Prepared remarks
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?
That's enough.
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 bio-focused fund.
It remains our intent to continue rewarding our shareholders with meaningful supplemental distributions from the realized capital gains on exits. 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. I'll now hand it over to you David to wrap us up.
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 with Berkshire Hathaway where they asked him, would you like to have something that pays a dividend every quarter, forever and a day, or would you rather have more income but have it come 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 are supplemental distributions that come from capital gains in one of our portfolio companies that goes public or is sold. The 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.
Questions and answers
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 that 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, it's 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 non-accrual 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?
Sure. So yeah, as I think we alluded to in the script, I think Rachael mentioned in her part that one of those companies is actually now profitable, indeed, that would be Hobbs. And the answer to your question is two things. One, we've made changes to the senior management team and we're really excited about the team that's there now, both the CEO and also the CFO, who has been relatively new to the company but now about six months or so. So we've got a really solid management team. That's the first thing. From the business perspective, keeping in mind that the nature of the business and where it got off track, to be perfectly honest, is they do contracting with general contractors who are building initially single-family homes, multifamily homes, and they've been expanding into some industrial commercial type projects. The problem that occurred going back a couple of years now is always a long-term contract.
Truthfully, they were either not very well priced, not very well managed. And so as a result of that, and recognizing that most of that accounting is done on a percentage of completion basis, we would end up with jobs that have what they in their terminology called job phase, meaning they're not able to recoup some of their expenses as the job potentially would go along, recognizing some of these jobs could go on for over a year, right? So we finally got a grasp on that aspect of it. Number two, they were able to then start taking jobs where they have a much higher margin, much higher reliability of being able to manage and reduce and eliminate, frankly, job fade, property pricing, and proper project management going forward. That also allowed for, believe it or not, a slightly lower revenue. This company is over $100 million plus in revenues, getting it down to a level that we are actually taking business only at a certain margin level and sticking with it.
So that's all starting to come through the system currently. So therefore, that's what we have done, how we have worked with the business and how we've helped get it to the level it is at. My hope would be, and it's just that, that coming back on accrual status could occur, frankly, probably not within the next six months, but hopefully shortly after that, we might start being able to bring some of it, maybe not all of it back on accrual. So it's a long answer to your question, but again, it's a good, solid business, good management team, making money now and not requiring any additional cash or support from us, which is a good thing.
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, I'm sorry to say, it's probably going to be a six to nine-month time frame. They started again to generate some cash flow right now, 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 very much.
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 extremely active opportunities out there. I don't know if I've heard you describe it like that before. Can you provide some details about that comment? Additionally, if you could give us an estimate of the opportunity in terms of the pipeline, that would be really helpful for us to better understand that comment.
No, I did use that word, and it's an adjective that I'm probably not going to use again. But seriously, I don’t want to say anything inappropriate here. I can tell you we are working very hard at all levels. One of my partners and senior Managing Director is sitting next to me on this call this morning. She is actively involved in a couple of deals that we hope will close in the next month or two, alongside new deals we are pursuing. Over the past few months, we've been submitting a significant number of indications of interest and Letters of Intent on businesses we find appealing. Many of these have high valuations, and we've missed some opportunities because we were two or three turns of EBITDA lower than others. Overall, there is a lot of positive activity. We are focusing on high-quality opportunities, and the quantity of deals is increasing. The quality is also higher, and the size of the companies we are targeting and willing to bid on has increased compared to what we have historically done. That’s why I’m extremely enthusiastic about our current position. We need to keep working hard, and I mentioned that we are conducting due diligence carefully. Thus, a lot of activity is happening within our team and the portfolio.
Okay. Dave, how do you assess the situation? You mentioned that some transactions are priced higher than what you would prefer based on EBITDA multiples. What gives you confidence that the deals nearing completion aren’t facing the same challenges?
