Gladstone Investment Corp. (GAIN) Q2 2027 Earnings Report, Transcript and Summary

Greetings. Welcome to Gladstone Investment Corporation Second Quarter 2026 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Dave Dullum, CEO. Thank you, sir. You may begin.

Thank you, moderator, and good morning all. This is Dave Dullum. I'm the CEO of Gladstone Investment Corporation, and this is the earnings conference call for the second quarter ended September 30, 2026. For all our shareholders and the analysts of Gladstone Investment, which is listed on NASDAQ under the trading symbols of GAIN, GAIN for the common stock. GAINZ , GAINI and GAING for our 3 different registered notes. So we appreciate you calling in. And at this point, I'm going to turn the call over to Catherine Gerkis, our Director of Investor Relations and ESG. So she can go ahead and give you some information regarding disclosure and regulatory matters. Catherine?

Thank you, Dave, and good morning, everyone. Today's call may include forward-looking statements, which are based on management's estimates, assumptions and projections. There are no guarantees of future performance, and actual results may differ materially from those expressed or implied in these statements due to various uncertainties, including the risk factors set forth in our SEC filings, which you can find on the Investors page of our website gladstoneinvestment.com. We assume no obligation to update any of these statements unless required by law. Please visit our website for a copy of our Form 10-Q and earnings press release for more detailed information. You can also sign up for our e-mail notification service and find information on how to contact our Investor Relations department. We are also on X @GladstoneComp as well as Facebook and LinkedIn. Keyword for both is The Gladstone Companies. Now I'll turn the call back over to Dave Dullum, CEO.

Thanks, Catherine. So good morning again, everyone. At GAIN, we had an extremely productive quarter with new deal origination, new portfolio company acquisitions as well as accretive add-on activity to some of our existing portfolio companies. For the quarter, which ended September 30, we deployed approximately $156 million of capital with $20 million of repayments so that our net investment growth for the quarter was $136 million, increasing our investment portfolio to approximately $1.4 billion at its fair value. Now subsequent to the quarter end, our acquisition activity continued and we also had a very exciting exit with a company called SFEG, which is one of our long-held portfolio companies, and we were able to exit at a value in excess of $400 million, which is our largest to date. This should generate and will generate a very significant capital gain for GAIN and therefore, benefit to our shareholders. And you'll hear more of this later on from our CFO, Taylor Ritchie. This transaction really highlights what I think is very important, which is a key strength of GAIN's investing approach where we can patiently build value through add-on investments and be proactive in the operational action that may be necessary to help our portfolio companies grow and prosper. And all of this activity indeed is consistent with our buyout strategy and the business plan for GAIN, which we've been following for a number of years, where we continue acquiring new portfolio companies through a combination of the equity and debt investments which do allow us to pay our monthly distributions to shareholders while we continue building the equity value for an exit and therefore, create the capital gains or further distributions to shareholders. This strategy has allowed GAIN to consistently achieve some of the highest overall returns to our shareholders amongst our public peer group. So along with this growth in assets, we've also, as we continue building out the business, we've been expanding our team of professionals so that we are able to continue building on this success, continue growing the firm and continue in our strategic growth plan. And so in this regard, I'd like to now turn it over to Erika Highland, who is our President, and she took over on October 1 and have her take over from here. Erika?

