Earnings Call Transcript - GAIN Q3 2023

Operator, Operator

Greetings and welcome to the Gladstone Investment Third Quarter Earnings Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Chief Executive Officer, David Gladstone. Thank you. You may begin.

David Gladstone, CEO

Well, thank you very much and welcome to all of you coming into this call. This is a good call coming up, so hope you stay tuned through the whole thing. This is the third quarter report for fiscal year 2023, which ended December 31. We are a little further away from that. This earnings and conference call is for shareholders and analysts of Gladstone Investment, listed on NASDAQ trading symbol GAIN for the common stock. We have two registered notes, one under GAINN and another under GAINZ. Thank you all for calling in; we are always happy to provide an update to our shareholders and the analysts who call in, offering a new point of entry in terms of information about the company. The two goals for this call are, first, to help you understand anything that has happened in the past through December and give you a current view for the future. Now, we will start out not with our General Counsel this time, but with his right hand man, Eric, who is going to do Michael LiCalsi’s call.

Eric Purple, General Counsel

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, 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. These factors are listed on our Forms 10-Q, 10-K and other documents we filed with the SEC from time to time. They can all be found on the Investors page of our 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 not a guarantee of future results. Please take the opportunity to visit our website and sign up for our email notification service. You can also find us on Twitter and on Facebook using the keyword, The Gladstone Companies. Today’s call is simply an overview of our results through December 31, 2022, so we ask you to review our press release and 10-Q, both issued yesterday, for more detailed information. I will now turn it over to Dave Dullum, President of Gladstone Investment.

Dave Dullum, President

Thanks, Eric, and everyone listening in, we appreciate you being here. We are pleased to report that GAIN did indeed have another good quarter for this part of the year ‘23, quarter ending 12/31, including this very challenging period of rising interest rates and inflationary costs. Our portfolio companies are meeting these challenges, and we must remain vigilant and cautious, not only with our portfolio management of these companies, but also with our new acquisition activity. We ended the fiscal third quarter on 12/31/22 with adjusted NII of $0.30 per share, slightly up from $0.29 per share in the prior quarter. You will hear more about this detail from our CFO, Rachael Easton shortly. This is good because we are also continuing our expectations for a strong fiscal year ending 3/31/23 and beyond that with future earnings. Total investments at fair value as of 12/31/22 increased to $760 million from $738 million at the 9/30 quarter end, primarily due to successful deal activity in the quarter. We invested $15.5 million in a dividend recapitalization of one of our existing portfolio companies. In connection with this investment, we received dividend income of $4.5 million and recognized a realized gain of $13.4 million, increasing our debt investment in that company to $40.5 million. This allows us to increase our investment in a quality company while harvesting income and capital gains. The buyout market remains quite active, and we will pursue opportunities that allow us to create value within our portfolio, while rewarding our shareholders. During the quarter, we also invested an additional $8.4 million to fund an add-on acquisition to one of our portfolio companies. We exited one investment with our debt investment being repaid, receiving success fee income of $1.1 million. We also increased our monthly dividend by 6.7% to $0.08 per share, up from $0.075 per share, marking a new annual run-rate of $0.96 per share. Additionally, we paid a supplemental distribution of $0.12 per share in December 2022 and subsequently declared a supplemental distribution of $0.24 per share, to be paid in March 2023. We anticipate continuing to fund these supplemental distributions from recognized realized capital gains and future exits, compensating for other recapitalizations. Our Ohio-focused strategy consistently generates solid income from distributions to shareholders and capital gains on equity, which enables these supplemental distributions. During the quarter, we experienced a very small decline in valuations across our portfolio, primarily due to declining valuation multiples, even though many of our portfolio companies saw increases in their actual EBITDA. Our balance sheet remains strong with low leverage, positive liquidity, and significant availability in our credit facility, allowing support for our portfolio companies and new buyout opportunities. Looking forward, despite some declines in multiples, the market remains competitive with substantial liquidity in the buyout funds we compete with. We will be selective while aggressively seeking new acquisitions, practicing patience in our diligence and review process. In summary, we believe the state of our portfolio is healthy from a credit perspective. We have a solid liquid balance sheet and active buyout activity, with good prospects for earnings and distributions over the next year. Now, I will turn it over to our CFO, Rachael Easton, for more detail.

