Gladstone Capital Corporation (NASDAQ:GLAD) Q2 2024 Earnings Call Transcript

Gladstone Capital Corporation (NASDAQ:GLAD) Q2 2024 Earnings Call Transcript May 2, 2024

Gladstone Capital Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Gladstone Capital Corporation Second Quarter Earnings Conference 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, Mr. David Gladstone, Chief Executive Officer. Thank you, sir. You may begin.

David Gladstone: Thank you, Latanya, that was a nice introduction and hello everybody. This is David Gladstone, Chairman, and this is the earnings conference call for Gladstone Capital for the quarter ending March 31, 2024. Thank you all for calling in. We’re always happy to talk with our shareholders and analysts and welcome the opportunity to provide updates to the company. I hope we have some good questions today, but we’re going to start off first with our General Counsel, Michael LiCalsi. He’s going to make a few statements regarding 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 and the Securities Exchange Act of 1934, including those regarding our future performance. Now 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, and you can find them on our Investors page of our website, gladstonecapital.com. And while you’re on there, you could also sign up for our email notification service.

You could also find the documents 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 simply 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 the call over 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 before turning the call over to Nicole to review the details of our financial results for the period. So beginning with our last quarter results, fundings last quarter were modest at $45 million given the traditionally slow first quarter and limited new deal buyout activity in the market. And like recent quarters, about two-thirds of the fundings were add-ons to the existing portfolio investments. Prepayments and amortization totaled $15 million, so net originations were $30 million for the period. SOFR rates were unchanged, so the weighted average yield on our investment portfolio was largely unchanged at 14%.

However, average earning assets for the period rose 3.5% resulting in a 3% increase in our total interest income to $23.7 million for the quarter. The combination of increased interest costs from higher average bank borrowings and an increase in non-earning assets offset the increase in earning assets and net interest was unchanged at $17.5 million for the quarter. Management fees rose to $5.7 million in the absence of new deal advisory fee credits and net investment income declined by 9.7% to $10.8 million. However, net realized gains rose to $2.2 million and the combination totaled $0.298 per share or 120% of dividends for the period. In the aggregate, net realized and unrealized gains on the portfolio totaled $12.9 million, which lifted our ROE for the quarter to 22.3% and 17% for the last 12 months.

With respect to the portfolio, our portfolio continues to perform well, with senior debt representing 71% of the portfolio and we ended the quarter with 2 non-earning debt investments which represent $20.4 million at cost or 1.8% of assets at fair value. Appreciation for the quarter of $12.9 million was led by the appreciation of 5 equity positions driven by strong underlying operating performance or preferred share liquidation preference amounts and a $1.9 million realized gain related to residual interest associated with the sale of a former investment. Regarding our near term outlook, I’d like to leave you a couple of comments. We continue to benefit from our incumbent position supporting growth oriented businesses across a variety of industry sectors.

And with PE sponsors facing extended investment hold periods, if they have not hired a banker to sell, they are continuing to seek ways to creatively grow and recapitalize their investments, and supporting these performing businesses we know well is a low risk way to grow our assets. The syndicated loan market for larger well-established credits improved significantly last quarter, which has led to some spread compression for these companies, which we expect will trigger an uptick in prepayment activity for some of our larger positions over the balance of the year. We ended the quarter with conservative leverage position at just below 89% of NAV and ample availability under our bank credit facility. So, we’re well positioned to grow our earning assets and fee income to continue to support our shareholder distributions in the coming year.

Now, I’d like to turn the call over to Nicole Schaltenbrand, the CFO of Gladstone Capital to provide some more details regarding the fund’s financial performance for the quarter.

Nicole Schaltenbrand: Thanks, Bob. Good morning, everyone. During the March quarter, total interest income rose $700,000 or 3% to $23.7 million with the increase in average earning assets. The weighted average yield on our interest-bearing portfolio was largely unchanged at 14%. The investment portfolio weighted average balance increased to $680 million, which was up $23 million or 3.5% compared to the prior quarter. Other income was $300,000 and total investment income rose $800,000 or 3.3% to $24 million for the quarter. Total expenses rose by $1.9 million as net management fees rose $1 million with lower new deal closing and advisory fee credits and a $700,000 increase in interest expenses from higher bank borrowings. Net investment income for the quarter was $10.8 million, which was a decline of $1.2 million, compared to the prior quarter or $0.2475 per share.

The net increase in net assets resulting from operations was $23.6 million or $0.54 per share for the quarter ended March 31, as impacted by the realized and unrealized valuation depreciation covered by Bob earlier. Moving over to the balance sheet. As of March 31st, total assets rose to $812 million consisting of $792 million in investments at fair value and $20 million in cash and other assets. Liabilities rose as net originations to $380 million as of March 31 and consisted primarily of $254 million senior notes. And as of the end of the quarter, advances under our $244 million credit facility were $117 million. As of March 31, net assets rose to $431 million from the prior quarter end with investment appreciation. NAV rose 3% from $9.61 per share as of December 31 to $9.90 per share as of March 31.

