Gladstone Investment Corporation\De Q2 FY2025 Earnings Call

Greetings. Welcome to Gladstone Investment Corporation's Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. It is now my pleasure to introduce David Gladstone, Chief Executive Officer. Thank you, Mr. Gladstone, you may begin.

Okay, Sherry, thank you very much. This is David Gladstone, Chairman of Gladstone Investment, and this is the second quarter of fiscal year ending 2025. It ends on September 30th, 2024. Earnings conference calls for shareholders and analysts are our chance to talk with you and tell you about what we're doing and where we're going. But before we get started, I'm going to turn it over to our Chief Counsel. What else do you do, Mike? Okay, let's hear from Michael. 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, and they're based on our current plans, which we believe to be reasonable. The 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 Forms 10-Q, 10-K, and various other documents we file with the SEC. Find all these documents on the Investors page of our website at gladstoneinvestment.com or the SEC's website, which is www.sec.gov. And 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, past performance or market information is not a guarantee of future results. We ask that you visit our website, gladstoneinvestment.com, sign up for our email notification service. You can also find us on Facebook. Keyword to Gladstone Company is now on Twitter, which is now X. The handle there is Gladstone Comps, @GladstoneComps on X. Today's call is simply an overview of our results through September 30, 2024. 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.

Mike, thank you very much and good morning. Welcome to all our shareholders and analysts. For this second quarter of fiscal year ‘25, I'm pleased to report that the GAIN team has continued to produce consistent and positive quarter-over-quarter results. We ended the second quarter of this fiscal ‘25 on 09/30/24 with adjusted NII of $0.24 per share and total assets of $869 million, which is a bit down from the prior quarter, but we'll explain that in a minute. We are in an extremely active investing period, and I believe this will continue for a while. We have been and continue to review and conduct due diligence on a significant number of new investment opportunities. At the same time, we've been managing various activities within our 22 existing portfolio companies. We invested about $18.5 million in the form of a secured first lien debt, which was to help fund an add-on acquisition for one of our existing portfolio companies, Nocturne Luxury Villas. As I've mentioned in prior calls, this follows some of our other significant add-on activities at a few of our other portfolio companies over the past year, where these add-on opportunities will allow us to increase our investment, build value in companies where we have confidence in the management team, have a strong belief in its future, and enhance the opportunity for future equity gains. This quarter, we also had a very successful exit of our portfolio company Nth Degree, where we generated a meaningful realized capital gain of around $42.3 million. We maintained our monthly distribution to shareholders at $0.08 per share or $0.96 per share on an annual basis. We also declared a supplemental distribution of $0.70 per share during the quarter that was paid in October. Now this large supplemental distribution is a direct result of our buyout strategy and our ability to reward our shareholders with meaningful supplemental distributions from the realized capital gains generated on the equity portion of our exits, further reinforcing our model of a buy-focused fund. It remains our intent to continue rewarding our shareholders with meaningful supplemental distributions from the realized capital gains on exits. And as our portfolio continues to mature and equity values increase, we will constructively harvest these gains for the benefit of shareholders. It is important here, though, to emphasize that we will always be investing in new portfolio companies and strive to balance the timing of exits without sacrificing the level of debt assets that produce the income to support and grow our monthly dividends, which is extremely important to our shareholders. Now our balance sheet continues to be strong with low leverage, a positive liquidity position, with additional availability on our credit facility. We continue providing support to our portfolio companies for add-on acquisitions, as I mentioned, and interim financing if the need arises while actively growing our assets to new buyouts. Looking forward, and obviously, there are many uncertainties as we look over the next number of years, but we feel very good about where we are, and as I mentioned, we are seeing an increase in opportunities for new acquisitions, and there seems to be growing momentum in new deals coming to market. There is significant liquidity in the M&A market, which makes for a very competitive environment with upward pressure on valuations. We will have to aggressively compete and acquire new companies that we believe fit our financial model by investing a combination of debt and equity, maintaining our principles of being a value investor and generating income on a current basis with upside to capital appreciation. With the current level of analysis and due diligence we're doing on our number of new buyouts, I'm encouraged that we'll be adding to our assets with new portfolio companies in the very near term. 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, a positive level of buyer activity, and the prospect of continued very good earnings and distributions over the next year. So with that, I'd like to turn it over to Rachael Easton, our CFO, and have her elaborate on more detail on the financial results. Rachael?