Okay. Thank you, Dave. From a deal activity perspective, the second quarter was one of our most active on record. We acquired new portfolio -- we acquired our new portfolio company, DHE Computer Systems to start the quarter and ended the quarter with the acquisition of Extrude Hone. Further supporting our investment in Global GRAB Technologies, we completed 2 add-on acquisitions for $20.9 million through a combination of first lien debt and preferred equity. We also deployed $18.6 million to Detroit Defense to support an acquisition to further expand their product offerings. Subsequent to the quarter end, we continued the robust deal activity as we completed the acquisition of a new portfolio company, McFarlane Toys for $56.1 million of debt and equity while also supporting our existing portfolio company, Smart Chemical, with $3.7 million of debt to fund an acquisition. On the investment exit front, as Dave already mentioned, we closed on the sale of the operating entity in our investment of SFEG Holdings. We received full repayment of our debt investment in October, and we also anticipate receiving our equity proceeds over the coming months pending the final dissolution of the business and escrow settlements. The fair value of our equity investment in SFEG as of September 30 of $167 million includes an estimated amount of escrow proceeds to be received. Including new investments and add-on activity from Q1 and Q2, along with the deal activity to start Q3, we have invested approximately $206 million through the first 8 months of the fiscal year. This exceeds our yearly average of $183 million over the past 3 years. It also puts us on track to have [ record ] production volume since inception subject to deal activity continuing for the remaining 4 months of the fiscal year. [ There ] continues to be ample liquidity in the M&A market, creating a competitive environment for new acquisitions at reasonable valuations. As our production volumes show, we have been able to compete effectively for acquisitions that fit our model. This is where we provide both debt and equity to complete the transaction with a meaningful fixed charge coverage and an interest income yield on our total investment in excess of the cost of [ capital ]. We continue to be in varying stages of diligence on new possible acquisition opportunities including accretive add-on acquisitions to existing portfolio companies, and we are in review and negotiation with a number of other new opportunities. As to our existing portfolio, most of the companies have experienced positive results to date, though we continue to be cautious due to macroeconomic factors such as elevated energy prices and inflationary pressures. We continue to work with all of our portfolio companies to support cost efficiencies and growth initiatives, which may include strategic M&A as we continue to navigate the current environment. In this regard, a couple of companies to highlight in the portfolio. Pyrotek has experienced growth with existing artists and new touring productions. Utah Pacific has grown with infrastructure investment in the United States. And recently, Global GRAB and Detroit Defense have completed strategic add-on investments in order to meet demand in the defense and security sector. We continue to have no software exposure in the portfolio and to focus our investment activity on companies that offer critical products and/or solutions for their customers. In summing up the year-to-date, our current portfolio is in solid shape. We have a strong and liquid balance sheet and we continue to execute on our investment strategy with a healthy deal pipeline providing for the prospect of continued strong earnings and distributions over the next year, while we continue to navigate the challenges of an uncertain economic landscape. I'll now turn it over to our Chief Financial Officer, Taylor Ritchie.

