Fidus Investment Corporation Q1 2023 Earnings Call
Good day and welcome to the flight Fs Investment Corporation first quarter 2023 earnings Conference call.
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After the Speakers' remarks, there will be a question and answer session.
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I'd now like to welcome Shelby Sherard to begin the conference shall be over to you.
Thank you Gavin and good morning, everyone. Thank you for joining us for fight US investment Corporation's first quarter 2023 earnings conference call by just issued a press release yesterday afternoon with the details of the company's quarterly financial results. A copy of this press release is available on the Investor Relations page of the company's website.
And at the U S Dot Com I'd also like to call your attention to the customary safe Harbor disclosure regarding forward looking information included on today's call. The conference call today will contain forward looking statements, including statements regarding the goals strategies beliefs future potential operating results and cash flows the brightest investment Corporation.
Although management believes these statements are reasonable based on estimates assumptions and projections as of today may 5th 2023. 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 brightest undergoes 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, Shelby and good morning, everyone welcome to our first quarter 2023 earnings Conference call.
On today's call I'll start with a review of our first quarter performance and our portfolio at quarter end and then give you an update on our views about market conditions in the lower middle market for the rest of 2023.
Shelby will cover the first quarter financial results and our liquidity position.
After we have completed our prepared remarks, we'll be happy to take your questions.
Yeah.
Our first quarter results demonstrate the enhanced earnings power of our portfolio, which derives from our success in building our portfolio of income producing assets last year and from higher yields our first quarter performance also demonstrates the efficacy of our experience and industry knowledge.
Relationships with deal sponsors as we continued to build our portfolio without sacrificing quality, even though credit conditions remain tough and deal activity remained relatively slow in the lower middle market.
Our strategy of selectively investing in high quality companies with defensive characteristics and positive long term outlooks.
That operate in industries, we know well and generate strong free cash flow continues to produce a healthy and high performing portfolio.
We generated adjusted net investment income well in excess of the base dividend for the quarter.
Adjusted net investment income, which we define as net investment income excluding any capital gain incentive fee attributable to realized and unrealized gains and losses increased 42% to $14 9 million or <unk> 60 per share compared to $10 six.
Million dollars or <unk> 43 per share last year.
A 52% increase in interest income drove this performance and reflected the positive combination of higher average debt investment and a debt yield of 14, 3%, which is 240 basis points higher than the debt yield for the first quarter last year.
For the first quarter, we paid dividends totaling 66 cents per share consisting of our base dividend of 40 <unk> per share supplemental dividend of <unk> 15 per share and a special cash dividend of <unk> 10 per share as.
As a reminder, we are distributing a special cash dividend of <unk> 10 per share each quarter. This year.
Satisfy ric requirement and to bring our spill over income in line with our target level.
For the second quarter on May one 2023, the board of directors declared dividends totaling 70 cents per share consisting.
The base dividend of 40 <unk> per share a supplemental dividend of <unk> 19 per share equal to 100% of the surplus and adjusted NII over the base dividend from the first quarter.
And a special cash dividend of <unk> 10 per share, which will be payable on June 28, 2023 to stockholders of record as of June 21 2023.
Including the special cash dividend of <unk> 10 per share we ended the quarter with a N a V a $484.6 million or $19 39 per share.
In terms of originations for the quarter, we invested $51 $5 million further expanding our portfolio of debt securities that generate recurring interest income while also continuing to execute our strategy of co investing in equity securities.
To add a margin of safety and the opportunity to generate incremental profits.
This quarter $42 million or a little more than three fourths of total originations was invested in three new portfolio companies and.
In each case the investments were made in connection with M&A transaction. We also continued to support the M&A activity of our existing portfolio companies.
In terms of repayments and realizations in the first quarter, we received proceeds totaling $15 $9 million, including $15 7 million in first lien debt repayments.
With net <unk> net originations of $35 $6 million for the quarter. The fair value of the portfolio at quarter end grew to 897 $3 million equal to 103, 7% of cost.
We ended the first quarter was 78 active portfolio companies and two companies that have sold their underlying operations.
