Fidus Investment Corporation (FDUS) Q4 FY2025 Earnings Call Transcript & Summary

Good day, and welcome to the Fidus Investment Corporation's Fourth Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jody Burfening. Please go ahead.

Thank you, Dave, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's Fourth Quarter 2025 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, February 27, 2026, 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.

Good morning, Jody, and good morning, everyone. Welcome to our fourth quarter 2025 earnings conference call. On today's call, I'll start with a review of our fourth-quarter performance and our portfolio at quarter end and then share with you our outlook for 2026. 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. During the fourth quarter, deal flow was strong, driven by a healthy M&A environment compared to earlier in the year. This resulted in originations of $213.7 million, the highest amount of capital we have invested in a quarter. From our perspective, this quarter's surge in originations was primarily related to the demand that had been pent-up since Liberation Day was announced last April, which essentially froze decision-making across wide swaths of the economy and activity in the M&A market for a period of time. Once rattled markets began to settle down early in the summer, deal flow picked up in the third quarter. Also contributing to the fourth quarter surge for Fidus were a few deals that spilled over from the third quarter. Over the course of 2025, we invested a total of $498.2 million in new and existing portfolio companies, a higher amount than in 2024. Net originations in 2025 amounted to $210.2 million. As a result, we grew the total portfolio to $1.3 billion on a fair value basis extending our track record of steady portfolio growth since we went public in 2011. As we further build the portfolio, we continue to apply our strict underwriting standards in selecting investments in niche market leaders in the lower middle market with proven business models that generate recurring revenue and cash flow, coupled with well-defined value creation strategies. In addition, we continue to structure our debt investments with significant loan-to-value cushions. Fidus's debt portfolio continued to perform well in the fourth quarter. Adjusted NII grew 5.1% to $19.4 million, boosted by higher average income-producing assets and a 60% increase in fee income compared to the prior year Q4 2024. On a per share basis, adjusted NII was $0.52 compared to $0.54 for Q4 2024. We continue to overearn our base dividend of $0.43 per share and continue to pay out excess earnings. Total dividends paid in the fourth quarter were $0.50 per share. We ended the year with estimated spillover income of $1.01 per share. For the first quarter of 2026, the Board of Directors declared a total dividend of $0.52 per share, which consists of a base dividend of $0.43 per share and a supplemental dividend of $0.09 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 30, 2026, to stockholders of record as of March 20, 2026. Net-asset-value grew 13.2% to $741.9 million at quarter end compared to $655.7 million as of December 31, 2024. On a per share basis, net-asset-value was $19.55 as of December 31, 2025, compared to $19.33 as of December 31, 2024. With respect to originations in the fourth quarter, $121.5 million or a little more than half of the $213.7 million in total originations was invested in 8 new portfolio companies, primarily in connection with M&A transactions. We invested $206.5 million or 97% in first lien securities. In addition, we invested $3.2 million in equity securities, giving us opportunities to enhance returns. Proceeds from repayments and realizations totaled $84.7 million for the fourth quarter, resulting from a mix of M&A and refinancing activity. Subsequent to the quarter end, we have invested an additional $7 million in one new portfolio company, executed numerous small add-on investments and realized a $3.4 million gain on the exit of our equity investments in CIH Intermediate, LLC. We ended the year with a portfolio totaling $1.3 billion on a fair value basis, equal to 102% of cost. First lien investments comprised 86% of our debt portfolio, reflecting the ongoing migration of our debt portfolio towards first lien securities, and our equity portfolio stood at $142.3 million or 10.7% of the total portfolio on a fair value basis at quarter end. Our portfolio remains well diversified by industry, consisting of a mix of manufacturing, distribution and services companies. Given the current environment, we wanted to address our software and tech-enabled services portfolio. Worth noting, we have been investing in software companies for over 10 years at Fidus alongside leading private equity firms, and it's been a strong performing industry vertical for us. As with all investments we make, we underwrite with an acute focus on determining the value proposition of a business and its overall durability, meaning its ability to thrive and generate cash flows over our investment period and beyond. With regard to software-related businesses, this includes evaluating and ultimately getting comfortable not only with the company's growth prospects and market position, but importantly, each company's technology was risk, including AI risk over the past 3 years or so. At Q4 2025, our software and tech-enabled services portfolio, so our portfolio exposed to AI opportunities and risks was $464 million, which comprised of 92% first-lien