Fidus Investment Corporation Q3 2023 Earnings Call
Good day and welcome to <unk>.
Third quarter 2023 earnings call.
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I'd like to turn the conference over to MS. Jody Buffering. Please go ahead.
Thank you Nick and good morning, everyone and thank you for joining us for finest investment corporations third quarter 2023 earnings conference call.
With me. This morning are Ed Ross I, just investment Corporation's Chairman and Chief Executive Officer, and Shelby Sherard, Chief Financial Officer.
<unk> 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 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.
Conference call today will contain forward looking statements, including statements regarding the goals strategies beliefs future potential operating results and cash flows.
This investment Corporation.
Management believes these statements are reasonable based on estimates assumptions and projections as of today November three 2023.
But they are not guarantees of future performance.
I'm 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 Companys filings with the Securities and Exchange Commission findings undertakes no obligation to update or revise any of these forward looking statements with that I would now like to turn the call over to Ed Good morning.
Yeah.
Good morning, Jody and good morning, everyone welcome to our third quarter 2023 earnings Conference call.
On today's call I'll start with a review of our third quarter performance and our portfolio at quarter end.
And then share with you our outlook for the remainder of 2023.
Shelby will cover the third quarter financial results and our liquidity position.
After we have completed our prepared remarks, we'll be happy to take your questions.
We delivered strong results for the third quarter with our portfolio continuing to grow adjusted net investment income and.
And with adjusted net investment income remains well in excess of our base dividend.
Much like the first half of 2023 deal flow was decent but not robust by any means.
Activity remained subdued in the lower middle market.
We're patient and we're disciplined and we're staying focused on our proven strategy of selectively investing in value added businesses that generate high levels of free cash flow.
Positive long term outlooks.
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 46% to $18 $2 million in Q3 compared to $12 five.
$5 million last year.
Interest income growth drove this increase reflecting both higher average loans outstanding and a 170 basis point increase in average debt yields to 14, 6%.
Taking into account the increase in weighted average shares outstanding resulting from our equity raised during the quarter adjusted net investment income on a per share basis increased 33, 3% to 68.
From 51.
We paid dividends totaling 72 cents per share consisting of our base dividend up <unk> 41 per share supplemental dividend of <unk> 21 per share and a special cash dividend of <unk> 10 per share.
As a reminder, we are distributing a special cash dividend of <unk> 10 per share each quarter. This year to satisfy ric requirements and to bring our spill over income in line with our target level roughly the equivalent of dividends for three quarters.
For the fourth quarter on October 30th 2023, the board of directors declared dividends totaling 80 cents per share.
You can have a base dividend of 40 <unk> per share.
Couple of mental dividend of 27 cents per share equal to 100% of the surplus in adjusted NII over the base dividend from the prior quarter and a special cash dividend of 10 cents per share, which will be payable on December 27, 2023 to stockholders.
As of record as of December 20th 2023.
Net asset value at quarter end was $548 $6 million or $19 28 per share compared to $483.3 million or $19 13 per share as of June 30th.
During the quarter, we continue to invest in our portfolio of debt securities that generate recurring interest income and co invested in equity securities as a means of adding a margin of safety and creating the opportunity to enhance returns.
Originations totaled $56 $7 million.
Consisting of $48 $5 million in debt.
$8 $2 million in equity.
First lien investments accounted for $43 $1 million or nearly all of the additions to the debt portfolio.
We invested $33 $1 million in two new portfolio companies.
There were added to the portfolio financing M&A transactions. The remaining portion of originations was invested in add ons in support of our existing portfolio companies.
Proceeds totaling $69 $9 million were slightly higher than originations for the third quarter, reflecting for debt repayments in two equity realizations, including the sale of hallmark, which occurred earlier than we had expected.
From an equity perspective, we received proceeds of $11 million, resulting in realized gains of $9 $8 million most of which came from the sale of our equity investment in hallmark.
Our portfolio of debt investments on a fair value basis was $798 million or 86% of the total portfolio at quarter end.
First lien investments continue to account for the largest piece of the debt portfolio at 65%.
Including the fair value of our equity portfolio of $128 $8 million the fair value of the total portfolio at quarter end stood at $926 $9 million equal to 103, 5% of cost we ended the third quarter with 80 active port.
