Fidus Investment Corporation

Good day and thank you for standing by. Welcome to the FIDA's first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to turn the call over to your speaker today, Jody Berferning.

Thank you, Lisa, and good morning, everyone, and thank you for joining us for FIDUS Investment Corporation's first quarter 2021 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. Vitus 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. The conference call today will contain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results, cash flows of FIDX Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions, and projections as of today, May 7, 2021, 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. BIDIS 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.

Good morning, Jodi, and good morning, everyone. Welcome to our first quarter 2021 earnings conference call. I hope all of you, your families, friends, and coworkers are staying healthy and well. I'm going to open today's call with a review of our first quarter performance and portfolio at quarter end, and then share with you our views on deal activity in the lower middle market. Shelby will cover the first quarter financial results and our liquidity position. Once we have completed our prepared remarks, we'll be happy to take your questions. Our first quarter results demonstrate the stability of our portfolio and the effectiveness of our strategy to build a well-diversified portfolio of debt and equity investments in lower middle market businesses that we believe will produce high levels of recurring income and offer us the opportunity to participate in equity gains, thereby preserving capital and generating attractive risk-adjusted returns over time. We carefully select companies that have strong yet defensible market positions, resilient business models that generate free cash flow and have positive long-term outlooks for growth over the long term. Our first quarter operating results were solid, with our portfolio performing well and generating adjusted net investment income, which we define as net investment income, excluding any capital gain incentive fee trivial to realized and unrealized gains and losses of $11.2 million, or 46 cents per share. This compares favorably to adjusted NII for the fourth quarter of last year of 44 cents per share. FIDUS paid a base quarterly dividend of 31 cents per share and a supplemental cash dividend of 7 cents per share to stockholders of record as of March 12th, on March 26, 2021. As a reminder, the Board has devised a formula to calculate the supplemental dividend each quarter, under which 50% of the surplus in adjusted NII over the base dividend from the prior quarter is distributed to shareholders. For the second quarter, the surplus is 15 cents per share. Therefore, on May 3, 2021, the Board of Directors declared a base quarterly dividend of $0.31 per share and a supplemental quarterly cash dividend of $0.08 per share. The base quarterly dividend and the supplemental cash dividend will be payable on June 28, 2021 to stockholders of record as of June 14, 2021. NAV continued to improve as a result of both our solid operating performance and the underlying portfolio fair value appreciation. We ended the quarter with net asset value of $413 million, or $16.90 per share, a level that is, I'd like to point out, above the NAV of our portfolio as of December 31st, 2019, before we were all dealing with the pandemic. Deal flow activity during the first quarter was at reasonable levels, driven by both M&A and refinancing opportunities. In terms of originations, we invested $63.1 million in debt and equity securities. $56.9 million, or 58.5%, was invested in first lien debt. Investments in new portfolio companies consisted of $7.5 million in first lien debt and common equity in Garlock Printing and Converting, a converter of plastic film into flexible packaging solutions. $6.5 million in first lien debt in core business technology, provider of revenue management and payment solutions to government, healthcare, and education sectors. We also made a $2 million delayed draw term loan commitment to this company, which was unfunded at close. $8.9 million in first lien debt in Ziva, Inc., a global provider of intelligent cloud-based direct spend management software solutions. We also made a $.4 million delayed draw term loan commitment to this company, which was unfunded at close. And finally, $17 million in subordinated debt and common equity in Lifespan Biosciences, Inc., a global provider, developer, and distributor of antibodies and related reagents, primarily to the academic and pharmaceutical research markets. The remaining $19.2 million consisted of add-on investments in six portfolio companies, primarily related to recapitalizations of two In terms of repayments and realizations, we received proceeds totaling $98.6 million, collecting another quarter of relatively strong M&A activity and higher debt refinancing volume. In terms of exits, we received payment in full of $15.6 million, including a prepayment penalty