debt, 4% junior debt and 4% equity. This portfolio is well diversified across 28 total names and all but one are backed by financial sponsors we know well who have significant expertise in the space, resulting in an average exposure per name of $17 million. The weighted average loan-to-value for this portfolio was 37%, well below our total portfolio weighted average loan-to-value of 44%. In addition, substantially all of our first-lien investments are highly structured investments with at least 2 maintenance covenants. In short, we feel extremely good about the health of this portfolio and its long-term outlook. In addition, the characteristics of our overall portfolio remain quite positive from a credit quality and capital preservation perspective. We ended the year with nonaccruals accounting for less than 1% of the total portfolio on a fair value basis and 2% on a cost basis. Overall, our portfolio is healthy and well-structured to deliver both high levels of recurring income and capital gains from monetizing equity investments. In summary, in the fourth quarter and over the course of 2025, we demonstrated that our model clearly continues to work well and that our long-standing sponsor relationships, investment strategy and industry knowledge in the fragmented lower middle market continue to differentiate Fidus. Looking ahead, we are starting the year with a decent level of deal flow. We expect activity levels will pick up during the year as some private equity owners are likely to need to bring certain portfolio companies to market. As we deploy capital, we intend to stay focused on our long-term goals of generating attractive risk-adjusted returns for our shareholders and growing net-asset-value over time. Now I'll 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 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 2025. Total investment income was $42.2 million for the 3 months ended December 31, a $4.9 million increase from Q3, primarily driven by a $2 million increase in interest income as a result of increased average debt investments outstanding and which includes a $0.3 million of accelerated amortization of closing fees related to debt repayments, a $3.5 million increase in fee income given an increase in investment activity in Q4, which was partially offset by a $0.8 million decrease in dividend income from equity investments. Total expenses, including tax provision, were $22.5 million for the fourth quarter, a $2.6 million higher than Q3, primarily driven by a $1.4 million increase in income tax provision related to the annual excise tax accrual in Q4, a $1.8 million increase in interest expense related to higher average debt balances outstanding, including the $100 million add-on to our 6.75% notes due in March 2030 and $0.8 million increase in base management and income incentive fees given increase in assets under management and higher investment activity in Q4, offset by a $0.6 million decrease in the capital gains fee accrual and a $0.5 million decrease in G&A expenses. G&A expenses in Q3 were higher due to some onetime items related to the exit of our former debt investment in U.S. GreenFiber. Net investment income or NII for the 3 months ended December 31 was $0.53 per share versus $0.49 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 $0.52 per share in Q4 versus $0.50 in Q3. For the 3 months ended December 31, we recognized approximately $1.5 million of net realized losses related to a realized loss on the exit of our debt investments in U.S. GreenFiber, which was partially offset by realized gains related to the sale of our equity investments in Aldinger Company and Garlock Printing and Converting. We ended the quarter with $658.3 million of debt outstanding, comprised of $237.5 million of SBA debentures, $325 million of unsecured notes, $83.9 million outstanding on the line of credit and $12 million of secured borrowings. Our net debt-to-equity ratio as of December 31 was 0.8x. Our statutory leverage, excluding exempt SBA debentures was 0.6x. The weighted average interest rate on our outstanding debt was 5.2% as of December 31. Turning now to portfolio statistics. As of December 31, our total investment portfolio had fair value of $1.3 billion. Our average portfolio company on a cost basis was $13.4 million, which excludes investments in 6 portfolio companies that sold their operations or in the process of winding down. We have equity investments in approximately 85.4% of our portfolio companies with an average fully diluted equity ownership of 1.9%. Weighted average effective yield on debt investments was 12.6% as of December 31 versus 13% at the end of Q3. 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 Q4, we used the net proceeds from the $100 million debt add-on to fully redeem the remaining $100 million of unsecured notes due in January '26. In December, we exercised the accordion feature on our line of credit and increased our borrowing capacity from $175 million to $225 million. In Q4, we issued accretive shares under our ATM program and raised $31.5 million of net proceeds. As of December 31, our liquidity and capital resources included cash of $79.6 million, $141.2 million of availability on our line of credit and $84 million of available SBA debentures, resulting in total liquidity of approximately $304.8 million. Now I will 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 Fidus for their dedication and hard work and our shareholders for their continued support. I will now turn the call over to Dave for Q&A. Dave?