Yeah, only because of the way our process works. Let me define, if it’s alright with you, getting close to the finish line. For us, there are two levels. One would be when we do what we call an indication of interest, which means we're putting out what we say we're willing to do. That leads generally then to an opportunity, as you would know, to go and meet the management team, et cetera, if we sort of made that first cut, right? So after we've done that, we then think this is worthy of moving to the next level, we do some work. We then would put together what we call a letter of intent, which now pretty much solidifies for us what we're willing to pay. That LOI has to get approved by our investment committee. And if that is the case, we then submit that back. So at that point, that's getting close to the finish line, right? So when we do that, we generally have a relatively high degree of confidence that we are going to probably get selected.
We don't always do. If we get selected then, frankly, and that's kind of in a stage we're in with a number of companies right now, it's really up to us in terms of finalizing the due diligence and unless we find something that really came out of the woodwork that we don't think really fits, we're going to get that deal done. And that's why I'd say those that I would put into that category, we have a reasonably high degree of confidence we're going to get closed here in the next number of months. So I don't know if that helps you, but I don't think I can be any more really specific than that. But I've got folks sitting around the table that would probably hit me all in the head if I got more specific.
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 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.
Yeah, absolutely. I think we historically have kept a very conservative balance sheet, and it's kind of for this reason, right? It's so we have the flexibility and the liquidity available to be nimble when the team has the opportunities in place that need funding. So obviously, utilizing the large capacity we have available on our credit facility is something we consider to be very important. And then two quarters ago, we started our new $75 million ATM program, and we have not tapped into that yet. So we consider that to be a very meaningful kind of lever within our capital raising mechanism. And also, we remain open to the potential of other future debt issuances as well, whether that might be in the near term or further out into the future. But I think we kind of look at it all holistically and what makes sense in order to fund the 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 and then 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 in the portfolio remained steady during the quarter, which is not something we have commonly observed across the industry. We have experienced significant yield compression with the ongoing earnings season. When do your floating rate debt investments have their interest rate reset?
So, 100% of our portfolio is variable rate debt. So there are some ins and outs kind of in that number. So while it remains consistent quarter-over-quarter, obviously, we did see the impact of decreasing so far in there. It was just generally offset by changes within the portfolio. So specifically, Nth Degree, that exit during the quarter, just had a yield that was a little bit lower than the total average. So by removing that, it was an offsetting increase.
And remember, Bryce, we also have floors. Even though we have floating rates, we've benefited to some extent from SOFR being high. I may be thinking about this the wrong way, but I don't feel strongly about the issue of yield compression. We approach new deals and past deals with careful consideration of the floors we want to achieve relative to our total dollar investment. When evaluating the yield on our entire investment, which includes both equity and debt, we aim for a specific level. We set the floor on the debt pieces to blend that yield with the assets we are acquiring. Overall, I think we're in pretty decent shape. Would you agree with that?
Yes. And so in reference to what Dave's discussing, regarding 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? 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 performance across the portfolio as it impacted fair value this quarter, we had a decent amount that was up in performance. So then you'll see that in the increasing EBITDA range. That was sort of offset by a handful of companies that saw a 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 curious if there's some conservatism being baked into fair value estimates or yeah, it's a multi-part, but that would be helpful. Thanks.
From a fair value perspective, we had the exit of Nth Degree, which generated a $42 million realized gain. For our portfolio, that was a fairly outsized unrealized appreciation that we have been carrying until the exit when it was realized. So that's really responsible for the overall, I'd say, portfolio decrease when you're looking at that fair value percentage. Overall, excluding that reversal of any unrealized appreciation related to Nth Degree when it was exited, we did experience about $0.11 per share of unrealized appreciation across the portfolio in the aggregate. So excluding that, we did see fair values across the board go up.
And 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, either positive or negative?
We’re not experts on policy either, but we believe things will stabilize over time, with fluctuations in various areas. One significant concern that we’re monitoring closely involves tariffs, especially for our companies with products manufactured overseas, particularly in China. Many of these companies have been operating in a tariff-focused environment for several years. Some have moved production to different countries when feasible, and some have returned to the United States. Currently, I cannot point to any major issues resulting from potential changes we might hear about in the next six months. We’re aware of the situation and will continue to evaluate it.
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 to call out. There was nothing unusual in there. I think it's just a result of the calculation. So, ends coming out, reduced 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. Actually, we just got one. Mark Farone, he's a private investor. Please proceed.
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, 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.