Gladstone Capital (GLAD) Q3 2024 Earnings Call Transcript

Gladstone Capital (NASDAQ:GLAD) Q3 2024 Earnings Conference Call August 8, 2024 8:30 AM ET

Company Participants

David Gladstone – Chief Executive Officer
Michael LiCalsi – General Counsel and Secretary
Bob Marcotte – President
Nicole Schaltenbrand – Chief Financial Officer and Treasurer

Conference Call Participants

Robert Dodd – Raymond James

Operator

Greetings, and welcome to the Gladstone Capital Corporation Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] 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.

David Gladstone

Thank you, Kate. It’s a nice introduction and good morning and hello to everyone out there. And this is David Gladstone, Chairman. And this is the earnings conference call for Gladstone Capital for the quarter ending June 30, 2024. Thank you all for calling in. We’re always happy to talk with our shareholders and the analysts, who follow us and welcome the opportunity to provide an update.

We now will hear from our General Counsel, Michael LiCalsi, who will make a statement regarding some certain forward-looking statements. Michael?

Michael LiCalsi

Thanks, David. Good morning, everybody. Today’s report may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that 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. You can find them on the Investors page of our website www.gladstonecapital.com. We can also sign up for our email notification service. You can also find them on the SEC’s website which is www.sec.gov.

Now 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. Today’s call is an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Again, you can find them on the investors page of our website.

With that, I’ll turn it back to Gladstone Capital’s President, Bob Marcotte.

Bob Marcotte

Thank you, Michael. Good morning. And thank you all for dialing in this morning. I’ll cover the highlights for last quarter, and then turn to the call over to Nicole Schaltenbrand to review the details of our financial results for the period.

Beginning with our last quarter results, funding’s last quarter were a modest at $46 million as new deal buyout activity was building over the period. And several transactions carried over to the current quarter. We did close two new platform investments, which represented two-thirds of the originations with add-ons to our existing portfolio representing the balance.

Consistent with the spike in refinancing activity for larger middle market credits, two of our larger investments in Giving Health and Pansophic were refinanced, lifting the total prepayments and amortization for the quarter to $86 million. So net originations were negative at $40 million. Short-term SOFR rates were unchanged, so the weighted average yield on our investment portfolio was largely unchanged to 13.9%. Average earning assets for the period declined slightly, resulting in a 2.2% decline in total interest income to $23.2 million for the quarter.

However, other income rose to $2.5 million with an increase in prepayment fees and dividends, which lifted total investment income by $1.7 million to $25.7 million. Interest costs declined slightly on reduced line borrowings, and net management fees rose with the increased income. However, net investment income rose by $1.6 million or 15%, to $12.4 million. Net realized and unrealized gains on the portfolio totaled $6.7 million, which lifted our ROE to just under 18% for the quarter in the last 12-months.

With respect to the portfolio, our portfolio continues to perform well with senior debt representing 72% of the portfolio and our three non-earning investments representing $26.4 million at cost, or $13.9 million, or 2.1% of assets of fair value. Appreciation for the quarter of $6.7 million was led by $3.3 million of realized appreciation, the unrealized appreciation of our position in ARA, which was partially offset by the depreciation of several smaller manufacturing, consumer, and service-related businesses.

Regarding our near-term outlook, I’d like to leave you with a couple of comments. The majority of our investments are proprietary originations of lower middle market buyouts, often associated with a business founder transition or first institutional capital raise, and are not driven by refinancing activities. While several more mature and larger investment positions in the portfolio did take advantage of credit market conditions and lower spreads, we continue to see a healthy level of attractive lower middle market financing opportunities, typically with under $10 million of EBITDA.

We entered the current quarter with a significant pipeline of awarded and high probability transactions, which we expect will support the resumption of our asset growth in the near-term. In addition to recycling some of our matured investments, we expect to continue to benefit from our incumbent position as the originator, lead lender, and in some cases, equity co-investor in a variety of smaller growth-oriented businesses as they look to grow through acquisition or expansion to support the appreciation of their equity position.