Subsequent to quarter end, we invested $2 $5 million in debt and a new portfolio company and exited our debt and equity investments in Rhino Assembly company, recognizing a net realized gain of approximately $2 $1 million.
In terms of the total portfolio mix on a fair value basis. We ended the first quarter with debt investments of $772 $8 million and equity investment of $124 $5 million debt investments accounted for 86% of the total portfolio with first lien debt.
Representing the majority of the debt portfolio.
Overall, our portfolio remains healthy from a credit perspective cost pressures and supply chain challenges are showing signs of easing.
By enlarge our portfolio companies are performing reasonably well and doing what they need to do to navigate current economic uncertainties, especially those with pricing power.
We are however, dealing with select company performance issues, which led us to place one additional company on non accrual during the quarter as of March 31, non accruals represented 2% of the total portfolio on a fair value basis.
As a reminder, we have residual debt investments in two legacy portfolio companies that were previously sold as part of the nonaccrual list.
Importantly, our non accruals are all isolated company specific issues versus related to macroeconomic factors applicable to the entire portfolio.
As always we are managing our overall portfolio in a proactive manner and more specifically working closely with the financial sponsors and management teams of our portfolio companies.
In summary, thus far 2023 is unfolding as we thought it would and our proven investment strategy and underwriting standards continue to serve us well.
Although the pace of new deal activity in the lower middle market has been slower than it was in 2021 and most of 2022, we are continuing to find attractive opportunities to invest in high quality high cash flow generating companies and grow our portfolio.
With an expanding portfolio of income producing assets and the benefits of our balance sheet and a widening spread environment. Our portfolio remains very well positioned to generate adjusted NII in excess of base dividend and to grow.
Net asset value over the long term supporting our long term goals of preserving capital and generating attractive risk adjusted returns for our shareholders.
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 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.
2022 total investment income was $29 1 million for the three months ended March 31st.
<unk> 6 million increase from Q4, primarily due to a $1 9 million increase in interest income, including pig and point 2 million increase in dividend income, partially offset by a <unk> 6 million decrease in fee income the increase in interest income was driven by an increase in average debt investment balances outstanding.
As well as an increase in the yield on our debt investments given increase in interest rates on variable rate loans.
Total expenses, including tax provision were $14 3 million for the first quarter of <unk> 7 million lower than Q4, driven primarily by a $1 4 million decrease related to the annual excise tax accrual that occurs in Q4.
Outset by a point 6 million increase in income incentive fee and a <unk> 3 million increase in interest expense related to incremental debt outstanding, but SBA debentures and borrowings under our line of credit.
We ended the quarter with $446 $6 million of debt outstanding comprised of $165 million of SBA debentures $250 million of unsecured notes 15 million outstanding on our line of credit and $16 6 million of secured borrowings our debt to equity ratio as of March 31st was <unk> nine times.
Our 0.6 times statutory leverage excluding exempt SBA debentures.
Weighted average interest rate on our outstanding debt was four 2% as of March 31 2023.
Net investment income or NII for the three months ended March 31st with 59 cents per share versus 51 cents per share in Q4.
Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments was <unk> 60 per share in Q1 versus 51 cents per share in Q4.
Turning now to portfolio statistics as.
March 31st our total investment portfolio had a fair value of $897 $3 million, our average portfolio investment on a cost basis was 11.1 million, which excludes investments in two portfolio companies that sold their operations are in the process of winding down we have equity investments in approximately $76 three.
<unk> of our portfolio companies with an average fully diluted equity ownership of three 9%.
Weighted average effective yield on debt investments was 14, 3% as of March 31st versus 13, 8% at December 31st the weighted average yield is computed using the effective interest rates for debt investments at cost, including the accretion of original issue discount and loan origination fees, but excluding investments on nonaccrual.
If any now.
Now I'd like to briefly discuss our available liquidity as of March 31st our liquidity and capital resources included cash of $36 4 million $5 million of available SBA debentures and $85 million of availability on our line of credit, resulting in total liquidity of approximately $126 4 million 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 <unk> for their dedication and hard work and our shareholders for their continued support and I will now turn the call over to Gavin for Q&A Gavin.