Palio companies and two companies that have sold their underlying operations.
Subsequent to quarter end, we invested $31 $8 million in first lien debt and preferred equity in two new portfolio companies and we had debt repayment and three companies generating net proceeds of approximately $29.
$3 million.
As we added debt and equity investments to our portfolio.
We continue to carefully select high quality companies that generate excess levels of cash flow to service debt and restructure our investments with a high percentage of equity cushion in an effort to manage downside risk, which is especially important in today's higher rate environment.
For the most part our portfolio companies have adjusted the current economic conditions.
With pricing power generally found ways to prosper, despite inflationary cost pressures and higher interest rates.
<unk> portfolio of companies are continuing to navigate.
<unk> tougher conditions, and we are monitoring them closely.
As of September 30, we had two operating companies on non accrual unchanged from the second quarter.
Non accruals represented one 3% of the total portfolio on a fair value basis in summary, the credit quality of our portfolio overall remains very solid.
As we close out the year the pace of deal activity in the lower middle market has been picking up relative to Q3, our portfolio remains healthy.
And with our strong liquidity, we are well positioned to grow the portfolio selectively and deliberately investing in high quality companies in the lower middle market that possess resilient business models and positive long term outlooks and generate high levels of cash flow.
As always we are committed to managing the business for the long term and to our goals of preserving capital generating attractive risk adjusted returns and delivering value for our shareholders now I will 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 third 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 Q2 2023.
Total investment income was $34 2 million for the three months ended September 30th.
$3 6 million increase from Q2, primarily due to a $3 7 million increase in interest income, including pig offset by a slight decrease in dividend income.
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 and give an increase in interest rates on variable rate loans public.
Total expenses, including income tax provision were $17 5 million for the third quarter $3 8 million higher than Q2, driven primarily by a $2 7 million increase in the accrued capital gains incentive fee a point for a million increase in interest expenses in part due to incremental SBA debt outstanding and a point $7 million.
And the base management and income incentive fees.
We ended the quarter with $454 3 million of debt outstanding comprised of $188 million of SBA debentures $250 million of unsecured notes and $16 3 million of secured borrowings our debt to equity ratio as of September 30th was <unk> 83 times, our 0.49 times statutory leverage excluding exempt.
Debentures.
Weighted average interest rate on our outstanding debt was four 3% as of September 30th 2023.
Net investment income or NII for the three months ended September 30th was 63 cents per share versus 67 cents per share in Q2, adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments were 68 cents per share in Q3 versus.
62 cents per share in Q2.
In Q3, we realized net gains of $9 8 million primarily related to the exit of Iraq with your investment in Hallmark Health care solutions.
Turning now to portfolio statistics as of September 30th.
Total investment portfolio had a fair value of $926 9 million, our average portfolio company investment on a cost basis was $11 2 million, which excludes investments in two portfolio companies that have sold their operations and are in the process of winding down.
We have equity investments in approximately 76, 8% of our portfolio companies with average fully diluted equity ownership of three 2%.
Weighted average effective yield on debt investments was 14, 6% as of September 30th versus 14, 5% of June 30, 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 I'd like to briefly discuss our available liquidity in Q3, we issued three 2 million shares at an average share price of $19.54 raising net proceeds of approximately $61 5 million as of September 30th our liquidity and capital resources included cash of $80 3 million.
22 million of available SBA debentures, and $100 million of availability on our line of credit, resulting in total liquidity of approximately $202 3 million now I'll turn the call back to Ed for concluding comments.
Thanks Shelby.
As always I'd like to thank our team and the board of directors at Phi This for their dedication and hard work and our shareholders for their continued support I will now turn the call over to Nick for Q&A.
Thank you now begin the question and answer session.
That's my question My first of all the one on your Touchtone phone.
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Withdraw your question. Please press Star then two.
I'm, a momentarily paused to assemble the roster.
First question will be from Bryce Rowe with B Riley. Please go ahead.
Hey, Thanks, good morning.
Good morning Bryce.
I wanted to.
Ask you guys you talked to talk about the ATM usage.
Obviously nice to see the stock trade above NAV and give you the ability to raise some equity in the third quarter, you know pretty pretty substantial amount.