Thank you, Dave, and good morning. Looking at our operating performance in the second quarter of fiscal year ‘25, we generated total investment income of $22.6 million, up from $22.2 million in the prior quarter. Net expenses for the quarter were $15.3 million, up from $9.8 million in the prior quarter. This increase was primarily due to a $5.4 million increase in accrued capital gains-based incentive fees due to the net impact of realized and unrealized gains and losses during the quarter as required under US GAAP. This resulted in net investment income for the quarter of $7.3 million compared to $12.4 million in the prior quarter. Adjusted net investment income, which is net investment income or loss, exclusive of any accrued capital gains-based incentive fees for the quarter was $8.9 million or $0.24 per share, up slightly but remaining consistent on a per-share basis from $8.6 million or $0.24 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. Consistent with the prior quarter, at September 30, 2024, we continue to have four portfolio companies that are on non-accrual status. Overall, there are no portfolio-wide credit concerns. We continue working closely with these companies to get back on accrual status when possible. We continue to see improvement at one of the companies in particular that has been on non-accrual for some time as they are back to generating a profit and we continue to work closely with them. Valuations in the aggregate were up $3.9 million across the portfolio excluding the reversal of unrealized appreciation related to the exit of Nth Degree. This unrealized appreciation was driven by higher valuation multiples across the portfolio and increased performance at a number of our portfolio companies, which was partially offset by decreased performance at other portfolio companies. Our NAV decreased to $12.49 per share compared to $13.01 per share at the end of the prior quarter. The decrease was primarily driven by $0.94 per share of distributions declared to common shareholders during the quarter, of which $0.70 per share was a supplemental distribution paid in October. Our NAV was also impacted by $0.93 per share of net unrealized depreciation on investments, which was comprised of $0.11 per share of unrealized appreciation experienced across the portfolio and $1.04 per share of unrealized depreciation due to that reversal of unrealized appreciation on the exit, as previously mentioned. These amounts were partially offset by increases in NAV of $1.15 per share of realized gains on investment and $0.20 per share of net investment income. 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. And as of yesterday's release, we had approximately $160 million available on our $200 million credit facility. Overall, our leverage remains relatively low with an asset coverage ratio at September 30th of 229.3%, providing us plenty of cushion to the required 150% coverage. Consistent with prior quarters, distributable book earnings to shareholders remains strong. We started the fiscal year with $20 million or $0.55 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, as mentioned, we declared a $0.70 per share supplemental distribution, which was paid in October. And we will look to continue funding future supplemental distributions as we recognize realized capital gains on the equity portion of future exits. Using the monthly distribution run rate of $0.96 per share per year and $0.70 per share in supplemental distributions paid so far in fiscal year 2025, our aggregate estimated fiscal year distributions would yield about 12% using yesterday's closing price of $13.80. This covers my part of today's call. Before turning the call back over to David to wrap us up, I would like to take a moment to mention that as announced last month, today will be my last earnings call and my last day with Gladstone Investment. I'm proud of the work I've done for the past three years with Dave, David, and the team as I pursue a personal change. I'd also like to introduce everyone on the call to Taylor Ritchie, who has been with Gladstone Investments for the past six years in the role of Controller and Director of Financial Reporting. We are all very excited to have him step into the CFO role, in what we believe will be a seamless transition.

All right. Thank you, Rachael. I don't like to see you go, but I'm glad you're replaced by a really strong accounting guy. And the good information that you've given us over the years has just been wonderful. This call, the 10-Q we filed at the SEC yesterday, should bring everybody up to date. The team has reported solid results for the quarter ending September 30th, 2024, and we believe the team is in a great position to continue these successes through the rest of the fiscal year that ends in March 30. Gladstone Investment is, if you think about it, an attractive investment for people. I once read an interview of Berkshire Hathaway and they asked him, would you like to have something that pays a dividend just every quarter, forever and a day, or would you rather have more income but have it come in at variable times as we do in our company? He selected that one. He always likes to get the most money out of any company that he's invested in. So we believe Gladstone Investment is a very attractive investment firm. It has to seek continuous monthly distributions. We meet that one because we've been doing it forever. And then there's supplemental distributions that come from capital gains in one of our portfolio companies goes public or is sold, team hopes to continue to show you strong returns on your investments in this fund. Now, let's stop here and ask for questions. Sherry, if you'll come on, that would be good.