[Operator Instructions] Our first question comes from Robert Dodd with Raymond James.

Congratulations on another good quarter. I do want to touch on software, and I think everybody appreciates the extra disclosure you gave on that this quarter. But before I get to that, on the activity levels, I mean, a really strong back half to the year. Is there any -- it seems unlikely to be the case, given what you disclosed about Q1. But is there any spillover of deals given how busy you were in Q4 into Q1? Or should we expect after that ramp and the kind of the release of pent-up demand in the back half of last year, should we expect Q1, maybe Q2 like the first half of '26 to be much more modest in terms of new portfolio company activity maybe? I mean always be some add-ons. But can you give us any color how much of that was in the back half?

Sure, sure. It's a great question. Look, Q4 was a quarter where most things kind of came to fruition, if you will, very different than Q3 for us. And there was a pretty healthy amount of deal flow towards the end of Q3 and then Q4. And again, I think it was pent-up demand. I think now in Q1 ' 26, deal flow is a little more modest in nature. We believe it's somewhat due to seasonal patterns, if you will. And our current expectations are for an increase in both deal flow and activity throughout the year. We are, as we sit here today, working hard on new investment opportunities as well as add-on investment opportunities. And so is Q1 going to be anything like Q4? I don't think so. But I do think investment activity, we'll have some real investment activity here in the last month. I think from a repayments perspective, there'll be some repayments, but less than -- as I sit here today, no crystal ball, but repayments will be less than originations. So our expectation would be some growth this quarter, but nothing like the growth in Q4. So hopefully, that's helpful. It is picking up a little bit, and it will -- we expect it to pick up a fair bit more here as the year goes on.

Perfect. That is very helpful. On the software, and you gave the incremental information that AI has been part of a key risk assessment for 3 years. On -- I mean there's obviously -- can you give us any type of businesses? Because obviously, there's a big potential difference in risk between something that's a piece of application for software that just sits on top of an OS somewhere versus something that might be running the operations at a specialty manufacturing plant or something like that. Obviously, those face very different risks. So can you give on a pretty extreme example. Can you give us some color on like the type of businesses that you have? I mean, yes, you expect them to thrive, you expect them to be resistant, but why?

Sure, sure. Well, let me -- it's an important topic. So -- and let me give you some more thoughts. So I mean, first and foremost, let me say that we believe the recent headlines, although meaningful and serious, the market dislocation in software has been blown out of proportion from our perspective. When we think about software companies and AI risk, it's important to remember that not all businesses are the same, right? There are varying degrees of quality out there, and that has to do with really every type of lower middle market company or larger market company for that matter. For us, we look for characteristics that provide long-term barriers to entry, elements that help protect the viability and durability of the company's value proposition. And ultimately, it's revenues and cash flows. So what are we looking for? We're looking for companies that have things like data moats. So think about enterprise solutions that serve as a system of record for critical operating data, which is hard to replicate. Think about vertical markets, specialized industry software that is complex and requires deep industry and process expertise, regulated sectors, software that tracks, audits and secures data, deep relationships, so contractual revenue streams, trusted customer relationships, which typically creates high switching costs. And then obviously, management. Management is critical. You want a management team that is leveraging their market positions and their incumbency position to embrace change and create value for their customers. So those are the types of things we look for from a qualitative perspective. And then just to touch a little bit more on the portfolio. Some of this will be duplicative, but all deals are backed by high-quality sponsors with proven track records in the space. That's a critical component for us. Nearly all of our portfolio companies are currently adding AI features to products and using AI tools to reduce operating costs. Nearly all of our portfolio debt investments are structured as first liens. Our current weighted average loan-to-value for this portfolio is 37%. The current average contractual duration, so maturity date is approximately 2.5 years for our software and tech-enabled services portfolio. And lastly, the portfolio is performing very well and currently marked all the debt investments as a whole at 100% of cost. So we feel good about it. Hopefully, that gives you some more color and some context on the types of things we look for.