Rachael Easton, CFO

Thanks, Dave. I will start with a summary of the fund’s operating performance for the quarter ended December 31, 2022. In the fiscal third quarter of FY ‘23, we generated adjusted net investment income of $10 million or $0.30 per share, up from $9.7 million or $0.29 per share in the prior quarter. We continue to believe that adjusted net investment income, exclusive of any capital gains-based incentive fees, is a useful and representative indicator of our ongoing operations. In the fiscal third quarter, we generated total investment income of $21.6 million, up compared to $20.8 million in the prior quarter. The increase in total investment income was primarily due to improved yields on our debt investments driven by increased LIBOR and interest income on additional debt investments made during the current quarter. The rise in total investment income was offset by increased net expenses to $13 million from $9.4 million in the prior quarter, mainly due to a $3.1 million rise in accrued capital gains-based incentive fees due to realized and unrealized gains and losses as required under U.S. GAAP. Consequently, net investment income decreased to $8.6 million or $0.26 per share from $11.4 million or $0.34 per share in the prior quarter. During the quarter, one portfolio company was moved to non-accrual status, and we believe it will start paying interest in the next couple of quarters. We now have three portfolio companies on non-accrual status, and we will continue working to return them to accrual status when possible. Maintaining liquidity and flexibility to support our portfolio is essential for our success. We had over $150 million available on our $180 million credit facility at December 31, 2022. Additionally, we raised approximately $3 million in net proceeds under our common stock ATM program. Overall, our leverage remains low, with an asset coverage ratio of 250.5% as of 12/31/2022. Our NAV per share increased to $13.43 per share at 12/31/2022, compared to $13.31 per share at 9/30/2022. The increase was primarily driven by $8.6 million in net investment income, $3.8 million of net realized gains, $3.4 million of net unrealized depreciation, and $3 million in proceeds under our ATM program, offset by $12 million in distributions to common shareholders. Consistent with previous quarters, distributable book earnings to shareholders remain robust. We increased our monthly distribution to $0.08 per share, marking a new annual run-rate of $0.96 per share, and paid a $0.12 per share supplemental distribution in December 2022. In January, we declared a $0.24 supplemental distribution to be paid in March 2023. With these figures, our aggregate fiscal year distributions would total $1.44 per common share or yield around 10.5% based on yesterday's closing price of $13.70. This concludes my part of today’s call. Back to you, David.

David Gladstone, CEO

Thank you very much, Rachael. It’s great that Dave and Eric provided more information to our shareholders. This call, plus the 10-Q filed at the SEC yesterday, can also be found on our website and brings everyone up to date. The team has reported solid results for the quarter, and I believe the team is well positioned to continue success through the remainder of our fiscal year, which ends on March 31, 2023. Gladstone Investment is an attractive investment for those seeking continuous monthly distributions and supplemental dividends from capital gains. The team aims to maintain strong returns for our fund’s investments. Folks, you are currently receiving $0.96 per year, which translates to a nice 7% yield, and if we can pay supplemental dividends, that will bring the total up to 10.5% for this year. This is fantastic performance, so I suggest you buy a significant amount of shares because I believe in our strength. You have been paying dividends for how long, Dave? About 200…

Rachael Easton, CFO

227.

David Gladstone, CEO

227, that’s just fantastic. I think all of you know that the team here has presented our plan for going forward and paying dividends to shareholders. Now, let’s have some questions from our analysts and shareholders. Operator, please come on and provide the instructions for participants.

Operator, Operator

Thank you. Our first question comes from the line of Mickey Schleien with Ladenburg. Please proceed with your questions.

Mickey Schleien, Analyst

Yes, good morning, everyone. Dave, I understand that you said in the prepared remarks that the market for buyouts remains frothy, but are you seeing any improvement in opportunities available to you given all the risks and headwinds that we are seeing in the market currently?

