Gladstone Capital Corporation (NASDAQ:GLAD) Q1 2023 Earnings Call Transcript

Gladstone Capital Corporation (NASDAQ:GLAD) Q1 2023 Earnings Call Transcript February 7, 2023

Operator: Greetings. Welcome to the Gladstone Capital Corporation’s First Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I will turn the conference over to Mr. David Gladstone, Chief Executive Officer. Mr. Gladstone, please go ahead.

David Gladstone: Thank you, Rob. Nice introduction, and good morning, everybody. This is David Gladstone, Chairman, and this is the earnings conference call for Gladstone Capital for the quarter ending December 31, 2022. Thank you all for calling in. We’re always happy to talk with our shareholders and analysts, and welcome the opportunity to provide the update for the company. Now, we’ll hear from our General Counsel, Michael LiCalsi, who will give a statement regarding certain forward-looking statements. Michael?

Michael LiCalsi: Thanks, David, and good morning, everybody. Today’s report 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 that are based on our current plans, which we believe to be reasonable. And 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 we file with the SEC. You can find them on the Investors page of our website www.gladstonecapital.com. You can also sign up for email notification service.

You can also find the documents on the SEC’s website at 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 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 those on the Investors page of our website. With that, I’ll turn it over to Bob Marcotte. Bob?

Bob Marcotte: Thank you, Michael. Good morning all and thank you for dialing in this morning. I’ll cover the highlights for last quarter and conclude with some market commentary as we look forward to the balance of 2023, before turning the call over to Nicole Schaltenbrand, our CFO, to review our financial results for the period and our capital and liquidity position. So, beginning with last quarter’s results, originations for the quarter were modest at $11 million for the period, which were all add-on investments to existing portfolio companies. Amortization, repayments and exits were $39 million, so our ending investment balance fell by $28 million for the period. Interest income for the quarter rose 18% to $18.4 million, as the weighted average loan yield rose 110 basis points to 12.3% and the average investment balance rose 6.6% to $589 million.

Fee income rose on the period to — by $900,000 with a number of year-end equity distributions and contributed to the 21% rise in total investment income, which was $19.3 million for the quarter. Borrowing costs increased $900,000 or 22% with higher SOFR rates. However, our net interest margin also rose $1.9 million or 17% to a record $13.4 million for the quarter. Administrative costs were largely unchanged. However, net management fees rose by $1.2 million to $4.6 million or 2.9% of assets, as new deal closing fee credits were down and incentive fees associated with the increase in investment yields rose compared to the prior quarter. Net investment income increased $1.2 million or 17% to $8.7 million or $0.25 per share. The net realized and unrealized losses on the portfolio for the period came in at $3 million, and as a result, NAV declined $0.02 per share to $9.06.

Photo by Austin Distel on Unsplash

While higher rates lifted our net interest income, we also reduced our leverage last quarter and we were still able to generate a 10.9% ROE for the quarter. Based upon the portfolio performance, an increase in net interest income, we recently announced a monthly dividend increase to $0.075 or $0.90 annually, and we’ll consider further increases in the coming quarters. With respect to the portfolio, portfolio continues to perform well with generally modest leverage metrics and favorable liquidity profile. However, aftermarket auto and building sector headwinds caused us to reclass Edge Adhesives to a non-earning, which represents $6.1 million or 0.4% of assets at fair value. Depreciation for the quarter of $3 million was primarily related to small moves in several equity positions with very little of the depreciation associated with stress or performance of our debt portfolio.

Notable portfolio exits for the period included the sale of a couple of equity investments in Targus and Leeds Novamark Capital, which generated realized gains of $10.3 million, and the repayment of R2i, which is a highly leveraged credit, and contributed to the 35% drop in PIK income for the quarter. In reflecting on our outlook for the balance of ’23, I’d like to leave you with a couple of comments. Our balance sheet leverage at the end of last quarter was a bit elevated relative to our target range, and the investment exits along with the accretive ATM share issuance last quarter have positioned us well to support the further growth of our asset base in coming quarters. While disappointed with the level of originations last quarter, we continue to be optimistic and are well positioned to continue to grow our debt investments in growth-oriented lower middle market companies by $50 million to $100 million over the balance of the year as we did last year.

Most recently, in January, we closed the new deal, NeoGraf, which was a $29 million first lien debt and 2 million of equity co-investment. We have managed our underwriting rigor in the face of interest rate escalation and our fortunate to have our portfolio heavily weighted to senior secured loans, which, at present, represents 72% of our investments. And secured investments have increased to 91% of the total investments with a modest overall leverage of under 3.5 turns. With our floating rate investments exceeding our floating rate liabilities by approximately $425 million and the current floating rates on pace to be up at least 70 basis points for the quarter, we would expect our net interest margin to be up in the range of $750,000 this quarter.

And now, I’d like to turn it over to Nicole Schaltenbrand. Nicole?

Nicole Schaltenbrand: Thank you, Bob. Good morning. During the December quarter, total interest income rose $2.8 million or 18% to $18.4 million based on the increase in prevailing floating rates and increase in earning assets. The weighted average yield on our interest-bearing portfolio rose 110 basis points to 12.3%, with the increase in floating rates on the 91% of the investment portfolio that carries those floating rate. The investment portfolio weighted average balance increased to $590 million, which was up $37 million or 6.7% compared to the prior quarter. Other income increased by $600,000 to $900,000, which contributed to the $3.4 million or 21% increase in total investment income for the quarter. Total expenses rose by $2.1 million quarter-over-quarter, as interest expenses rose $900,000 and higher net management fees rose by $1.2 million with higher average assets, increased investment yields and reduced new deal closing fee credits.

