Gladstone Investment Corporation (GAINI) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation's Second Quarter Earnings ended September 30, 2017 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, David Gladstone, Chairman. You may begin.

All right. Thank you, Glenda. Nice introduction. Hello and good morning to all of you out there. This is David Gladstone, and this is the quarterly earnings conference call for shareholders and hopefully we have a few analysts on the phone as well. This is for Gladstone Investments, stock trading symbol is GAIN and we have 3 preferred stocks. Thank you all for calling in. We're always happy to talk to our loyal shareholders, potential shareholders and analysts. I'd like to give you an update on the company and the investments that we're doing and what's going on in the business environment. I wish we could do this more often. Also, you have an invitation to stop by our McClean, Virginia office. It's located just outside of Washington D.C. Please stop by and say hello if you're in the area. There's a lot of people here. Many of them are on the road so you won't see them, but come by and say hello. Now we hear from our General Counsel and Secretary, Michael LiCalsi. Michael is also President of Gladstone Administration, which serves as the administrator to all of the Gladstone public funds and related companies. He'll make a brief statement regarding forward-looking statements and some other important information. Michael?

Thanks, David. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those with regard to our future performance. These forward-looking statements involve certain risks and uncertainties and 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 in our Forms 10-Q, 10-K and other documents that we file with the SEC. These can be found on the investor relations page of our website, www.gladstoneinvestment.com, or on the SEC's website, www.sec.gov. 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 of course as required by law. Please take the opportunity to visit our website, once again, gladstoneinvestment.com. Sign up for our e-mail notification service so you can keep up to date on the company. You can also find us on Facebook, the keyword there is The Gladstone Companies. And we have our own Twitter tag and that's @GladstoneComps on Twitter. Today's call is just an overview of our results. Therefore, we ask you to review our press release and our Form 10-Q which we filed with the SEC yesterday for more detailed and complete information. Those of course can be found on our website as well. Now please, we will move the presentation over and pass the baton over to Gladstone Investments' President, David Dullum. Dave?

