Gladstone Capital Corporation (NASDAQ:GLAD) Q4 2024 Earnings Call Transcript

Gladstone Capital Corporation (NASDAQ:GLAD) Q4 2024 Earnings Call Transcript November 14, 2024

Operator: Greetings. Welcome to Gladstone Capital Corporation Year-End and Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this call is being recorded. It is now my pleasure to introduce David Gladstone, Chief Executive Officer. Thank you, Mr. Gladstone. You may begin.

David Gladstone : All right. Thank you very much. This is David Gladstone, and I’m Chairman, and this is the call for Gladstone Capital for the quarter ending September 30, 2024, and it’s also our year-ending at September 30. Thank you all for calling in. We’re always happy to talk to you and our shareholders and analysts, and welcome the opportunity to update you on what we’ve been doing for you, and now we’ll hear from — well, before I get started with Michael LiCalsi, I’m not going to be on the call at the end of this. I’m going downtown for a 9:30 meeting with my wife and her foot doctor, so I’m going to miss out on all the wonderful things they’re going to tell you about next quarter that we did at the end of this quarter. So, and now we’ll hear from Michael LiCalsi, he’s our General Counsel regarding certain forward-looking statements. Michael?

Michael LiCalsi : Thanks, David. Good morning, everybody, and good luck to you and your wife, David, in the appointment this morning. Today’s report may include forward-looking statements of the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance, and 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 the risk factors in our Forms 10-Q, 10-K, and other documents that we file with the SEC. You can go to the Investors page of our website, gladstonecapital.com, you can also sign up for an email notification service there.

You can also find the documents on the SEC’s website at 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-K, both issued yesterday, for more detailed information. Again, they’re on the Investors page of our website. With that, I’ll turn it over to 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, the fiscal year ended September 30, and subsequent events before concluding with some comments about our near-term outlook for the company. Beginning with our last quarter results, funding’s last quarter were $29 million and included several add-on investments to our existing portfolio companies. The pace of new buyout activity picked up significantly last quarter. However, the funding’s carried over to the current quarter, which we’ll cover later. Refinancing and amortizations were light last quarter at $13 million, so net originations came in at $16 million. The Fed’s reduction in short-term rates was late in the quarter, so our weighted average portfolio yield was unchanged and with limited movement in our average earning assets, total interest income rose marginally to $23.4 million for the quarter.

Given the modest asset turnover for the period, other income fell to $300,000, and total investment income declined by $2 million to $23.7 million. Interest and financing costs were unchanged for the period on a modest reduction in average line borrowings, while net management fees declined, so net investment income declined by $1.4 million or 12% to $11 million for the period. A highlight of the period was the increase in realized and unrealized gains on the portfolio, which came in at $21 million and lifted our ROE to 21.5% for the last 12 months. With respect to the portfolio, our portfolio continues to perform well and while senior loans dropped to 70% of the portfolio, this was largely due to equity appreciation. Our three non-earning investments were unchanged from last quarter and represented $28.3 million at cost or $12.8 million or 1.9% of assets at fair value.

Appreciation for the quarter of $21 million was led by the unrealized appreciation of our position in ARA, which was partially offset by the depreciation of several smaller manufacturing, consumer and service-related businesses. With respect to subsequent events, after the end of the quarter, we exited our investments in ARA, which included a debt investment of $31.3 million and equity proceeds of $63.7 million. In addition to being a very successful outcome, much of the gain was sheltered by our capital loss carry forwards for tax purposes. As a result, we intend to make a capital gains based supplemental distribution of $0.40 per share in December and retain the balance to support the growth of the investment portfolio. Pro forma for the realized gain, supplemental distribution and ATM issuance after 9:30, the NAV per share will be approximately $20.98 compared to the $21.18 reported as of 9:30.