Our first question is from Mickey Schleien with Ladenburg Thalmann. Please proceed.

Hi, yes, good morning, everyone. Dave, a couple of questions today. I've noticed that the fee credits from the external manager for their portfolio company managerial assistants have been running much lower quarterly this year than last fiscal year. Can you give us some insight into what's causing that decline? And what's the outlook for that line item?

Rachael?

Sure. Hi, Mickey, good morning. So when looking at that, it's going to be correlated to the deal activity that takes place during the quarter. So it's a little bit challenging to project that out. But I think you can look at the last couple of quarters have been a little bit quieter from an investment perspective. So that's why it's a little bit lower.

There’s no fundamental change in anything we do, just the timing as Rachael pointed out.

Yeah, I understand. I just thought that some of that was also due to sort of ongoing assistance. But I do understand your answer. My follow-up question relates to Hobbs, which has been on nonaccrual for more than two years, which would seem like more than enough time to address whatever its issues are. Can you update us on what the company has done over that two years to get back on track? And when do you expect it to go back on accrual? And if it's not possible, have you thought about selling it?

Certainly. Regarding Hobbs, I can confirm that it is now profitable. In previous calls, I've mentioned changes to the senior management team, and I’m quite pleased with the current CEO and CFO, who has been with us for about six months. Our management team is strong. From a business perspective, the issues stemmed from contracting with general contractors primarily for single-family and multifamily homes, but they have started to expand into some industrial and commercial projects. The challenge a few years ago was with long-term contracts that were poorly priced and managed. This led to situations where they couldn't recover some costs over lengthy project timelines. We've worked to address this. They have now shifted to taking on projects with higher margins and better management practices, effectively reducing or eliminating job fade. This has allowed for a strategic reduction in revenue, focusing only on projects that meet certain margin criteria. We're seeing positive results from these changes. While I hope we can return to accrual status, it may take longer than six months, but we should begin moving in that direction afterward. Overall, the business is solid, has a capable management team, is currently profitable, and does not require any additional financial support from us, which is encouraging.

That's really good to hear, Dave. And in terms of the profitability you've mentioned, are they generating enough cash flow to service the debt at this point or are we not there yet?

No. As I mentioned, looking forward and to getting back on accrual; it's probably going to be a six, nine month time frame, and they started again some because right now, they're generating cash, but it's obviously flowing back into the business from a working capital perspective.

Okay. I understand. Those are my questions for this morning. Thanks for your time. And Rachael, good luck on your future endeavors.

Thanks, Mickey.

Bye-bye. Can we have who’s up next, Bryce?

Yes. Our next question is from Bryce Rowe with B. Riley Securities. Please proceed.

Thank you and good morning. Congratulations to Rachael and Taylor. It's exciting stuff. I wanted to start with your comment about the numerous opportunities available. I don't recall hearing you describe it in that way before. Can you elaborate on that comment and provide any details? If possible, could you also give us an estimate of the opportunity in terms of the pipeline? That would certainly help us understand your comment better.

No, I did use that word, and it's an adjective that I probably won't use again. But seriously, I don't want to say anything here that we shouldn't, but I can tell you that we are working very hard at all levels. One of my partners and senior Managing Director is here next to me on this call this morning. She’s actively involved with a couple of deals that we hope will close within the next month or two, along with new deals we’re pursuing. Over the last few months, we've seen a significant increase in the number of deals we've put indications of interest and letters of intent on that we consider good businesses. Several of these have high valuations, and we've lost some opportunities because we were two to three turns of EBITDA lower than the next bidder. Overall, there’s a lot of positive activity. We're not engaging in deals that waste time; it’s all high-quality work. The quantity is higher, and I would say the quality has also improved. Additionally, the size of the companies we are looking at and are now prepared to bid on has increased compared to what we typically pursue. This is why I’m very enthusiastic about our position. We need to continue our diligence, and as you know, we are very careful in that process. There is a lot of activity happening right now within the overall team and the portfolio.

