GAIN - NASDAQ

Greetings, and welcome to the Gladstone Investment Corporation Second Quarter Earnings Conference Call. [Operator Instructions] 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 1 that ends in September 30, 2023. So we're bringing everybody up to date. And Gladstone Investment is listed on NASDAQ and has the trading symbol of GAIN, for the common stock. And then we have 3 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 that are following us and provide a view of the current business environment, a little bit about the future, hopefully. Two goals is to help you understand what has happened and give you a current view of the future. And 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. And 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, www.gladstoneinvestment.com and the SEC's website, which is www.sec.gov. And 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, once again, gladstoneinvestment.com, sign up for email notification service. You can also find us on Twitter, @GladstoneComps, and our Facebook keyword there is, the Gladstone Companies. 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. And with that, I'll turn it over to Dave Dullum, President of Gladstone Investment.

Thanks, Mike. So 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 is following 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. So deal activity is obviously important to us. And for this quarter, we invested approximately $65 million, and that was between 1 new buyout investment, and we made an add-on acquisition to 1 of our existing portfolio companies. As we've said before and will continue forward, we will continue to seek these add-on opportunities, as they do allow us to increase, obviously, 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. So actually in this regard and subsequent to the quarter end, we invested an additional $65 million to fund another add-on acquisition to another 1 of our existing portfolio companies. So following in the same vein, and we find that this sort of activity these days is actually a good area for us to look at, as we continue to build overall incremental value in the portfolio. We also, though, did have a successful exit of 1 portfolio company, and this generated a meaningful realized capital gain of around $43.5 million. So again, we continue to make new acquisitions, add-on to our existing portfolio companies and likewise, exit companies when it makes sense and that, of course, generates some capital gains. We also maintained our monthly distribution to shareholders at the $0.08 per share, which is $0.96 per share on an annual basis and then paid a supplemental distribution of $0.12 per share in September of this year, 2023. Subsequent then to the quarter end, we declared aggregate supplemental distributions of $1 per share to be paid incrementally in November and December. So in aggregate, it will be $1 being paid between those 2 months. Now this fairly large supplemental distribution highlights the strength of our buyout strategy and our ability to reward our shareholders with a meaningful supplemental distributions from these realized capital gains, which are generated on the equity portion of the exits. So in addition, of course, to the income which we generate on a monthly basis to be able to fund the monthly, at least currently, $0.08 per share. The balance sheet, of course, is important, and that continues to be strong. We have low leverage, pretty positive liquidity position with additional availability on our credit facility. So we obviously continue to provide support to our portfolio of companies for these add-on acquisitions, I mentioned, and also any interim financing if the need arises, of course, why we continue to actively grow our assets through new buyouts. In that regard and looking forward, currently, deal flow seems to be picking up sellers who have been holding back in the past, say, 6 months, I believe, are starting to test the market. And we do hear from a lot of the merger and acquisition and the sell-side investment bankers that we deal with that the backlog of new opportunities seems to be building. There is -- obviously, continues to be significant liquidity with buyout funds that we compete with, which reinforces a strong competitive environment, so we must remain value-sensitive, while aggressively competing for new acquisitions. One thing we should note in this environment, of course, with interest rates being relatively high with somewhat lack of liquidity in the debt side from the commercial banks, which generally provide the leverage to the traditional private equity fund, who we compete with, we have the benefit of providing both the debt and the equity when we make an acquisition. So we believe that looking ahead that we have somewhat of a competitive edge because we are the supplier of the debt and the equity when we do compete for a specific new potential add on -- a new potential investment. So 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. We have an active level of buyout activity and continued prospects of very good earnings and distributions over the next year. So 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 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 reoccur in the current quarter. Net expenses as of September 30, 2023, $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, which is net investment income or loss exclusive of any accrued capital gains-based incentive fees 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. Consistent with the prior quarter, at September 30, we continue to have 3 portfolio companies that are on nonaccrual status. And we will continue 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 3 public note issuances, we have long-term fixed rate capital in place. And 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 in the aggregate were 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. The increase was 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 remains 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. During this past quarter, 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 [indiscernible] fiscal year 2024. 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 covers my part of today's call. Back to you, David.