And the next question comes from Mickey Schleien with Clear Street Capital.

Ed, thanks for the insight into your software sector. I just want to ask whether that -- whether Fidus has any focus on ARR loans? Or are these mostly cash flow loans?

No, ARR loans are part of our portfolio and have been a focus. And the context I would give you, about 22% of our software portfolio today or 7.5% of our total portfolio are ARR loans as we sit here today. A few of those -- a few that aren't in that percentage were previous ARR loans that are now EBITDA loans. So when we structure an ARR loan, we force growth through covenants. We have covenants that require growth. And we also force a transition to cash flow, meaning EBITDA positive and EBITDA support for the interest expense as we move forward.

And Ed, 3% of the portfolio's value is in Pfanstiehl, and you've held that a long time. It's a great -- been a great investment. But it's your largest single investment. And I'd like to understand how comfortable you are holding it at this level from -- just from the perspective of portfolio risk.

It's a great question. It is -- I guess, in short, in summary, we are extremely comfortable with that position. I think the long-term outlook for that business, they're a leader in their space. And I think it's a growing business and their portfolio of products are also growing. And again, they're differentiated in the market, and we see that -- them being able to maintain that differentiation. So I feel great about the business and the outlook. And I hear you on that, but I think we're very comfortable with the position today. And obviously, there will be a day when we will look to monetize it, but we feel good about it today.

And the outlook for dividends from Pfanstiehl, I think you had 2 quarters of dividends in 2025. Can we expect that to continue? Or are they in growth mode and they need to reinvest their capital?

Yes. It's a great question. We -- as you know, we're not in control of those dividends at all. And so I would view them as more episodic in nature, but also reoccurring annually in some way, shape or form. That's what the history has been, and that's what our expectation would be going forward. And I think the last point I would make is they're very well positioned to make distributions, meaning very underlevered to no leverage and plenty of liquidity to do those types of things.

And my last question, can you give us an update on the average floors in your floating rate debt portfolio? In other words, how much exposure do you have to still declining forward SOFR curve?

Sure, sure. Most of our floors that we've been originating here over the last, let's say, 3, 4 years are in the 2% range, Mickey. So that's kind of somewhat of a market convention from our perspective, but that's a large majority of what we have today.

So if the Fed were to cut a couple more times this year, that would still flow into your -- flow through your portfolio?

Yes, it would. Now remember, we have about 25% of our debt investments are fixed rate debt investments. So not 100% flow-through. But yes, we do have -- if SOFR is reduced this year, then the answer to that is yes. We would expect some decline in total yields, if you will.

And the next question comes from Christopher Nolan with Ladenburg Thalmann.

On your comments earlier in terms of increased deal flow from M&A and so forth, is this really driven just by private equity firms seeking to get an exit so they can get liquidity back to their LPs? Or do changes in the tax or regulatory structure start affecting some of this deal activity?

Yes. Great question. I would say a large preponderance of the comment comes from more just pent-up demand from a PE perspective. The average hold for the PE portfolio has expanded, as you know, and there is a desire for LPs to get capital back. And that is probably -- is the biggest driver by a long shot from our perspective.

And then a follow-up for Robert -- and a follow-up on the software questions from Robert. Are you seeing that the software companies are deleveraging or are private equity firms trying to just unload them? I'm just trying to get a sense as to what they're doing financially.