Thanks, Mike. Good morning, everyone. So today I'm pleased to report that Gladstone Investment had another strong fiscal quarter which ended 9/30/17. Our net investment income increased to $0.18 a share over last quarter at $0.17 a share and we also had the closing of one new buyout investment. The net asset value, which is our book value, also increased by $0.22 per share primarily as a result of a $7.8 million net unrealized appreciation during this period. So based on our results, in October we were also able to announce an increase of over 1.5% in our monthly distribution rate to our common shareholders and that's from $0.064 per share or roughly $0.77 annually to $0.065 per share monthly or $0.78 per share annually. We also announced an additional supplemental distribution of $0.06 per common share to be paid in December which indeed is our second planned semiannual supplemental distribution. So similar to the distribution paid in June, we expect the December distribution to be made again primarily from capital gains. We also have seen our stock price increase to closing yesterday at $10.26 per share which is an increase of about $1.73 over the past year or roughly 20% from $8.53 as of October 31, 2016. So this is encouraging certainly to me because I believe that the market is now beginning to recognize the success of what our business model is in that the stock price also now is above our NAV per share of roughly $10.10. So you may say, well what is that business model? Well we focus on the buyouts of US businesses with annual earnings before interest, taxes, depreciation and amortization, otherwise known as EBITDA, generally between the ranges of about $3 million on the very low end and about $10 million on the upper end. The structure that we use for funding these buyouts consists of a secured first or second lien debt, which is in combination with a direct equity investment for a significant ownership position. This means, and we keep saying, that we are differentiated from the traditional credit oriented BDCs in that the target proportion of the equity to debt for the investments in our portfolio is roughly 25% in the equity bucket and about 75% in the debt bucket at cost. So that compares to most other BDCs as far as we know that are generally more around 10% equity and 90% debt. So again, that orientation to credit with them, we are more oriented to the income and also equity upside. So this leads the stockholder value proposition as I like to think of it as follows. First, the debt portion of our investments provides that steady income to pay, and we expect over time to grow our monthly distributions. As I mentioned earlier, last month we did indeed increase our monthly distributions to an annual run rate of $0.78 per share. Secondly, along with the debt investment, we do invest in direct equity and therefore we own significant equity positions in each portfolio company so that an increase in the equity value helps to provide capital gains and other income along with that, over the life of the investment or upon exit. So these potential capital gains and the other income that they generate may then be distributed to our stockholders in the form of what we are calling supplemental distributions. And again, to this point, we paid the first of such planned supplemental distributions in the amount of $0.06 per share in June, 2017 and then just recently declared the second of such planned supplemental distributions to common stockholders to be paid in December, 2017. And third, a further advantage to our approach is that as a provider of a significant portion of the equity and most of the debt in our transactions, we really generate this flexibility of establishing the term and the interest rate on the debt securities, and that gives us influence with our companies which helps us to provide in the downside. This also reduces the risk of our debt being refinanced prior to maturity in periods where there is yield compression and we've certainly seen some of that recently. Now let's take a look at our historical performance. In May we made an initial scorecard report, thought it was important to start doing that, and really talk about the results of our performance beginning with our fiscal year ended March 31, 2010. And now from time to time we will continue to provide these highlights of our relative performance on this quarterly basis. So the highlights from March 31, 2010 through September 30, 2017 include the following. One, excellent growth in net assets, increasing the NAV per share by $1.36, from $8.74 at 3/31/2010 to recently $10.10 as of 9/30/17. Secondly, increasing the annual run rate of our regular monthly distributions per common share by $0.30, going from about $0.48 per share to $0.78 as recently announced in October, 2017. And as importantly, delivering on our buyout strategy. And so from 2010 through September 30, we have exited 11 buyout investments which has helped to generate significant net capital gains and frankly, in the very near term, we hope to add to these results. Now this exit activity has allowed us to pay that first, these supplemental distributions, the first one again in June and the second one which will be paid in December. We certainly anticipate and hope to continue these supplemental distributions on a semiannual basis. Now as we continue with new buyouts and building our investment portfolio, we as I mentioned, also managed the sale, turnover, or exit if you will in the portfolio. And this is very consistent with our strategy. We obviously will be guided by market conditions, we always are assessing the risk return in continuing to hold an investment versus exiting, and we certainly remain sensitive to preserving our portfolio of assets, which helps to produce that income for our monthly distributions. From inception in 2005, in this regard through September, 2017, our buyout liquidity events have actually achieved an aggregate cash-on-cash return on the exit of the equity portion of those investments of approximately 3.4x, with a total increase to our net assets of about $107 million. Now as we grow, we will consider raising equity capital in a responsible manner. Since our IPO in 2005, we have raised common equity in 3 secondary market transactions, most recently May of this year when we issued 2.3 million shares, which was inclusive of the over-allotment, which actually was exercised in June. We believe that each of these offerings followed our responsible capital raising efforts. Our results today show that we've been able to invest proceeds constructively which resulted in growing our NAV while also generating capital gains. From a deal origination standpoint, we are mindful that whenever we obviously sell a portfolio company, it may reduce that income producing asset base and therefore the income which is a very important factor to us in maintaining distributions to stockholders. Therefore, our deal generation activities continue to have a very high priority. And to generate new investment opportunities, as I generally mention, we call on independent sponsors, middle market investment bankers and other sources to help create these proprietary investment opportunities. Generally, our investments include partnering with management teams in the purchase of a business, and we do believe that our financing package or structure, which includes both secured debt and the majority of the equity, is a competitive advantage as it gives the seller or the management team a high degree of comfort that the purchase will occur at least from the financing perspective. And we believe that our adherence to investment fundamentals and our thorough due diligence process have enabled us to provide shareholders returns in both our consistent regular monthly distributions as well as the supplemental distributions. How are we doing on this origination? Well, we are actively reviewing and conducting due diligence on a number of new potential investments and look forward to new investment announcements as a result. I still caution that we are operating in a buyout environment where the competition for new investments is elevated, purchase prices still being paid are high, and this increases the difficulty of closing deals given our conservative value approach and the expected financial returns. Although, the new acquisition of Pioneer Square Brands which we made in August was at a value which we believe is