Prepared remarks
Greetings, and welcome to the Gladstone Investment Corporation Third Quarter Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Gladstone. Thank you, Mr. Gladstone, you may begin.
Thank you, Kat. That was a good beginning. This is David Gladstone, Chairman of Gladstone Investment, and we're discussing the third quarter for the year ending December 31, 2023. Our fiscal year concludes in a couple of months, and this earnings conference call is for all shareholders and analysts who follow us. We're listed on NASDAQ under the symbol GAIN, which stands for capital gains. Additionally, we have three registered notes: GAINN, GAINZ, and GAINL. You can purchase those if you wish, but we won't be focusing on them today. Thank you for joining us. We're always pleased to update our shareholders and analysts on our perspective of the current business environment. Our goals here are twofold: to help you understand what has occurred in the past and, although we don’t have a crystal ball, to provide our current outlook on the future. Now I will turn it over to our Deputy General Counsel, Erich Hellmold. Erich?
Thank you, and good morning, everyone. 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 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, including all risk factors listed in our Forms 10-Q, 10-K and other documents we file with the SEC. These can all be found on the Investors page of our website at www.gladstoneinvestment.com or the SEC's website at www.sec.gov. 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, www.gladstoneinvestment.com, and sign up for our email notification service. You can also find us on Twitter at GladstoneComps and on Facebook, keyword The Gladstone Companies. Today's call is simply an overview of our results through December 31, 2023, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Now I'll turn it over to Dave Dullum, President of Gladstone Investment.
Thanks, Erich, and good morning, everyone. We are happy to report that GAIN produced very good results for this third quarter of fiscal year '24, which follows on the previous solid first 2 quarters of fiscal year '24, which, of course, ends in March. We ended the third quarter of fiscal year '24 on 12/31/23 with adjusted NII of $0.26 per share and total assets of $918 million. You'll learn more about this from Rachael Easton, our CFO, when she describes the details around that. Again, those are good results. In regards to activity for the quarter, we did invest $65 million, which helped us to fund an add-on acquisition in one of our existing portfolio companies. And again, we are always looking and are doing new deals, making new investments and new acquisitions, and that continues to be our goal and objective. However, doing add-ons to certain of our existing portfolio companies is really an important aspect of our value-building process because it allows us to increase our investment in companies where we know the management team, the business itself and where we have a strong belief in its future, and it continues to allow us to really build very good value in these fundamental businesses.
So we'll continue to do that as necessary and in certain specific cases, obviously, while pursuing our main business, which is adding new acquisitions as we go along. We also, as we have in our buyout strategy exits, and we did have a very successful exit with one of our portfolio companies where we actually generated pretty meaningful realized capital gain for us of about $43.5 million. We were able to maintain our monthly distribution to shareholders at $0.08 per share or $0.96 per share on an annual basis, and we paid an aggregate supplemental distribution of $1 per share during November and December of 2023. Again, this large supplemental distribution is a result of the buyout strategy and is our ability to continue rewarding our shareholders with these meaningful distributions from realized capital gains, which are generated on the equity portion of our exits, in addition, of course, to the income that we continue to generate for the monthly distributions and which is obviously very important for the basis of distributions to our shareholders on a monthly basis.
Our balance sheet continues to be strong, with very low leverage and a very positive liquidity position with additional availability on our credit facility. So we will continue providing support to our portfolio companies, both for add-on acquisitions, interim financing if the need arises, while actively growing our assets through new buyouts. Turning to the outlook. The deal flow, as we call it, appears to be picking up somewhat as the sellers who have been holding back over the past 6 months or so are testing the market. And we do hear from the merger and acquisition groups, investment bankers, who are our primary sources for new acquisition opportunities, that the backlog of new opportunities has been building. It seems like the last 6 months or so of last year were fairly slow somewhat and deals were coming to the market and they were being taken back, etc. Now it looks like there's continue to be a bit of an increase in this regard, maybe somewhat, as a result of interest rates perhaps coming down, etc. But in any event, we continue working on a few new possible buyout deals, and we are currently in that early phase of the process.
There does continue to be very significant liquidity in the market, meaning that our competitive situation is, of course, being challenged all the time. So we're going to remain value sensitive while we aggressively compete for new acquisitions. 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 prospects of very good earnings and distributions over the next year. So I'll turn it over to Rachael Easton, our CFO, and she can give more details on the financials of the quarter.
Thank you, and good morning, everyone. Looking at our operating performance in the third quarter of fiscal year '24, we generated total investment income of $23.1 million. That was up from $20.3 million in the prior quarter. This increase was primarily due to increased interest income, which was driven by new debt investments made in the quarter, as well as higher dividend and success fee income resulting from fees received associated with an exit during the quarter, as compared to not receiving any of these fees in the prior quarter. Net expenses as of December 31, 2023, were $13.3 million. This was down from $22 million in the prior quarter. This decrease is primarily due to a $10.4 million decrease 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. This decrease was partially offset by an increase in borrowing costs.
