Fidus Investment Corporation (NASDAQ:FDUS) Q3 2023 Earnings Call Transcript

Fidus Investment Corporation (NASDAQ:FDUS) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Good day and welcome to Fidus Third Quarter 2023 Earnings Call. [Operator Instructions]. Please note that this event is being recorded. I'd like to turn the conference over to Ms. Jody Burfening. Please go ahead.

Jody Burfening: Thank you, Nick, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's Third Quarter 2023 Earnings Conference Call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial Officer. Fidus 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 fdus.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 of Fidus Investment Corporation.

Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, November 3, 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. Fidus 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, Ed.

Edward Ross : 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 with adjusted net investment income remaining well in excess of our base dividend. Much like the first half of 2023, deal flow was decent but not robust by any means as M&A activity remains 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 and have 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 $12.5 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 raise during the quarter, adjusted net investment income on a per share basis increased 33.3% to $0.68 from $0.51.

We paid dividends totaling $0.72 per share, consisting of a base dividend of $0.41 per share, a supplemental dividend of $0.21 per share and a special cash dividend of $0.10 per share. As a reminder, we are distributing a special cash dividend of $0.10 per share each quarter this year to satisfy RIC requirements and to bring our spillover income in line with our target level, roughly the equivalent of dividends for 3 quarters. For the fourth quarter, on October 30, 2023, the Board of Directors declared dividends totaling $0.80 per share, consisting of a base dividend of $0.43 per share, a supplemental dividend of $0.27 per share, equal to 100% of the surplus and adjusted NII over the base dividend from the prior quarter and a special cash dividend of $0.10 per share, which will be payable on December 27, 2023, to stockholders of record as of December 20, 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 30. During the quarter, we continued 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 and $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 2 new portfolio companies that 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 4 debt repayments and 2 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 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%. And 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 portfolio companies and 2 companies that have sold their underlying operations. Subsequent to quarter end, we invested $31.8 million in first lien debt and preferred equity in 2 new portfolio companies, and we had debt repayments in 3 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 to structure 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 of companies have adjusted to current economic conditions and those with pricing power, generally found ways to prosper despite inflationary cost pressures and higher interest rates.

An executive in a suit, seated with a laptop, confidently overseeing the development of the company's investment portfolio.

Select portfolio companies are continuing to navigate today's tougher conditions, and we are monitoring them closely. As of September 30, we had 2 operating companies on nonaccrual, unchanged from the second quarter. Non-accruals represented 1.3% 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. into our goals of preserving capital, generating attractive risk-adjusted returns and delivering value for our shareholders. Now I'll turn the call over to Shelby to provide some details on our financial and operating results. Shelby?

Shelby Sherard : 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 3 months ended September 30, a $3.6 million increase from Q2, primarily due to a $3.7 million increase in interest income, including PIC, offset by a slight decrease in dividend 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 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 $0.4 million increase in interest expenses, in part due to incremental SBA debt outstanding and a $0.7 million increase in 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 30 was 0.83x or 0.49x statutory leverage, excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 4.3% as of September 30, 2023. Net investment income or NII for the 3 months ended September 30 was $0.63 per share versus $0.67 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, was $0.68 per share in Q3 versus $0.62 per share in Q2. In Q3, we realized net gains of $9.8 million, primarily related to the exit of our equity investment in Hallmark Healthcare Solutions.

Turning now to portfolio statistics as of September 30. Our 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 2 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 3.2%. Weighted average effective yield on debt investments was 14.6% as of September 30 versus 14.5% at June 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 nonaccrual, if any.

Now I'd like to briefly discuss our available liquidity. In Q3, we issued 3.2 million shares at an average share price of $19.54, raising net proceeds of approximately $61.5 million. As of September 30, 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.

Edward Ross : 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 Nick for Q&A. Nick?

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