consistent with our expectation of returns. What are those expectations? Well the target for the equity portion of our investments is a minimum of 2 to 3x cash-on-cash return. Our secure debt investments, primarily first lien loans, typically do carry a cash yield in the low mid-teens. This balances the equity portion of our investment which is helping to produce a blended current cash yield on our total investment that supports our stockholder distribution expectation. The debt typically also has a success fee component, which is a yield enhancement that is generally contingent on a change of control such as sale or exit. However, in limited circumstances, these success fees may be paid in advance at the portfolio company's option. What's our investment focus? Well again, hasn't changed really. We generally invest in companies with good consistent EBITDA and operating cash flow with a potential obviously to expand. The areas of interest that we like are light specialty manufacturing, gi plastek, one of our portfolio companies, falls in that category. Specialty consumer products and services. Our recent acquisition of Pioneer Square Brands falls in that category. Industrial products and services, such as JR Hobbs, which we acquired earlier in the year. And we do some aerospace and energy selectively and we do have a company called Galaxy Tools that's in that category. So let's take a quick look at our investment activity for the quarter ending September 30. As mentioned, we closed one new buyout investment which was for about $28.3 million and this was of Pioneer Square Brands which designs, manufactures and markets premium mobile technology bags and cases which serves a very diverse customer base, but primarily in the education and corporate sectors. We also invested about $1.2 million in existing portfolio companies. So as we look forward, we will continue executing our plan. We will be adding accretive investments to grow both income generating, or debt portion, and the equity portion of our assets while positioning the portfolio for potential exits, thus helping to maximize distributions to stockholders such as the recently declared second supplemental distribution to common stockholders which will be paid in December. We do anticipate paying these semi-annual supplemental distributions as the portfolio continues to mature and we are able to manage the exits and realize capital gains. These distributions are generally expected to be made from undistributed net capital gains, but may also include undistributed net investment income from time to time. We and our Board of Directors will evaluate the amount and the timing of these semiannual and supplemental distributions as we continue forward with our strategy. Since Julia Ryan, our CFO, is on temporary leave, I'm going to give a very quick update on the funds' financial performance to kind of fill in for her here if I may. So on the balance sheet at the end of September we had nearly $530 million in assets which consisted of about $520 million in investments at fair value, about $2 million in cash and cash equivalents, and about $7 million in other assets. Our liabilities at the end of the quarter consisted of $56.7 million in borrowings outstanding on our credit facility, about $139 million in term preferred stock at liquidation value, and about $5 million in other liabilities, which leaves over $328 million in net assets. Our net asset value per share as mentioned earlier was $10.10 as of September 30, which is up $0.22 from June 30. And again, primarily resulted from unrealized appreciation of about $7.8 million in our investment portfolio. From an income standpoint, total investment income was $13.1 million for the quarter versus $13.6 million in the prior quarter. Total expenses net of credits were $7.4 million compared to $8.2 million in the prior quarter, which leaves net investment income of $5.8 million in this quarter compared to $5.4 million in the prior quarter. Other income, which is important to us, was approximately 15% of total investment income in the current quarter. This compares to about 21% in the prior quarter. As mentioned on previous calls, we expect the other income category, which is primarily composed of dividend and success fee income, to be a meaningful component, but also as we've indicated, will be variable from quarter to quarter. Net expenses decreased by about $800,000 in the current quarter which is primarily driven by a $500,000 decrease in bad debt expense and a $300,000 increase in credits from the advisor. As a result of these factors, our net investment income per share was able to increase to $0.18 per share in the current quarter, up from $0.17 in the prior quarter. Current and prior period net investment income again covered current quarter distributions from net investment income by a significant margin as reflected in our distributions coverage ratio of over 208% this quarter. After our supplemental distribution in June and as of September 30, 2017, undistributed income and net realized gains totaled approximately $13 million or about $0.40 per common share. So we continue to actively manage our undistributed income and the net realized gains with the goal to cover and over time increase distributions to our stockholders. So besides our regular monthly distributions which are generally made from operating income, we do expect to continue making these supplemental distributions, again, like the one paid in June and the one to be paid in December. From a realized and unrealized change in assets for the quarter ended September 30, 2017 we recorded minimal realized activity. We recorded $7.8 million of net unrealized appreciation, which was predominantly due to improved operating performance in portfolio companies and an increase in some comparable multiples in certain of these portfolio companies. Overall, our fair value to cost for the portfolio was about 97.3% versus 95.7% last quarter. We do continue to use an external third-party valuation specialist that helps to provide additional data points regarding market comps and other information related to certain of our more significant equity investments. Certain loans of 3 portfolio companies are on non-accrual which represents about 6% of the fair value and 7% of the cost basis of our total debt investments as of September 30. We are actively working with these companies as we always do in an effort to improve the operating performance and liquidity and we certainly are hopeful that at least one of these actually will return to accrual status in the very near term. Our portfolio is made up, as mentioned earlier, of approximately about 72% in debt and 28% in equity at cost as of September 30. The debt portfolio is well positioned for any interest rate increases with about 97% of the loans having variable rates with a minimum or a floor and the remaining 3% having fixed rates. The weighted average cash yield on interest-bearing debt investments increased slightly quarter-over-quarter to about 12.8% versus 12.6% in the prior quarter. Keeping in mind this yield excludes success fees which is on our debt investments. And so for comparison purposes, if we had accrued success fees, and some BDCs actually do with what's called paid in kind or PIK interest, the weighted average yield on our total debt investments would actually be closer to about 14%, similar to what it was in the prior quarter. As of September 30, 2017, unrecognized contractual success fees total about $26 million or $0.80 per share which is actually up from $24.1 million or $0.74 per share in the prior quarter. Now again, there is no guarantee that we will be able to collect any or all of these success fees or actually have any control over the timing of collection. From a credit priority standpoint, 100% of our loans are secured with 79% having a first lien priority and the remaining 21% having a second lien priority in the capital structure of the respective portfolio companies and that's at cost. So overall at Gladstone Investments, we had another quarter of consistently strong operational performance as well as investment transaction successes. In addition, subsequent to quarter end, again, we increased our regular distribution rate and declared another supplemental distribution while remaining committed to covering our distributions with our income. So with that, I'll turn it back over to David Gladstone for his comments.