This resulted in net investment income for the quarter of $9.7 million compared to a net investment loss of $1.7 million in the prior quarter. This fluctuation is primarily due to the large accrued capital gains-based incentive fees recognized during 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 $9.1 million or $0.26 per share, up $0.02 from $8.1 million or $0.24 per share in that 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 December 31, 2023, 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 when possible. 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 announced yesterday, we have amended and expanded our credit facility, increasing the capacity to $200 million. And as of yesterday's release, we had over $120 million available of that capacity. Additionally, during the quarter, we were very successful on our common stock ATM program, raising approximately $21 million in net proceeds as well as an additional $7.7 million in net proceeds raised in January, with all sales being accretive and above the then current NAV. We anticipate continuing to be active in the ATM program. Overall, our leverage remains relatively low with an asset coverage ratio at December 31, 2023, of 207%, providing plenty of cushion to the required 150% coverage. Our NAV decreased to $13.01 per share for the quarter compared to $14.03 per share at the end of the prior quarter. The decrease was primarily driven by $1.36 per share in net unrealized depreciation on investments and $1.24 per share of distributions paid to common shareholders during the quarter, of which $1 per share related to supplemental distributions.
These decreases were partially offset by $1.27 per share of realized gains on investments and $0.28 per share of net investment income. Consistent with prior quarters, distributable book earnings to shareholders remained 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 per month for an annual run rate of $0.96 per share. During this past quarter, in November and December 2023, we paid an aggregate $1.00 per share supplemental distribution. We look to continue funding future supplemental distributions as we recognize realized capital gains on the equity portion of our assets. Using the monthly distribution run rate of $0.96 per share per year and $1.24 per share in supplemental distributions paid so far in the 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 $13.96. This covers my part of today's call. Back to you, David.
Thank you very much. That was a very, very good quarter, Rachael and Dave, you've done a great job, and Erich, good information for our shareholders. This call and the 10-Q filed yesterday with the Securities and Exchange Commission should bring everyone up to date. The team has reported solid results for the quarter ending December 31, including the add-on investments and exit activity associated with net realized gains. We believe the team is in a great position to continue these successes through the remainder of the fiscal year, and that fiscal year ends March 31, 2024. I just think Gladstone Investment is an attractive investment for investors at this point in time. And you got monthly distributions, and then you got supplemental distributions from the potential capital gains and some other income. The team hopes to continue, of course, to show you a strong return and rather than keep talking about it, let's get some questions from the analysts and shareholders that are on the line. So operator, if you'll come on and manage that, that'd be good.
Questions and answers
We will now be conducting a question-and-answer session. Our first question comes from Mickey Schleien from Ladenburg Capital.
Dave, I wanted to understand from you how your portfolio companies are progressing in terms of their revenues and margins outside of consumer. We're all aware that the consumer-facing companies have headwinds, but are you seeing any trends in the rest of the portfolio?
Mike, it's great to speak with you. We're experiencing what I would describe as consistent growth, though it has slowed a bit. Overall, things are holding up quite well, although we've faced some impacts from rising costs of materials and distribution in our industrial companies due to supply chain issues. However, those costs have eased somewhat. In general, the situation remains moderate; there's nothing particularly drastic in either direction. Interestingly, some of our consumer products companies are performing reasonably well, despite the current slowdown on the consumer side. Overall, I would say the stability remains strong.
That's good to hear. Dave, regarding deal flow, we have observed that some private equity funds are conducting dividend recaps for their stronger performers to generate returns for themselves and their shareholders. Is this something you are thinking about for your better performing companies in the near future, as it might also help improve their balance sheets?
Right now, there isn't anything on the table in terms of dividend recaps. We've done a few over the past couple of years, including multiple with one company and another last year, all for the reasons you mentioned. While we are always evaluating it as a potential option, especially for businesses we favor that allow us to stay meaningfully involved and create value for shareholders and management teams, I don't see that happening at the moment. Regarding the market overall, the latter half of last year was quite strange, with many deals being pulled. However, we are starting to see a gradual return of deal flow. For the opportunities we're interested in, we're sticking to valuations that make sense for us, which seems to be working well. That said, there are still some inflated prices in the market that we won't engage with. Overall, the outlook appears reasonably positive.
Okay. That's interesting and helpful. Dave. My last question, the more liquid markets for credit have reopened as we all know. Are you concerned about refinancing risk for some of your better-performing investments? In other words, could some of these investments go to other suppliers of debt capital at cheaper rates than you're offering them and you'd be taken out?