Can you kind of delineate between.
The opportunistic being opportunistic with the stock above NAV.
And maybe just just raising raising the equity in anticipation of some.
Some more activity whether it be in the fourth quarter or into the first part of 'twenty four.
Sure. It's a great question Bryce I think.
So from my perspective first off and I think we're very pleased with our overall performance and where the stock has been trading but I think more importantly, you know what we're pleased with is the opportunities that we are seeing in the market.
And in particular these are mostly very high quality companies that we are pursuing.
You know the leverage levels are very reasonable loan to values are 30% to 50%. If you will and so we think from a risk adjusted return basis. This is a great time to invest.
And quite frankly, the companies that are coming to market from an M&A perspective are very high quality companies that we believe can withstand.
Any of the uncertainties that we're you know we're all feel for them.
Fearful of.
But we feel good about the opportunity set and obviously, we feel also good about the fact that our stock has been trading well.
Okay, Great that's helpful.
And then maybe another question here just on the dividend nice to see.
The bump higher in the dividend.
At least the regular dividend just curious how you're thinking about.
You know, possibly paying out the excess excess earnings over and above the base dividend about do you expect to continue to pay out the full access or will you moderate that a bit as we as we move into 'twenty four thanks.
Sure Great question Brian.
I think again.
You know, we're thrilled with the performance of the business and as you know we've had.
Very meaningful equity realizations over the last really several years and so the earnings power of the business is at a higher level and so we're very pleased to have embraced the base dividend.
Our current posture is to continue to pay out our excess earnings.
Yeah, you know.
As we are today and so that would that's our current posture and that's our expectation as we move into 2024. Obviously this quarter Q4 is the last quarter, we intend on paying this extra <unk> 10, special which we've been paying for the past five quarters, including Q4.
This year, but we do intend on continuing to pay out 100% of our excess earnings in the prior period.
As we move forward or move into 2024.
That's great I appreciate the commentary on great quarter, and I'll jump back in queue. Thanks, Alright, great. Thank you Bryce good talking to you.
Yeah.
Thank you next question will be from Mickey Schlein Homeland and spark. Please go ahead.
Oh, yes, good morning, Ed and Shelby.
I wanted to start with a high level question, perhaps for Ed.
In the upper middle market, we're starting to see spreads come in.
Just as a function of the amount of private capital that's out there and you know the lack of M&A volume and you know we have a supply and demand mismatch.
Are you starting to see that trickle down into the middle market and lower middle market, where you operate.
Great question Mickey.
And the short answer to that is a little bit I would say that you know spreads narrowed.
Maybe 25 basis points uncertainty.
Uhm 50 over the last six months or so.
There was a period of 12 months ago nine months ago, where they.
There were certain lenders that were really not in the marketplace at all.
Today, they're there appears to be more competition, it's not crazy at any level people are being disciplined but I do think further high quality situations, which is what we're focused on that spreads have narrowed a little bit here over the last three to six months.
Very similar in nature.
Okay I appreciate that insight.
Going back to the equity issuance question I just wanted to understand are you still expecting to operate the BDC.
Somewhere between 0.8 and $1 one times on a debt total debt to equity basis, and and is the current level, which as you know the bottom end of that range.
So factoring in some expectation about headwinds for the economy.
Sure Great question I think.
I think your initial comment a 0.8 to one one is it is a good one.
You know, where we have operated really has been 0.8 to one to one historically, we are comfortable going over one to one as opportunities arise, but you know there was an opportunity to raise capital here. We saw that Q4 was going to be active we also believe.
<unk> 2024 will probably show up a little bit more active than in 2023, there's just pent up demand out there and Theres a need you know more of a need for actually transactions.
Take place.
We thought <unk> be.
Being prepared for that made a ton of sense.
So I wouldn't say, we're concerned and we were we were raising capital to position the business to withstand.
You know concerns about the economy it was more.
To position the business.
To handle the opportunities that we think we're going to see here going forward.
Okay I understand my last question is more a little bit more of a housekeeping question on interest income which increased.
