Earnings Call Transcript - FDUS Q1 2025

Operator, Operator

Good day and welcome to the Fidus First Quarter 2025 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jody Burfening from Alliance Advisors. Please go ahead.

Jody Burfening, Alliance Advisors

Thank you, Danielle and good morning everyone, and thank you for joining us for Fidus Investment Corporation’s first 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, May 9, 2025, 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, CEO

Good morning, Jody and good morning everyone. Welcome to our first quarter 2025 earnings conference call. On today's call, I'll start with a review of our first quarter performance and our portfolio at quarter end and then share with you our outlook for the rest of 2025. Shelby will cover the first quarter financial results and our liquidity position. After we have completed our prepared remarks, we'll be happy to take your questions. In the first quarter, deal activity in the lower middle market was at more modest levels, continuing the lackluster M&A trends we have been seeing, including a couple deals held over from the fourth quarter. We continue to build our debt portfolio on the strength of our durable sponsor relationships, proven industry expertise and investment experience, carefully and deliberately selecting portfolio companies that fit our strategy of investing in high-quality companies with resilient business models, strong cash flow generation and achievable prospects for growth. Consistent with our strategy, we co-invested in the equity of nearly all of the new portfolio companies. As a result, at quarter end, assets under management stood at approximately $1.2 billion on a fair value basis, up 6% compared to December 31, 2024. Adjusted net investment income for the quarter was $18.5 million compared to $18.1 million in the prior year Q1 2024. On a per share basis, adjusted NII was $0.54 compared to $0.59 for the same period last year, including the impact of incremental shares issued under our Equity ATM program over the past 12 months. Net asset value was $677.9 million, or $19.39 per share at quarter end compared to $655.7 million or $19.33 per share as of December 31, 2024. For the first quarter, dividends paid totaled $0.54 per share, consisting of the base dividend of $0.43 per share and a supplemental dividend of $0.11 per share. For the second quarter of 2025, the Board of Directors declared a total dividend of $0.54 per share, which consists of a base dividend of $0.43 per share and a supplemental dividend of $0.11 per share equal to 100% of the surplus in adjusted NII over the base dividend from the prior quarter, which will be payable on June 25, 2025, to stockholders of record as of June 13, 2025. Originations totaled $115.6 million for the first quarter, $102.1 million of which was invested in seven new portfolio companies. Reflecting our practice of investing in industries we know well, most of our investments in new portfolio companies focused on business service companies with relatively high enterprise value multiples, and we continued to structure our debt investments with attractive loan-to-values well less than 50%. Debt investments totaled $111.6 million. First lien securities accounted for approximately 94% of the total. We co-invested in the equity of six of the new portfolio companies for a total of approximately $4 million. Subsequent to quarter end, we invested $5.8 million in first lien debt and equity in another new portfolio company. Proceeds from repayments and realizations totaled $57.3 million for the first quarter and we monetized equity investments in two portfolio companies, Medsurant Holdings and Healthfuse, both of which have been evaluating strategic alternatives for a realized gain of $13.3 million. With $58.3 million in net originations for the first quarter, our total portfolio on a fair value basis increased to approximately $1.2 billion, equal to 100.5% of cost. Our debt portfolio totaled approximately $1 billion on a fair value basis, 79% of which consisted of first lien investments, and our equity portfolio stood at $137.8 million, or 11.9% of the total portfolio at quarter end. Our portfolio is well diversified and is structured to produce both high levels of recurring income and the potential for capital gains from our equity investments. From a credit quality perspective, the portfolio remains healthy with companies on nonaccrual remaining under 1% of the total portfolio on a fair value basis and 3.9% of the total portfolio on a cost basis. With respect to the macroeconomic challenges and uncertainties associated with the Administration's current trade policies, we believe our portfolio companies are reasonably insulated from the stresses and challenges that may lie ahead. Not only are they domestic businesses with limited tariff exposure, but the vast majority of them are niche market leaders with pricing power and proprietary services and products, and they have effective risk mitigation levers to pull as necessary. While M&A activity overall is currently slowing down because of market turbulence, a fluid macroeconomic environment and a higher level of uncertainty, we have a decent outlook for originations in the second quarter based on our new investment pipeline, which consists of both new investment opportunities and add-on investments in existing portfolio companies. As we look forward, we believe we are well-positioned from a capitalization and liquidity position as we expect a more interesting investment environment, which we have experienced historically in periods of high volatility. And should economic conditions deteriorate, our debt portfolio is well-positioned to weather a storm, as a vast majority of our portfolio companies possess resilient cash flow generating business models that can absorb economic stresses and possess moderate leverage levels and robust equity capitalizations. As in the past when we faced uncertainties and challenges, our philosophy of managing the business cautiously and deliberately in the long-term interest of our shareholders keeps us active and focused on generating attractive risk-adjusted returns while preserving capital. Now I'll turn the call over to Shelby to provide some details on our financial and operating results.