And subsequent to March 31, as I think most of you are aware, we executed a 1 for 2 reverse stock split and our shares of common stock and as a result the approximate NAV per share is $19.80 and the ongoing monthly distributions doubled to $0.165 per share per month. Additionally, after the end of the quarter, we invested $7.3 million in a new proprietary investment, including senior debt and preferred equity. We also received the payoff of our second lien debt investment in Giving Home Health, which included prepayment penalties of $900,000 and a distribution on our warrant position of $2.5 million. We also received the payoff of our second lien debt investment in Gray Matter Systems, which included prepayment fees of $200,000. With respect to distribution, our monthly distributions to common shareholders of $0.165 per common share were announced for the months of April, May and June, which is an annual run rate of $1.98 per share.

The Board will meet into July to determine the monthly distributions to common stockholders for the following quarter. At the current distribution rate for our common stock and with the common stock price at about $21.77 per share yesterday, the distribution run rate is now producing a yield of about 9.1%. And now, I’ll turn it back to David to conclude.

David Gladstone: Thank you. And you did a great job Nicole and Bob with earnings for that quarter. Michael, you did a great job too in letting our stockholders know and the analysts know that they’re following our company and all about our recent performance. Highlights to me would be the Company continues to scale its investment portfolio and have eclipsed now the $800 million last quarter which is over 37% in the past 2 years while maintaining the lower middle market focus. It’s a different discipline than others might see but this is a good yield for this kind of Company with such a good track record. While we saw a small uptick in the non-performing assets, the investment team is on top of the situation and otherwise portfolio continues to perform well having supported significant net and portfolio appreciation again this quarter, which lifted net asset values by share of 6.8%.

And between the high rates and the portfolio performance, GLAD has achieved a return on investment of about 17% for the past year which puts the company in the top end of all the business development company peers that we compare ourselves too. In summary, the company continues to be well positioned as a portfolio and it’s in good shape and strong balance sheet and I think that will support us well for further growth and hopefully the growth orientation will increase our dividends as well. Many of these investments are in support of midsize private equity funds that are looking for experienced partners to support their acquisition and growth of their businesses in which they have invested pretty substantial amount of equity. This gives us an opportunity to make an attractive interest paying loans to support our ongoing commitment and to pay cash distributions to our shareholders.

So now, Latanya, if you’ll come on, we’ll get some good questions from the people that have called in today. Latanya?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Mickey Schleien with Ladenburg.

Mickey Schleien: Bob, according to LSEG, lower middle market spreads have contracted about 50 basis points over the last year, but they’re still above pre-COVID levels. So when you think about the supply and demand for lower middle market capital and the health of the economy, what’s your view and the outlook for loan spreads in your business?

Bob Marcotte: I think that indication of where the compression is coincides with what we’re seeing. Obviously, that’s a much lesser level than what is happening at the upper middle market realm where frankly you have broadly syndicated loans in the CLO market red hot and driving spreads down, that doesn’t generally apply to credits where deal started under $10 million of EBITDA. You have to remember that most of our portfolio companies start under 10 in EBITDA and grow over time. It’s only when they get to larger scale that we see that price compression. So, we’re expecting some in the line — in the range of what you’re outlining. But just to give you an example, the prepayment that we just disclosed in our subsequent events was a very large credit that we were opportunistically invested in several years ago.

And the company’s EBITDA was in the range of north of $100 million just for indication purposes. And when it repriced, it priced at levels that just don’t make sense for us. So, we let that pay off. Going forward, we’ll continue to focus in our market where we can think there’s enough competition is less and the scale does not warrant the kind of price compression that you’re alluding to.

Mickey Schleien: Bob, I realize they’re relatively small investments, but could you give us a quick update on the outlook for DKI and B&T?

Bob Marcotte: DKI is a business that’s in the restoration type business. It’s a business that there’s obviously a wide swath of players in that marketplace. We’re talking about storms, fires, events like that, which obviously continue to happen fairly regularly. The business has been in transition, going from a franchise-oriented business to more of a TPA type of business. That’s required the business to alter some of its marketing and retool some of its cost structure and it’s in that process. We are working with the team to try to expedite the matter and if we can’t find a way to organically grow it, there’s enough players in the marketplace that we believe that there’s strategic exit alternatives that we would pursue. In the case of B&T, it’s largely an engineering platform.

It has some unique advantages. It’s extremely experienced in the wireless engineering business. Unfortunately, there’s only couple of major players in that business that drive most of the revenues. It has the capabilities to outsource to offshore in sources, which are far more cost effective to support some of that engineering capability. The problem is, in a business like that, the CapEx cycles are very difficult to predict. When networks get upgraded, when cell sites and things get altered, when they spend money on a spectrum, it can be up and down. We are going into a new cycle of spend in the telecommunications realm. We still have some 5G spend that’s going on. You have people like T-Mobile and Verizon spending on additional wireless capacity as an alternative Internet service offering.