13% quarter to quarter, but the debt portfolio at cost actually declined 1% and your average portfolio yields only increased 10 basis points. So the interest income growth seems high unless I'm doing my math correctly, what was there anything sort of nonrecurring in interest income.
Crude this quarter, then we should be aware of.
Sure I'm going to let Shelby take that I understand your question, but I'll, let her take that.
No. There there were there were no you know kind of particularly unique items, you know with debt repayments, we will have acceleration of OID.
But that's kind of a routine course with respect to repayments.
We also that so well.
We also had interest income from some of the cash on our balance sheet throughout part right.
Average loans outstanding were higher during the quarter than they were a quarter at some of the repayments right. Yeah I was going to just say it in may it sounds like it has to do with the cadence of the investment the investments that you made right.
Alright.
Correct.
That's it for me. This morning, Thank you for your time.
I appreciate it good talking to you Mike.
Thank you next question will be from Robert Dodd Raymond James. Please go ahead.
Hi, guys and congratulations on the quarter.
Not at all.
I'm all in on the kind of heard about.
I mean, I'm wondering the ATM, because you're seeing more opportunities.
Can you tell us about the call I mean, you you mentioned here that the quality of deals available now with a high quality if I look back last quarter obviously.
Batteries about what you are assuming the mobile but last quarter some of them some of the available bills in the market and you described this is hit or Miss So have you seen.
A change in the mix of deals that are coming to market that are that are higher quality, which then.
Suffice.
Running the ATM.
Unless you win those deals it's great for portfolio quality overall, I mean, there's not any mix going on with mix shift.
No.
Not really.
You know what I would say is look deal flow actually deal flow wasn't bad by any stretch of imagination in Q3 quality has been hit or Miss.
All year, though.
What I would say so.
That's a big piece of the puzzle and then in terms of our investment activity.
In Q3, we had a couple of deals spill over into Q4.
We think Q4 will be a stronger investment periods in Q3, partly because of that and also just to pick up in activity.
You know type of business or mix that we're seeing it's really largely across the board.
Where we're spending time are those companies that have recurring or reoccurring.
Revenues.
Pretty strong stability.
Background, if you will and and high free cash flows and so those are the types of businesses that we are focused on.
And we are seeing a little bit of an uptick but some of Thats just Q4 versus Q3, you know where the summer slows things down a little bit.
But you know we are hopeful that next year will be and kind of anticipate a little bit of a pick up in AR and AR and am of M&A activity in 2024.
Got it got it. Thank you and then just on the well and obviously your credit quality across the portfolio.
Well.
More than one way.
Got it.
The reactions and I'll ask you about this before.
In terms of sponsor interactions.
Is there anything changing on that front given now.
We have been and I hate I hate lot high rate environment pool of only could be prolonged periods now.
Are they starting to change how they're looking at supporting portfolio companies. So it doesn't just business as usual.
I'm not seeing really any noticeable change I mean, we've seen some support and you know tougher situations that we have where do you go through an amendment, we're requiring support we have a portfolio. That's very active from an add on acquisition perspective, and our folks are doing that.
I am what I'm seeing and what we're seeing is up.
This is a pretty high level of or a pretty high interest in trying to define you know.
High quality companies are recognizing.
Recognizing that rates are higher and maybe quite frankly in some cases private equity groups are paying a little more than they would like to.
But for a assets I think thats, where there is a flight to quality from an equity perspective and from a debt perspective, and if people can locate.
And get an opportunity to invest in a very high quality AA type business than our folks are willing to still pay up for them quite frankly.
And you're seeing that in some ways realizations.
That we have as well.
Got it I appreciate that thank you.
Thank you Robert good talking to you.
Again, if you have a question. Please press Star then one.
Next question will be from Paul Johnson with CBW. Please go ahead.
Hey, good morning, Thanks for taking my question.
On the the Hallmark just going back to the Hallmark health games sale.
I'm, just trying to understand kind of.
Obviously that was a successful exit for you guys just kind of understanding what's going on there with the company. It looks like he has a little bit of.
And equity investment left in the portfolio just any color you can kind of you know what.
What perpetuated ice sale and what what you guys have left remaining in the portfolio with that company.
Sure.
Great question, Paul Paul You know Walmart has been a great performer for us.