Shelby Sherard, CFO

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 2024. Total investment income was $36.5 million for the three months ended March 31, a $1 million decrease from Q4 driven primarily by a $1.1 million decrease in interest income primarily due to a decline in the weighted average yield on debt investments, a $0.9 million decrease in fee income given a decrease in prepayment and amendment fees in Q1, offset by a $1.1 million increase in dividend income from equity investments. Total expenses, including the income tax provision, were $18.3 million for the first quarter, $5 million less than Q4, driven primarily by a $1.8 million decrease in income tax provision related to the annual excise tax accrual in Q4, offset by a $0.5 million increase in interest expense related to higher average debt balances outstanding and an increase in the weighted average interest rate following the issuance of incremental debt in March 2025 and a $0.2 million increase in management and income incentive fees and a $0.5 million increase in the capital gains incentive fee accrual. Net investment income, or NII, for the three months ended March 31 was $0.53 per share versus $0.55 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 $0.54 per share in both Q1 and Q4. For the three months ended March 31, we recognized approximately $11.5 million of net realized gains net of income tax related to the sale of two portfolio companies. We recognized a gross realized gain of $10.1 million, not including the income tax provision on our equity investments in Medsurant Holdings, and a $3.2 million realized gain on our equity investment in Healthfuse. In March, we issued $100 million of 5-year unsecured debt with a 6.75% coupon and received net proceeds of $96.9 million. We ended the quarter with $545.6 million of debt outstanding comprised of $182 million of SBA debentures, $350 million of unsecured notes, and $13.6 million of secured borrowings. Our net debt-to-equity ratio as of March 31 was 0.7 times. Our statutory leverage excluding exempt SBA debentures was 0.5 times. The weighted average interest rate on our outstanding debt was 4.8% as of March 31. Turning now to portfolio statistics, as of March 31, our total investment portfolio had a fair value of $1.2 billion. Our average portfolio company investment on a cost basis was $12.5 million, 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 85.4% of our portfolio companies with an average fully diluted equity ownership of 1.9%. The weighted average effective yield on debt investments was 13.2% as of March 31 versus 13.3% at the end of Q4. 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 briefly like to discuss our available liquidity. As of March 31, our liquidity in capital resources included cash of $67.5 million, $140 million of availability on our line of credit, $24 million of available SBA debentures, resulting in total liquidity of approximately $231.5 million. As reported later this month, we plan to redeem $25 million of the notes due in January 2026. Now I will turn the call back to Ed for concluding comments.

Edward Ross, CEO

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 Danielle for Q&A.

Operator, Operator

The first question comes from Robert Dodd from Raymond James. Please go ahead.

Robert Dodd, Analyst

Excuse me, sorry. Good morning. Ed, thank you for bringing up kind of like the environment and the tariff issue. I mean, as you said, the vast majority should be reasonably insulated. I mean, have you done any first versus second order effects? I mean, obviously you don't have anybody based overseas, but any color you can give on impacts from your companies that are importing goods versus those doing something in the U.S. but maybe their customers are overseas? Any additional color you can give on the potential exposure there?

Edward Ross, CEO

Sure, absolutely. And good morning, Robert. I'm going to just talk about the portfolio for a quick sec here, but what I would say is, overall we continue to be very pleased with the performance and its overall quality. As always, we have some companies that are exceeding expectations and some that aren't and are underperforming. As we all know, we are experiencing a heightened level of uncertainty, and tariffs have certainly entered the equation in a real way from that perspective. What I would say is Fidus' direct exposure to tariffs is quite limited. Just over 5% of our portfolio has direct material exposure, meaning exposure to China and exposure to other high tariff entities. So that's a pretty small percentage for sure. And I think what's more important is really based on our assessments, and we've discussed and assessed the plans that our high and medium-risk companies have put in place. What I would say is we feel like the situations are very manageable. The plans that are being put in place are prudent. It's not going to be perfect; there is chaos out there trying to deal with the issues. But overall, we feel very good about the portfolio, the plans that the management teams are putting in place, and the long-term outlook for those businesses. So hopefully that's helpful. But I think the percentage is quite low. And more importantly, it is really how our portfolio companies are dealing with the issues and tariffs in particular. What I would say is they are doing so very proactively, and there are risk mitigation levers that can be pulled, and we feel good about.