on our first lien debt in Bandon Fitness, Inc. We received payment in full of $6.6 million, including a prepayment penalty on our first lien debt in Alzheimer's Research and Treatment Center, LLC. We received payment in full of $10 million on our subordinated debt investment in OMC Investors and reinvested $5 million in new second lien debt. We exited our debt and equity investments in FDS, Avionics, Corp receiving payment in full of $5.1 million on our revolving and subordinated debt investments and realized a gain of $0.9 million on our equity investment. We received $0.1 million in first lien debt and common equity of the Acquirer Spectra Aerospace and Defense Acquisition, Inc. We received payment in full of $20.4 million on our second lien debt in Wheel Pros Inc., including prepayment penalties. We received payment in full of $4.2 million on our first lien debt in French Transit LLC. We exited our debt and equity investments in Software Technology LLC, receiving payment in full of $10 million on our subordinated debt investments and realized a gain of approximately $1.4 million on our equity investment. And we exited our debt and equity investments in Rohwer Corporation, receiving payment in full of $14 million on our subordinated debt investments and realized a gain of approximately $0.9 million on our equity investment. Subsequent to quarter end, we invested $11 million in first lien debt of Wynonna Foods, Inc., a leading provider of natural and processed cheese products, sauces, plant-based alternatives. We invested $5.5 million in first lien debt and $1 million in common equity of Level Education Group, LLC, doing business as CE for Less, a leading provider of online continuing education for mental health and nursing professionals. We exited our debt investment in Kaizen Company, LLC, doing business as Outward Hound, and received payment in full of $15 million on our second lien debt, which includes a prepayment fee. We invested $25.5 million in first lien debt, common equity, and made a commitment up to $2 million of additional first lien debt of ISI PSG Holdings LLC doing business as Incentive Solutions Inc., a tech-enabled incentive rewards, and digital marketing firm that facilitates and optimizes its clients' indirect sales channel strategies. We exited our debt investment in MedShirt Assurance Holdings LLC and received payment in full of $8 million on our second lien debt, and we exited our debt investment in Virginia Tile Company LLC, and we received payment in full of $12 million on our second lien debt. With repayments and exits outpacing originations during the first quarter, assets under management as of March 31st, 2021 was, as expected, lower than December 31st, 2020. As of March 31st, the fair market value of our portfolio was $711.9 million, equal to 108.4% of cost, and we ended the first quarter with 67 active portfolio companies and four companies that have sold their underlying operations. In terms of portfolio construction, we continue to increase the mix of first lien debt investments on an absolute basis and as a percent of the total portfolio, and at quarter end, first lien debt accounted for 27.5 percent of the portfolio on a fair value basis compared to 25.2% as of December 31, 2020. The breakdown of the rest of the portfolio by investment type as of March 31 was as follows. Second lien debt, 41.5%, subordinated debt, 14%, and equity investments, 17%. With this security mix, our portfolio remains well-structured for current economic conditions and positioned to provide us with a high level of current and recurring income from debt investments, along with the opportunity for incremental returns from monetizing equity investments. Moving to portfolio performance, overall our portfolio is performing well, and risk is at comfortable levels. Some of our portfolio companies have encountered supply chain disruption, higher input costs, including freight costs, But overall, they are managing these issues well, and the long-term fundamentals of their businesses remain in good shape. Eblen's remains on PIC non accrual, representing 0.8% of total fair value of the portfolio. We track several quality measures on a quarterly basis to help us assess the overall health, stability, and performance of our investment portfolio. First, we track the portfolio's weighted average investment rating based on our internal system. Under our methodology, a rating of 1 is outperformed and a rating of 5 is an expected loss. March 31st, the weighted average investment ratio for the portfolio was 2 on a fair value basis. Another metric we track is the credit performance of our portfolio, which is measured by our portfolio company's combined ratio of total net debt through FIDUS's debt investments to total EBITDA. For the first quarter, this ratio is 4.4 times, excluding equity-only and ARR deals. The third measure we track is the combined ratio of our portfolio companies' total EBITDA to total cash interest expense, which is indicative of the cushion our portfolio companies have in aggregate to meet their debt service