Dave Dullum, President

Hey, Mickey. Good morning. So the short answer is we are seeing opportunities. There are still good companies out there. I would say that even though I describe the market as frothy, it remains competitive. There remains a significant amount of money to be put to work, which means that the companies coming to market, represented by good-quality investment bankers, are seeing aggressive multiples from a valuation standpoint. However, the overall volume has decreased slightly, indicating a holding pattern. Some companies that might typically come to market are waiting to see how their earnings perform this year. Nonetheless, there are still good companies, and we are currently exploring several indications of interest on sizable businesses and are moving towards letters of intent, which initiate the due diligence process. We hope that we will conclude some decent deals this year, which I think is highly likely, but we must remain careful with our valuation metrics as we deal with both debt and equity.

Mickey Schleien, Analyst

I agree and appreciate that. Dave, I have a few questions about portfolio credit quality given the difficult outlook for the economy, so bear with me here. When did you place Edge on non-accrual? Did you reverse any previously accrued interest income on it?

David Gladstone, CEO

Rachael, would you like to answer that?

Rachael Easton, CFO

Yes, we placed Edge on non-accrual at the beginning of the quarter, so as of October 1, and we reversed one month.

Mickey Schleien, Analyst

You reversed a month, okay. And Dave, broadly speaking, what issues is Edge confronting? The previous valuation was already stressed, and now it’s on non-accrual, but you mentioned that you are hoping for a positive outcome in a couple of quarters. What insights can you share regarding that company?

Dave Dullum, President

Interestingly, some cases show that the company is generating cash. While we might have another lender with constraints stemming from fixed charge coverage metrics that they look at, the company is positioned to pay our interest. We may need to adjust our perspective occasionally, but fundamentally, the company is performing quite well going into the beginning of this year. As Rachael mentioned, I would expect we can bring it back to accrual status within the next few quarters.

Mickey Schleien, Analyst

Understand. I see that you recapitalized Mountain, which has been on non-accrual for a while, but it’s still on non-accrual? Can you provide insight regarding the outlook for that company?

Dave Dullum, President

I don’t believe we will return this one to accrual status for quite a while. We have essentially restructured the debt at a slightly different valuation, which allowed us to mitigate some of the debt from a valuation perspective. However, I do not anticipate the company returning to accrual status anytime soon.

Mickey Schleien, Analyst

Does that mean their end-user is consumers? Is that weakness in consumers something we are observing elsewhere in the portfolio?

Dave Dullum, President

In that particular sector, we did see some softness in December. January traditionally is a slow month for them, so that isn't unusual. However, we see a slight uptick in February. The company's customer base comprises specialty stores and institutions like zoos and museums, which have seen reduced activity levels. So while the company is doing okay, management concerns have been an ongoing issue that we must address, but we are actively working on solutions to maximize the outcome.

Mickey Schleien, Analyst

I appreciate that. Dave, you mentioned in your prepared remarks that, on a net basis, the decline in unrealized depreciation in the portfolio outside of Old World and Mountain was mainly driven by multiples. Is that the case for Horizon Facilities, which was marked down? Are there performance issues there as well?

Rachael Easton, CFO

Horizon specifically was both a decline in multiples and a decline in EBITDA.

Mickey Schleien, Analyst

Okay. That’s it from me this morning. I appreciate your time. Thank you.

Dave Dullum, President

Just one last thing on Horizon: that company is solid and performs well despite the slight decline in EBITDA and multiples. It's a well-managed company, and we feel very good about it, just to be clear.

Operator, Operator

Thank you. Our next question comes from the line of Kyle Joseph with Jefferies. Please proceed with your question.

Kyle Joseph, Analyst

Good morning, guys. Thanks for taking my question. Can you provide insight on how your companies have been adjusting to the higher rate environment and increased debt servicing costs, and how this impacts the overall leverage of your portfolio?

Dave Dullum, President

Aside from the companies we specifically discussed, we are not seeing significant stress. Most of our debt has a floor, which requires LIBOR to rise dramatically before we exceed these floors. As Rachael pointed out, increases in net investment income have arisen as a result of higher interest coming in. Overall, stress on leverage among individual portfolio companies is not an immediate concern.