Sure, sure. Great question. From our perspective, what we're seeing in our portfolio is growth, which is what you would expect, and it's a critical component of our underwriting. So we are seeing deleveraging, whether it's an ARR loan or it's EBITDA-based loan. And -- but we -- at the same time, we're seeing sponsors continue to look at high-quality software names, and we are also looking at them. I mean I think in the lower middle market and what we are experiencing is at the lack of a better word at the operating level and we're financing transactions and what have you, it's somewhat status quo. I mean I think -- look, everyone kind of is fully aware of the concerns out there. We have been aware of the concerns and the bar probably only gets higher for everyone, including us. But we feel very good about the portfolio and the outlook of the portfolio. And so no one's doing anything drastic or reacting in a huge way. Clearly, if you get into the liquid markets, that's different, right? A lot of loans have traded down. Some folks are taking advantage of them. Some folks are trying to loosen up their exposures, if you will. But that's not the market that we play in, and we are kind of one investment in a time and really working with each portfolio company. But again, we're not seeing performance issues right now. And so it's -- hopefully, that gives you some context and it's helpful.

[Operator Instructions] Our next question comes from Paul Johnson with KBW.

I'm just curious, within the lower middle market, from your experience, either -- whether it's observations of other restructurings or of your -- within your own book, what has been kind of like the typical average or if you will, recovery rate on just a regular first lien kind of direct lending, lower middle market loan historically? And how you think about that in terms of software going forward? Has that traditionally been in line kind of with direct lending recoveries? And with everything going on with compressed EV multiples, et cetera, potentially compressing margins? And what's kind of your thoughts on potential recoveries if we were start to see some turbulence in that sector?

Great question. Look, I think recoveries in the lower middle market are similar to the broader market. I don't have that data in front of me, and I don't want to misspeak. But I think in first-lien loans, recoveries have been generally more in the 60% to 85% range, depending on a vintage or what have you. And we feel -- we're not -- it's very interesting and fully understand the risks and are paying attention more than most, I would argue. But we're not seeing the concerns that obviously are in the marketplace, as I stated at the beginning of the discussion with Robert. And we feel good about -- and we don't see changes in recoveries or drastic changes in values of businesses. Clearly, today, a lot of software companies, my guess is the equity value has been hit by what's going on in the market. But again, our -- at 12/31, our loan-to-value is 37% -- so there's a huge cushion there between 37% and our security to kind of weather a storm. And we would -- we don't think these companies -- these are very value-added, high-quality businesses that we've invested in. We don't see the value just dissipating overnight by any stretch of the imagination, quite frankly. So if there were problems, I would expect them to kind of react in a similar fashion as you would a normal kind of restructured deal or bad deal, if you will, from a recovery perspective. Hopefully, that's helpful. I'm just trying to give you a little color.

And the next question comes from [ Dylan Haynes ] with B. Riley Securities.

Great quarter. I was wondering about software and tech names just in terms of deployments and like what the private markets are looking like, given like the BDC headlines and more on the specific tech names, how this impacted pricing and yield? Is there anything -- any new trends that you could take advantage of for deployments?

Sure. Great question. What I would say there -- we are continuing to look at best-in-class software names, niche market leaders that have competitive position and quite frankly, product and service positions that are differentiated enough to get us comfortable to invest. And so we are looking for those kinds of names. We do expect there to be, and I'm looking forward, it's not really happened yet. But we do expect there to be some unique opportunities that come about due to the recent dislocation in the market. I do think it will trend down a little bit. And so we are -- though we think our overall portfolio positioning is kind of where we want it. But we -- if the right opportunities come along at the margin, we are interested in and continuing to invest in the sector, and we'll do so at the margin. And so it's a focus of ours. It's something we've had a lot of success with. There are very differentiated companies and opportunities out there, and we want to continue to focus on that group. And so if they come up, yes, we will try to take advantage of it. The public markets, that's a different -- and the liquid software names that you see from a debt perspective, that's a different market, different underwrite, different type of situation. And it's really not kind of the market we play in or what we're seeing right now. But we do expect some dislocation.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Ed Ross, CEO, for any closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.