obligations to us. For the first quarter, this metric was 3.4 times, excluding equity-only and ARR deals. With high levels of repayments and exits exceeding originations recently, we are pleased to see that M&A activity in the lower middle market remains robust and is expected to remain strong throughout the year, offering us opportunities to invest in high-quality companies that meet our underwriting standards and supporting our positive outlook to build our portfolio of debt and equity investments in a disciplined and measured way as we have in the past. At the same time, we do expect repayments to continue through the year, but at a slower pace than the recent past. Overall, we believe the portfolio is headed in the right direction and remains well-structured in support of our capital preservation and income goals. Our strategy is working, and we remain committed to our goal of growing net asset value over time through careful investment selection and focus on preservation and on generating attractive risk-adjusted returns. I will now turn the call over to Shelby to review our financial results and liquidity position. 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 2020. Total investment income was $23.3 million for the three months ended March 31st. A $.3 million decrease from Q4 primarily due to a $1.7 million decrease in dividend income offset by a $.9 million increase in fee income from new investments, amendments and prepayments and a .5 million dollar increase in interest income. Interest income in Q1 included approximately 1 million dollars of accelerated amortization of closing fees and OID from the Band and Fitness and WillPros repayments. Total expenses including income tax provision were 12.2 million dollars for the first quarter. Approximately 5.4 million dollars lower than the prior quarter primarily due to A $4.6 million decrease in the capital gains incentive fee accrual. In Q4, we accrued $4.7 million of capital gains incentive fees, giving meaningful appreciation and the fair value of the portfolio. And a decrease related to $0.7 million of annual excise tax, which was accrued in Q4 related to estimated 2020 spillover income. Note the capital gains incentive fee is accrued for GAAP purposes, but not currently payable. As of March 31st, the weighted average interest rate on our outstanding debt was 4.3%, and we had $356.1 million of debt outstanding comprised of $133.8 million of SBA debentures, $207.3 million of unsecured notes, and $15 million outstanding on our line of credit. In Q1, using the proceeds from our December bond offering, We fully redeemed our 5.875% $50 million notes due 2023 and partially redeemed 50 million of our 6% public notes due 2024. In addition, we paid down 19.2 million of SBA debentures and our second SBIC fund. We realized a one-time loss on extinguishment of debt in Q1 of approximately 2.2 million from the acceleration of unamortized deferred financing costs on the redeemed bonds and SBA debentures. Our debt to equity ratio as of March 31st was 0.9 times or 0.5 times statutory leverage excluding exempt SBA debentures. Net investment income or NII for the three months ended March 31st was 45 cents per share versus 25 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 46 cents per share in Q1 versus 44 cents per share in Q4. For the three months ended March 31st, we recognized approximately 3.2 million of net realized gains from the sale of several equity investments including software technology, a $1.4 million gain, FDS, a $0.9 million gain, and ROAR, a $0.9 million gain. Turning now to portfolio statistics, as of March 31st, our total investment portfolio had fair value of $711.9 million, down from $742.9 million at year end, as repayments outpaced new investment activity in Q1. Our average portfolio company investment on a cost basis was $9.8 million at the end of the first quarter. which excludes investments in four portfolio companies that sold their operations and are in the process of winding down. We have equity investments in approximately 87.3% of our portfolio companies with weighted average fully diluted equity ownership of 5.3%. Weighted average effective yield on debt investments was 12.3% as of March 31st. The weighted average yield is computed using the effective interest rate for Zed 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. As of March 31st, our liquidity and capital resources included cash of $60.2 million, $5.5 million of available SBA debentures, and $85 million of availability on our line of credit, resulting in total liquidity of approximately $150.7 million. Taking into account subsequent events, we currently have approximately $142.8 million of liquidity, gap leverage of 0.8 times, and access to $150 million of additional SBA debentures under our third SBIC license, subject to SBA regulatory requirements and approval. Now I will 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 FIDUS for their dedication and hard work, and our shareholders for their continued support. I will now turn the call over to Lisa for Q&A. Lisa?