Yes. No, that's a great question, and obviously something we always look at and have looked at over many, many years. And frankly, I can only think of one company where that actually happened was an unusual circumstance. I would say the fact that our capital is really, as you know, is a combination of the debt and the equity, right, in the transaction. So the effective yield, so to speak, is comparison to say what just pure debt might be even with this environment where debt is coming down, I would say we're still very competitive in that regard. The relationship with the portfolio companies is probably as important as anything. And then the other aspect to that is, while, as you point out, the spreads might be getting a bit tighter, meaning interest rates are coming down, the availability still, I think, at least from what we're seeing, is not just all of a sudden the flood gates have opened, so to speak, right, and you can get all the capital you need at low rates. So right now, honestly, I'm not seeing any challenges for our portfolio companies in that regard. Could it happen? Sure. But I'm not seeing anything right now. And so I'm not overly concerned we're going to get taken out in any situations that we may not want to be taken out of.
Our next question comes from Kyle Joseph from Jefferies.
Just want to get your thoughts on leverage. Obviously, you guys have a lot of dry powder right now, and it sounds like you're getting more optimistic about deal flow into '24. But just talk about where you're comfortable taking leverage to if we do get that deal flow? Or is it really just more a function of the market and what deals get done?
Kyle, I think what you said, a function of the market and what deals we get done. So as you know, we keep a pretty conservative leverage profile, I think, compared to the greater BDC peer group. And that's something we do believe is really important, but it's also to provide us the flexibility to support that potential new deal flow. So we want to be able to be in a position where, if we need to fund new deals, we have the ability to take on additional borrowings and it doesn't threaten breaking that 150% test.
Yes. I would like to add to that, and as Rachael mentioned earlier, our ATM program has been fairly successful. We have implemented it carefully, ensuring we maintain a solid cushion relative to NAV, and we plan to continue that approach. We are committed to avoiding any risky actions. This strategy gives us the flexibility we need moving forward, and we hope to engage in new deals while also maintaining support from the equity side to sustain a coverage ratio that keeps us secure.
I have one follow-up question regarding the competitive landscape in the lower middle market private equity. While you anticipate an increase in deal flow, how has the competition changed, especially with interest rates rising from nearly zero to significantly higher levels, even though there may be some cuts coming this year?
I would say that the market, from our perspective, has shown some changes, particularly towards the end of last year. While this may not be the case universally, we've noticed that rising interest rates have slowed not only costs but also the availability of leverage. Consequently, the deals we are closing might be overly reliant on equity to get them done. We are observing some shifts, but I don't anticipate a sudden return to high leverage multiples of EBITDA. The environment will likely remain cautious. There are instances where the relative enterprise value of deals appears to be 1 or 2 multiples higher than we believe they should be, but there are still parties willing to engage in those transactions. If they proceed, it seems they are using more equity than debt. The debt market hasn't reached a stage where we are seeing significantly higher leverage per transaction, even with the elevated valuations.
Our next question comes from Bryce Rowe from B. Riley Securities.
I wanted to ask about the upsized credit facility. You've had, I guess, some changes, I think you took the available amount down last quarter, and obviously it's moved back up. So maybe there was a bit of a process to get to that higher level. Could you just, if you can, kind of talk about that process? And did you add some banks to the facility? Just any kind of detail there would be helpful.
Yes, we are very pleased to announce that we have expanded the credit facility to $200 million. During our regular amendment process that concluded in October at the start of the quarter, we had to reduce the facility to $135 million due to the loss of a couple of banks. We were in the process of working on this expansion, but we couldn't close both matters simultaneously. We successfully increased the facility by adding a new bank, Fifth Third, and also received additional commitments from one of the other banks to return to the $200 million level. We believe this additional capacity is crucial for providing flexibility as we consider future projects and deal flow.
That's helpful context, Rachael. I have a question for Dave. Can you discuss the add-on opportunity for an existing portfolio company this quarter? Additionally, are there other opportunities for your existing portfolio companies to pursue add-on acquisitions?
Sure. That company has been part of our portfolio for a few years. It's primarily an industrial business, and we've been working to enhance it at all levels of management. Recently, we acquired a substantial business that integrated well with ours, improving our manufacturing capacity and distribution, particularly in Europe and other regions. This helped us grow our revenue from approximately $40 million to over $100 million, along with a significant increase in EBITDA. The integration process has gone smoothly, enhancing overall value without putting the company in a highly leveraged position. We see good opportunities ahead, and some of our existing portfolio companies are also exploring similar chances. Some smaller companies in our portfolio don’t require additional funding from GAIN because they have strong balance sheets that allow them to pursue smaller add-ons when it makes sense. We will continue to look for ways to add value to our existing companies, and one of them recently made a sizable acquisition with our support. In summary, we will keep seeking out these opportunities.
This concludes our question-and-answer session. I would like to turn the floor back over to David Gladstone for closing comments.
Thank you. That was a good quarter, and I think when we put the numbers together for the year ended March 31, it's going to be one of our best years ever. I mean we'll probably be over $1 billion in assets by then, but anyway, I don't have a crystal ball, so I have no idea what's really going to happen. But we're guessing that things are back strong and growing, a lot of people in the investing world are thinking that business development companies like this one is a place to put some money. But thank you all, and that's the end of this presentation.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.