We ended the quarter with a conservative leverage position at 77% of NAV and have increased the size of our bank credit facility to $269 million to support the growth of our earning assets and fee income to continue to support our shareholder distributions in the coming year.

And now I’d like to turn the call over to Nicole Schaltenbrand, the CFO for Gladstone Capital to provide some more details on the fund’s financial performance for the quarter. Nicole?

Nicole Schaltenbrand

Thanks, Bob. Good morning, everyone. During the June quarter, total interest income declined $500,000 or 2.2% to $23.2 million with the decline in average earning assets as the weighted average yield on our interest bearing portfolio was largely unchanged at 13.9%.

The investment portfolio weighted average balance declined to $665 million, which was down $16 million or 2.3%, compared to the prior quarter. Other income of $2.5 million and total investment income rose $1.7 million or 7.1% to $25.7 million for the quarter. Total expenses rose $100,000 quarter-over-quarter as net management fees increased $300,000 with higher investment income and interest expenses declined $200,000 from reduced bank borrowings.

Net investment income for the quarter ended June 30 was $12.4 million, which was an increase of $1.6 million, compared to the prior quarter or $0.57 per share. The net increase in net assets resulting from operations was $19.1 million or $0.88 per share for the quarter ended June 30 as impacted by the realized and unrealized valuation depreciation covered by Bob earlier.

Moving over to the balance sheet, as of June 30, total assets declined to $775 million, consisting of $758 million in investments at fair value and $17 million in cash and other assets. Buyability has declined with net origination to $330 million as of June 30 and consisted primarily of $254 million of senior notes and as of the end of the quarter advances under our line of credit of $66 million.

As of June 30, net assets rose to $439 million from the prior quarter end with investment appreciation and undistributed earnings. NAV rose 2% from $19.80 per share as of March 31, which is retroactively adjusted for the one for two reverse stock split, to $20.18 per share as of June 30.

Our leverage as of June 30 declined to 77% of net assets. Subsequent to the end of the quarter, a $5 million syndicated loan paid off at par. And we funded an additional $6.5 million senior first lean investment to an existing portfolio company. As far as distribution, we will pay distributions for July, August, and September of $16.50 per common share, which is an annual run rate of $1.98 per share. The Board will meet again in October to determine the monthly distribution to common stockholders for the following quarter.

At the current distribution rate for our common stock and with the common stock price at about $22.28 per share yesterday, the distribution run rate is now producing a yield of about 8.9%.

And now I’ll turn it back to David.

David Gladstone

Well, thank you, Nicole, Bob, Nicole, Michael. You all did a great job of informing our shareholders and the analysts that follow the company with information that should be good for them.

In summary, another solid quarter for Gladstone Capital, including net investment income, rose by 15% to $0.57 per share and provided ample coverage of our current common distribution. So in good shape there and running at 8.9%. Strong portfolio performance generated net portfolio appreciation, which increased net asset value by $0.38 per share from last quarter and $1.64 or 9% from June 2023.

For the past year Gladstone Capital achieved returns on equity of 18%, which compared favorably to the BDC peer group that we follow. The company is also very well positioned for the coming year as the portfolio is in good shape, modest leverage, and a strong balance sheet to support further growth of the lower middle market investment portfolios that we look at.

In summary, the company continues to stick with a strategy of investing in growth-oriented lower middle market businesses with good management. Many of these investments are in support of mid-sized private equity funds that are looking for experienced partners to support their acquisition and grow the business in which they’ve made a strong investment.

This gives the opportunity to make attractive and interest-paying loans and to support the ongoing commitments to pay cash distributions to our shareholders.

And now, operator — Kate, if you’ll come on and let’s see if we have some questions from the folks out there.

Question-and-Answer Session

Operator

Certainly. We will now be conducting the question-and-answer session. [Operator Instructions] Our first question comes from Robert Dodd from Raymond James. Please proceed.

