Gladstone Investment Corp (GAIN) 2023 Q2 法說會逐字稿

Greetings, and welcome to the Gladstone Investment Second Quarter Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Gladstone, Chief Executive Officer. Thank you, sir. You may begin.

Thank you, [Latonia]. That was a very nice introduction, and good morning to all of you that are listening in. This is David Gladstone, Chairman in Gladstone Investment. This is the second quarter ending, that's for the fiscal year that ends March 31, 2023. And we're ending the quarter at September 30, 2022, to talk to you about all the shareholders and analysts that are on, hopefully, you're all ready to ask us lots of good questions when we get to that part of it. And we are talking about the symbol GAIN, as well as two others. GAIN is the Common Stock and GAINN and GAINZ is for the registered notes and things that we've listed as well.

So thank you for calling in. We're always happy to provide updates to shareholders and analysts who are on the phone call. And two goals here to help you understand what happened in the last quarter and also to give you a current view of the future.

Now I'll start out with our General Counsel, as we always do, Michael LiCalsi. Michael?

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. Now 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 risk factors listed in our Forms 10-Q, 10-K and other documents we filed with the SEC. You can find them on the Investors page of our website at www.gladstoneinvestment.com or 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 any past performance or market information is not a guarantee of any future results. We ask that you take the opportunity to visit our website, once again, gladstoneinvestment.com, sign up for our e-mail notification service. You can also find us on Twitter @GladstoneComps and on Facebook, keyword is The Gladstone Companies.

Today's call is simply an overview of our results through 9/30/22, so we ask that you review our press release and 10-Q both issued yesterday for more detailed information.

With that, I'll turn it over to Gladstone Investment's President, Dave Dullum.

Mike. Thank you very much, and good morning, everyone. Welcome. Again, we're pleased to report that GAIN had another good quarter for fiscal year '23. This follows on the previous solid first quarter of the fiscal year.

We clearly are in a challenging period with rising interest rates and inflationary costs. However, our portfolio companies, we're happy to say, are meeting these challenges. And as a result, we ended the second quarter of fiscal year '23, which was on 9/30/22, with adjusted NII of $0.29 per share and total investments at fair value of $738 million, which is up from $690 million at 6/30/22.

Our deal activity this quarter was fairly good as we made one new acquisition and investing $39 million. We also invested $30 million and recapitalized one of our existing portfolio companies.

Now in connection with this investment, we received a return of our preferred equity investment of $10 million. We received dividend and success fee income of $4.8 million and recognized a realized gain of $2.2 million, thereby increasing our debt investment in that company when the dust settled to $57.7 million. So again, we were able to generate capital gains, fee income and indeed increase our actual investment in this portfolio company.

I should note that we will have opportunity for recapitalizations from time to time. Now these are positive events as they generally allow us to generate capital gains and other income while increasing our investment in a company where, clearly, we know the management team and the business. So it's a good opportunity.

With the buyout market still frothy, meaning relatively expensive and pretty competitive, this is a good way for us to create value within the portfolio and therefore, reward shareholders.

Now subsequent to the quarter end, we invested an additional $8.4 million to fund an add-on acquisition to one of our portfolio companies. Also subsequent to the quarter end, we announced a 6.7% increase in our monthly dividend to $0.08 per share, up from $0.075 per share for a new annual run rate of $0.96 per share.

Additionally, we declared a supplemental distribution of $0.12 per share, which will be paid in December of 2022. We currently anticipate being able to fund future supplemental distributions, and this comes as we recognize realized gains -- excuse me, realized cap gains on the equity portion of future exits and potentially from other recapitalizations that we might do.

Our buyout-focused strategy continues to successfully generate both income from monthly distributions to shareholders and capital gains on equity for supplemental distributions.

Now we did experience a small decline in valuations in the aggregate across our portfolio. Now this was primarily as a result of declining valuation multiples even though we had increases in EBITDA at many of our portfolio companies.