Okay. Thank you. Very nice, Rachael. Well, actually wonderful news for everybody, a very nice report by Dave and Michael, information for shareholders. I think this completes everything in terms of the past, this call and the 10-Q filed by the SEC yesterday -- to the SEC yesterday should bring everyone up to date. So 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. Now skipping ahead and looking at the quarter ending December 31, 2023, the company also has declared but not yet paid 2 more supplemental extra distributions. The November 17 distribution is $0.12 per share and December 15 distribution is $0.88 a share. So aggregate supplementals for the quarter ending December 31 will be $1 per share. And then if you include the distribution declared a regular is $0.24. That's $1.24 for the quarter. So please be aware that the record date for the November supplemental distribution is November 7. So you have to buy before then. And the same thing is true for the December supplemental distribution, is December 5. So you need to own the stock before those dates in order to get the supplemental distributions. So get busy and get out and buy some shares so that you get those 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. And I'll say this again, I keep saying it, and for those of you who have listened to me, you've gotten some real good extra dividends. We believe Gladstone Investment is an attractive investment for investors seeking continuous monthly distributions and the supplemental distributions from potential capital gains and the other income that we generate. The team hopes to continue to show you strong one -- 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. So Latonya, would you come in and tell them how they can ask a question.

We will now conduct a question-and-answer session. [Operator Instructions] 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 are going to be very pleased with the dividends that are related to that. Dave, I wanted to ask you about a couple of investments. First, E3 operates in the oil and gas sector, which is obviously cyclical. So I want to know what is it about this company and the deal structure that gives you comfort ahead of a potential slowdown in the economy and making an investment in a cyclical sector?

Mickey, good. Thanks for the question. Yes, you're right, E3 is a little bit out of the norm for us in that regard. What they do, though, they mainly provide a -- I call it, a product that goes mainly to the guys that do the fracking. So if you understand where you go from the well to the pipeline coming out from a fracking situation, you have times when these valves that they have will basically -- the pressure gets too high and they sought to blow, right? And the way they mechanically do it, have done it for many, many, many years, is literally have somebody take and go internal ranch and relieve a valve and it can be very dangerous. What these guys have developed over the last number of years is a system that sits on a skid about the size of a decent-sized table, if you will, that actually control electronically. So it understands pressure building and has a relief. And they've got some technology in the valve system itself that allows for, I'd call it, some proprietariness to the system. So they are really in a position where as long as you're doing some of the fracking and unless that business completely went to 0, they're going to have -- still have a very substantial opportunity. They rent their product. The payback literally is like less than 4 months on what they rent, and they are building them as fast as they can make them. So that's kind of a high level. And you're right, it can be cyclical, but given the profitability, given the level of cash that they have, we believe even if we had somewhat of a slowdown, we would be in really good shape going forward. It's a pretty unique situation, frankly, and by the way, run by very experienced folks, and we went out and brought in some very experienced management to the deal guy came in from Halliburton, who is the actually CEO. We brought him in. So I think we've got a really great management team that knows the industry.

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

Okay. SFEG, I want to be sure we're on the same page, it's not an electrical business really. It really is a combination of a couple of other companies that provide product like welding devices, cutting and so on, going to pipelines and what have you, which is broader than certainly oil and gas as well. So we had the base business, SFEG, which is based in Houston, and we acquired a company called Climax, which is actually based in Portland, Oregon that has operations, frankly, throughout the world. And that's -- as SFEG does by the way. We made an acquisition with them in France about 2 years or so ago that expanded our product line. We also have operations in the U.K. So the combined entity today, by the way, is something in excess of $100 million in revenues and a very significant EBITDA sort of close to 20% EBITDA margins. So collectively, they have a very broad suite of products going to mainly pipeline both in terms of field operations as well as in the manufacturing process, and again, a very strong management team. And so we like the whole thing. It's very strong. We put in a significant amount of money. It's a big investment for us. We have significant ownership. And in our general structure, even though we might have a second lien, a lot of times, the first lien is going to be the lender, the bank who we bring in as a revolving line of credit. And so that's not unusual, frankly, that we would have someone in a first lien position above our debt, which looks -- the language might look more like a mezzanine or what have you. But again, of course, we own a significant portion of the equity. I don't know if that helps or not.

Just to make sure I understand the first lien then is a bank revolver probably with accounts receivable and inventory, as the 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.

And again, that's not unusual, right, for us -- certainly bigger companies.

Sure. I understand. That's all my questions. And again, congratulations on a very good quarter.

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

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

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

Thank you for your question. So that is correct we -- I mentioned in my prepared remarks, we started the year with that $32 million or about $0.95 a share. In spillover, we do not provide updates during the quarter. But I think 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 spillover that we started the year with. I can tell you that is the amount we are comfortable with, rolling into next year, but I cannot, unfortunately, give you update kind of mid-quarter and where we are.