At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one. on your telephone keypad. Your first question comes from the line of Ryan Lynch with KBW.

Thanks for taking my questions. The first one I had was you guys obviously had a very strong fee income in Q1. I'm assuming that was driven by the strong level of repayments that you had. Can you just talk about, you know, I know repayments have been pretty strong so far in Q2. Can you just talk about your expectations for, you know, fee income levels in Q2 compared to Q1?

Sure. Good morning, Ryan. You know, yes, what I would say, you know, Q1 fee income was, you know, a little higher than normal. You know, there were some events there that were large events, not small, but obviously positive, and it's a benefit of our model. But it's not something that I would say is going to, you know, reoccur every quarter for sure. So, when I look at Q2 from a fee perspective, my current expectation would be for fees to be lower. And that also is dependent on what activity happens here the rest of the quarter, which, as you know, there's a fair number of unknowns, what deals that we're working on now do actually close and what, you know, repayments actually occur. And so, but my expectation would be for fees to come down a little for sure.

And Ryan, I would just add to that to put it in perspective. In Q1, we had about 3.1 million of fees. Approximately half of that was from prepayments. And so in Q2, I would expect our fees to really be driven more from origination activity and maybe to a minor extent, maybe a few amendment fees, but not the level of prepayment fees we saw in Q1. Okay.

And then a question kind of on the market environment and your outlook, kind of a two-part question. You talked about M&A, you know, continuing to be pretty active, you know, in that space. Obviously that presents, you know, a lot of deal activity for you guys to deploy capital, but also it can put pressure on repayments. Can you just talk about first, what do you think that your guys' ability to actually grow the portfolio over the next coming quarters is? Again, I know it's hard to tell, not asking you necessarily for a prediction, but just high-level thoughts on that. And then also, the environment has gotten very competitive, certainly in the upper-middle market, certainly back to pre-COVID levels. I'm just wondering – you know, as far as the terms and structures that you guys are seeing kind of in the lower middle market and middle market, you know, have those sort of returned back to pre-COVID levels or are those still a little bit more favorable?