Thank you, Dave and Erika,, and good morning, everyone. Our second fiscal quarter reflected significant investment activity growth in our interest-bearing investments, along with net unrealized appreciation across the portfolio. For the quarter, we generated net investment income of $4.8 million or $0.12 per share and $7.3 million or $0.18 per share on an adjusted net investment income basis. This compares to prior quarter's net investment income of $15.9 million or $0.40 per share and adjusted net investment income of $10.4 million or $0.26 per share. The quarter-over-quarter decline in adjusted net investment income was primarily a result of lower success fee income and higher borrowing costs associated with the new investment fundings. These decreases were partially offset by higher interest income from our growing debt portfolio. Total investment income was $24.2 million compared to $28.4 million in the prior quarter. The decrease was due to $5.6 million of success fee income from the prior quarter that did not reoccur during the second quarter partially offset by a $1.4 million increase in interest income. As we've discussed previously, the timing of our collection of success fee income and dividend income can vary significantly between reported period. It's important to evaluate these income streams over longer periods rather than exclusively on a quarterly basis. The weighted average principal balance of our interest-bearing investment portfolio increased to $734 million during the quarter compared to $706 million in the prior quarter. The increase is a result of the recent investment activity, including new portfolio company acquisitions and add-on activity at existing portfolio companies. These recent originations have increased our income-producing asset base and positioned us to generate higher recurring interest income in future periods. The portfolio's weighted average yield increased slightly to 13% compared to 12.9% in the prior quarter. This increase corresponds with the 11 basis point increase in average SOFR during the quarter, in addition to our debt investments in DHE and Extrude Hone, both having interest rate floors in excess of the weighted average of the existing portfolio. The interest rate floors, which are included in each of our debt investments, remain an important component of our strategy to maintain stable investment yields through changing interest rate conditions. We believe our debt investment portfolio is well positioned across a range of interest rate environments. As disclosed in our Form 10-Q, based on the current portfolio composition, combined with our floating rate credit facility exposure, a 50 to 150-basis point increase in SOFR would be expected to increase annual net investment income by approximately $0.01 to $0.08 per share. An equivalent decline in SOFR would still result in an increase to annual net investment income by approximately $0.01 to $0.02 per share. This positioning helps mitigate interest rate volatility while maintaining the opportunity for incremental earnings as rates change. Turning to expenses. Our net expenses increased to $19.2 million compared to $12.4 million in the prior quarter. The increase was primarily driven by an $8 million increase in capital gains-based incentive fee accruals. These accruals are recorded in accordance with GAAP and do not represent amounts that are currently contractually payable under our advisory agreement. The significant deal activity during the quarter provided the benefit of a $2.1 million increase in fee credits, while also contributing to an increase of $1 million in interest expense from our credit facility. Focusing on portfolio valuations, we recognized $12.2 million of net unrealized depreciation during the quarter compared to $18.8 million of net unrealized depreciation in the prior quarter. The net increase in fair values was primarily driven by increased performance in a number of our portfolio companies, combined with higher market valuation multiples. As a result, net asset value increased to $16.43 per share as of September 30 compared to $16.24 per share as of June 30. This increase was driven by $0.31 per share of net unrealized appreciation and $0.12 per share of net investment income. These increases were partially offset by our $0.24 per share of distributions paid to common shareholders. Our investment portfolio increased to approximately $1.43 billion at fair value, representing an 11.6% increase from prior quarter. We ended September with investments in 31 portfolio companies compared with 29 at the end of June 30. This growth reflects approximately $156.5 million of investments during the quarter, including 2 new portfolio company acquisitions and additional investments to support the expansion of our existing portfolio companies. We continue to monitor our nonaccrual investments closely and work with portfolio company management teams to address operating challenges. As of September 30, loans on nonaccrual status represented 3.4% of our investment portfolio at cost and 0.5% at fair value. We anticipate that 2 of the nonaccrual investments will be exited in the coming months, while the third continues to see positive results and has begun making incremental payments towards their past-due interest balance. These payments are included as interest income upon collection. Turning to our balance sheet. We ended the quarter with approximately $300 million outstanding on our credit facility with $105 million of unused commitments. Combined with the accordion feature from the facility, we have the flexibility to increase this unused commitment amount to $200 million as we look to support our pipeline of potential new deals. Our asset coverage ratio was 189% at the quarter end, declining from past quarter as we funded our significant investment activities with proceeds from our credit facility. Similarly, our debt-to-equity ratio increased to slightly under 1.1x. We anticipate reduced leverage as we receive equity proceeds from the SFEG exit, but expect this amount to fluctuate as we continue future investment activity. Regarding the equity proceeds from SFEG, approximately 15% of our equity fair value of $167 million is related to escrows to be settled in the coming quarters. This estimated amount has been discounted from the total escrows associated with the exit, given the uncertainty of collection. We anticipate the remaining 85% of SFEG's fair value to be received by GAIN in the coming months. Finally, on distributions. We ended the fiscal year was $21.3 million or $0.53 per share of spillover income. As of quarter end, our spillover was $19.9 million or $0.50 per share. This balance is sufficient to support approximately 6 months of our current $0.08 per share monthly distribution. Our ability to retain and reinvest spillover income provides an additional source of capital to support portfolio growth and future earnings. We believe this approach complements our focus on generating strong shareholder returns as demonstrated by our industry-leading return on equity of approximately 25% over the past year and an annualized 18% in the last 3 years. We continue to evaluate the timing and amount of potential supplemental distributions based on portfolio realization, including the estimated SFEG proceeds to be collected, taxable income considerations and our broader capital allocation priorities. Overall, we believe that our quarterly results align with our focus on maintaining a disciplined capital structure, supporting the performance of our existing investments and pursuing new investment opportunities that we believe can generate attractive returns for our shareholders. This covers my part of today's call. I'll now hand it back over to you Dave to wrap this up.

Gladstone, would you like to say a few words if you are in here.

Yes. Thanks very much, Dave. That was a good presentation and your fund is doing very well. We're very happy with it. And I think we'll see a lot more dividends. I wish we could settle up on SFEG only because people don't -- because it's been so spotty and out of sequence, it's really hard for people to see what a fabulous business that was and still is, but it was related to things in the defense area, and we had to go through some really crazy areas because we were selling outside of the United States and each government has its own way of looking at things. So for me, I haven't been coming in this morning simply because I've got a tad of a cold, I don't want to get my folks involved in this kind of coughing that I've been doing. So anyway, a nice move for us in Gladstone Investment, and we look forward to many more opportunities. In fact, we had 1 that I thought would be done with by now, but we've got 1 more, I'll say, medium sized, but probably large size if it comes along. So keep listening to us, and we'll tell you what we can. In the meantime, I'm just going to get off and stop talking because I'm losing my voice. I'm sure if there's anything you need, you can call into the office, and they'll help you out at the end of this call now.