In addition to ARA, we had one additional repayment of $15 million from Perimeter Solutions that have also made significant progress in reinvesting the ARA proceeds. Since 9:30, we have funded one new platform investment with foreign documentation and expect to close shortly, which should exceed the proceeds received to date and make this the most active quarter of originations for the company. In reflecting on our outlook for the next quarter or two of our fiscal 2025, I’d like to leave you with a couple of comments. As we have suggested in the past, a few of our pre-COVID investments have grown and the underlying sponsors have reached the end of their investment period and the companies are expected to be sold. We are actively monitoring these situations and while we may consider financing the purchaser, we’re also focused on the timely redeployment of these exit proceeds.

In the process of portfolio turnover, we expect our prepayment or closing fees should increase and thus far we have not seen significant margin erosion in connection with our lower middle market debt origination activity. We continue to see a healthy level of attractive lower middle market financing opportunities. These are typically with EBITDAs under $10 million and where low leverage or pricing dictate, we will consider teaming with commercial banks to blend down the overall cost of the financing solution we can deliver. In addition to recycling some mature investments, we expect to continue to benefit from our incumbent position as the originator, lead arranger, lead lender and in some cases equity co-investor in newer vintage growth oriented businesses as they look to grow through acquisition, expansion and support their appreciation of their equity position.

We ended the quarter with a conservative leverage position with leverage at 73% of NAV and with the reinvestment of the ARA equity proceeds and the bulk of our bank facility available to support growth of our earning assets, we’re well positioned to absorb the impact of lower SOFR rates and support our shareholder distributions in the coming year. And now I’d like to turn the call over to Nicole Schaltenbrand, the CFO of Gladstone Capital, to provide some details of the fund’s financial results for the quarter.

Nicole Schaltenbrand : Thanks, Bob. Good morning. During the September quarter, total interest income rose $200,000 or 1% to $23.4 million with average earning assets and the weighted average yield on our interest bearing portfolio largely unchanged. Other income was down $2.2 million and as a result, total investment income was down $2 million or 8% to $23.7 million for the quarter. Total expenses declined $500,000 quarter-over-quarter as net management fees declined and interest-related expenses were largely unchanged. Net investment income for the quarter ended September 30th was $11 million, which was a decline of $1.4 million compared to the prior quarter or $0.50 per share. The net increase in net assets resulting from operations was $31.8 million, or $1.46 per share, for the quarter ended September 30th, as impacted by the unrealized valuation appreciation covered by Bob earlier.

Moving over to the balance sheet, as of September 30th, total assets rose to $812 million, consisting of $796 million in investments at fair value and $16 million in cash and other assets. Liabilities rose with net originations to $342 million as of September 30th, and consisted primarily of $254 million of senior notes and $71 million of advances under our $294 million line of credit. As of September 30th, net assets rose to $471 million from the prior quarter end, with investment appreciation and ATM issuance. During the quarter, we issued 476,000 shares under our ATM program, raising $10.8 million at an average price of $23.10 per share. NAV per share rose $1, from $20.18 as of June 30th to $21.18 as of September 30th, and our leverage as of September 30th declined to 73% of net assets.

Subsequent to September 30th, in addition to ARA and Perimeter solutions exits, we funded a $28.9 million second lien investment in giving home health. With respect to distributions, monthly distributions for October, November, and December will be $16.5 per common share, which is an annual run rate of $1.98 per share. The Board will meet in January 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 $25.68 per share yesterday, the distribution run rate is now producing a yield of about 7.7%. In addition to the regular monthly distribution, GLAD will make a supplemental distribution of $0.40 per share on December 18th to shareholders as of December 4th.

And now I’ll turn it back to Mike to conclude.

Michael LiCalsi : Thanks, Bob and Nicole. In summary, it was another great quarter for Gladstone Capital, including net investment income for the year rose by 12% to $46.1 million, providing ample coverage of the current common distribution. Strong portfolio performance generated another quarter of net portfolio appreciation, which brought the cumulative total for the past year to $2.39 per share and lifted the NAV per share by 12.7% compared to September of ’23. The recent realization of the gain on Glad’s investment in ARA, certainly a home run in between the $0.40 per share supplemental distribution in December and the reinvestment of the equity proceeds into interest earning investments and low leverage, the company is in great shape to continue providing strong returns for its shareholders.

