Fidus Investment Corporation (NASDAQ:FDUS) Q4 2024 Earnings Call Transcript

Fidus Investment Corporation (NASDAQ:FDUS) Q4 2024 Earnings Call Transcript March 1, 2024

Fidus Investment Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to the Fidus Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jody Burfening. Please go ahead.

Jody Burfening: Thank you, Drew, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation’s Fourth 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. The 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, March 1st, 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. 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 fourth quarter 2023 earnings conference call. On today’s call, I’ll start with a review of our fourth quarter performance in our portfolio at quarter end and then share with you our outlook for 2024. Shelby will cover the fourth quarter financial results and our liquidity position. After we have completed our prepared remarks, we’ll be happy to take your questions. Our strong fourth quarter performance reflects the benefits to Fidus of our strategy of both serving the lower middle market, which has remained reasonably active in a less robust environment and selectively investing in companies that possess resilient and strong cash flow generating business models and positive long-term outlooks.

Our patience during the year has paid off with the typical year end push in deal activity, originations totaled $132.7 million and proceeds from repayments and realizations totaled $112.5 million for a net origination of $20.2 million and we grew the total portfolio to $957.9 million on a fair value basis. Adjusted net investment income increased 49% to $18.8 million in Q4 compared to $12.6 million last year. As was the case for each quarter in 2023, interest income growth drove this year over year increase, reflecting both higher average debt balances and higher weighted average yields. Taking into account the higher average share count resulting from the equity raises we completed during the year, adjusted net investment income on a per share basis increased 27.5% to $0.65 from $0.51.

We paid dividends totaling $0.80 per share, including a base dividend of $0.43 per share. For the year, we distributed a total of $2.88 per share to shareholders consisting of regular dividends of $1.66 per share, supplemental dividends of $0.82 per share and special dividends of $0.40 per share. Adjusted NII of $2.56 per share comfortably covered base dividends. As a reminder, we distributed a special cash dividend of $0.10 per share each quarter of 2023 to satisfy RIC requirements and to bring our spillover income in line with our target level, which is roughly the equivalent of the base dividend for three quarters. For the first quarter of 2024, the Board of Directors declared dividends totaling $0.65 per share consisting of a base dividend of $0.43 per share and a supplemental dividend of $0.22 per share equal to 100% of the surplus in adjusted NII over the base dividend from the prior quarter, which will be payable on March 27, 2024, to stockholders of record as of March 20th, 2024.

Net asset value quarter end was $589.5 million or $19.37 per share, a meaningful increase as compared to $548.6 million or $19.28 per share as of September 30th, 2023. During the quarter, we grew our portfolio, investing as always in high quality companies that generate excess levels of cash flow to service debt and structuring our investments with a high level of equity cushion to give us an added margin of safety. Originations totaled $132.7 million consisting of $123.5 million in debt and $9.2 million in equity. First lien investments accounted for $110.5 million or approximately 90% of the additions to the debt portfolio. We invested $94.6 million or about three quarters of total originations in six new portfolio companies, which were added to the portfolio through financing of M&A transactions.

The remaining $38.1 million was invested in add-ons in support of existing portfolio companies, almost all of which was M&A driven. Proceeds from repayments and realizations totaled $112.5 million for the fourth quarter, reflecting exits and some strategic pruning of the portfolio on our part. We received $87.2 million in debt repayments, primarily due to M&A activity and received proceeds of $25.3 million from the sale of equity investments, resulting in net realized gains of $19.8 million. Our portfolio of debt investments on a fair value basis was $832.8 million or 87% of the total portfolio at quarter end. First lien investments continue to account for the largest portion of the debt portfolio, now at 69%. Including the fair value of our equity portfolio of $125.1 million, the fair value of the total portfolio at quarter end stood at $957.9 million, equal to 102.3% of cost.

We ended the fourth quarter with 81 active portfolio companies. Subsequent to quarter end, we invested $17 million in first lien debt and equity in two new portfolio companies and we had a debt repayment and equity realization in one company, generating net proceeds of approximately $24.3 million and a realized gain of $1.5 million. Overall, our portfolio from a credit quality perspective remains solid. As of December 31st, we had two operating companies on nonaccrual, unchanged from the third quarter. Nonaccruals represented approximately 1% of the total portfolio on a fair value basis. The vast majority of our portfolio companies continue to capture growth opportunities and sustain profitability supported by resilient business models. We do, of course, have a few companies that are experiencing difficulties for a variety of reasons, but there is no one market condition that is weighing on their operations.