Great questions. Questions, should I say. And so let me, maybe I'll start with just the market, you know, and give you a little context on originations and repayments and then try to address those last questions. You know, from a market perspective, as you know, Q1 started out, I'd say, a little slow, and that was just timing given the Q4 activity levels. I would say towards the end of Q1, things started to pick up in the M&A market in, you know, a meaningful manner, in our market at least, the lower middle market. You know, in Q4, we saw a high level of deal flow. More importantly, a lot of high-quality and actionable you know, opportunities as the market was flocking to, you know, very high quality businesses that hadn't been impacted by COVID. I would tell you the market seems to be, you know, continue to be focused on those businesses that haven't been meaningfully impacted by COVID. And so, you know, we are, you know, in fact, I'll tell you there's a premium paid for those businesses. So there is a fair bit of activity today. You know, as I sit here today, I would suggest activity levels are good, and we expect a strong to what I would say robust M&A market throughout the year at this point. You know, anything can change, but that's what we're hearing. That's what we're seeing. So from an originations perspective, obviously we're focused on capital preservation, attractive risk-adjusted returns, and, you know, we're being, you know, very disciplined and we're going to continue to focus on first lien investments and strong credits. And we will continue to opportunistically focus on second lien investments in what I would call, you know, just superlative-type situations. And so, you know, we expect Q2 to be relatively busy from, you know, origination perspective. This quarter was, you know – You know, I guess in April we had 43 million in origination. You know, we're working hard on several opportunities right now, but, you know, as you know, it's too – it's hard to tell what will close and what won't. I think it happened with the deal. And so that's the challenge when I look at it, but I do expect some incremental originations, obviously. With regard to repayments, you know, we've had three debt repayments this quarter. At this point, we do expect some additional realization activity. We have one company that's in the process of refinancing its balance sheet, and we have two others that are in the market, you know, executing a strategic alternatives process. Don't know the timing or certainty of those, but that's going on. So overall, what I would expect is originations this quarter to, I'd say, maintain or exceed repayments. And it's really just, it depends on what occurs here in the last 50 days of the quarter. So it's dynamic, it's fluid, but it's very active. As I look forward or I try to answer your two last questions, can we grow the portfolio You know, as I see it today is I do think repayments will slow down a bit. I think a lot of the low-hanging fruit in our portfolio has kind of transpired, if you will. And, you know, so I do expect for the – you know, portfolio to grow the rest of the year. You know, what happens this quarter is kind of hard to tell, but just based on activity levels and activity levels compared to repayments that we can see, I would expect originations to outpace repayments and exits. In terms of the competitive environment, it obviously is competitive. Good news is we're participating in the lower middle market that's, you know, highly fragmented and represents, you know, close to 90% of the transactions that take place in the marketplace. So we like what we're seeing. What I would tell you is, you know, from a competitiveness terms, you know, terms aren't changing. Leverage is, you know, probably lower levels than pre-COVID levels overall. So I think that's a positive. And pricing is probably in line with pre-COVID levels at this point. You know, for the last year, obviously, pricing has been above where things were, and I do think pricing overall has come down here over the last three or four months to more of pre-COVID levels. At least that's what we're experiencing. So that's a long-winded way to try to answer those questions, but hopefully that's helpful.

Yeah, I really appreciate the color and commentary on the market environment and also on your kind of thoughts for portfolio growth the rest of the year, fully knowing that if you don't have a crystal ball, you know, sit on your desk, so understanding that. So I appreciate the time today. I'll hop back in the queue.

Okay. Thanks, Ryan. Good talking to you.

Your next question comes from the line of Bryce Rowe with Havdi.

Great. Thank you. Good morning, Ed and Shelby.

Good morning, Bryce.

Ryan asked some good questions there on repayments and originations and appreciate the color you gave, Ed, on the market and the pace of deal flow. Maybe just wanted to ask a little bit about the SBA and the use of SBA to ventures. It's a topic that we've talked about in past calls quite a bit and understand that you all look to redeem those that are kind of coming due a little bit early in terms of the SBA debentures. But it was good to see you all draw some again here in the quarter. And so just kind of curious what your outlook is for, you know, newer originations kind of fitting the SBIC bucket, whereas maybe it's been a little bit more limited, you know, over the last couple of years in terms of being able to use that bucket.

Sure. Great question, Bryce. I think, you know, just our SBA situation, we are generally, you know, winding down SBIC 2 and, you know, obviously starting to build in a more meaningful manner SBIC 3. You know, from an origination perspective, my expectations, you know, we're continuing to play in the same old market we've played in for a long time. My expectation would be for, you know, the SBIC-3 to grow, you know, here over the next, you know, whatever, 12, 24, 36 months in a, you know, in a reasonably meaningful way. You know, as you know, there are hurdles we have to get over from a qualification perspective that, you know, do impact. And sometimes, you know, companies don't qualify. You know, do they have you know, too many operations overseas, things like that. But, you know, at the same time, we're very focused on the U.S. market, as you well know. But there are a lot of nuances that get in the way sometimes of, you know, deals qualifying for the SBA. But, you know, when they do qualify, we intend to use the, you know, our funding, our vehicle, you know, to the largest extent that we can. You know, the SBA has been a great partner for VITAS and we continue to want to build that portfolio and be a good partner for the SBA as well. So, hopefully that's helpful. I would expect it to grow, you know, at what pace it's possible to kind of know.