Robert Dodd

Good morning and congratulations on the quarter. Bob, last quarter you told us you expected repayment activity to pick up in the second-half and you were definitely right? Do you expect that to you know how much of what you expected to be elevated repayments has actually already happened now? I mean this past quarter was extremely elevated. What do you expect that to — do you expect it to moderate a little bit from that level or remain elevated for the rest of the year? And I think you gave the indication that you expect the portfolio to grow on a net basis. But any additional comments?

Bob Marcotte

Good morning, Robert. I think it will moderate slightly. Clearly, anybody who had access to the bank market and the spreads that were out there jumped. I will say that there are several on the queue, but it has less to do with refinancing activity and has more to do with companies that are long in their hold cycle as much of the private equity market is. And so there are a number of our companies that are testing the waters for potential sale transactions.

The predictability of those sale transactions is obviously less certain than a refinancing activity. We are tracking a handful of companies that are various stages of offering. I would expect some of our larger positions to continue to come forward, but probably the high watermark was established last quarter. So I think there will be continued activity, but it may not be at quite the same pace as we’ve experienced recently.

And I think the other thing to keep in mind is, as I alluded to in my comments, the sale activity will obviously then create more investment activity for us, given the general buyout activity. So the first quarter was dominated, because it was refinancing and not buyouts. As we go forward with the buyout activity and potential repayments, we should expect a reasonable position in new investment opportunities. So the two should be more in lockstep as we go out over the balance of the year.

Now I will say one last comment there. Mature portfolio companies that have grown that are well north of the $10 million where we typically enter a company, there are going to be larger deals. And so we may see some of the larger companies prepay at maturity levels, whereas we’ll be investing in new deals at a lower point in their growth cycle. So it will be a bit more of an accelerated pace to offset some of those larger roll-offs, but the activity should be more closely aligned as we go out over the balance of the year.

Robert Dodd

Got it, thank you. Very clear. There’s just one more, if I can, on credit. You put on some trenches of B&T, which I think is a wireless cellular network engineering firm, which is obviously, you’ve given us some color earlier in the year that you were seeing headwinds in consumer facing businesses, et cetera, and wireless engineering obviously is very much a business services. So can you give us any color on, why is that idiosyncratic to the company, obviously, but what your level of optimism or pessimism is for that business which is not really [Technical Difficulty] my impression, at least, is it’s not consumer facing, and maybe the headwinds are different?

Bob Marcotte

Yes, the challenge associated with a business like that is — it’s a CapEx business. So, the limited number of customers out there are highly driven by, you know, CapEx. And there’s two factors, I think, that are driving CapEx these days. One, the interest rates are relatively high. So for companies in that sector, incurring additional investment activity or funding CapEx, given the pressure on general cash flows is certainly challenging.

The second is the consumer market and the net ads in the wireless business are somewhat more modest. I do think there is a positive in the business in that there continues to be a reasonably elevated level of spend on fiber, which is somewhat surprising. Just internet and infrastructure spend that, in some ways, is supported by Washington’s infrastructure bills is positive, but it’s more fragmented.

I would tend to say that business is going to continue to face some headwinds, net-net of all those pressures. So it’s a CapEx cycle business. We generally steer clear of CapEx cycle businesses. The expertise that they have and the long-term view of wireless continues to grow. But it’s a concentrated customer base with significant CapEx headwinds that probably make us a little bit less optimistic on where that business is going to go. But we’re continuing to focus on it and we’ve brought in some additional resources to try to steer that in the right direction to capitalize on their competitive advantages.

Robert Dodd

If I can dig in, it sounds like it’s a cycle issue. It’s not like loss of a major customer or anything like that, so…

Bob Marcotte

No, they’re just — they’re battling quarter to quarter for awards of business. And depending on how active people are, some people will, you know, underprice that business to keep working and that’s not a particularly positive way to grow a business. So the pricing discipline and the volume of CapEx opportunities affect the revenue line for that services-oriented business.

Robert Dodd

Got it. Thank you. Really appreciate that.

Bob Marcotte

Thanks for calling in.

David Gladstone

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