Our balance sheet continues to be strong with low leverage and a very positive liquidity position with significant availability in our credit facility, and you'll hear a lot more about this from Rachael Easton, our CFO. This allows us to continue providing support to our portfolio of companies for add-on acquisitions and interim financing if the need arises, while actively seeking new buyout opportunities and growing our assets.

So looking forward, even though there does seem to be some moderation in the multiples being used to determine the values of buyouts, the market is still very competitive with deal flow being strong and significant liquidity in buyout funds, of course, is our competition. We will remain patient and selective in our due diligence and review process while aggressively seeking new acquisitions and implementing recapitalizations with existing portfolio companies as appropriate.

Well, let you know that the new acquisition effort is very important and is a high priority for us. So in summing up the quarter and looking forward, we believe the state of our portfolio is very good. We have a strong and liquid balance sheet, an active level of buyout activity and continued prospect of good earnings and distributions over the next year.

So Rachael, would you tell us a little bit more detail about all of that?

Absolutely. Thanks, David. Good morning. I'll start with a summary of the fund's operating performance for the quarter ended September 30, 2022. In the second quarter of fiscal year '23, we generated adjusted net investment income of $9.7 million or $0.29 per share. This was up from $8.3 million or $0.25 per share in the prior quarter.

We continue to believe that adjusted net investment income, which is net investment income exclusive of any capital gains-based incentive fees is a useful and representative indicator of ongoing operations. The increase in adjusted NII was driven by an increase in total investment income to $20.8 million compared to $19.3 million in the prior quarter as well as a decrease in net expenses to $9.4 million from $11.9 million in the prior quarter. The $1.5 million increase we saw in total investment income was primarily due to an increase in debt investments in the current quarter as well as an increase in LIBOR impacting our interest rates.

Additionally, driving the increase in interest income, we had one portfolio company that was previously on nonaccrual, come back on accrual status this quarter.

Going forward, there are two portfolio companies that remain on nonaccrual status, and we will continue working with those companies to get back on accrual status, if possible.

The $2.5 million decrease in net expenses we experienced was primarily driven by a decrease in accrued capital gains-based incentive fees. This is due to the net impact of realized and unrealized gains and losses as required under U.S. GAAP.

We believe that maintaining liquidity and flexibility to support and grow our portfolio are key elements of our success. We have long-term capital in place and at 9/30/2022 had $163.4 million available on our $180 million credit facility. Additionally, we raised approximately $0.5 million in net proceeds under our new common stock ATM program, all sales of which were above NAV.

Overall, our leverage is low with an asset coverage ratio at 9/30/2022 of 254.1%. Our NAV per share declined during the quarter to $13.31 per share at 9/30. This is compared to $13.44 per share in the prior quarter. The decrease was primarily driven by $10.6 million of net unrealized depreciation and $7.5 million of distributions paid to common shareholders. These amounts were partially offset by $11.4 million of net investment income and $2.3 million of realized gains on investments.

Consistent with prior quarters, our distributable book earnings to shareholders remain strong. With that in mind and as previously announced in October 2022, our Board of Directors increased our monthly distribution run rate to $0.96 per share per year and declared a $0.12 per share supplemental distribution to be paid in December of this year.

Using the new monthly distribution run rate of $0.96 per share per year and the $0.24 per share in supplemental distributions paid and declared so far for the year, noting that this may not actually be indicative of what ultimately may be declared for the year. Our fiscal year distributions would total $1.20 per common share or a yield of about 9.2% using yesterday's closing price of $12.99. This covers my part of today's call. Back to you, David.

Thank you. Very nice, Rachael. It was very nice for Dave and Michael as well, we've given good information to our shareholders. This call and the 10-Q filed with the SEC yesterday should bring everyone up to date on the company. The team has reported solid results for the quarter and we believe this team is in a great position to continue these successes through the remainder of our fiscal year, March 31, 2023. And I'm telling you getting over 9% yield on the price of the stock these days, it's very strong return. I hope all of you call your broker and get some shares.

We believe that Gladstone Investment is an attractive investment and we're seeking continuous monthly distributions and supplemental distributions from potential capital gains and other income.