Sure, that's helpful. Go ahead, Shelby, sorry.

I would just add that prior to COVID, and this is just a function of timing, we had a number of repayments in FMC2. And so as we had new SBIC eligible originations, we actually used funds out of SBIC2 to redeploy capital as opposed to growing the third fund at that point in time. Then we kind of had a little pause with COVID. But I'd say, as Ed mentioned, now we've really got SBIC2 in wind-down mode. And so any new originations will place in three. So you'll start to see a little bit more growth in three. Okay.

Okay. Maybe one follow-up on a on the liability structure, you know, you've got some cash sitting on the balance sheet. It sounds like you've got uses for them from an origination perspective, but also pressure from repayment. So, Shelby, just curious, you know, how you think about the, you know, the remaining, you know, more expensive notes that are sitting out there, you know, tied to those that you've already redeemed a portion of.

Yeah, just in the subsequent events, we did pay down the $15 million outstanding on our line of credit with excess cash. That being said, as you noted, we did have some repayments, so we do still have some excess cash. But right now, I'd say we've kind of really got that more queued up for origination activity. From a maturity date perspective, there's not really a real need to pay down the other baby bonds. Certainly, it's something if we found ourselves in a situation where repayment started outpacing investments, we'd reevaluate that just because it is more cost effective. And then the only other thing I'd add is right now, most of our cash is really sitting at the BDC as opposed to trapped in the SBIC. So it really is available for any type of origination activity.

Great.

That's good stuff. Thanks.

Thanks, Bryce. Good talking to you.

Your next question comes from the line of Matt Jaden with Raymond James.

Hey, all. Good morning, and I appreciate you taking the time. First question maybe for you, Ed. I know over the past couple quarters we've talked on the transition to a higher percentage of first lien investments in the book. I'm interested. Is that driven by a desire to be higher in the capital structure, or is it driven by, you know, less second lien opportunities available or kind of some combination of the two?

Great question, Matt. You know, I think in short and in summary, I'd say it's a couple things. We made a strategic decision several years ago to focus a little bit more on first lien investments. We thought it would you know, enhance really, quite frankly, our opportunity set, and it has done that. And it gives us a chance to provide full solutions, which we like that aspect of it as well. And then your comment on, you know, are there as many second lien opportunities out there today vis-a-vis, you know, I would say three or five or seven years ago, the answer is no. There's more first lien Unitronch investments being made. You know, I think the move we've made, you know, we like from a lot of angles, but, you know, we do think it's increased our opportunity set as we look forward and as, you know, as, you know, what we've had over the last, you know, several years. You know, so it is, you know, first lien investments represent a majority of what we're doing from an origination perspective and has done so really the last three years or so. So hopefully that's helpful, but it's been a good transition for us. We've always made first-lane investments, but we are now, it's a majority of what we're doing, and we're very much going to market as a solution provider, and I think that's working very well.

Okay, that's helpful. I guess kind of as a follow-up to that as well, as first-lane continues to trend higher, How do you think about leverage? Are you comfortable taking leverage, you know, modestly higher with a higher first lien book?

Great question. Comfortable, the answer is yes. You know, we've quite frankly, as you know, an SBIC fund can be funded two to one and even with junior capital funds. investments, you know, and when we were private, that's where we were levered. So, we're comfortable with junior debt investments, you know, being levered, you know, higher. So, comfortable, absolutely. We think, though, as we, you know, just thinking about the market and whatnot, you know, we've targeted a one-to-one leverage number. You know, our plan is not to, you you know, exceed that greatly, for sure. And we don't – we haven't changed those thoughts. But, you know, from a comfort, we're very comfortable with those levels and even higher. It's just, you know, that's the general kind of view is, you know, with the complexion of our portfolio, it makes sense to be more in the one-to-one leverage. And, you know, I think we like that, you know, that kind of flexibility that it gives us – We've always operated carefully and with sometimes an abundance of caution, and that's kind of how we think about it at this point.

