Earnings Call Transcript - GLAD Q3 2024

Operator, 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. 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, Chairman

Thank you, Kate. It's a nice introduction and good morning and hello to everyone out there. 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 forward-looking statements.

Michael LiCalsi, General Counsel

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. We can also sign up for our email notification service. You can also find them on the SEC's website. 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.

Bob Marcotte, President

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 the call over to Nicole Schaltenbrand to review the details of our financial results for the period. Beginning with our last quarter results, funding last quarter was 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 at 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 at 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 Schaltenbrand, CFO

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 ending 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 ending 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. We funded an additional $6.5 million senior first lien 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, Chairman

Thank you, Nicole, Bob, Michael. You all provided valuable information to our shareholders and analysts that should be beneficial. In summary, we had another strong quarter at Gladstone Capital, with net investment income increasing by 15% to $0.57 per share, which adequately covers our current common distribution. We are in a solid position with an 8.9% yield. The strong performance of our portfolio led to net portfolio appreciation, boosting our net asset value by $0.38 per share from the last quarter and $1.64, or 9%, from June 2023. Over the past year, Gladstone Capital achieved an 18% return on equity, which is favorable compared to our BDC peer group. The company is well positioned for the upcoming year, as our portfolio is in good condition, with manageable leverage and a robust balance sheet to support further growth in the lower middle market investment space we are focusing on. In summary, we remain committed to investing in growth-oriented lower middle market businesses with strong management. Many of these investments back mid-sized private equity funds seeking experienced partners to aid with acquisitions and business growth in which they've invested significantly. This positions us to make attractive, interest-bearing loans and continue fulfilling our commitments to distribute cash to our shareholders. Now, Kate, please join us, and let’s see if we have any questions from the audience.

Operator, Operator

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

Robert Dodd, Analyst

Good morning and congratulations on the quarter. Bob, last quarter you mentioned that you expected repayment activity to increase in the second half, and you were right. Can you share how much of the elevated repayments you anticipated has already occurred? The past quarter saw significantly high activity. Do you think this will decrease a bit or stay elevated for the remainder of the year? I believe you indicated that you expect the portfolio to grow on a net basis. Do you have any additional comments?

Bob Marcotte, President

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 refinancing activity. We are tracking a handful of companies that are at 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, Analyst

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 service. 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 what I'm perceiving, at least? It's not consumer-facing, and maybe the headwinds are different?

Bob Marcotte, President

Yes, the challenge with a business like this is that it's a capital expenditure business. The number of customers available is limited and largely influenced by capital spending. There are two main factors affecting capital expenditures currently. First, interest rates are relatively high, making additional investments or funding for capital expenditures difficult for companies in this sector, especially given the strain on overall cash flows. Second, the consumer market and the net additions in the wireless sector are somewhat limited. However, there is a positive aspect in that spending on fiber remains unexpectedly high. This spending, related to internet and infrastructure, is partly supported by government infrastructure bills, but it is fragmented. Overall, I believe this business will continue to encounter challenges due to these pressures. It remains a capital expenditure-based business, and we typically avoid these types of enterprises. Although there is expertise and a long-term growth outlook in wireless, the concentrated customer base faces significant capital expenditure challenges, which makes us somewhat less optimistic about its future. Nonetheless, we are still focusing on it and have brought in additional resources to help leverage their competitive advantages effectively.

Robert Dodd, Analyst

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, President

No, they are just battling each quarter for business awards. Depending on how active the companies are, some may underprice their services to maintain work, which is not a particularly positive strategy for business growth. Thus, pricing discipline and the volume of capital expenditure opportunities influence the revenue for that services-oriented business.

Robert Dodd, Analyst

Got it. Thank you. Really appreciate that.

Bob Marcotte, President

Thanks for calling in.

David Gladstone, Chairman