Gladstone Investment Corporationde (GAIN) Q2 2022 Earnings Call Transcript

Greetings, and welcome to the Gladstone Investment Third Quarter Earnings Call. This conference is being recorded. It is now my pleasure to introduce your host, David Gladstone. Thank you, David. You may begin.

Well, thank you, Paul, and good morning to everybody. This is David Gladstone, Chairman of Gladstone Investment, and this is the second quarter of our fiscal year ending March 31, 2022. This is a conference call for shareholders and analysts of Gladstone Investment. We're listed on NASDAQ under the trading symbol GAIN, and we have some registered notes as well. Thank you all for calling in. We're always happy to provide updates for our shareholders and analysts and provide our view of the current business environment. Our goals today are to help you understand what happened and also give you our view of the future. We always start out with our General Counsel and Secretary, Michael LiCalsi. Go ahead, Mike.

Good morning, everybody. Today's call may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties and other factors, though they're based on our comp plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all the risk factors listed on our forms 10-Q, 10-K, and other documents that we file with the SEC. You can find them all on the Investors page of our website, www.gladstoneinvestment.com, or on the SEC's website, which is www.sec.gov. Now 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 never a guarantee of any future results. Please take the opportunity to visit our website, once again, gladstoneinvestment.com, and sign up for our email notification service. You can also find us on Twitter at Gladstone comps and on Facebook, with the keyword being The Gladstone Companies. Today's call is an overview of our results through 9/30/2021. We ask that you review our press release and Form 10-Q, both issued yesterday, for more detailed information. And with that, I'll turn it over to the President of Gladstone Investment, David Dullum.

Mike, thanks. Good morning, shareholders, analysts, and interested parties. I'm happy to report another very good quarter for this second fiscal quarter. The operating results from our portfolio companies have been encouraging, and I'm really pleased with the quality of the portfolio at this point. While some of our companies have made progress towards pre-Covid operating status, we are certainly very mindful of the challenges that our economy still faces, such as supply chain issues, which we've all heard about, and obviously inflationary trends. With that, we ended the second quarter of fiscal year '22 with adjusted NII of $0.23 per share, which continues the improving trend of the previous three quarters, where we reported adjusted NII per share of $0.20, $0.24, and $0.24, respectively. We are encouraged by these results, as they reflect the previously mentioned improvements in operations and the health of our portfolio of companies and certainly the prospects for future earnings. Our net asset value per share increased from $12.66 at 6/30/21 to $13.27 at 9/30/21, and our assets increased to $746 million from $713 million over the same period. This is largely due to the continued recovery of the values of our equity portions of our holdings, which is crucial for us and which actually comprises about 26% currently of our portfolio at cost. Subsequently, we increased our monthly distribution to shareholders by 7%, which is $0.075 per share or effectively $0.90 per share on an annual run rate basis. We also paid a supplemental distribution of $0.03 per share in September 2021 and declared another supplemental distribution of $0.09 per share, which will be paid in December 2021. During the second quarter of fiscal '22, we made one new buyout, which pertains to a company that's been around for quite a while; a very good company, family-owned for many years, related to infrastructure expansion. We made incremental investments in existing portfolio companies to support some add-on acquisitions, which is an area of focus for us as it presents opportunities to build value in existing portfolio companies. Our buyout strategy continues to generate income from monthly distributions to shareholders and capital gains on equity, allowing these supplemental distributions. Our balance sheet remains strong with very low leverage and positive liquidity, allowing us to continue providing the support our portfolio companies need for these add-on acquisitions and value-building, as well as interim financing if necessary. We're actively seeking new buyout opportunities to continue growing our assets. Looking forward, the flow of buyout opportunities continues to be strong; however, purchase price expectations remain elevated. Therefore, we need to remain patient and selective in our due diligence and review process. In summing up, the state of our portfolio is very good. We have a strong and liquid balance sheet, an active level of bid activity, and the prospect of continuing good earnings and distributions during this fiscal year. Now I'll turn it over to Julia Ryan, our CFO, for more details. Julia?