Team hopes to continue to show you strong returns for your investment, and we'll take good care of your money. As you know, most of us here at the company have a lot of shares in this company as well as the other funds.

So now I'm going to stop, and we'll ask our analyst friends and maybe some shareholders to ask us some questions, and we'll do our best to give you a good answer.

(Operator Instructions) Our first question comes from Mickey Schleien with Ladenburg Thalmann.

Dave, I wanted to ask you about how business owners are behaving in terms of their willingness to perhaps sell their businesses when we think about the headwind of rising interest rates for them and the headwinds also from a potential recession. In other words, is that driving them to have more interest in selling and providing you perhaps a bigger pipeline than you have in the past?

Mickey, thanks for that question. I can't honestly tell you that we're seeing that. I would say that there has been probably a bit of a slowdown in a pure family owned or controlled business somewhat to that degree. Obviously, there are other variables such as what sort of succession there is. And what we're finding, unless -- and we've had a few situations like this where you start getting into diligence and the values come down when you really get into it. And as a result of that, actually, the sellers then will back off and not move forward.

So to your point, there is a bit of that where they'd love to try to sell it. But if it's not at a value, they'd rather stick with it and so on. So I wouldn't say that's really helping improve the deal flow in that regard.

And then the other, obviously, seller group would be other private equity firms, frankly, and they're more looking to at the point where they need to exit, they're going to exit sort of regardless. But having said all of that, as I mentioned, there is still enough demand, if you will, and capital that is still keeping some of those valuations at a higher value than, frankly, we think we can support. So net-net, it's a struggle.

Okay. I appreciate that, Dave. Your portfolio sort of includes many companies that are fundamental businesses focused on the U.S. economy. So I think it'd be really interesting to understand if you -- or if you could just give us some a sense of how their revenues are developing and their margins as well given all this tightening that the Fed is doing?

So I would say we're starting to just feel a little bit of a slowdown -- as you know, we have -- what I think of as 3 sort of categories, I don't call them necessary industries, but categories, manufacturing, business services and specialty consumer. We're starting to see a little bit of a slowdown, I would say, on the demand side, on the consumer side, manufacturing that's slowing a little bit also. And then on the business services side, that's actually pretty robust right now.

The bigger challenge continues to be in certain categories, finding labor even though we know that there are folks that are not looking for jobs frankly, which I think impacts the way in which we think of unemployment. But having said that, the bigger challenge really is more around good quality labor prices and labor prices seem to be moderating a bit. And obviously, supply chain struggles are improving. Also, we've seen clearly the cost for argument's sake of importing from, say, China or the Far East, where you're dealing with container costs that were $15,000 to $20,000 back not with 6 months ago, now those are back more normal, kind of in the $5,000 to $7,000 per container type of cost. And that impacts clearly those companies that we have that are importing. So we're seeing improvement there. So across the board, I would say it's starting to slow a little bit, but nothing dramatic in that regard.

And Dave, when you think about all those comments you've just made, and look at the forward interest rate curves, what level of concern do you have regarding your company's ability to fund their debt service in terms of cash interest coverage ratios and their ability to absorb, what looks like going to be meaningfully higher interest rates over the next couple of quarters?

Right. So currently, as you know, the way our deals are structured with a LIBOR plus on floors, we've been always pretty much in the category where we're above the floors. We are at our floors, if you will. And so now with LIBOR increasing, we're starting to see a bit of an increase over and above what they've been paying. So because our floors, so to speak, have been relatively high, I would say, because as you know, the yield on our total portfolio is 11.9%, 12%. So we're not seeing as big an impact right now.

And the other thing, obviously, which as you well know, because of the way in which we own these companies and the way in which we capitalize these companies, we have a little bit of flexibility if we weren't needing to give our company some help, so to speak, in a deferral or a slight reduction as things really got tight, which we've had to do in the past from time to time. But right now, we're not seeing that to be a big problem with any of our portfolio companies. We obviously have two that have been on nonaccrual for a while, one that actually came off of nonaccrual, which is a very good thing. And the two that are currently on nonaccrual, we -- and as Rachael said, we're working hard with those companies. I think one of them, very good chance it will sometime in the next 6 to 9 months could come off nonaccrual. The other one, not so sure, but that's not a huge frankly, driver to affect our results going forward.