All right, thank you, Dave. That was a good report. Michael's was a good report and you did a good job of filling in for Julia. But nonetheless, we're looking forward to Julia coming back. We are reporting some significant accomplishments for the quarter in addition to the new buyout investment. It did what has taken us a while to get to. We increased the regular monthly distribution and again, declaring, we declared another supplemental distribution to common shareholders. Continued strong performance of the companies that we're invested in as shown by the net asset value. It went from $9.88 to $10.10 so you can see the portfolio is getting better. I because we can continue this success going into the second half of the fiscal year which ends March 31, 2018. The economy today is really strong. It seems to be hitting on all cylinders. I always have concerns when it's this nice out there. To counter the unforeseen, we are building a very strong balance sheet and I think we'll be in great shape if something should come along. Now if Congress will just deliver changes on the tax code and some changes to the health insurance problems, I think the US midsized businesses like the ones we finance will really take off. And it would be impossible to have a better economy than we have today, but hopeful that the president will name today the Fed Chairman Powell, that would be terrific. That would mean a continuation of what's going on in a lot of places. In October our Board of Directors increased the monthly distribution to common stockholders from $0.064 to $0.065. That's for October, November and December of 2017. I'm pretty optimistic that we can continue that $0.78 per share and that's up from $0.77, so about a 1.5% increase. In addition, the Board declared the supplemental distribution of $0.06 a common share and that's payable in December at a separate time from our regular December dividend. We hope to make the additional distributions and the raise in the regular distributions something we do in the future. Again, that's always our goal is to increase the dividends. And as the largest shareholder, or one of the largest shareholders, I'm loving it. And I think the other thing that I love about this company is last year this time we were an $8 share kind of stock and now we're a $10 share. So I think that's just wonderful and I think our net asset value will continue to increase. Through the date of the call, we've made 148 sequential monthly cash distributions to our common shareholders. In addition, we've made the several supplementals that we hope can continue. And as of September, 2017, we've distributed a total of about $205 million or $8.74 per share to our common shareholders and that's based on the number of shares outstanding at the time of payments of each of the distributions. The current distribution rate on the common stock with the common stock trading at about $10.26 yesterday, the yield currently is 7.6, that's about 7.6%, but if you include the June and December supplementals, which is another $0.12 per share, that drives it up to 8.7% yield. So great stock and a great yield at this point in time. We do have the 3 preferred stocks trading above $25 per share which is what they were issued at. They are yielding anywhere from 6% to 6.5% currently depending on the series. In summary, this company looks like a very attractive investment for investors seeking monthly distributions and some supplemental distributions. We expect a good quarter ending December 31, 2017 and certainly for the yearend. But now, Glenda, if you'll come on and we'll get some questions from our wonderful shareholders and perhaps a few from some analysts.