Now, in summary, the company continues to stick with its strategy of investing in growth-oriented lower middle market businesses. Good management in many of these investments are in support of midsize private equity funds that are looking for experienced partners to support the acquisition and growth of the business in which they’re investing. This gives us the opportunity to make attractive interest-paying loans and small equity investments along the way to support our ongoing commitment to pay cash distributions to stockholders on a monthly basis. And now with that, I’ll ask Sherry to set us up for some questions from our listeners. Sherry?

Q&A Session

Operator: [Operator Instructions] Our first question is from Mickey Schleien with Ladenburg Thalmann. Please proceed.

Mickey Schleien : Yes. Good morning, everyone. First off, I just want to congratulate you on an excellent year overall. I’m sure your shareholders really appreciate it. Moving on, can you help us understand why you have issued common equity at the same time that the balance sheet is already under levered and NII is near the distribution and now we have the added pressure of declining SOFR?

Bob Marcotte: Mickey, there was a lot of negotiation back and forth on the investment that we exited ultimately at the end of the quarter. As you can appreciate, that’s a pretty meaningful percentage of our assets. We did not want to be in a position where we were put into a box of having to defer that sale and being pressured on the balance sheet. It was more a matter of a very, very modest issuance expecting that we might have to play through and defer that fairly large liquidity event that was on the horizon. Certainly, most of that equity appreciation was a single investment which is appreciated dramatically and that too also factored into the equation of making sure that we weren’t in a position to be short should that valuation be impaired in some way. It was a modest move to counter a fairly significant concentrated event that we could not necessarily control.

Mickey Schleien: I understand. Bob, can you remind us, are you still looking for balance sheet leveraged debt to equity of 0.9% to 1.25% or have you changed that target range?

Bob Marcotte: No, we will move that back up. It will take powering through some liquidity proceeds. I would also say that there were significant times over the course of the last quarter that our marginal funding cost of our equity was below the marginal funding cost of our debt. The idea that we will increase our leverage but at the current time, the yield on our equity was below the yield on our debt which is not necessarily pushing us to push leverage as much as we might have in the past.

Mickey Schleien: I understand. That’s helpful. Just a few more questions. Are there any success fees receivable from the antenna research exit?

Bob Marcotte: No, that was a straight up equity gain. Most of the exit fees are — we don’t use that in the normal course. It may have been a few legacy investments. That’s predominantly associated with some of the gain investments that we’ve co-invested in the past. So that’s not a material factor on our investment activity.

Mickey Schleien: I understand. And Bob, in the past, I think I’ve asked you about DKI and its outlook. I think you were optimistic. I’m just curious if that’s still the case. Also, what’s your outlook for EGs which seems to be struggling a little bit?

Bob Marcotte: I’d probably say my optimism for DKI is probably diminished. It’s been a challenging circumstance and we’re working on the best way to probably exit that investment. In terms of EGs, we are elevating our engagement on that particular situation. The restaurant business is not the easiest business in the current market environment. We will move forward to try to step up the prospect of realization on that. There have been some discussions about potential sales and other forms. I would say at this point, we’re stepping up our engagement to realize on that investment. There are definitely things including cost cuts that are part of the equation in any business like that. We will be moving forward with those value adjustment steps to effectively try to exit that situation in the coming quarters.

Mickey Schleien: I understand. One last housekeeping question for me. I noticed that you’re reporting now your preferred dividends below the line. Have you considered including those above the line for purposes of calculating the pre-incentive fee income? I realize the number right now is not large, but the amount of prefers could grow over time since that’s an ATM program?