Great. That's it for me. I appreciate the time.

Yeah. Thank you, Matt. Appreciate it.

Your next question comes from the line of Chris Katowski with Oppenheimer.

Yeah. There may not be an answer to this question, but I'm kind of thinking – Back at this time last year, we were all just kind of wondering, you know, how much the economy would slow down and how high unemployment would go and, you know, how much damage it would do to debt payment capacity. And now we have the vaccines and the stimulus in place, and it just seems too good to be true. And so I'm wondering, are there any signs as you look through your portfolio companies of companies overheating, labor shortages, pressure on, you know, inflationary pressures, or any other adverse impact of, like, too much good news?

Sure. Great question, Chris. Yeah, it's amazing. A year later, you know, the difference, right? Close to 10% of our portfolio and, you know, being impacted meaningfully by shelter in place orders. a year ago when we spoke to you, so it's a very different time period, which is good, obviously. The answer to your question is yes, we are seeing certain companies impacted by labor shortages. It's tougher to get people to work in certain environments when there's opportunity that's being provided by the government that sometimes exceeds that pay. Hopefully that subsides at some point later in the year, but it's something that our portfolio companies are managing and dealing with, but at the same time, I'd say it's far from Far from perfect. And then from input cost perspectives, whether you name it, I do think there has been an increase in prices. And it just kind of varies by portfolio company what the reason is. As we all know, freight costs, for instance, are very high today relative to a year ago. and you know someone you got to pass those costs on and so um that's a you know one very good example that we're seeing and you know more than a few companies and the good news is the environment's good enough to where you can pass those you know you can implement price increases to offset those types of situations but the short answer is yes that's very real uh in the environment today and You know, the good news is, you know, the portfolio companies that we have are dealing with it and addressing it. You know, in a couple cases, to be honest, it took a couple quarters to figure it out and to address it. But, you know, what we've seen is a pretty healthy ability to manage through those issues, albeit labor is difficult and sometimes limits capacity of certain manufacturing companies. Right. they're still operating. It's just maybe not at the optimal level, if you will.

Okay. All right. Like I said, I'm not, I, but I guess it doesn't sound like it's impacting in a, to a significant degree, the financial performance of the portfolio companies.

That's what we're seeing. That's exactly right. You know, I think it's given the overall environment, what we're seeing is there's an ability for the, the, the companies to manage through the issues, but, The real world is there are issues that they're having to address and find ways to improvise and deal with.

Yeah. Okay. Thank you. That's it for me.

Okay. Thank you, Chris.

Your next question comes from the line of Sarkis.

Hey, thanks for taking my question here. Most of them were asked, but I do want to ask, and Lauren, if your team sees more opportunities in certain industries that fit your risk profile better in this current environment. Just looking at the industry composition table on an invested cost basis, quarter on quarter it looks like manufacturing and healthcare moved up. So any insight you can share here?

Sure. I mean, I think what I would say from a strategy and approach perspective, you know, we're We're focused very much on cash flow and high free cash flow businesses. And you can find those in a large variety of markets, right? So recurring revenue, close to recurring revenue type business models with positive outlooks and that haven't been greatly impacted by this environment. Those are the types of end markets and situations that we are you know, we're looking for. And, you know, we also have the ability and do execute some more asset-oriented type situations. I can think about, you know, from a recurring revenue perspective, ARR deals, you know, that's something that we've, you know, and we view that very much as a, and those are typically lean investments, but that's been a big focus for us in the, I'd say, software space and tech-enabled space. And so that is something we've done a lot over the years, but now I'd say an increased focus even over the last several years. And in this COVID environment, again, we're looking for recurring revenues. So healthcare clearly is an area where we've spent a lot of time over the years. We're staying away from more companies that can be impacted by reimbursement rate changes. But there's obviously a lot of other opportunities in the healthcare arena or businesses that serve the healthcare arena that we've tested in and that we see. And that's an area we like very much. Again, looking for more repeat-type business situations, recurring revenue-type situations.