Okay. And, Dave, how do you assess the situation? You mentioned that some transactions are priced higher than you prefer based on EBITDA multiples. What gives you confidence that the deals nearing completion aren't facing the same challenge?

Our process has specific stages. First, we issue an indication of interest where we outline our willingness to invest. This typically leads to an opportunity to meet the management team if we make it past the initial review. If we decide to proceed, we then conduct further analysis and prepare a letter of intent, which details our offer. This letter must get the go-ahead from our investment committee, and if approved, we move forward. At this stage, we are nearing the finish line and usually have a strong belief that we will be selected. Although it’s not guaranteed, if we are selected, we focus on finalizing due diligence. Unless any significant issues arise that were not identified during our preliminary evaluation, we are confident in closing the deal. Thus, I believe those under consideration have a good chance of being finalized in the coming months. However, I can't disclose more specifics without facing some backlash from my team.

That's fine, Dave. And kind of in that context, as we think about funding new deals, I mean, obviously, you've got plenty of room on the credit facility at this point? How do you kind of weigh that relative to maybe raising equity by the ATM or looking at the unsecured market for another debt raise?

Yeah, that's a great question. It's something, obviously, we're looking at doing it. But I'll turn it over to Rachael, I'd like to have her address that.

Sure, I think we've historically maintained a very conservative balance sheet for this reason. It allows us the flexibility and liquidity to act quickly when the team identifies funding opportunities. Utilizing the significant capacity we have on our credit facility is very important to us. Additionally, a couple of quarters ago, we initiated our new $75 million ATM program, which we have not yet utilized. We view this as a significant tool in our capital-raising strategy. We're also open to the idea of pursuing other debt issuances in the future, whether soon or later on. Overall, we consider all options collectively to determine the best way to fund our pipeline.

Okay. I think another way to briefly add to that is we are in a position where as we need to, and there's a good likelihood we might, obviously, as we hopefully continue growing, we will go and access certainly the ATM market, if we need to, if the stock is trading above NAV. And likewise, more long-term permanent capital, which is a positive thing for us. So yeah, we feel reasonably good around where we are today about the ability to raise capital as we need it for the new deals that we're looking at doing, including working with our line of credit that we currently have. Obviously, we do a new deal, we'll use a line of credit. We get to that point. And then we think, okay, let's go raise long-term permanent capital and use that capital to pay down the line of credit and so on and so forth. So with the conversations we've certainly had with bankers and others, we feel pretty good about that.

Okay. Two more questions for me, kind of housekeeping. Number one, the dividend income in the quarter, I assume that was just one portfolio company. Any detail around that?

That's correct. Yeah. It was just one portfolio company. Really no additional detail. They were in the position to be able to pay us some dividend income. So as you know, that can be kind of volatile quarter-over-quarter and is a little bit challenging to project out, but you have just one company there.

The debt yield for the portfolio remained stable during the quarter, which is not something we've observed widely in the industry. We've experienced significant yield compression during the earnings season. When do the interest rates reset for your floating rate debt investments?

All of our portfolio consists of variable rate debt. There are some fluctuations in that number. While it stays consistent from quarter to quarter, we have noticed some decrease, which is generally balanced out by changes in the portfolio. Specifically, the exit of Nth Degree during the quarter had a yield that was somewhat lower than the overall average. Removing that has resulted in an offsetting increase.

And remember, Bryce, we also have floors that even though we have the floating we've benefited some extent by that, obviously, with SOFR being up where it is. I don't feel too strongly about this issue of compression of yield because of the way in which we think about and certainly new deals we do and deals we've done in the past where we think very carefully about the floors that we want to have to achieve relative to the total dollars that we invest. And we may have talked about this in the past. When we look at yield on our total dollar investment, which means both the equity and the debt, we have a level that we want to strive to get to. So we either will set the floor on the debt pieces so that we can blend that yield around the assets that we're putting on. So yeah, I think we feel like we're in pretty decent shape. Would you agree with that?

