to show up for us. And so we've made 2 mezzanine investments last quarter in very high quality companies. And so we're going to continue to look for those types of situations where we like the debt and the equity of those prospective portfolio companies. But what I would suggest is the 1st lien solution is a large majority of the market and what I would and I would also expect that to continue to be a large majority of our investments as we move forward. But we are actively looking for attractive mezzanine opportunities.

Speaker 7

Thanks for that, Ed. That's very interesting. All for me.

Speaker 2

Okay. Thanks, Paul. Good talking to you.

Operator

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

Speaker 8

Good morning, Ed and Shelby. I wanted to first just start with a bit of a follow-up. You mentioned the market is fairly active at this point and competition is, I guess, somewhat intense that's impacting spreads. Curious if you're seeing any deterioration in the market on the structure side, if you're finding that you're losing any deals where you're sticking to your guns, so to speak, in terms of your credit quality standards at underwriting and others are starting to bend at all?

Speaker 2

Sure. Great question. We haven't really seen structural changes. One of the things we like about the lower middle market is we have real maintenance covenants. Many times we have 2 covenants, both the leverage and a fixed charge.

Speaker 2

That's a large majority of our situations or our investments. And that's different than the upper market, if you will, the larger market, very different. And I would say the spreads to those maintenance covenants are also narrower. So we like the ability to have a seat at the table and we have not seen any real changes from that perspective. Clearly pricing and spreads narrowing is a part of the market in the business today.

Speaker 2

But structures have not started to change yet, which is a good thing. And to be honest, in the lower middle market, you don't really see a deviation away from pretty strong structures at the end of the day. So again, it's one of the things we really like about the lower middle market and our ability to manage risk manage our investments, if you will.

Speaker 8

Thanks, Nai. I agree with you. That's good to hear. And then the last one for me. I think you mentioned in your comments for the 2 existing non accruals that the situations there are improving, but remain at high risk.

Speaker 8

Wondering if you could just maybe provide a little bit more color to the term and improving if it's of the underlying financial metrics and trends at the companies or just progressing towards some sort of resolution and what you're kind of referring to there with that comment?

Speaker 2

Sure. Great question. What I'm referring to there is really the EBITDA levels. So EBITDA levels in both cases are growing and improving on a current basis and on a last 12 month basis and in a meaningful way. But at the same time, these businesses had some idiosyncratic issues that were meaningful as well.

Speaker 2

And so if the EBITDA performance is improving, we do not expect any quick resolutions or anything like that in either case. And so we're just managing through kind of the situation trying to work through an improved outlook in both cases. And I would also say we've got supportive equity sponsors in both those cases as well, which is great. There's a lot of work being done to try to improve the overall position of both assets, but we've got a ways to go.

Speaker 8

I appreciate the update. Thanks for taking my questions today.

Speaker 2

Absolutely. Thank you.

Operator

For any closing remarks. Please go ahead.

Speaker 2

Thank you, Chuck, and thank you everyone for joining us this morning. We look forward to speaking with you on our Q2 call in early August 2024. Have a great day and a great weekend.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Fidus Investment Q1 2024
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