Yeah.
Reminder, if you would like to ask a question. Please press Star then the number one on your telephone keypad that is star one to ask question what pulls with just a moment to compile the Q&A roster.
And just last question comes from the line of Mickey Schlein of led embed your line is open.
Yes, good morning, Ed and Shelby.
Can you hear me all right.
Yes, I can yeah.
Hey, good morning, how are you, making good thank you Ed.
Ed I see that the portfolio's cash interest coverage ratio increased.
As a bit of a surprise considering the increase in interest rates.
Do see that most of your net investments were in first liens and it may have better ratios and you have almost a third of the portfolio in fixed rate investments, but could you comment on what's supporting that trend. Please.
Sure I think there's a there's a few things there one is our you know our leverage right.
So our leverage is four times.
On an average basis, so it's much more than what you see in some of the bigger companies.
I think that's part of it interest rates didn't really start to rise a lot until last year late last year second half.
I think that's part of the equation and then also some of the newer.
Portfolio companies also kind of improve that ratio. If you will so I think there's a few factors there.
But I do think that it is.
Only four times leverage is a big piece of the puzzle.
I understand.
Yep.
Thanks, Thanks for that a couple more questions.
How exposed are your five aerospace portfolio companies to any sort of potential cuts in military spend.
They are they are exposed for sure.
At the moment based on.
The platforms that they're on.
And quite frankly, the outlooks are quite strong so.
So we feel.
Very good about our aerospace portfolio long term.
The fits and starts supply chain issues and whatnot.
Sure.
You know our company as well as at the customer level.
Still being worked through quite frankly, but when I think about our aerospace portfolio long term if it feels.
Very good and very healthy.
Alright, that's good to hear.
Lastly, one sort of technical question I think in the press release, you mentioned you received a distribution on your Rhino equity and I'm, just curious whether youre going to recognize a dividend from that investment or a realized gain below the line.
Sure Great question.
That'll be a realized gain.
Effectively the underlying operations were sold and so it's effectively a liquidation so it'll be a realized gain on our GAAP financial statements.
Okay. That's helpful. That's it for me thanks for your time.
Thank you Mickey good talking to you.
Your next question comes from the line of Robert Dodd of Raymond James Your line is open.
Hi.
Congratulations on the quarter one on the the the.
The nonaccrual commentary.
Diet.
[laughter].
You said, obviously isolated company specific issues.
Okay.
Can you give us any more color.
Maybe not.
Also could you give us any color around what the sponsor the sponsor has been so far obviously is the <unk>.
Once being supportive.
That's why it always is.
Sponsor beam.
Twitchy or lack of it.
Tim and I realize some of that confidential, but.
Sure.
Sure sure no absolutely so of the three operating companies on non accrual.
Two of them.
If you include us and another partner we have been supportive.
Hum.
And that one's airplanes, and that's you know that's a tougher situation right now is what I would tell you the <unk>.
Other two are owned by financial sponsors in one case to financial sponsors and other case, one and in both cases the sponsors have been very active with the portfolio of companies as well as supportive from a capital perspective.
And in both cases, we believe in the long term.
Those businesses as due to the sponsors.
And.
They're going through you know some tougher situations right now and we're working hard to maximize those outcomes.
And play them the best way, we can for you know for all stakeholders, but in particular us.
Got it got it and then on the new one.
Is to come.
It's a relatively new asset light I think you've originated at the end of 2021.
So you mentioned isolated company specific issues I mean was there something that develops.
Thirdly all.
Just kind of building that.
Okay.
Okay.
And any color on that because you did seem to occur relatively quickly after the original underwriting.
Sure sure.
The connectors that digital lead generation platform, it's focused on the mortgage sector home services sector and insurance verticals.
What I can tell you is right the mortgage sector has not been hard to say, the least and nor has the insurance vertical for different reasons and so.
It did you know kind of.
<unk> deteriorate from a performance perspective.
During last year.
And so.
So you know the good news is that we believe we have a very good operating company a very good management team.
Tough market conditions and so.