I appreciate that, Dave. A couple of last questions, more housekeeping sort of questions. The portfolio's weighted average yield climbed only 20 basis points, but during that period, LIBOR increased 150 basis points. You just talked about LIBOR floors. Were your LIBOR floor so high that, that accounts for that change? Or is there something else that I should understand?

So you're right there. Our floors are generally around 2% to 3% across the portfolio. So as LIBOR continues to increase this quarter, we should see that yield lift as well.

Okay. So your floors are higher than what's typical in the middle market. And my last question is just your view on balance sheet leverage. What sort of level of debt to equity are you comfortable with in the current market environment?

Right now, we're at about 250%. And I think that's a level that we are comfortable with. We have -- we're at current about $20 million out on our line of credit. So I think we have a lot of room there, but we look at it holistically at our business and our capital structure. And we were conservative in our leverage metrics, and I don't think we're looking to change that. .

Yes. And obviously, as we look forward and start, hopefully, we'll be making some new acquisitions this year. We have the capacity. That's the good news, as Rachael is pointing out, in terms of where we would start to be a little nervous, call it, around the leverage ratio. I would say, if we start to get in the kind of 180% sort of range is probably where we start to look at it. As you know, we put in an ATM program earlier this year in common stock, and we were raising not aggressively, but we were raising until, of course, price has started moving down for everybody. So we're clearly -- we're slowly back to above NAV, we're a little bit below NAV. So we're certainly not going to raise any common -- certainly at this level as we go forward and as prices hopefully would start -- stock prices move back up, we'll gradually add some equity to the balance sheet as we look forward and sort of match it with new acquisitions that we're making.

But right now, as Rachael said, to reinforce that, we are in really good shape right now. And we think as we look forward, even with some pretty good new acquisitions, we'll be in decent shape, both from a leverage perspective and from a capital perspective, probably up through halfway of next year, they are above. That would be my thinking.

Okay. That's it for me this morning. I appreciate your time, as always.

(Operator Instructions) Our next question comes from Kyle Joseph with Jefferies.

Just curious on your commentary regarding things remaining competitive in the middle market in terms of buyout. What would be the outlook for you? If rates continue to rise, do you ultimately see some competitive disruptions there? And then in terms of capital allocation priorities, are add-on acquisitions kind of the near-term focus for you guys?

Yes. Kyle, good to talk to you. So add-ons, yes, we've been making some of those. And as we mentioned this past quarter, we added on to one of our portfolio companies, and we're continuing to grow that business. We're aggressively looking for add-ons, that's a good way for us to do, as I mentioned, recapitalizations with some of the companies that are sensible. That's another good way for us to do it.

In terms of the competitiveness, though what we're starting to see is as rates rise, where the impact there, clearly, is around for the traditional private equity funds, meaning our competition, the leverage that there being made available for them is certainly declining a little bit, we think.

In other words, it's getting tougher for them to get leverage, forget the rate even, so that should thereby mean that we are more competitive because we, right, we bring our own leverage with us, and it's a total package.

We are seeing some of that. But having said that, what we're also seeing is private equity firms, frankly just being more aggressive on the equity. In other words, they're less leverage putting more equity in the deal and presumably, that thinking that down the road, they'll be able to lay that off in some regard. So the short answer would be, it's still a struggle. It's still competitive. And we're not going to pay some of the multiples that we're seeing because it really doesn't work for our model, and it's not the right way to go.

So we'll keep being patient. And I think we'll do a good job this year, but it's going to again take us a while to make the kind of acquisitions we'd like to make.

Next question, please.

There are no further questions in queue at this time, Mr. Gladstone. So if you have any closing comments for the group?

Well, that said, we like good questions. So we're missing out on this one. We'll have to wait till next quarter in order to hear some really strong questions, hopefully, next time. That's the end of this. Thank you all for tuning in.

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