Gladstone Investment Corporationde Q2 FY2020 Earnings Call

Greetings, and welcome to the Gladstone Investment Corporation Earnings Call for the quarter ended September 30, 2020. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. David Gladstone, Chief Executive Officer. Thank you, sir. You may begin.

Okay. Well thank you, Donna and good morning to everyone out there. This is David Gladstone and this is the second quarter ending March 31, 2021, as we begin the year. This is the conference call for shareholders and analysts of Gladstone Investment, which is listed on NASDAQ under the trading symbol G-A-I-N for the common stock. We also have two preferred stocks, G-A-I-N-M and G-A-I-N-L. Thank you all for calling in. We're always happy to provide an update to our shareholders and analysts, give our view on the current business environment. Two goals, of course, are to help you understand what's happening and give you a glimpse of the future as we see it. Now, we will hear from our General Counsel and Secretary, Michael LiCalsi. Mike?

Good morning, everyone. Today's call may include forward-looking statements under the Securities Act of 1933 and Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties and other factors, even though they are based on our current plans, we believe are reasonable. Many factors may cause our actual results to differ materially from any future results expressed or implied by these forward-looking statements, including all risk factors listed on our Forms 10-Q, 10-K, and other documents we filed with the SEC. You can find these on our website www.gladstoneinvestment.com or on the SEC's website at www.sec.gov. We undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. Please also note that past performance or market information is not a guarantee of any future results. Again, please visit our website, gladstoneinvestment.com, and sign up for our email notification service. You can also find us on Twitter @GladstoneComps, or on Facebook with the keyword The Gladstone Companies. Today's call provides an overview of our results through September 30, 2020, so we ask you to review our press release and Form 10-Q, both of which were issued yesterday for more detailed information. With that, I'll turn the presentation over to Gladstone Investment's President, Dave Dullum. Dave?

Great. Thanks, Mike, and welcome, good morning to all our shareholders and analysts. We appreciate you being on. We're pleased today that we can report good operating results for the quarter ended September 30, 2020. Considering the past six months and the ongoing challenges due to COVID-19, we are very pleased with our current position and our outlook going forward. We ended the quarter with adjusted net investment income of $0.15 per share, compared to $0.11 per share for the quarter ended June 30, 2020. On a comparative basis, our total portfolio income has improved, in part due to the resumption of some interest on certain portfolio company debt securities that we had to adjust somewhat as a result of COVID. We are now back to, in some cases, our pre-COVID levels, which is positive. Additionally, we made one acquisition, a company called Mason West Industries, which adds to our income stream along with an investment in equity. Our primary operating focus continues to be close monitoring of our portfolio companies, with an emphasis on cash flow and working capital dynamics during this challenging time. We've not needed to provide much additional financial support to our portfolio companies, which is a good sign. At the same time, we are focused on rebuilding our portfolio, given that we had significant exit activity last year, which reduced assets in a good way and the slowdown in new investment activity since COVID. In July, we made a new buyout investment through a combination of equity and debt. Our net asset value for the quarter was $10.86 per share, consistent with the prior quarter. Touching briefly on pandemic actions, we proactively engaged with the management teams of our portfolio companies, providing support related to HR, legal issues, and financial concerns. While we're still engaged with our companies on pandemic-related issues, attention is now turning to forward planning for their 2021 budgets and new acquisitions. Our aggregate portfolio fair values have stabilized since the initial effects of the pandemic, although market multiples' recovery has been slower. Overall, our portfolio values have increased quarter-over-quarter. Our balance sheet remains strong with low leverage, positioning us well to assist our companies as necessary. Most of the debt securities in our portfolio are performing well, while the valuation impact has been more pronounced on equity values. In terms of our outlook, the buyout industry has faced a significant slowdown in new deals. Capstone Headwaters, a major investment banking firm, reports new deal activity down approximately 40% from Q1 and about 22% year-over-year. However, we are seeing new signs of deal activity picking up. As I mentioned, we made a new investment in July, and we are pursuing a number of prospects that we'll see develop over the next six to nine months. Our focus is on maintaining close involvement with our portfolio companies, providing assistance, and making new acquisitions. We have maintained our monthly distributions to shareholders at current levels and look forward to continuing to do so. The Board will continue to evaluate any supplemental distributions based on capital gains. With that, I'm going to turn it over to our CFO, Julia Ryan, for more details on the financials. Julia?