Net investment income for the quarter ended December 31 was $8.7 million, which was an increase of $1.2 million compared to the prior quarter or $0.25 per share, which exceeds the $0.21 per share dividends paid and supported the increase to $0.225 per quarter announced in January. The net increase in net assets resulting from operations was $5.7 million or $0.16 per share for the quarter ended December 31, as impacted by the realized and unrealized valuation depreciation covered by Bob earlier. Moving over to the balance sheet. As of December 31, total assets declined to $640 million, consisting of $622 million in investments at fair value and $18 million in cash and other assets. Liabilities declined to $315 million as of the end of the quarter and consisted primarily of $150 million of 5.125% senior notes due 2026, $50 million of 3.75% senior notes due May 2027, and as of the end of the quarter advances under our line of credit declined to $108 million.

As of December 31, net assets rose by $8.8 million from the prior quarter-end with the realized and unrealized valuation depreciation, which was more than offset by net proceeds from our common share issuance under the ATM program of $10.5 million. NAV declined slightly from $9.08 per share as of September 30 to $9.06 per share as of December 31. Our leverage as of December 31 declined with a decrease in total assets and ATM share issuance to 97% of net assets. With respect to distributions, Gladstone Capital’s monthly distributions to our common stockholders was increased to $0.075 per common share, effective for the months of January, February and March, which is an annual run rate of $0.90 per share. The Board will meet in April to determine the monthly distribution to common stockholders for the following quarter.

At the current distribution rate for our common stock with a common stock price at about $10.36 per share yesterday, the distribution run rate is now producing yield of about 8.7%. And now, I’ll turn it back to David to conclude.

David Gladstone: Thank you, Nicole. You and Michael and Bob, all did a great job of informing our stockholders and analysts that are following the company. In summary, another solid quarter for Gladstone Capital. Company didn’t close much last quarter, but it did a good job of exiting some assets and deleveraging the company. So, the company is building additional capacity to support the existing portfolio, but also additional investments in the coming quarters. The company has about $112 million of availability under its bank line, so great shape there. Portfolio is in good shape, modest leverage and very low non-performing assets. Net interest income in the quarter was up 17% based on the higher interest rates in the company’s favorable capital structure, and more support the 7% increase to the common distributions that was announced last month.

In summary, the company continues to stick with its strategy of investing in growth-oriented middle market businesses with the good management. Many of these investments are in support of midsized private equity funds that we partner with and they are looking for experienced partners to support their acquisition and growth of the business in which they have invested, usually a lot of equity. This gives us an opportunity to make an attractive interest-paying loans to support our ongoing commitment to pay cash distributions to shareholders. And now, we’ll call the operator, Rob, to tell us how to ask questions about the company.

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Q&A Session

Operator: Thank you, Mr. Gladstone. Thank you. And our first question is from the line of Mickey Schleien with Ladenburg. Please proceed with your questions.

Mickey Schleien: Yes. Good morning, everyone. Bob, first a high-level question. Could you give us a sense of what’s going on in the market that prevented you from closing new originations during the quarter?

Bob Marcotte: Good morning, Mickey. As you may recall, we had a couple of the two strong quarters leading up to last quarter, so we were probably pretty well focused on closing, I think, about $120 million of assets. So, our pipeline was a little bit thinner. We’re also facing a pretty significant step-up in underlying rates. So, I think we were being a little bit more conservative in the approach that we were taking in terms of which industries, which sectors, we’re going to be able to support the significant step-up in rate. I think we are being very careful about not only rates, but what’s the economic headwinds that are going to affect the revenues in the underlying portfolio. So, while we saw a number of credits that were not clearing, we were a little bit more conservative.

I think, the fact that we’ve already closed one in January and their number is still to come, I’m not too worried about a quarter blip. We tend to have those from time to time. Don’t tend to happen in fourth quarter, but the overall level of deal activity in the December quarter was generally lighter than what we would normally expect in our end of the market.

Mickey Schleien: Thanks for that. That’s very helpful. And it actually leads to my next question in terms of rising interest rates. With the strong January jobs report, as you know, the forward interest rate curve implies about another 50 basis points of Fed tightening. So, how do you see that potentially impacting the portfolio’s ability to service its debt?

Bob Marcotte: Yes. Let me give you a couple of quick stats and we’ve talked about this before. You have to understand the nature of our portfolio. We start with smaller credits and they gradually grow. At the moment, roughly 70% of our portfolio is to companies with EBITDA under $25 million. So that leaves 30% that’s over $25 million. Of the 70% that are the smaller credits that you would be probably most concerned about those issues, 56% of those credits have leveraged under 2.5. So, the majority of the credits where we would probably face stress are extremely lowly leveraged, in fact, bordering on typical bank type leverage. And the overall leverage profile for that 70% is 3.1x. So, a interest rate move is certainly meaningful, but we’re nowhere near anything that would cause particular stress.

So, we’re feeling like the vast majority of our smaller credits today are very lowly leveraged and absorbing any issues that are currently outstanding. And as I’ve said in the past, we have roughly 70% of the portfolio that is sponsored back. So, it again has additional supports that come with it. So, at the moment, if we were seeing anything in the way of stress, I think you would have seen a little bit more movement from our third-party outside evaluations of the portfolio. So, since the majority of the loan movements were very minor, I think it just affirms the fact that the leverage profile and the performance of our portfolio in the face of the escalating interest rates is well positioned.

Mickey Schleien: All right. I understand. That’s a great explanation, Bob. And one last sort of housekeeping question maybe for Nicole. When did you actually place Edge on non-accrual? And did you reverse any previously accrued interest income on Edge?