It's a strong franchise that the risk profile of our debt and equity investments are refracted and the evaluation of those investments.
Got it got it thank you.
For that in terms of just more broadly I mean.
Excellent market commentary as always I mean.
Things are relatively small I mean, you still deployed $50 million.
First quarter, which is a seasonally slow quarter. So.
Do we need to kind of.
So I need to recalibrate, what slow means in the context of your business, which has grown your portfolio's larger.
This was a slow quarter for you know me 50 million.
Whereas the third quarter might have been if I gave you guys a lot of it.
20.
It is the scale of the business just do so enhanced so much and hence now that debt.
Okay.
The commentary just something different than it used to a few years ago.
I do think that scale of the business is different there was five years ago.
A material way.
Slow for us So if you think about.
The fall of last year and.
October November December M&A leased new deal volume slowed down quite a bit.
It was.
It was pretty anemic at the end of the day and that started.
First quarter started out that way, but it has changed since then and I will tell you at the <unk>.
Moment.
Deal flow has actually picked up quite a bit quality is a little hit or Miss the deal flow has picked up quite a bit and to the positive M&A.
M&A processes have also commenced and so they're starting in their engagements are starting to take place.
Theres a fair number of companies out there that are performing just fine and I think.
Recognizing where we are in the cycle a lot of folks who are making decisions that look this is where we are companies performing great. Let's let's go make the most of it and so we expect.
Though it was slower in the first quarter for sure overall, we do expect as the year progresses for for transaction volumes.
To increase.
I'm not going to go crazy not going to be like the.
Middle of last year, our 2021 at all but we do expect an increase overtime.
And I do too.
And overall just scale and for us that was a slower quarter from our perspective.
Got it I appreciate it thank you.
Absolutely good talking to you Robert.
Your next question comes from the line of <unk> of B Riley Your line is open.
Thanks, Good morning.
Wanted to maybe just start or talk to talk about.
The dividend construct Ed.
You, obviously have a pretty powerful dividend.
At this point with with all three elements kind of thrown in there.
Regular the supplemental on the special.
Quite quite a good kind of dividend profile, our dividend coverage profile that you have.
And.
Even even in some down rate type scenarios you you look like you're comfortably still cover that dividend. So could you talk a little bit about.
The discussions at the board level in terms of maybe adjusting that regular or the base hire would you would you consider doing that or are you kind of comfortable with with the with the current construct the way it is.
Sure. It's a great question Bryce.
And you know what I would say is we are.
We are continuing to spend a lot of time on it and to evaluate debase dividend bank.
We're pleased that we've increased that quite a bit here over the last 18 months or so.
And we're also pleased about and which gives us less need to.
To make decisions right now is that the way we are dividend construct has the shareholders fully participating in all earnings of the of the companies that we're paying out 100% of the access and so.
That gives us a fair bit of comfort and flexibility.
But your question is a very good one.
So we feel very good about the outlook and the performance of the business.
Something that's on our mind.
But we thought this quarter a lot going on it just in <unk>.
The shareholders are fully participating in the dividend and then we can oh wait a quarter or two to kind of see more results in and.
And whatnot, so thats the thinking.
I think the positive from our perspective is we're paying out 100% of adjusted NII.
We feel very good about that.
So there's no rush to do incremental base dividends, if you will.
Yes, okay. Okay.
And then maybe.
Maybe.
A question around kind of the market environment.
And pricing and maybe.
How you are interacting with.
Some banks I know you partnered with some banks in the past on some deals so if he can.
Could speak to.
That's evolving in this current market.
And then maybe just any kind of general commentary around pricing spreads et cetera.
Sure.
So for a minute from a market perspective, it was slower as I just talked about.
And we we are seeing actually a lot of deal flow right now again quality is a bad hit or Miss.
And so we expect that.
Quite frankly to continue.
Then we expect and we expect activity to increase here and then.
The rest of the year, if you will.
And in particular in the second part of the year from the pricing standpoint, I would say you know spreads are still wider.
I'd say, even a 100 basis points wider than they were let's say pre COVID-19 if you will.
Leverage levels are lower terms are good we've always in the lower middle market.