Thank you, Dave. Let me start with a summary of the fund's operating performance. We generated NII of $4.4 million this quarter, which was slightly higher than NII of $4.2 million in the prior quarter. Interest income increased by approximately $1.3 million primarily due to the new investments made during the current quarter, as Dave mentioned, and to a lesser extent, increased interest rates on one investment back to pre-COVID levels. We continue to monitor and closely work with companies that have loans on non-accrual status and believe we can expect some improvement in the balance of this fiscal year. Net expenses totaled $7.5 million in the current quarter compared to $6.5 million in the prior quarter. This increase was primarily related to accrued capital gains-based incentive fees of $0.5 million this quarter versus a $0.8 million reversal of previously accrued cap gains incentive fees last quarter. This reflects the net impact of realized and unrealized gains and losses between the two quarters. After adjusting net investment income to exclude the cap gains incentive fee reversal, adjusted net investment income per weighted average common share was $0.15 in the current quarter, representing a $0.04 increase compared to last quarter. We believe this metric is a useful indicator of operations, exclusive of any capital gains-based incentive fee. Moving to the balance sheet, we believe that maintaining liquidity and flexibility to support and grow our portfolio is crucial to our success. In this regard, we amended our credit facility during the current quarter to improve our flexibility should our portfolio face COVID-related disruptions. We had about $64 million availability under the credit facility as of 9/30/2020. Additionally, we raised approximately $3.9 million in net proceeds under our Series E Term Preferred Stock ATM. Our NAV remained consistent quarter-over-quarter with a net pickup in unrealized appreciation of $1.6 million. Distributable income to shareholders remained solid. On a book basis, undistributed net investment income combined with net realized gains totaled over $5 million, or about $0.16 per common share. This amount is reduced by the capital gains-based incentive fee that is required under U.S. GAAP, roughly $7 million, which is not contractually due yet. All else equal, the $0.16 per common share would be available for distribution to shareholders in future periods, even if the entire capital gains-based incentive fee accrual were to become contractually due. As previously announced in October 2020, our Board of Directors maintained the current monthly distribution run rate of $0.84 per common share, representing a yield of about 9.8%, excluding any supplemental distribution. This concludes my part of today's call and back to you, David.

Okay. Thank you, Julia. Dave and Michael provided good information for our shareholders, and those presentations in the Form 10-Q filed yesterday should bring everyone up-to-date. We believe the team is well-positioned to continue its successes in our fiscal year ending March 31, 2021. We are now entering a time to designate some members of the future management team. We appointed two members to Executive Vice Presidents as announced in our press release: Kyle Largent and Peter Roushdy, alongside our Chief Financial Officer, Julia Ryan, who ensures the future of this fund is in really good hands. Working together, they have their responsibilities to the senior leadership team for continued success and long-term growth. Dave Dullum and I are not changing our positions; we're just expanding the group. We believe Gladstone Investment is an attractive investment for investors seeking continuous monthly distributions and potential supplemental distributions from capital gains. So Donna, if you'll come on now, we'll have some questions from the analysts and shareholders out there. Tell them how they can ask a question.

Thank you. The floor is now open for questions. Our first question is from Ryan Carr of Jefferies. Please go ahead.

Hi, good morning, guys. Thanks for taking my questions, and congratulations on the good quarter. First question from my end. It looks like this quarter you didn't have any other income. What really drove the decline there? And then moving forward, is there a change in the outlook for that area?

Hi. This is Dave. I'll take a crack at that, and if Julia wants to add certainly. Keeping in mind that our other income line item is something that is a function of dividends on preferred investments we might have in some of our portfolio companies, which we harvest from time to time. The other is basically from what we call exit fees or success fees, which we also harvest from our portfolio companies. Consistently, we've shown that it's always going to be volatile and certainly different quarter-to-quarter. What we have done in this last couple of months and quarters is tried to consider the cash flow issues without burdening our portfolio companies, meaning we have not taken some of these fees that might have previously been taken. So there's no change in policy; we expect to see some of that going forward. It's a bit unpredictable, but we manage it carefully. Hopefully, that answers it.