Kyle Joseph, Analyst

Got it. Helpful. As a follow-up on Old World Christmas, could you give a sense of the timing, rationale, and its impact on the overall capital structure of that company?

Dave Dullum, President

This is the second time we have recapitalized Old World Christmas. The timing was right near the end of the year in December. It's an extremely strong company with very low leverage and strong EBITDA. So it was an ideal opportunity to allocate more capital, allowing some management who hold ownership interests to receive rewards and enabling us to distribute to shareholders.

Kyle Joseph, Analyst

That’s very helpful. Thanks a lot for answering my questions.

Eric Purple, General Counsel

Next question.

Operator, Operator

Thank you. Our next questions come from the line of Bryce Rowe with B. Riley. Please proceed with your questions.

Bryce Rowe, Analyst

Thanks. Good morning, everyone. I wanted to start with a simple question around the portfolio yield. When do the floating rate loans reset from a base rate perspective? Did they reset after the end of the year or early January? Do you expect continued yield expansion from that floating rate debt portfolio?

David Gladstone, CEO

Yes, Bryce, I will try to answer and then allow Rachael to add. The rate resets automatically. Rates appear to be stabilizing or potentially decreasing, making us cautious about further expansion above current levels. Rachael, do you want to add anything?

Rachael Easton, CFO

Yes, we exceeded our floor late last year. Most of our portfolio has a floor set around 2%. Thus, in this quarter, we did see LIBOR's increase lift our overall yield.

Bryce Rowe, Analyst

Got it. Maybe I didn’t ask it the right way, but I’m trying to understand if the recent rate moves are fully reflected in that 13.4% weighted average yield, or if we might see some carry-through in the March quarter?

Rachael Easton, CFO

Yes, it is fully reflected in that 13.4%.

Bryce Rowe, Analyst

That’s helpful. Let’s see, to follow up on Mickey’s questions about portfolio valuation, Dave, you mentioned an overall net decline in portfolio valuation outside of Old World Christmas. However, there were notable increases from an appreciation perspective. Can you discuss what’s driving those higher valuations? Is it higher EBITDA, higher multiples?

Dave Dullum, President

I will not go through each company, but to give you a general idea, companies such as Brunswick Bowling, Mason West, Dema, Nth Degree, and Schilling saw increases mainly due to EBITDA appreciation, which helped offset slight multiple declines. We do not determine those multiples; they are assigned to us. Our portfolio's balance remains solid, as we maintain companies across various industries. I expect EBITDA will stay stable, with potential for a few increases, while multiples may remain steady or slightly decrease.

Bryce Rowe, Analyst

That’s helpful. Last one for me, about dividends and supplemental: it seems you plan to continue supplemental dividends as appropriate. Can you share the estimated UTI balance? How do you feel about the annualized supplemental level of $0.48?

Dave Dullum, President

As mentioned in previous communications, our model as a “buyout fund,” is unique in the BDC space, given our significant equity investments. This allows us to provide steadily increasing monthly distributions to shareholders, which we have maintained for a long period. We will sustain this, and we intend to keep raising these distributions as we did previously. However, our supplemental distributions can be less predictable. We intend to continue using capital gains for supplemental dividends but cannot guarantee exact timings since it depends on managing the portfolio and successful exits.

Bryce Rowe, Analyst

Understood. Thank you for your time this morning.

David Gladstone, CEO

And Bryce, just so you know, occasionally, analysts write about our number of non-accrual deals. Comparatively to all other BDCs, we have a 7% yield and an opportunity for significant capital gains that lead to additional dividends, so we shouldn’t be compared to BDCs that only lend money. We are engaged in both, which should be highlighted.

Bryce Rowe, Analyst

I appreciate that.

Operator, Operator

There are no further questions. I would like to hand the call back over to you, Mr. Gladstone.

David Gladstone, CEO

Thank you very much. It was wonderful to have such a strong quarter to report on. Dave and Rachael did an exceptional job managing and implementing our plans. If there are any last questions, now is the time to ask. If not, we’ll see you again next quarter. That concludes today’s call.

Operator, Operator

Thank you. That does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.