Gladstone Investment Corporation\De Q2 FY2024 Earnings Call

Greetings, and welcome to the Gladstone Investment Corporation Second Quarter Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Gladstone, Chief Executive Officer. Please proceed, sir.

Thank you, Latonya, and good morning to everybody. This is David Gladstone, Chairman of Gladstone Investment, and this is the second quarter end in our fiscal year that ends March of 2024. The quarter that we're talking about, though, is the one that ends in September 30, 2023. So we're bringing everybody up to date. Gladstone Investment is listed on NASDAQ with the trading symbol GAIN for the common stock. We also have three preferred stocks that are out there, and those are registered notes. Thank you all for calling in. We're always happy to provide updates to our shareholders and analysts following us and to provide a view of the current business environment, and a little bit about the future, hopefully. Our two goals are to help you understand what has happened and give you a current view of the future. Now I'll start out with our General Counsel, Michael LiCalsi.

Thanks, David. 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, even though they're based on our current 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 in our Forms 10-Q, 10-K, and other documents that we filed with the SEC. You can find them on the Investors page of our website and the SEC's website. We undertake no obligation to publicly update or revise any 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. We ask everybody to visit our website, sign up for our email notification service, follow us on Twitter, and the Gladstone Companies on Facebook. Today's call is an overview of our results through September 30, '23, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. With that, I'll turn it over to Dave Dullum, President of Gladstone Investment.

Thanks, Mike. Good morning, everyone. We are happy to report that GAIN again produced very good results for the second quarter of fiscal year '24. This ends March 31, '24, and this follows on the previous really solid first quarter of this fiscal year. We ended this second quarter with adjusted NII of $0.24 per share, total assets of $928 million, which is up from about $847 million at the prior quarter end. Deal activity is obviously important to us. For this quarter, we invested approximately $65 million, which was between one new buyout investment and an add-on acquisition to one of our existing portfolio companies. As we've said before and will continue forward, we will seek these add-on opportunities, as they allow us to increase our investment in companies where we know the management team, we know the business, and we have a strong belief in that company's future, and therefore, we can and do generally build incremental equity value. It's a good way of continuing the growth of our assets and the underlying fundamentals of the business. Subsequent to the quarter end, we invested an additional $65 million to fund another add-on acquisition to another one of our existing portfolio companies. In this regard, we find that this sort of activity these days is a good area for us to look at, as we continue to build overall incremental value in the portfolio. We also had a successful exit of one portfolio company, which generated a meaningful realized capital gain of around $43.5 million. We continue to make new acquisitions, add-on to our existing portfolio companies, and exit companies when it makes sense, generating capital gains. We also maintained our monthly distribution to shareholders at $0.08 per share, which is $0.96 per share on an annual basis, and paid a supplemental distribution of $0.12 per share in September of this year. Subsequent to the quarter end, we declared aggregate supplemental distributions of $1 per share to be paid incrementally in November and December. This fairly large supplemental distribution highlights the strength of our buyout strategy and our ability to reward our shareholders with meaningful supplemental distributions from these realized capital gains generated on the equity portion of the exits. The balance sheet is of course important, and that continues to be strong. We have low leverage and a positive liquidity position with additional availability on our credit facility. We continue to provide support to our portfolio of companies for these add-on acquisitions and any interim financing if the need arises, while we continue to actively grow our assets through new buyouts. Looking forward, deal flow seems to be picking up. Sellers who have been holding back in the past six months are starting to test the market. We hear from many of the merger and acquisition and sell-side investment bankers we deal with that a backlog of new opportunities seems to be building, which reinforces a strong competitive environment. We must remain value-sensitive while aggressively competing for new acquisitions. With interest rates being relatively high and somewhat lack of liquidity in the debt side from commercial banks, we believe that we have a competitive edge because we can provide both the debt and equity when we make an acquisition. In summing up the quarter and looking forward, we believe the state of our portfolio is very good. We have a strong liquid balance sheet and continued prospects of very good earnings and distributions over the next year. With that, I'll turn it over to our CFO, Rachael Easton, for some more details.