Looking ahead, we are well positioned to build on our successes in 2023. During 2023, we expanded our portfolio of debt and equity investments on a fair value basis by nearly $100 million to $957.9 million, despite subdued levels of M&A activity in the lower middle market. This performance speaks to our experience, our relationships with financial sponsors and industry knowledge that together enable us to remain highly selective investing in high quality companies that meet our investment criteria. By building our portfolio of income producing assets and with an assist from widened spreads, we enhanced the earnings power of our healthy and high performing portfolio, generating a 46.4% increase year over year in adjusted NII to $67.5 million.

Our strategy of coinvesting in equity investments continued to work well for us, producing approximately $22.4 million in net realizable gains for the year. Finally, we continue to deliver value for — to our shareholders, distributing 100% of our earnings and demonstrating our ability to generate gains in excess of losses while maintaining an overall healthy portfolio, thanks to our rigorous underwriting standards. While we are positioned to build on our successes of 2023, we remain committed to managing the business for the long term to our underwriting disciplines in selecting investments and to our long-term goals of growing net asset value over time, 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?

Shelby Sherard: Thank you, Ed, and good morning, everyone. I’ll review our fourth quarter results in more detail and close with comments on our liquidity position. Please note I will be providing comparative commentary versus the prior quarter Q3 2023. Total investment income was $36.3 million for the three months ended December 31st, a $2.1 million increase from Q3, primarily due to a $0.4 million increase in interest income including PIC, a $1.3 million increase in fee income due to higher levels of investment activity and a $0.5 million increase in interest income on excess cash. The increase in interest income was driven by an increase in average debt investment balances outstanding, partially offset by a decrease in yield on new debt investments and the repayment of two higher yielding debt investments.

Total expenses, including income tax provision, were $19.4 million for the fourth quarter, $1.8 million higher than Q3, driven primarily by a $1 million increase in income taxes related to the annual excise tax accrual, a $0.3 million increase in professional fees and a $0.4 million increase in the capital gains fee accrual. We ended the quarter with $475.9 million of debt outstanding, comprised of $210 million of SBA debentures, $250 million of unsecured notes, and $15.9 million of secured borrowings. Our debt-to-equity ratio as of December 31st was 0.8 times or 0.5 times statutory leverage excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 4.3% as of December 31st, 2023. Net investment income or NII for the three months ended December 31st was $0.58 per share versus $0.63 per share in Q3.

Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments, was $0.65 per share in Q4 which includes a $0.03 per share excise tax accrual versus $0.68 in Q3. For the three months ended December 31st, we recognized approximately $19.8 million of net realized gains related to the sale of our equity investments in Power Grid Components, Avionics, Road Safety Services and Comply365, offset by realized losses on the exit of our debt investment in K2 and equity investment in Techniks Industries. As Ed mentioned, in 2023, we paid total cash dividends of $2.88 per share versus $2 in cash dividends in 2022. Turning now to portfolio statistics. As of December 31st, our total investment portfolio had fair value of $957.9 million.

Our average portfolio company investment on a cost basis was $11.6 million, which excludes investments in one portfolio company that sold its operations and in this process of winding down. We have equity investments in approximately 79.3% of our portfolio companies, with an average fully diluted equity ownership of 3%. Weighted average yield on debt investments was 14.2% as of December versus 14.6% at September 30th. 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 nonaccruals, if any. Now I’d like to briefly discuss our available liquidity. In Q4, we issued approximately 2 million shares under our ATM program at an average share price of $19.79, raising net proceeds of approximately $38.7 million.

As of December 31st, our liquidity and capital resources included cash of $119.1 million and $100 million of availablity on our line of credit, resulting in total liquidity of approximately $219.1 million. Subsequent to year end, we repaid the remaining $35 million of outstanding SBA debentures in our second SBIC fund. We have submitted a new license application to the SBA for a fourth SBIC license, which, subject to SBA approval, will provide us with access to $175 million of additional SBA debentures. Now I will 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 Drew for Q&A. Drew?

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Robert Dodd with Raymond James. Please go ahead.

Robert Dodd: Good morning and congratulations on another really good quarter. Couple questions. On the — Ed, you mentioned strategic pruning of the portfolio during the opening rights. Could you give us any more color on that? I mean, a decent chunk of that sounds like it was equity. Was it people requesting dividend recaps you weren’t comfortable with that drove you to prune it or can you give us any color on the reasons that you decided to do that?