Robert Dodd, Analyst

Got it. Thank you for that additional comment. And then tied to the things that you described, the M&A market as lackluster, which is not a surprising description, but also not surprising that it is given all these question marks. I mean, harder question, what do you think needs to change for the M&A market to rebound? I mean, is it tariffs going away or is it just, for example, or is it tariff certainty? Or is it the uncertainty that's causing the lackluster market? Or is it the existence of these potential trade barriers that are creating more of the problem there, do you think?

Edward Ross, CEO

It’s a great question, Robert. My view is that it's the uncertainty. I think it is a more uncertain world today, and people are aware of that. With uncertainty, spreads rise, right? Prices go down as we saw in the public markets. Until we have a little more stability, and I think we will, I don't think tariffs have to go away; it's just the stability and then a new level playing field. I do think M&A will come back. The long-term fundamentals for M&A are quite strong, and the current uncertain environment obviously has put a major dent in that market activity. But having said that, I'll also say in the lower middle market we expect continued activity, just at lower levels than even the lackluster levels. There is activity; there's add-on activity. There are plenty of companies that really aren't impacted by tariffs. So we expect to continue to be active, maybe not at robust levels, but we do expect to continue to be active as we move forward. There is a chance that it becomes a pretty interesting investment environment as well, meaning from a higher spread or higher opportunity perspective. That hasn't occurred yet, but there is that chance; in previous periods of high volatility, that has occurred, and so we are prepared for that if it does.

Robert Dodd, Analyst

Thank you for that insight. If I could ask one more question, congratulations on being proactive in addressing next year's maturity. You've essentially pre-funded. Do you believe additional adjustments to your financing structure are necessary ahead of the maturities next year? Given that you have two due, do you think your current actions are sufficient and timely enough to manage everything in the next year and 18 months, or are there more steps you need to take? It's clear that you've acted early, and that's commendable.

Edward Ross, CEO

Sure, sure. Great question. What I would say is, I think we've created some flexibility with the capital raises, and that was the $100 million offering Shelby spoke about, obviously. The ATM program as well raised about $20 million and it created some real flexibility for the near and medium-term. Longer-term, do we need to refinance unsecured notes? I think the answer to that is yes; there are multiple ways to do that. We feel like the offering we did in March was well-received out there, and we feel great about that. So we're well-positioned to deal with the markets and refinancings. But what we have done is created flexibility for the near and medium-term, which was part of the intent. I don't know if Shelby wants to add anything to that.

Shelby Sherard, CFO

No, I would just echo that. I would say ideally I'd like to see us raise additional debt capital in the second half of this year, but if for some reason rates are particularly unattractive or markets are closed, we have other ways of dealing with the remaining $100 million coming due in January of 2026.

Robert Dodd, Analyst

Got it. Thanks a lot.

Edward Ross, CEO

Absolutely, good talking to you, Robert.

Operator, Operator

The next question comes from Mickey Schleien from Ladenburg. Please go ahead.

Mickey Schleien, Analyst

Yes, good morning, Ed and Shelby.

Edward Ross, CEO

Good morning, Mickey.

Mickey Schleien, Analyst

Ed, you mentioned that M&A in the lower middle market is sort of muddling along, but there's also just a tremendous amount of capital being created to serve private credit. Meanwhile, we saw increased risk perception recently leading to stability in spreads. So do you think that spread stability can hold or will the effects of all that capital reappear and drive spreads even lower?