Well, thanks, David. And moderator, we'll go ahead and take some questions now from the folks on the phone call. Thank you.

[Operator Instructions] Our first question is from Erik Zwick with Lucid Capital Markets.

I wanted to start with a bigger kind of picture question either for Erika or David or maybe you can both weigh in. But just curious with the midterm elections past us now and based on the results of the elections. Curious if you could talk about any kind of potential impacts, either positive or negative that you anticipate on the economic activity and the lending environment.

Yes. Erik, I can take a crack at that. And Erika, you certainly weigh in here. I don't think we right now see any significant impact. Obviously, we don't know what will happen to interest rates to some degree, but that's not necessarily just a function, right, of the election. But I think as Taylor correctly said in his presentation, we believe the way we're structured with the floors that we have on our debt securities and what have you, that we feel pretty good about whichever way, say, SOFR moves as an example and we'll continue with that structure. As you know, that's the way in which we try to -- when we price our deals, how we look at it. So from that perspective, I think we feel good. I think are there certain sectors that could see some impact clearly, things around defense. However, in our case, with the portfolio companies we have, most of these are on platforms or on programs that we know have been funded. And so we'll be cautious as we look at new deals perhaps that are in that sector. But other than that, I think we feel pretty good where we are. Erika, do you have anything you want to add to that?

No. I think the only thing I would add is our underwriting process at tends to avoid those sectors that are obviously susceptible to major swings in policies, of course, if something comes as unexpected, we need to be responsive. But overall, our portfolio companies have shown a tremendous amount of resiliency, especially over various economic policies over the last several years. So no, I don't expect anything immediate coming out of the midterm elections, as Dave described.

And next one, maybe for Taylor, thank you for giving the range of potential increase to NII for increases in SOFR rates. Just curious, do you also have the average debt service coverage ratio for your portfolio? I'm just curious if rates do go higher, are there any companies that -- you have any concerns about being able to handle a higher interest burden today?

Sure. Thanks, Erik. So from a debt service coverage ratio, that does fluctuate pretty meaningfully from company to company. But I think I would point to the fact that most of our portfolio companies have been in the portfolio for a while now, including years where SOFR was higher than where it is now, SOFR, previously LIBOR from where it is today. So I believe our companies are still positioned to manage that debt service coverage going forward despite rates rising, especially considering many of our investments are at their interest rate floor. So while they may see some level of increase, it will take a little bit more time for SOFR to rise to where they'll start being impacted necessarily.

And last one for me and then I'll step aside. Erika, I think you mentioned -- I think you used the term healthy when referring to the pipeline today. And that's great to hear, given that the strength that you had in the most recent quarter. Wonder if you could just give a little bit more color in terms of kind of what you're seeing as -- maybe with the midterm elections passed now, some companies that were sitting on the sidelines feel more comfortable kind of going through its plans. But just curious, do you expect origination activity, both new and add-on to continue being kind of positive over the next quarter or so?

Yes. I don't see any changes to the pipeline, again, as a result of the midterm election. We have been hearing from a number of industry participants, advisers in the M&A space that pitch activity continues to be strong and companies that have been sitting on the sidelines perhaps are considering going to market because they can only wait so long, so to speak. So from that standpoint, that's all anecdotal. But I think our pipeline itself has remained pretty stable over the last several months. And while the size of the pipeline may not be at record levels, our actionable opportunities, especially with our ability to provide all of the capital for a transaction remains pretty appealing in the marketplace and has allowed us to have the record that we have had in terms of new production activity. So a long way of saying, I don't think -- I don't see a change in that in the near term here.

Our next question is from Christopher Nolan with Ladenburg Thalmann.

David Gladstone, glad to hear that you're doing okay, and I hope you're feeling better. Always good to hear from you. Given the jump in originations in the quarter. Were there any timing issues where investments came on later, so we could see a bump to revenues in the next quarter?