Thank you, Dave, and good morning. Looking at our operating performance. In the second quarter of fiscal year 2024, we generated total investment income of $20.3 million, consistent with the prior quarter. While total investment income in the aggregate did not change quarter-to-quarter, there were fluctuations in components including increased interest income driven by new debt investments made in the quarter and increased SOFR, as well as lower dividend and success fee income, which is variable in timing and did not recur in the current quarter. Net expenses as of September 30, 2023, were $22 million, up from $11.9 million in the prior quarter. This was primarily due to a $9.7 million increase in accrued capital gains-based incentive fees due to the net impact of realized and unrealized gains and losses as required under U.S. GAAP, as well as an increased margin. This resulted in a net investment loss of $1.7 million for the quarter, primarily due to the large accrued capital gains-based incentive fees recognized during this period. Adjusted net investment income for the quarter was $8.1 million or $0.24 per share, down just a penny from $8.5 million or $0.25 per share in the prior quarter. We continue to believe that adjusted net investment income is a useful and representative indicator of our ongoing operations. As of September 30, we continue to have three portfolio companies that are on nonaccrual status, and we will keep working with those companies to get back on accrual status. We believe that maintaining liquidity and flexibility to support and grow our portfolio are key elements of our success. With our three public note issuances, we have long-term fixed rate capital in place. As of yesterday's release, we had approximately $66 million available on our newly amended and extended $135 million credit facility. Additionally, during the quarter, we raised approximately $4 million in net proceeds under our common stock ATM program, all sales of which were above NAV. We anticipate continuing to be active in the ATM program. Overall, our leverage remains relatively low with an asset coverage ratio at September 30, 2023, of 211%, providing plenty of cushion to the required 150% coverage. Valuation overall was up $48.7 million, driven by unrealized gains at a portfolio company that was marked up to reflect the fair value of the expected exit, which took place in October, as well as higher valuation multiples across the portfolio and increased performance at many of our portfolio companies. Our NAV increased to $14.03 per share compared to $12.99 per share at the end of the prior quarter, primarily driven by $1.44 per share of net unrealized appreciation of investments, partially offset by $0.36 per share of distributions paid to common shareholders during the quarter, of which $0.12 per share related to a supplemental distribution and $0.05 per share of net investment loss. Consistent with prior quarters, distributable book earnings to shareholders remain strong. We started the fiscal year with $32 million or $0.95 per share in spillover and our monthly distribution remains consistent at $0.08 per share for an annual run rate of $0.96 per share. In September 2023, we paid a $0.12 per share supplemental distribution, and as you heard in October, we declared an additional aggregate $1 per share supplemental distribution to be paid in November and December 2023. We look to continue funding future supplemental distributions as we recognize realized capital gains on the equity portion of our exits. Using the monthly distribution run rate of $0.96 per share per year and $1.24 per share in supplemental distributions, our aggregate estimated fiscal year distributions would total at least $2.20 per common share or a yield of about 16% using yesterday's closing price of $13.74. This concludes my part of today's call. Back to you, David.

Thank you very much, Rachael. That was a wonderful report. Well, actually wonderful news for everybody, and a very nice report by Dave and Michael provides good information for shareholders. I think this completes everything in terms of the past, this call and the 10-Q filed by the SEC yesterday should bring everyone up to date. For the quarter ending September 30, 2023, the company paid a regular distribution of $0.08 per share per month or $0.24 per share for the quarter. Looking ahead at the quarter ending December 31, 2023, the company also has declared but not yet paid two more supplemental distributions. The November 17 distribution is $0.12 per share and the December 15 distribution is $0.88 per share. Aggregate supplementals for the quarter ending December 31 will be $1 per share. If you include the regular distribution declared, that's $0.24, bringing the total to $1.24 for the quarter. Please note that the record date for the November supplemental distribution is November 7. You need to buy before then. The same is true for the December supplemental distribution, which is December 5. So you need to own the stock before those dates to receive the supplemental distributions. The team has reported solid results for the quarter ending September 30, 2023, including buyout investments, exit activity, and associated net realized gains. We believe the team is in a great position to continue these successes through the remainder of the fiscal year ending March 31, 2024. I keep saying it, and for those of you who have listened to me, you've received some real good extra dividends. We believe Gladstone Investment is an attractive investment for investors seeking continuous monthly distributions and supplemental distributions from potential capital gains and the other income that we generate. The team hopes to continue to show you strong results, but I'm going to stop at this point and let's get some questions from our analysts. Some of you teed up really early this morning, so we're ready for you. Latonya, please tell them how they can ask a question.

We will now conduct a question-and-answer session. Our first question comes from Mickey Schleien with Ladenburg.

I want to start by congratulating you on the sale of Counsel Press, which is a very impressive outcome, and I'm sure shareholders will be pleased with the dividends related to that. Dave, I wanted to ask about a couple of investments. First, E3 operates in the oil and gas sector, which is obviously cyclical. What is it about this company and the deal structure that gives you comfort ahead of a potential slowdown in the economy when making an investment in a cyclical sector?

Mickey, good. Thanks for the question. Yes, you're right; E3 is a little bit atypical for us in that regard. What they do, though, is mainly provide a product that goes to the fracking industry. If you understand the process, you go from the well to the pipeline coming out from a fracking situation. There are times when the pressure gets too high, and valves need to relieve this pressure, which can be very dangerous. E3 has developed a system that sits on a skid about the size of a decent-sized table that electronically controls the pressure and provides relief. They've developed proprietary technology in the valve system, positioning them well as long as fracking operations are ongoing. Their payback period is less than four months on rentals, and they are ramping up production as quickly as possible. So while it can be cyclical, given their profitability and cash level, we believe we will be in good shape going forward, even if there’s a slowdown. It's a unique situation, and we brought in an experienced CEO from Halliburton, enhancing our management team significantly.