Understood. Let's see. In terms of the fair value marks within the portfolio in the quarter here, Dave. I mean, obviously, they reflect the Counsel Press exit. But also, as you noted in your prepared remarks, good upside from several different investments in the quarter. You mentioned higher multiples as well as better company performance. Could you maybe expand on that comment a bit?

I'll take a shot and then certainly, Rachael, please feel free because you -- I would say that of all of the portfolio companies there are, the majority of them were benefited by a little bit of up in multiple [ EBIT ] as well as up in EBITDA. And then some of the others, which are still fundamentally very strong companies just quarter-to-quarter, even though they were slightly off EBITDA-wise, slightly up with multiple. And so there were some changes in probably 6 or so of the portfolio companies where we had a slight, again, change downwards from the prior quarter, but nothing where I am certainly concerned about from just a valuation perspective. Rachael, you got any -- you want to add to that?

I don't think so. And if there's something specific, you'd like to call out. I think we saw some really great unrealized depreciation at companies like Educators, Brunswick Bowling, Nth Degree, SFEG which Dave, you touched on earlier.

Yes, I think, Bryce, again, without going through each company per se, what have you, I don't see any significant change, as you know, quarter-to-quarter, month-to-month, just because, again, as you know, somewhat it gets magnified, right? If you have 7 or 8x multiple and you get a modest change in EBITDA, that multiple can have a little bit of $1 million as an example. I'm making that up of a reduction in a valuation on something that might be worth, $30-plus million. I mean, so again, I don't see any significant concerns relative to the few that we did have on a slight decline valuation-wise.

Okay. Okay. That's helpful. And then last 1 for me, just looking at the balance sheet structure. You're using the credit facility a bit more with portfolio growth. And if I heard you correctly, $65 million into SFEG would likely kind of call into using that even a bit more unless you access other sources of capital. So if you could just speak to your comfort with the capital structure at this point, would you look to add more notes like you've done here recently? Are you comfortable with where the balance sheet structure is or the capital structure is at this point?

Yes. Well, again, I'll have Rachael add in here, but that amount that we have currently available on our line, of course, is the net amount currently based upon the cash coming in from, say, Counsel Press, et cetera -- the new investment, et cetera. So as of where we are today, that certainly is available capital for anything net new that we plan to do. We also, obviously, as I mentioned -- generally, we're in the market sometimes looking to exit certain of our portfolio companies and is some of that might occur over the next, say, 6 months or so, that capital likewise will obviously come in. So short answer is right today, yes, we feel pretty good about where we are. We always will continue obviously exploring the idea of going out and doing another, say, baby bond. And as we look forward to our deal flow and the opportunities coming forward, we certainly would look to potentially access that market and have the availability then on our line to provide the ups and downs. So today, I think we feel we're in good shape. Rachael?

I completely agree, Dave. I think 1 other thing to add to that is continuing to use our ATM program when...

Right. Certainly supplemental, but we don't certainly concern about anything from a ratio perspective in terms of the fixed asset or the asset coverage ratio. And again, we are pretty active in keeping in touch with what's going on in the market. So if we need to do something, we'll do it. But right now, we feel pretty good.

Our next question comes from [indiscernible] 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 and passing price through to customers?

Sure. No surprise perhaps the companies that we own that are in the, say, consumer product space. I would say we've obviously seen a little softness in some of those, nothing of any great significance at this point. But -- and we certainly have been able to pass through any cost increases that we were having. A lot of it, as you know, coming from the earlier increases in supply chain, transportation costs, et cetera. We've seen that come down pretty significantly, and that's been a positive thing. So in terms of as we look forward, even though in a few cases, we might be seeing some softness at the retail level in terms of revenue. Likewise, we're able to offset that to some degree with lowering our own costs. So from a margin perspective, we've actually seen a few cases where margins have improved even though overall volume has gone down. So net-net, I think we're not seeing any -- right now any big issues there but clearly anticipating there could be a bit of a slowdown in some of the consumer-type product areas from the -- some of the business service areas, and we have a fairly significant investment in that category as you might know. Most of those companies are pretty much operating according to plan. One or 2 might see a little bit again of a slowdown depending on what the sectors they are in. But again, everything seems to be holding up fairly well. And as we look forward, obviously, with our portfolio companies, we're trying to be conservative, wanting to be sure that they maintain margin, not just look to the top line. So all in all, I think we feel reasonable, again in good shape going forward.

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

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