Sure. Chris, it's Taylor. I'll take that one. So in particular, Extrude Hone, that one closed on 9/30, so while we did draw for that funding and that interest expense associated with the borrowings was reflected in 9/, 30. You really didn't see the corresponding interest income from that investment pick up in Q2. But that will contribute to Q3 and going forward, the revenues.

Great. And then on SFEG, should we see some sort of net gain on realization from the escrow or the rest of the equity. or the non-escrow equity?

Sure. So the way I would look at SFEG and where it's fair value currently, as I mentioned, about 85% of that fair value is associated with the cost basis and essentially built-in gain, which we expect to collect. The remaining 15% of it, so about $25 million or so is really the escrow amount that we've already materially discounted from where it may be ultimately. So yes, to answer that question, there is the potential for additional collections, but that would not occur probably for the next couple of quarters or so as escrows are finally settled. There's a time period after an exit where escrows stay outstanding as kind of the dust settles. So I would expect some fluctuation from where it's marked as of 9/30, but we do feel pretty confident in our ability to collect what we have fair valued and obviously, reserving some potential for future gains. But that's to be determined. So while I'm hopeful, and I would love to tell you that we're going to collect every dollar of escrows that is still outstanding.

Great. Final question for me is the investment in Detroit Defense. They have a cool business they were at your Investor Day a few months ago. And by the way, thank you for hosting that. Do you guys -- are these acquisitions tend to be immediately accretive to equity, so you can possibly see a bump up in your equity holding values in Detroit or is it one of these things which is sort of a longer-term accretion?

Yes. Chris, the short answer is yes. With these acquisitions are accretive and that company, I think, as you saw, having come to the conference, and thanks for coming. They had more of a slowdown as a result of some programs and some release of funds, et cetera, which have now occurred. So we have really, really high expectations for Detroit Defense, the quality of management and these new acquisitions are just adding to the overall capability. So yes, we definitely feel that that's going to keep us -- be accretive and certainly to the equity value as we move forward here.

[Operator Instructions] Our next question is from Mark Ferone, private investor.

This is Mark Ferone. I just wanted to say congratulations on the killer SFEG transaction. And I've got basically 2 questions on that. Will the Board try to pay the gain as a supplemental distribution and what range would we probably see on that -- you can do the back of the envelope calculations, maybe it's like $1.90 to $2.25 a share at some point. And then the other question has to do with you being a long-term shareholder and having most of my peers in qualified plans. Do you think the Board would commit to not retaining the proceeds as a deemed distribution due to the difficulties with the IRS refunding that taxes paid. Once again, thanks for killing it in the quarter and in the new year and appreciate the help.

Sure. Mark, thanks for calling in. This is Taylor, and I'll address those questions. First off, we want to make sure that we actually had the final numbers and collect the proceeds from the SFEG exit before we go to the Board to recommend the actual supplemental distribution. But yes, with our structure and having to distribute our realized gains to our shareholders, I would expect some supplemental to be paid going forward. That being said, the range is still to be determined as we look at our ability to reinvest our retained capital, especially as I mentioned with our spillover where it is and the ability for us to deploy that balance into new investments that are generating meaningful returns. You look at our return on equity and consistently lead the pack from that metric. So while, yes, we will distribute these gains, it's still to be determined what the amount is and our outstanding tax requirement where they are. Regarding the deemed distribution, I think while everything is on the table, I do think that the deemed distribution may not necessarily be the most advantageous path forward. So we will continue to look at other opportunities for distributing this supplemental.

I appreciate that and congratulations once again, great team.

Our next question is a follow-up from Christopher Nolan with Ladenburg Thalmann.

Taylor, is there any sort of expiration date for any of that spillover income where you need to distribute it before it expires?

Sure. So when we enter a new fiscal year with spillover income, that's required to be distributed to shareholders in the current fiscal year. So for example, we entered this one with a little over what was it, $20 million of spillover income going into the current fiscal year. That spillover does need to be distributed to shareholders before the end of 3/31/27. So we will look to work through what we entered the fiscal year as part of our distribution.

There are no further questions at this time. I would like to pass it back over to Dave Dullum to close this out.

Thank you very much, and we truly appreciate our shareholders, and we appreciate you all listening in, asking the questions that you asked are very important to us, and we'll continue try to -- the success that we've had to date and continue this performance. So thanks, and that's the end of this call.

Thank you. This will conclude today's conference. You may disconnect at this time, and thank you for your participation.