And you also have a significant amount and they do this as part of their business, significant amount of broadband money coming out of the Infrastructure Act that the administration signed into law. It’s taken a few years to ultimately get it aligned and get it beginning to be deployed. But I think if you look at this quarter, the amount of money per year that’s going to be put to move broadband to the rural markets has increased. It’s almost doubled. I think the numbers that I’ve seen are somewhere between $8 billion and $10 billion per year are going to be spent extending the broadband services more broadly across the U.S. So, we are beginning to see the release of those amounts and we’re hopeful that that will be part of what will lift the engineering services that B&T provide.

Mickey Schleien: Just a couple of housekeeping questions, sort of trying to gauge the portfolio’s risk. Can you give us a sense of the current average EBITDA, debt to EBITDA and cash interest coverage ratios?

Bob Marcotte: We cover the gamut as I have alluded to in the past in terms of overall EBITDA. EBITDA can generally start as low as $2 million to $3 million and range upwards to $150 million of EBITDA. So an average is pretty distortive. I think a simple average there just wouldn’t be reflective. The vast majority of our credits start in sort of $10 million of EBITDA and grow from there. In terms of overall leverage, I think the overall leverage profile is in the roughly 4x range. I think that’s consistent where we were before. And interesting, there’s probably a bit of a barbell. The businesses that have grown that we’ve been making additional investments in and are of size tend to be slightly lower leverage than the early stage credits where they’re still in a growth mode and they tend to be slightly higher leverage.

But it’s still in the range of roughly 4 turns of debt to EBITDA. And for the most part, that supports the kind of interest coverage that we typically would covenant. We generally have deals with at least 2 and mostly 3 covenants in the transactions and most of those would require debt service coverage in the range of 110 to 120.

Operator: The next question comes from Sean-Paul Adams with Raymond James.

Sean-Paul Adams: Could you add a little bit more color on the new nonaccrual WB Xcel? It looks like it’s only been on the books for about 3 years. So, I’m wondering if there was any residual impact from the buyers, as well as providing a little bit more color on the origination outlook for the rest of the year.

David Gladstone : Xcel was one of the few credits that we have a little bit more consumer-oriented exposure than I would normally expect in the portfolio. Xcel, if you don’t know, is a premium brand in the wet suit market. The business was doing fairly well and we probably were a little bit more optimistic about where it stood. COVID certainly lifted the luxury and athletic activities that were going on in the marketplace and it was fairly robust post-COVID, retail channels were reasonably full. The seasonality of those kind of offerings combined with just a consumer oriented pullback was more severe. As a result, we put it on nonaccrual, the company is in the throes of a new line launch which is lined up and expected to occur as of the mid-summer timeframe.

And I can say that we are very optimistic that the fall bookings are at a multiple of what they were last year. So we’re positioned to restart it, but it was a little bit of a hangover situation between COVID, retail channels, consumer and a refresh on the brand that we are working through at the moment. We have stepped in with a more significant involvement and we’ve recruited external expertise to assist us in repositioning and taking advantage of the opportunity. This is a global business. It is selling U.S., it is selling international and so there’s a lot of opportunity to go get in that business and I think we’ve brought in some resources to help us with that process.

Bob Marcotte: Picking up on the originations for the back half of the year, that’s the challenge for us. I will say that we are, as I mentioned, expecting an uptick in prepayment activities and we’re very much focused on sifting through and finding good growth opportunities to redeploy that capital. I will say that once the business is grown and it’s got $20 million, $30 million, $40 million of EBITDA on sales, our exposure tends to be a little higher. And so when we restart the process and bring in earlier stage younger businesses in the lower middle market, the initial exposures tend to be smaller and it will take a period of time for those to grow and mature into credits of comparable size. So, we are planting the seeds today.

I think the deal that we referenced that has been closed is a nice transaction that is intended to be a roll up or add on platform that is interestingly in the elevator repair business. It’s a fragmented market that there are plenty of opportunities to grow. And those are the kind of situations we’re currently working on to expand. So I think we will continue to see add-ons to some of the younger companies in the portfolio and we will continue to see opportunities at the lower end of the middle market where we’ll see that. In terms of overall, I think the challenge will be to drive net growth over the course of the balance of the year. I think given what could be $150 million plus of prepayments plus or minus, if we can originate and stay ahead of that curve, I think that’s what we’re currently kind of shooting for.

But it’s not going to be a ton of net asset growth given what we’re expecting to be refinancing activity because we’re going to maintain our yield discipline. And we can certainly scale up, but our cost structure and returns just it doesn’t make sense for us to do that.

Operator: Mr. Gladstone, there are no further questions in queue at this time. I’ll turn it back to you for closing comments.

David Gladstone: So you guys are not working very hard, so we’re not getting enough questions. We want to get some more questions. Of course, we don’t have a lot of problems in the portfolio. So I guess, we’re not going to get many questions. That’s the end of this conference call, and we thank you all for calling in and see you next quarter.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.