We actually the company was in the sponsor was evaluating a couple of things one was more of a dividend recap or a sale transaction.
And quite frankly, we werent.
In the no.
As much as maybe we would've even like.
And so the sale transaction transpired it was documented legally as a full sale of the whole.
Equity tranche haven't said that.
The sponsor.
<unk> is rolling over a significant portion.
Not up to 50% less than 50%, but a significant portion of their investment and we followed that lead and so we also.
Invested.
At the same percentage in the in the business on a go forward basis. So it was a full realization, but we invested a significant.
Amount and the go forward capitalization of the business.
That's helpful.
Yeah, that's very helpful. Thanks for that great color and obviously you guys recognize the gain on the sample was that investment also written up during the quarter are you able to quantify that at all.
Impact.
Jeremy do you have that.
Your fingertips or I'll give you a higher level.
I don't have the exact number but I can confirm that the realization that we had in Q3 was materially higher than the fair value. We had it marked at the end of Q2.
Alright, okay.
Okay, that's what I would say, okay. Thanks for that and then.
So what Corey you just kind of gave I think it was just an approximation of you know I think you said, 55% or so of your companies where we're still.
Growing EBITDA last quarter.
Are you able to provide any kind of somewhere approximation of percents.
Seth is your portfolio that you still see growing revenues or EBITDA at this point.
Sure sure. It's a great question you know the portfolio continues to perform well I think of our core lower middle market businesses that we're invested in our.
EBIT D a.
I guess, what's the number 35 of 56 companies that fall in that category.
And we also have some equity.
Sand alone that businesses are orphaned equity and debt investments.
Investments that are not included there.
And so about 63% of the company's grew cash flows or EBITDA.
And then overall our portfolio grew on an LTM basis. This quarter, just less than 5%. So we're seeing still healthy performance in healthy growth.
In the underlying portfolio, which we're very pleased with.
Thanks, that's very helpful.
And then a last one at this point.
You know.
Obviously 68 says very strong results this quarter.
I'm just curious you know at this point you kind of see this as sort of the full flow through if you will of you know higher rates at this point at least from an NII perspective in the portfolio or.
Is there a possibility.
And you know I guess, you know higher OID amortization, that's where I think these are.
Payments such to continue I guess generating results.
Around these levels or possibly even higher because color there it would be.
Helpful. That's all for me thanks.
Sure.
Question.
One that's not that easy to answer.
But.
I think we are.
Obviously, we're very pleased with the performance this quarter.
This next quarter I do want to highlight we will have.
<unk> expense, so that will impact NII in Q4.
And which is which is relevant I.
I do think interest income so on the revenue side.
It's you know it's at a pretty high level at this point I don't see that rate going higher you know obviously the fed they put in.
I actually see a couple of higher yielding investments in our portfolio that it'll probably repay and so I see stability there from a yield perspective.
But at the same time and I do think there'll be continued monetization of certain equity investments, it's not going to be like 2021, where there was just a you know a very robust amount of M&A activity, but M&A is still transpire and we expect the equity investments that still.
Hum.
Monetize if you will and so we think the outlook is very good.
As we move forward.
You know the.
Exactly where we ended up do we go above 68 is clearly possible. It has to do with a lot of things getting more invested.
Our fee income at a reasonable level that quarter or not are there any dividends.
All of those things you got to take into account a little bit but.
Obviously, you know 68 cents is a great quarter, and we would you know.
We're going to strive to do better but at the same time, we're focused on.
Portfolio quality and consistency as opposed to just driving the highest earnings we can so.
Hopefully that's helpful, but Q4 will be impacted and I think that's relevant Shelby do you have anything to add to that.
Now you mentioned the excise tax.
That's just kind of an annual accrual that we have which will continue to have this year.
Got it thanks, guys I appreciate the answers and congratulations on a great quarter.
Thanks, Paul good talking to you.
Thank you. This concludes our question and answer session I'll like to turn the call back over to Mr. Ed Ross for closing remarks.
Thank you Nick and thank you everyone for joining us. This morning, we look forward to speaking with you on our fourth quarter call in early March 2024.
Have a great day and a great weekend.
Conference now concluded. Thank you for attending today's presentation you may now disconnect.
[laughter].
Okay.