[Operator Instructions] Andrew Stapp, Hilliard Lyons.

I guess I'll start out with the pipeline for new investments. Just wondering how they compare to a quarter ago.

So, Andy, it's Dave Dullum. I'll say that it feels a little bit stronger. We probably have gotten more that we're spending more serious time on than we might have a quarter ago. But it continues to be a slog, but I think seeing a little bit of an uptick.

Okay, and the -- excuse me, last quarter you talked about Alloy Die possibly going on accrual status. I think it realized another $1 million of depreciation in the quarter. Could you provide an update on this?

Yeah, it's moving in the right direction. We've done a good job with the management team. They are really actually doing quite well relatively speaking, and reworked our banking relationships in a positive way. So I think we're getting closer.

The Mountain Corporation realized a fair amount of depreciation in the quarter. Could you talk about the reverse of this deterioration?

Yeah, again, that's one where after we bought it, we had to make some frankly major changes in management team. We've got a great management team in there now. They've been changing some things that the company needed to do from the perspective of its products, the way in which it goes to market. We've added some incremental folks and as a result of that added incremental expense to the business. So it's positive EBITDA and it's again trending in the right direction and it's one of those that I think over time is going to end up being a very good investment. We just have to keep doing what we do when these companies aren't performing quite the way we'd like them to.

[Operator Instructions] Mickey Schleien, Ladenburg.

Perhaps a question for Dave. Clearly the equity markets have been very strong and we've seen multiples rising and that's partly helped support your NAV. So you now have some investments that are valued at very nice gains like Cambridge. I'd like to know how you're feeling about perhaps taking some of that money off the table and your willingness to shrink the balance sheet while these multiples are high and wait for better opportunities down the road.

Mickey, thanks for the comment. Well as you usually ask generally, where is our, why are we not more diversified? The last thing I probably want to do is necessarily shrink the balance sheet just for sake of shrinking. I think the best way to answer your question is back to really my overall approach goals that we have for how we see this company growing. And that is simply we will look to harvest companies as they grow and the value increases so that we can continue showing the results on our equity oriented strategy. At the same time, I don't necessarily feel it's necessary to get a company out of the portfolio because again, we still are very cognizant of growth in NII and also obviously from a distribution perspective. So I guess the best way to say it to you, you're right, it's always interesting to look at and just know that we manage the portfolio from both a growth of assets, a thinking about exits for the right time, maximizing value there. But at the same time, not necessarily reducing the balance sheet at the same time running the risk of reducing our operating income.

Okay, thanks for that. Dave, a couple more questions. We saw some nice upward valuation of Drew Foam and nth Degree. Was that operational or multiples or both? Could you give us a little background there?

Predominantly operational I would say. Both companies are doing very well. Obviously have seen slight pickup in multiples. I don't know, Nicole, if you'd like to add to that?

There was a slight pickup in multiples, but I'd say it was predominantly operational for those two entities.

That's good to hear. And lastly, Dave, I know it's difficult balancing for a company with your business model, but we have NII running a little bit below the dividend, so I'm trying to understand how the board is viewing future potential realized capital gains to cover the dividend from a taxable perspective. In other words, what was their thinking in terms of raising the dividend recently?

Well a couple of things and I certainly welcome certainly Nicole, John, anybody to jump in here. But again, I would come at it this way. First of all, I think about our dividend, even though we pay it monthly and we look at these things monthly and quarterly, I think about covering our dividend from an operating perspective on an annual basis. And the reason I do that is simply that as we've mentioned before, I keep making the point, the other income line item for us is important and is an aspect of our investment thesis. So that's, as we also indicate, it is something we try to manage, we have some ability to manage it. And I look forward as we manage that on an annual basis. So my expectation generally is going to be that we are going to cover our distribution, our operating distribution from our NII which is a component of interest income which incidentally is slightly up this quarter versus last quarter. And then the addition of our other income stream. So that's that aspect. As far as raising the distribution, we felt comfortable with and our Board felt comfortable with where we are operationally and looking forward to being able to do that within a modest range. But we keep trying to give a little bit back to shareholders. The cap gains piece is kind of a separate item now and the good news, again, we are seeing now that we are exiting companies, and you brought it up, on an I now hope a somewhat more consistent basis over the years, we're going to generate net realized capital gains that we're going to be able to give back to shareholders in that regard. I think that's how I'd say it, and Nicole, would you add to that?

I think you pretty much covered it.

I appreciate that, Dave. And if I could, just one last follow-up. I noticed there was a lawsuit between Pioneer Brands and Riverside Technology. I understand there's lawsuits all the time, but could you just tell us what the nature of that was?

I'll be honest with you, it's nothing significant that we would worry about. As you say, these happen from time to time and I can't tell you a good answer on that. It's nothing we need to worry about that's in our purview at this point.

I appreciate all your time this morning.

Thank you. As you can imagine, we are named in lawsuits that happen in our portfolio just because we are a big owner. So most of the time it's not a problem. Next question?

[Operator Instructions] I'm not showing any further questions over the phone lines at this time. I would like to turn the call back over to David Gladstone for closing remarks.

Thank you all for tuning in and we appreciate the questions and we'll see you next quarter. That's the end of this call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.