Fidus Investment Corporation

Good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the FIDUS Quarter 3 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, again, press star 1 on your telephone keypad. Thank you. Jody Berfening, you may begin your conference.

Thank you, Abby, and good morning, everyone, and thank you for joining us for FIDUS Investment Corporation's third quarter 2022 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. Finest 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 4, 2022, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of the 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.

Good morning, Jody, and good morning, everyone. Welcome to our third quarter 2022 earnings conference call. On today's call, I'll start with a review of our third quarter performance in our portfolio at quarter end. and then offer you an update of our views on market conditions in the lower middle market. Shelby will cover the third quarter financial results in our liquidity position. After we have completed our prepared remarks, we'll be happy to take your questions. For the third quarter, our portfolio delivered strong results, generating a 27% increase in adjusted NII on a larger debt portfolio with higher yields and net realized gains of $40 million or $1.64 per share from monetizing a meaningful portion of our equity portfolio. We ended the quarter in a net originations position with a portfolio that overall remains healthy even in the face of higher interest rates, persistent supply chain and inflationary challenges, and the potential for a recession. Although deal activity is slowing down relative to the high velocity we experienced last year, ample opportunities in the lower middle market that meet our investment criteria continue to be available to us. As a result, we continue to redeploy proceeds from equity realizations into income-producing assets, further building our debt portfolio while adhering to our proven strategy of investing in high-quality companies that operate in industries we know well generate cash flow to service debt and support growth, and possess resilient business models and positive long-term outlooks. Adjusted net investment income, which we defined as net investment income excluding any capital gain incentive fee, the tributal to realized and unrealized gains and losses was $12.7 million, or 51 cents per share. an increase of $2.7 million, or 11 cents per share, compared to last year. Growth in adjusted NII reflects both an increase in debt investments under management and higher yields at quarter end. Compared to the second quarter, debt yields increased 100 basis points. NAB was $474.4 million, or $19.41 per share, at quarter end. For the third quarter, FIDUS paid a base dividend of $0.36 per share and a supplemental dividend of $0.07 per share. In August, the Board also declared a base dividend of $0.36 per share and a minimum supplemental dividend of $0.07 per share for the fourth quarter. This skewed NAV at quarter end as the fourth quarter dividend declaration was recognized for GAAP purposes in the third quarter. As a reminder, the early declaration of a fourth quarter dividend was intended to satisfy the distribution requirement of our 2021 investment company taxable income. Adjusting for the early declaration of the fourth quarter dividend, NAV at quarter end was $19.84 per share for a modest increase of $0.04 compared to $19.80 per share at the end of the second quarter. As of September 30th, our spillover income is estimated to be $2.86 per share. On last quarter's call, I mentioned that we were evaluating a variety of options with respect to our excess of spillover income, including increasing the base dividend, payout of incremental supplemental dividends, a special cash distribution, and or a deemed distribution. In evaluating these options and looking ahead to 2023, we've carefully assessed our ability to continue delivering stable to growing dividends to our shareholders while retaining liquidity to grow NAV over the long term. If we look at the portfolio today in light of the recent period of high levels of M&A and investment activity, we have successfully built our debt portfolio on a fair value basis from $549.8 million as of December 31, 2021, to $747.3 million as of September 30, 2022, in part by redeploying proceeds from equity realizations into income-producing assets. In addition, since the beginning of 2020, we have generated proceeds from equity realizations totaling $192.3 million and accumulated net realized gains of $155.3 million. Based on this performance and our strong liquidity position, we believe we are well positioned to continue growing adjusted NII extending our track record of generating cumulative adjusted NII in excess of cumulative base dividends. For the fourth quarter, the Board of Directors has increased the supplemental dividend to $0.15 per share and declared a special cash dividend of $0.10 per share for a total cash dividend of $0.61 per share. The fourth quarter dividends will be payable on December 16th, 2022 to stockholders of record as of December 2nd, 2022. For the year, we will have paid shareholders total cash dividends of $2 per share, a 25% increase over the prior period. For 2023, our board has approved a dividend policy that encompasses a base dividend, a supplemental dividend, and a special cash dividend. First, with respect to the base dividend, I am pleased to announce that the Board has decided to increase the base dividend to 39 cents per share, restoring our pre-COVID base dividend. In addition, we will retain our formula for calculating a supplemental dividend equal to 100% of the excess adjusted NII over the prior quarter's base dividend. We will also pay out a special cash dividend of 10 cents per quarter. Finally, in order to satisfy the RIC distribution requirements, we will be making a deemed distribution for 2022. While the amount of the deemed distribution will depend on final 2022 results, our planned approach, as we have consistently stated, is to maintain a certain level of spillover in the business to ensure the stability of our base dividend. We plan to communicate more information regarding the 2022 deemed distribution in January 2023. Moving to originations and repayments for the quarter, we invested $107.9 million in keeping with our proven strategy of investing in debt securities to generate recurring interest income and in equity securities to generate a margin of safety and incremental profits. $75.1 million was invested in first lien debt, consistent with our focus on that security. Of the $107.9 million, a total of $82.3 million was invested in six new portfolio companies, comprised of $10.8 million in AmeriWater LLC, a leading provider of water purification systems and aftermarket parts and consumables, for health care and industrial applications, consisting of $7.8 million in first lien debt, $2 million in subordinated