Yes. Thank you. That was very helpful. In terms of the non-accruals, this quarter you saw some improvement on fair value and cost basis. However, it looks like the same investments have been on that list for quite a while: B&T, Horizon, The Mountain, PSI, and SOG. Have you made any progress in resolving these non-accruals, especially in the current environment? What’s the outlook over the next two quarters through the end of the fiscal year regarding resolution for these?

Sure. Yes. You're correct that the same companies have been on the list for the last two quarters. Horizon was added in April, so it hasn’t been on for too long. It is significantly exposed to COVID and the travel industry. The others have been on the list longer, but as I briefly touched upon, we are working with each of these companies and expect improvements over the next three to six months for this fiscal year. I can't guarantee when that will occur, but we're actively working on it.

Yes. The only further comment I'd make is that due to the definition we use for non-accrual and the timing, we could actually collect income from one or two of these companies but still leave them on non-accrual status. That's a positive for the income stream, and we're working on that as well.

Got it. Then lastly, could you give a sense of how deal activity has improved quarter-to-quarter? Has anything changed from the prior quarter regarding your deal-making ability, such as traveling to clients or an increase in discussions and potential transactions?

Yes. Good question. We’ve been traveling. Some of our managing directors have been visiting companies for management meetings. Overall, in the last couple of months, we have seen increased activity in viable and potential acquisitions. I'm optimistic going forward; however, the valuation landscape remains challenging as there is a lot of capital available even now. We'll continue to practice our conservative investment strategy, but I am encouraged by the recent uplift and activity in our space.

Okay. Donna, next question.

Our next question is coming from Mickey Schleien of Ladenburg Thalmann. Please go ahead.

Yes, good morning everyone. Hope all is well on your end. Dave, I just wanted to follow up on your comments about the market environment. It's clearly a world of haves and have-nots, and strong performing companies have capital being thrown at them. Within your portfolio, do you have visibility into potential exits to take advantage of a strong seller's market?

Mickey, to follow up on our general policies regarding exits: having solid businesses that continue to grow is our priority. We won't rush to exit unnecessarily; we will act if our CEOs feel the timing is appropriate for various reasons, or if we receive unsolicited offers. We are managing exits on a case-by-case basis, and if we can benefit from the current activity, we will. This will likely play out over the next six months or so.

Understood. Regarding the balance sheet's leverage, is this sort of the maximum level you're willing to operate Gladstone Investment at, or are you comfortable taking leverage even higher with the current economic outlook?

Sure. The leverage level is a little lower than what was reported as of September 30, following a significant paydown. We are confident in our portfolio and comfortable adding leverage if necessary, but we have no intention of changing our operating outlook or investment strategy to make reckless decisions with new investments.

That paydown relates to Mason West, which is a new investment. Can you walk us through why it turned around and repaid you shortly after? Is there any fee income associated with that we can expect?

There's no fee income associated with that. The repayment was anticipated at closing. It just took some time to finalize the legal aspects between the deal closure and the repayment.

Mickey, to clarify, we did the deal, and because of the investment size, we were positioned to close it. We aimed to bring in a partner, which led to the paydown from an investor that we have worked with before.

Understood. Dave, you mentioned resuming interest or changing interest rates on a deal affected by COVID. Are you referring to a PIK toggle or a re-pricing, and which deal are you talking about?

No PIK toggle, no re-pricing. We adjusted the interest rate temporarily to give a little breathing room and then resumed the previous rate once we were assured of stability. This flexibility is beneficial for our structure.

Just one last question for Julia. What month does your tax year end?

The tax year is the same as the fiscal year, which ends in March.

Thank you very much, and I appreciate your time.

Thanks, Mickey.

At this time, I'd like to turn the floor back over to Mr. Gladstone for closing comments.

Alright. We don't have any other questions today. We'll see you next time, probably in January, at the end of January or the beginning of February. Thank you all for tuning in, and that's the end of this conference call.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time or log off the webcast and have a wonderful day.