Thanks, Dave. As far as operating performance for the quarter, we continue to see improvement after the initial impact of the pandemic. We generated adjusted NII of $7.8 million, or $0.23 per share, as compared to adjusted NII of $8 million or $0.24 per share in the prior quarter. We continue to believe that this metric is a very useful and representative indicator of operations. Investment income increased quarter-over-quarter primarily due to other income. In the prior quarter, interest income was lifted by the collection of past-due interest, which did not recur to the same extent this quarter. While we added one loan to nonaccrual this quarter, causing part of the decline in interest income, we believe it will be a short-term change. As of 9/30/21, three of our portfolio companies were nonaccrual. Net expenses decreased by $4 million this quarter, primarily driven by a $4.7 million decrease in the capital gains-based incentive fee due to the net impact of realized and unrealized gains, which was lower than in the prior quarter. Given the issuance of our new 2028 notes, interest expense increased, but this increase was offset by a decline in dividend expense due to the redemption of our Series E Term Preferred Stock. We used proceeds from the note issuance to do so. We believe that maintaining liquidity and flexibility to support and grow our portfolio are key elements of our success. With the successful issuance of our 2028 notes and the redemption of Series E this quarter, we have new long-term capital in place and significant availability under our line of credit. Our NAV increased to $13.27 per common share this quarter, primarily related to the net unrealized depreciation on our portfolio. Consistent with prior quarters, distributable book earnings to shareholders remain solid, especially considering that book earnings have been reduced by $28.3 million of capital gains-based incentive fees, accrued under GAAP, which equates to about $0.85 per common share, which are not currently due or deductible for tax. As previously announced in October 2021, our Board of Directors increased our annual distribution run rate to $0.90 per common share and declared another $0.09 supplemental distribution to common shareholders to be paid in December 2021. Assuming the current monthly distribution run rate of $0.90 per share per year and estimating $0.18 per share in supplemental distribution, our annual distributions would total about $1.08 per common share or roughly just shy of a 7% yield on the closing part of our stock. This covers my portion of today's call, and back to you, David.

All right. Thank you, Julia. That was a very nice report. We had a nice report from Dave and Michael. The information we've given to our shareholders should bring you up to date. The presentation we just made in the 10-Q filed yesterday at the SEC should bring everybody up to date where we are now. The team has reported solid results for the quarter, including a buyout investment and financial transactions. We believe the team is in a great position to continue these successes through the remainder of the fiscal year ending March 31, 2022. As you know, we always look to sell some portfolio companies, and I'm sure we'll find some to sell in the future. We don't have any indication of what that's going to be until it gets very close. Gladstone Investment is an attractive investment for investors seeking continuous monthly distributions, and they do supplemental distributions mostly from potential capital gains and other income. The team hopes to continue to show you some strong returns. Now let's stop and have some questions from the analysts and others who follow us. Paul, if you'll come on and tell them how they can ask questions.

Our first question is from Mickey Schleien with Ladenburg.

Dave, I wanted to ask. You mentioned the supply shortage problems in your prepared remarks. Given your business model, I'd like to understand how you're seeing your portfolio companies deal with those shortages? And are they also able to pass on the inflation they're experiencing in their inputs to their customers?

Yes. Hi, Mickey, great. That's a very good question, and obviously one that many companies are focusing on. I would say from a general perspective, our companies are dealing with it fairly well. Some, due to the nature of their seasons, were ahead of the game and had product coming in early. We have a few companies that are exposed to the stacking up of containers and an increase in prices. However, we have worked with those companies and their customer base and have indeed been able to implement price increases, not necessarily completely covering all related costs, but they have been able to pass through price increases, with some doing so more than others. Overall, I'd say that those companies in our portfolio impacted by supply chain shortages and potential price increases have managed quite well. We may see a slight tightening of margins in a few of those companies, but on average, we believe we're in pretty decent shape. Another challenge is labor costs, and we have been working hard to ensure we can get people to work. Prices and costs are rising in that area as well; therefore, trying to find creative solutions for labor retention is an ongoing challenge. Nevertheless, several of our companies have performed better than we expected during the COVID situation, showing nice bounce-backs. That's why our operating results look very good, with increases in those results positively impacting our valuations.

Dave, if I could follow up, J.R. Hobbs is an HVAC company, if I'm not mistaken. Are the issues they're facing related to supply shortages or something else?

Yes, that's a good question. Their issue is more related to having an extraordinarily large backlog, probably the largest we've ever seen. Their customers are predominantly general contractors doing multifamily construction and some industrial commercial. While some buildings have been slowed down, it hasn't led to a loss of business. We now have a substantial backlog to work through, which is a positive development. It has strained working capital, but generally, they haven't faced significant shortages.

Just to make sure I understand, J.R. Hobbs customers are delaying construction projects. Is that due to ongoing labor shortages or something else?

I couldn't say definitively. It's likely due to several factors, such as the high cost of lumber, which has slowed down some projects either waiting for prices to come down or due to uncertainty. It's more related to that than anything foreseen at this point.

Okay. Just a couple more modeling questions. You had another very strong quarter of unrealized appreciation, and congratulations on that. I'm curious, was that due more to valuation multiples and spreads or to the performance of the companies themselves?

I'm going to let Julia jump in here and add some detail. I’ll say quickly that it was a combination—certainly improvement in operations and EBITDA improvements are crucial, but there wasn't much increase in multiples. Julia, do you want to take that further?

Yes, you're correct. It was a combination, but the performance uptick outweighed the uptick in multiples.

And Julia, one last question. Did you reverse any previous income accrued for J.R. Hobbs for previous quarters?

We did. Not a significant amount, but that portion ran through bad debt expense.

Next question, please.

There are no further questions at this time. I would like to turn the floor back over to David Gladstone for any closing comments.

Well, thank you all for calling in. It's been a wonderful quarter for us, and we hope to duplicate that in the next two quarters as well. This should be a wonderful year, but there are no guarantees in this world. Thank you all for calling in, and we'll see you in a month or two. This concludes our call.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.