Obviously very good maintenance covenants that continues so.
We view it as a very attractive.
Attractive time to invest.
And that's assuming that you can.
Find.
The opportunities that you want to pursue so we're working really hard at that we've always are working hard at that but we are in and we're being very selective as you might imagine.
But we feel we feel good about and then I guess you asked a question about the banks banks that clearly regional banks have pulled back.
It doesn't mean, they're out of business because they are not out of business because they have pulled back from and how aggressive they are and how active they are in.
That creates an opportunity for us quite frankly in this environment, but at the same time, they're they're still in business and we are.
Working with them on new transactions from time to time and.
Also quite frankly taken advantage of situations, where banks are not participating for whatever reason.
Again I think.
It's a good competitive dynamics for us.
And obviously I think it's a good pricing and terms dynamic as well.
Yeah.
Got it okay I appreciate the commentary.
Absolutely good talking to you Bryce.
Your next question comes the line of Erik Zwick.
Greg Your line is open.
Thank you good morning, I wanted to start with.
A question on the.
Pipeline, maybe kind of a multipart question in terms of as you look at the pipeline today, what does the mix look like in terms of <unk>.
Industry concentration and also maybe kind of a second part is asking about kind of your preference today and you know Ed I know you've mentioned earlier that youre seeing a lot more deal flow now, but the quality is bend header mesto curious if that's kind of bar specific or maybe there are certain industries that you are shying away from now may be seeing some some stress or <unk>.
From that perspective, so any color there would be great.
Sure sure.
Great question, there's a lot there. So so help me through it if I don't remember it all but from a.
What we're seeing right now at health care services.
Businesses, we're working on very hard.
We just closed on a collision repair business.
And then there is a fair number of business service.
Opportunities that we're looking at.
So I'm quite frankly in the software space.
So a variety of companies generally we're staying away from as you might imagine more capital intensive businesses. We're looking for companies with predictable revenues in sustainable revenues quite frankly in a variety of places too.
<unk> knows.
And where are we staying away from or where do we stand away from obviously, we think about retail or retail to maybe.
Lower income consumer focused retailer.
Those are definitely an area, where we're staying away from.
Capital intensive businesses.
Energy energy services.
We have one portfolio company that is performing very well in that sector, but overall, we're not looking too.
And two any exposure there.
So I think and then generally consumer businesses, obviously different ways to play that but where our portfolio is not focused on the consumer in March and we from a New addition perspective aren't as well.
Does that fully helpful from a generic.
Yes, that's that's great you hit it all thank you so much and just the second one I had today was looking at your leverage profile I'd say you have a more conservative stance than some others in the industry and just curious how you think about that today you mentioned that that's kind of the rest of the year you would expect more opportunity for originations going forward.
If you do see good risk adjusted opportunities, Okay, taking leverage higher or would you.
I really love to maybe just kind of hold the portfolio level, consistent and use prepayments and Paydowns to fund.
New opportunities.
Sure Great question.
We're obviously, we're under the one to one Mark you know our long term target right now is call it one to one.
But we are very comfortable going above one to one four.
An interim period of time or an extended period of time. So we're really more focused on trying to find great opportunities to invest we're obviously not going to get crazy from a leverage perspective, that's an outlier nature of our DNA, but we are very comfortable going over the one to one.
Leverage Mark if it if it makes sense that it would be more from an interim perspective. If you will at this point I also would note obviously our portfolio relative to <unk>.
678 years ago is much more.
First lien weighted and so it is easier and more comfortable to.
Leverage up a little bit more which is okay as well.
So we're positioned well to.
To take on more leverage if it makes sense, but I would stick with the target of one to one from our perspective.
Great. Thanks for taking my questions.
Absolutely good talking to Eric.
Once again, if you would like to ask a question. Please press star followed by one on your telephone and wait for your name to be announced.
And there are no further questions at this time, so I'd like to hand back to Ed.
Thank you Kevin and thank you everyone for joining us this morning, and look forward to speaking with you on our second quarter call in early August have a great day and a great weekend.
That does conclude our conference for today. Thank you for participating you may now disconnect.
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