Edward Ross, CEO

Great question, Mickey. I think yes, it is competitive. I think it's less competitive in the lower middle market. What I see today, the spreads for A-plus credits and businesses are probably pretty stable in an environment like this because there is pent-up demand to deploy capital in high-quality situations or very high-quality situations and a real flight to quality. I also think if there are some scratches or scars on a portfolio company's armor or a potential portfolio company's armor, there may be opportunities for spread widening in a market like this. I don't think it will be in a huge way by any stretch of the imagination, but in more complex situations, if you will. I think it'll remain competitive absent further negative changes. But at the same time, the M&A market is not dead; it's just down. There are some companies that need to wait, and there are some companies that don't. We are continuing to be active and busy, just not at robust levels overall. Spreads, though, I don't expect big changes, but I think it's really asset dependent at the end of the day.

Mickey Schleien, Analyst

Thanks for that explanation, Ed. Looking at your portfolio, the proportion of your portfolio companies rated 1 has increased to 12%. Those are obviously your best performers, which is great. But it leads me to ask how much prepayment risk there is among those companies and how much comp protection do you have in the investments you've made in those companies?

Edward Ross, CEO

Sure, sure. So prepayment risk continues to be something that I think everyone deals with and we clearly have to deal with. We had one mezzanine security that was prepaid last quarter; it should have been, it was very low leveraged and EBITDA had grown exponentially. And then we do have one company that's under contract to be sold, so we expect that to happen. That's both a debt and equity investment. We do have a couple of companies in our portfolio right now that we expect to be refinanced out of. So it's both M&A and refinancings, which is a typical quarter, and I think we've got a very high caliber portfolio. That will continue. We've been dealing with it for a long, long time, and it's just part of the business, but it's clearly transpiring in today's market for sure.

Mickey Schleien, Analyst

Okay, I understand. My last question relates to Quest Software, which has been marked at pretty distressed levels for a couple of quarters. I realize this is a second lien, but I'm curious what the challenges are there and do you expect that credit to remain on accrual?

Edward Ross, CEO

That's a great question, Mickey. You know, Quest is a full suite provider of cybersecurity solutions for both large and small companies and government entities. This is a much larger and probably the only large business in our debt portfolio. As we sit here today, we believe the long-term outlook here is solid. We also think the company is over-levered and is dealing with the impact of higher interest rates for an extended period of time. The market is concerned about a potential LME event, liability management execution, which has really hurt the valuations of the loans in the secondary market. However, there has been a recent uptick in LMEs in the BSL market, which is very unfortunate. There was a court ruling at the end of last year that really dampened the aggressiveness of such LME transactions. So that's good and arguably necessary. The risk profile of our investment is reflected in the valuation. There's some risk there, but we actually have a strong belief in the long-term outlook of that business and of that investment. Hopefully, that's helpful.

Mickey Schleien, Analyst

Yes, that is; I appreciate that explanation. Those are all my questions this morning. I hope you have a good weekend.

Edward Ross, CEO

You too, Mickey. Good talking to you.

Operator, Operator

The next question comes from Sean Paul Adams from B. Riley Securities. Please go ahead.

Sean Paul Adams, Analyst

Hey guys, good morning.

Shelby Sherard, CFO

Good morning.

Edward Ross, CEO

Hey, good morning, Sean Paul.

Sean Paul Adams, Analyst

Thank you. Most of my questions were already answered, but on Quantum IR, I know it was at its nonaccrual last quarter, and you guys were last out first lien holders. But can you provide any sort of update on this investment? I also see that there was a continued write-down in Vertex and Suited Connector.

Edward Ross, CEO

Yes. Regarding Quantum IR, there really isn't a material update other than we continue to have all hands on deck on that situation. As I mentioned, I think last call, there have been a series of pretty company-specific and very negative events that have impacted our debt and equity investments here. What I’d say is the risk profile of our investments is reflected in the value of our debt and equity investments on our balance sheet. For the other two names you just mentioned, I don't think there's anything big that has changed; both companies are operating and are doing decently well, but you have ups and downs from quarter to quarter, and that really reflects in the valuation. Nothing that we see as a significant change at the moment. Both companies are stable, and we and the management teams and the other capital providers in those situations are continuing to work well to move things forward. No update other than just typical quarter-to-quarter performance issues.

Sean Paul Adams, Analyst

Got it. I appreciate the color. Thank you.

Edward Ross, CEO

Absolutely. Good talking to you, Sean Paul.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Ed Ross for closing remarks.

Edward Ross, CEO

Thank you, Danielle, and thank you everyone for joining us this morning. We look forward to speaking with you on our second quarter call in early August 2025. Have a great day and great weekend.

Operator, Operator

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