Got it. That's all from me. Thank you.

Okay. Good talking to you, Sarkis. Thank you.

Your next question comes from the line of Mickey Shenan with Leidenberg.

Yes, good morning, Ed and Shelby. Congratulations on another strong quarter. Ed, I sort of wanted to follow up on a previous question. in terms of looking back over the last year, it is amazing to see how well, you know, your lower middle market portfolio has performed as well as some of your peers. And, and I'm curious to understand whether you've sort of done a postmortem on that performance, um, given the government's strong support of the economy? In other words, if the Fed hadn't come in with trillion-dollar checks the way it did and the stimulus payments and PPP, Main Street Lending Fund, everything, do you have a sense of how the portfolio would have performed? And is that impacting your target market in terms of perhaps going a little bit more upmarket to avoid having to count on the government in the future?

Great question, Mickey, a tough one. You know, postmortem, what I would say is clearly, you know, what the government did, the CARES Act and whatnot, was helpful to our portfolio companies, you know, were the ones that utilized the program. And so clearly that was helpful, you know, having a private equity driven portfolio where it represents, if you include fundless sponsors, you know, 90, 95% of our portfolio companies, you know, having some stewardship there and capital behind you was helpful, but they weren't huge investments made, but in certain cases it was helpful. So what I would say, you know, what's important in times like this, as you know, is having a business that can weather storms, but also just the underlying long-term fundamentals, you know, are positive, right, and should be, you know, strong, sustainable cash flow generator in, you know, good times and in bad, quite frankly. And, you know, so that's been our focus. We clearly, you know, haven't been perfect, but at the same time, I think we've done a good job of investing in businesses that had a real reason for being and had good long-term outlooks and good cash generation capabilities. And so I think that's ultimately more important than the support that the government gave. I think, put us in the position we're in today. I still think we would have gotten to this position, but I guess the timing of it would have been different, and it maybe would have been a little bit, you know, messier, if you will, not from a long-term loss perspective, but more from just dealing with, you know, credit issues, as we always have to do, you know, on a daily basis we do. So that's kind of how I think about it. You know, from a target market perspective, You know, we, you know, we continue to focus on the same, you know, call it $5 to $30 million EBITDA market. So there hasn't been a change there. We did make a move, I'd say, five years ago, six, seven years ago, to start moving, you know, our subordinated debt and second lien investments, making sure they were in bigger, more stable businesses. And, you And we made that move, and I think that's worked very well, quite frankly. Ability for larger companies, you know, to withstand events, you know, whether they're COVID-19 events or others, are usually, you know, a little bit better, generally speaking, not in all cases, but better. We still obviously are doing some smaller company deals, but more recurring revenue like software, what have you. And we're doing a lot of those more on a first lien basis. So we've made that, you know, I'd say structural change in alignment, if you will. So that's how we've managed it. But I, you know, our focus has not changed, you know, pre-COVID versus post-COVID. Other than I'd say during the COVID environment, we very much were focused on first lien and, you know, obviously risk mitigation. And we're still in this environment. We're still continuing that. And what I would tell you is I don't expect to change that as we move forward. I think our client base are, you know, very – they're embracing, you know, the solutions that we're providing. So I think we're on a good path from that perspective. Hopefully that's helpful.

That is helpful, and I appreciate you taking my question. Thank you.

Thank you. Good talking to you, Mickey.

Likewise.

At this time, there are no further questions. I would like to turn the call back over to Ed for closing remarks.

Thank you, Lisa, and thank you, everyone, for joining us this morning. We look forward to speaking with you on our second quarter call in early August 2021. Have a great day and a great weekend.

This concludes today's conference. You may now disconnect.