Edward Ross: Sure. There was one equity investment. There was — you could argue was strategic pruning in nature, Robert. And that was — I mean, it was an equity investment that we did very well on. I think we made eight times our money or something like that. So, we had an opportunity to stay in and we chose to go ahead and exit and saw risk greater than the opportunity, quite frankly. But really, what that was kind of meaning to talk about was a couple of debt investments. They weren’t huge, but they were ones that risk levels were higher than we were comfortable with. And so we made kind of the strategic decision to work to exit those investments. And in both cases, we were able to accomplish it in Q4. So it was more debt oriented than equity, but there was one equity investment. We did make that decision.

Robert Dodd: Got it. Thank you. On the credit situation, it seems — I mean, obviously, there’s clearly no broad based problems or you wouldn’t be lighting up any RIC. And you said the vast majority of portfolio companies performing fine. No single reason for that — maybe handful that aren’t. Are those idiosyncratic issues for the company or is it the labor market or anything? Could you give us more color? And how comfortable you are that those problems are being managed and aren’t showing rapid signs of deterioration, maybe or something like that?

Edward Ross: Sure. And the ones I was really kind of generally referencing are the nonaccruals…

Robert Dodd: Okay.

Edward Ross: Which have been there for a few quarters. And those are companies that are both supported by private equity groups. They are going through idiosyncratic type situations and in both cases improving, but we got ways to go. So that’s really what we were referencing primarily. In terms of other companies that are underperforming, again, kind of one-off type reasons for it. And we feel very good about our portfolio. There’s always a chance for another non-accrual, but that’s not our expectation and we clearly hope that we can keep managing the rest of the businesses in the way that we have in the past.

Robert Dodd: Okay, I appreciate it. Again, congrats on the quarter. Thank you.

Edward Ross: Thanks, Robert. Appreciate it. Good talking to you.

Operator: The next question comes from Bryce Rowe with B. Riley. Please go ahead.

Bryce Rowe: Thanks. Good morning, Ed and Shelby.

Edward Ross: Good morning, Bryce.

Bryce Rowe: I’m good, thank you. Maybe I’ll start on the capital structure. Shelby, appreciate the commentary around SBA license number two and kind of trying to re-up with a fourth license. How do you think about kind of timing of that fourth license and maybe access to that additional capital kind of relative to where the balance sheet? How the balance sheet looks today? You’re sitting on a lot of cash. And so just trying to think about how you work through that cash with the pipeline that you see in front of you?

Edward Ross: Sure. Great question, Bryce. As we think about the SBIC fund that we applied for, as you know that takes some time. And I think about it in terms of kind of a six-month window or so. So, that’s what RX expectation is. Our hope is that in 2024, we’ll be able to start utilizing that license, but obviously we’re still in the application mode. With regard to the cash, obviously, we did prepay debentures and fund too. But the other piece of the puzzle is we — this quarter is actually shaping up from our perspective. Assume things go as we expect to be a very active investment quarter, but it is going to primarily be in March. And so we’re currently in the execution phase, diligence and final execution phase of numerous investment opportunities.

And I would also say our portfolio continues to exhibit acquisition type activity as well. So, it’s shaping up to be a pretty active new investment quarter. And then from a repayment perspective, we actually think it’s probably going to shape up to be a lighter quarter. We’ve obviously had one sizable realization, meaning almost $25 million, but though it doesn’t appear that the calendar is very robust the rest of the quarter. We do have a few companies that are evaluating strategic alternatives. At the moment, we view those investments as probably more Q2 realizations and they also aren’t — the ones that we’re aware of they aren’t very large investments at the same time. So we think a fair bit of the cash that we have on the balance sheet today will actually go to new investments here as we move forward here over the next four to eight weeks.

Bryce Rowe: Okay, that’s helpful. And as beyond — I guess, we’ve heard M&A activity picking up from many of your peers in the lower middle market, does that M&A trend that you’re seeing and experiencing, does that continue beyond this March period? Are we going to continue to see it into second, third quarter just based on kind of what you’re hearing at this point?

Edward Ross: It’s a really good question, Bryce. I think it’s a little unclear. I mean, look, in the lower middle market, one of the reasons we like it, there’s more activity than the broader market. In terms of number of deals, it’s fragmented, which we like gives us a chance to kind of choose what we really are interested in. But activity levels are still well below 2021 and I’d say below normal activity levels. But there has been a little bit of an uptick here in Q4. In Q1 as well, in January, we obviously had some pretty robust deal flow in some high-quality situations. I think it’s unclear on how long, how sustainable that is, but the expectation, it’s more of a market expectation is for continued M&A activity at reasonable levels and above last year. And so that’s our hope. And so that’s what we’re planning for, but there’s no guarantee of that obviously.