debt, and $1 million in common equity. $21 million in BP Thrift Buyer LLC, a thrift store operator specializing in the sale of secondhand merchandise, consisting of $20 million in first lien debt and $1 million in common equity. $7.2 million in second-ling debt of Magenta Buyer LLC, doing business as Trellix, a global cybersecurity company. $27 million in first-ling debt of MBS Opco LLC, doing business as Marketron, a leading provider of enterprise software solutions for radio and television broadcasters. $11.5 million in OnePath Systems, LLC, a leading provider of a full suite of managed IT services, consisting of $11 million in first lien debt and $.5 million in common equity. And $4.8 million in second lien debt of SonicWall U.S. Holdings, Inc., a global provider of network and access security solutions. The remaining $25.6 million was comprised of add-on investments in eight existing portfolio companies, including a $10 million subordinated debt investment in Fansteel. In terms of repayments and realizations in the third quarter, we received proceeds totaling $60.2 million, of which monetization of equity investments accounted for $43 million, or a little more than 70% of the total. As you may recall, some of our portfolio companies had initiated strategic alternative discussions toward the end of 2021. In terms of sales and exits, we received a distribution on our common equity investment and realized a gain of approximately $1.9 million related to the sale of Palisade Company, LLC. We received a distribution on our common equity investment and realized a gain of approximately $3.2 million related to the sale of Bandon Fitness Inc. We received payment in full of $4.5 million on our first lien debt investment in Bedford Precision Parts LLC. We received a distribution on our common equity investment and realized a gain of approximately $9 million related to the sale of SES Investors LLC, doing business as SES Foam. We received payment in full of $5.3 million, including a prepayment penalty on our first lien debt investment in HealthFuse LLC. We sold a portion of our equity investment in Fansteel and realized a gain of $24.3 million. In conjunction with the transaction, we invested $10 million in subordinated debt, and we received a distribution on our equity investment and realized a gain of approximately $1.4 million, related to the sale of the transonic companies. With originations exceeding repayments, the fair value of the portfolio quarter end reached $856.9 million, a record level and equal to 103.6% of cost. We ended the third quarter with 75 active portfolio companies and 13 companies that have sold their underlying operations. Debt investments reached $747.3 million, demonstrating continued success in building our debt portfolio this year. In fact, our debt portfolio as of September 30, 2022, is now $197.5 million larger than it was as of December 31, 2021, on a fair value basis. Similar to the second quarter, the total portfolio mix on a fair value basis continued to shift in favor of debt investments, largely as a result of equity monetization. As of September 30th, debt investments comprised 87%, the total compared to 83% as of June 30th and about 80% as of March 31st. First lien debt as a percentage of debt has held steady at around 66%. Equity investments as a percentage of the total portfolio on a cost basis was 7.1% within the boundary of our target allocation of 10%. Taking into account the changes to the portfolio this quarter from net originations and the rotation of equity to debt investments, overall our portfolio remains healthy with credit quality solid and well-structured, to produce recurring income and through our equity investments to provide us with not only incremental profits, but also a reasonable margin of safety. With resilient business models designed to weather adverse economic conditions and geopolitical uncertainties, the vast majority of our portfolio companies are performing reasonably well, even in the face of ongoing inflationary cost pressures and supply chain disruption. However, risk is a bit elevated compared to the beginning of the year as these tougher economic conditions are weighing more heavily on select companies. In the third quarter, we experienced modest depreciation in our debt portfolio due to calibration and the financial performance of various companies. We did not place any conditional companies on non-accrual. And as of September 30th, non-accruals accounted for less than 1% of our total portfolio on a fair value basis. We will continue to proactively monitor operations of our portfolio companies, especially in light of current market headwinds. Subsequent to quarter end, we invested $1 million in common equity of EBL LLC, which was acquired under a new holding company, FOM Eblen's, Holdings LLC doing business as Eblens and became a controlled affiliate investment. In conjunction with the transaction, we amended the terms of our second lien debt investment and committed up to $0.4 million in incremental common equity. In addition, we exited our debt investment in UPG Company LLC. We received payment in full of $17 million on our first lien debt, which includes a free payment fee. We also exited our debt and equity investment in OMC Investors LLC, doing business as Ohio Medical Corporation. We received payment in full of $5.2 million on our second lien debt, which includes a prepayment fee. We received a distribution on our equity investment for a realized gain of approximately $0.7 million. Finally, we invested $6 million in second lien debt of Education Insights, LLC, doing business as Acceleration Academies, a leading provider of alternative education academies focused on high school dropout recovery throughout the United States. As we enter the last quarter of the year, we remain well positioned to continue building our portfolio in the current economic environment without sacrificing credit quality due to the strength of our rigorous underwriting standards, strong relationships with deal sponsors, and industry knowledge. For this reason, even with deal activity slowing down in the lower middle market, we remain optimistic about our opportunities to grow our debt portfolio for continued adjusted NII growth. While we are focused on growth, we will, as always, be patient and deliberate in our selection of investments in high-quality companies, and we will continue to structure our debt investments with a high percentage of equity cushions. Our focus on managing the business for the long term continues to serve us well, supporting our goals of preserving capital and generating attractive risk-adjusted returns for our shareholders. Our performance over the past two years positions us to continue delivering shareholder value through increased cash dividends while growing NAV over the long term. Now I'll turn the call over to Shelby to provide some details on our financials and operating results.