That sounds really interesting, Dave. My other question is about SFEG. As you know, it's an electrical manufacturer, which can also be cyclical. But in this company, you're in the second lien. Could you tell us the nature of the add-on acquisition and what gives you comfort to be in a second lien in a cyclical business, as well as who owns the first lien ahead of you?

SFEG, to clarify, is not strictly an electrical business. It combines several companies that provide products like welding devices and cutting tools for pipelines and more. We also acquired a company called Climax, which has operations worldwide. The combined entity now exceeds $100 million in revenues with an EBITDA margin around 20%. We have a strong management team and significant ownership. While we have a second lien, it is common for us to have the first lien held by a bank providing a revolving line of credit, which is not unusual for larger companies. We have significant equity ownership alongside this debt structure.

Just to make sure I understand, the first lien is likely a bank revolver probably with accounts receivable and inventory as collateral, and you have claims on the rest of the company's assets. Is that correct?

Correct. Yes.

Okay. That's helpful. I appreciate it.

Great to see you recently, by the way. Thanks for coming.

Our next question comes from Bryce Rowe with B. Riley.

Congratulations on the exit, David. I wanted to first ask about the level of spillover. Rachael, you did touch on what spillover was at the end of last year. Can you provide an update on where it sits now and if you could also provide it pro forma for the dividends declared for the December quarter as well as this gain that you just realized?

Thank you for your question. We started the year with $32 million or about $0.95 per share in spillover. We do not provide updates during the quarter, but given that we plan to declare a regular monthly distribution of $0.08 per month, coupled with the dollar that we declared supplemental and an additional $0.24 in supplemental, you can see we have well made our way through that initial spillover. I can tell you that we are comfortable rolling into the next year, but I cannot give you an update mid-quarter on where we currently are.

Understood. Let's see. In terms of the fair value marks within the portfolio this quarter, Dave, they reflect the Counsel Press exit, but also show good upside from several different investments. You mentioned higher multiples as well as better company performance. Could you expand on that comment a bit?

I'll take a shot and then certainly, Rachael, please feel free to weigh in. The majority of our portfolio companies benefited from a slight uptick in multiple EBITDA, while others, which remain fundamentally strong, experienced slight shifts quarter to quarter that did not significantly concern me from a valuation perspective. Rachael, do you have anything to add?

I don't have anything specific to add unless there's something in particular you want to call out. Several companies like Educators, Brunswick Bowling, Nth Degree, and SFEG saw unrealized depreciation as you noted.

No significant concerns relative to the few that we did have on a slight decline valuation-wise.

Okay. That's helpful. Lastly, regarding the balance sheet structure, you're using the credit facility more with portfolio growth. If I heard you correctly, $65 million into SFEG would likely mean using that even more unless you access other sources of capital. Could you speak to your comfort with the capital structure at this point? Are you looking to add more notes like you've done recently, or are you comfortable with where the balance sheet is?

Yes. Rachael can jump in here, but that amount available on our line is net based on cash coming in from Counsel Press and new investments. As of now, that capital is available for any new plans. We also plan to explore exiting certain portfolio companies in the next six months, which would bring in additional capital. As of today, yes, we feel good about our position. We are also considering doing another baby bond in light of future deal flow, and we feel our current capital structure is solid. Rachael?

I completely agree, Dave. I'll add that we are continuing to utilize our ATM program as needed.

We're not concerned about anything from a ratio perspective or asset coverage ratio. We're staying active in the market, so if we need to do something, we will. But for now, we feel good.

Our next question comes from an analyst with Jefferies.

I wonder if you could shed a little more light on the macro picture as we approach year-end and navigate budget projections for '24. Are any sectors seeing more headwinds than others? Or any sectors or end markets seeing pushback in passing price through to customers?

No surprise, perhaps, that the companies in our consumer product sector have experienced some softness. However, this isn't significant at this point. We have been able to pass through cost increases that arose from previous supply chain and transportation costs; those have decreased substantially, which is positive. As we look ahead, while some retail-level revenue might show slight softness, we've managed to offset that by lowering our own costs. From a margin perspective, there have been instances where margins improved even with reduced overall volume. In summary, we aren't seeing major issues right now. However, we anticipate some potential slowdown in consumer-type product areas, compared to business service areas, of which we have significant investments. Fortunately, most are operating according to plan, with only a couple potentially facing a slowdown depending on their sectors. Overall, we feel reasonably good looking ahead.

There are no further questions in queue at this time. Mr. Gladstone, I'd like to turn it back to you for closing comments.

Thank you all for calling in. It was a good quarter last quarter, and this quarter that we're in looks like a super quarter. We're all feeling good today. See you next time. That's the end of our comments.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.