Yes. And so in reference to what Dave's discussing in the floors, looking at our debt portfolio on a weighted average basis overall, it's about 12% floors in place. So that's going to be the minimum we'll ever get to.

Okay. All right. I think that's it for me. Appreciate your time.

Thanks, Bryce. Take care.

Next, please.

Our next question is from Matthew Hurwit with Jefferies. Please proceed.

Hi, good morning, everyone. First question is, I noticed in your Q, it looks like the weighted average revenue of the portfolio on the first lien decreased about 9%, but then EBITDA was up 7% quarter-on-quarter. So was that mostly Nth Degree or portfolio mix? Or was there some sort of cost efficiency in the portfolio? Or I'm just curious about that movement.

So I think from a revenue perspective, that's just going to be for the portfolio companies that are being valued using a revenue multiple. So that's only a small part of the portfolio as a whole. When we look at kind of performance across the portfolio as it impacted fair value this quarter, we had a pretty good amount that was up in performance. So then you'll see that in the increasing EBITDA range. And then that was sort of offset by a handful of companies that saw decreased performance, whether that is EBITDA or revenue. So the companies using a revenue multiple just saw a slight decrease this quarter.

I see. Okay, great. And then could you just walk through some of the puts and takes again on the net unrealized depreciation in the quarter? I noticed the portfolio fair value percent of cost went from 105% to 102% quarter-on-quarter. I'm kind of curious if there's some conservatism being baked into fair value estimates or yeah, it's a multipart, but that would be helpful. Thanks.

From a fair value perspective, we recorded the exit of Nth Degree, which yielded a realized gain of $42 million. This contributed to a significant amount of unrealized appreciation in our portfolio until the exit occurred. This is largely responsible for the overall decrease in the fair value percentage. Excluding the unrealized appreciation reversal related to Nth Degree, we experienced about $0.11 per share of unrealized appreciation across the entire portfolio. Aside from that, we observed increases in fair values across the board. Were you asking me to review the net asset value changes again?

Yeah. It was just some of the puts and takes on the net unrealized depreciation, which I think you mostly covered.

Okay.

And then if I could ask, please continue.

No. What's your next question?

The last one is not asking to be policy experts, but do you see any high-level impact from the election outcome at this point on your business or portfolio businesses in particular that are worth calling out, they're positive or negative?

We’re not policy experts, but we understand that things will stabilize over time with fluctuations. One significant factor we continually monitor is tariffs, especially concerning companies that produce goods overseas, including some in China. Many of these companies have been adapting for years to a tariff-centric environment. Some have moved their production to other countries, while others have brought it back to the United States. Currently, I don’t anticipate any significant issues arising from the upcoming changes we expect to see in the next six months. We remain vigilant and will continue to assess the situation.

Okay, great. That's helpful. Thanks very much.

Okay, next question.

And we do have a follow-up with Mickey from Ladenburg Thalmann. Please proceed.

So, just Rachael, just one sort of modeling question. The income-based incentive fee was lower than I anticipated based on your pre-incentive fee NII. Is there some noise in that number? Or any explanation as to why it's probably lower than we would expect?

Nothing that to call out. There was nothing unusual in there. I think it's just a result of the calculation. So yeah, ends coming out, reduce the asset base. Yeah, I can't think of anything else that would have impacted your modeling.

Does the dividend payable have any impact on that calculation?

No.

No, I didn't think so. Okay, that's it for me. Thanks.

Thanks.

Okay, next question.

There are no further questions at this time. I would like to hand it back off to management.

I don't know if you all can hear me, but I just wanted to thank Rachael for all her years of service. She's a clear-headed, no-nonsense advocate but her insights have been really, really great for us, individual investors and a big shout-out to Dave and Michael and Dave, and you guys just do a fantastic job taking care of us, individual investors. So thank you very much.

Thank you for being a shareholder.

And how much do we owe you for that discussion?

You already paid him with that special dividend.

You guys have paid me over and over again.

Okay. Thank you again for saying that. We'll move on now to say goodbye to all of you for this quarter, and we'll see you again next quarter. That's the end of this conference.

Thank you. This will conclude today's conference. You may disconnect at this time, and thank you for your participation.