Nicole Schaltenbrand: Yes. Mickey, this is Nicole. That’s an accounting concept and we do think about it above the line for purposes of some of our other modeling and calculations. Just the accounting rules are dictating us to classify it there on the balance sheet and also on the income statement.

Mickey Schleien: Okay. That helps. Again, congrats on a very good year. That’s it for me this morning.

Bob Marcotte: Thank you, Mickey.

Operator: [Operator Instructions] Our next question is from Robert Dowd with Raymond James. Please proceed.

Robert Dodd : Good morning. And Mickey congratulations on a really good year and obviously a really good outcome on Antenna. On that one, and thanks for all the clarity you gave us on the call, particularly on the tax implications. Between Antenna, I think you said you exited Perimeter as well. I mean, that’s $85 million, $100 million of repayments, just those two assets in the quarter. You gave us some indications that there had been spillover of funding activity in the Q4, but can you give us an indication of scale? I mean, is the portfolio likely to shrink? Obviously, not all of that exit was — I mean, most of it was non-income producing, but is it likely to shrink or be stable or grow in the December quarter in terms of the scale of the huge amount of cash collections that you’ve got versus the fundings you’ve put out?

Bob Marcotte: Robert, that’s my 24-hour-a-day question that I have to answer. Unlike our sister, BDC, who controls their destiny, we don’t necessarily control the destiny on whether and when some of these situations are going to be sold. What I can tell you today is the deals that we currently have in queue will more than exceed the cash proceeds. There are several other investments that may exit by the end of the year. I am right now tracking essentially to be flat. I think somewhere plus or minus that is the target right now, but the challenge is as much as you’ve added up the numbers that we’ve realized so far, there’s a few more. We are expecting, as I said, the most active quarter of potential turnover that we have ever had, and we are elevating our deal activity to respond to that.

And right now, I think if we hold serve, I think we’ve done pretty good relative to the total amount of liquidity proceeds we’ve realized. Obviously, as I mentioned in my comments, the ability to reinvest that equity proceeds combined with the natural turnover is going to drive a fair bit of fee activity for the quarter. So at the end of the day, even if we don’t necessarily get back to flat, the income implications should be pretty positive.

Robert Dodd: Got it. Thank you. Very, very helpful. Another one. In your prepared remarks, you said you would consider, I think, working with commercial banks on a blending solution. So you’re talking about basically first-in, last-out kind of structures for companies. Is that correct?

Bob Marcotte: It depends, Robert. It depends on the circumstance. Yes, we will consider that. It’s seamless from the sponsor’s perspective. It can work. Not all situations do that or work that way. We also see situations where the commercial banks will deliver an asset-backed solution at a very low price and very low amortization. That’s actually more consistent with what the sponsors want to support the acquisition and growth of their companies today. We’re just mindful. The fact of the matter is the banks that are open where they’re interested in lending, we need to take advantage of that and participate with them where possible. We are looking at a few more of those situations. I think, in general, I would assume as rates continue to compress, we may see an increase in our subordinated or last-out financings because that’s obviously where our capital structure is most cost-effectively and from a yield perspective deployed.

That’s kind of the subtlety of that comment that we may see that increase slightly in the near term.

Robert Dodd: Got it. Thank you. And then one — a question on my portfolio construction. Just I mean with — you obviously have been clearly — you’ve said a couple of you got very, very active Q4. That’s going to mean — is that going to be — going to end up with — I mean are you going to be over exposed to a single vintage? And I’m not sure that vintage is how you think about portfolio construction, but it’s one of the elements that you could end up with such a large amount of activity in one quarter that you end up with a concentration to one year, one type of thing and deals tend to come in flows as well like type of business tend to et cetera. So is there tend to be concentrated in certain periods? So is there a concentration issue that you’re focused on going through the rest of this year? Or is that just not a factor at this stage?

Bob Marcotte: It’s an interesting question. Generally, the vintage has not really been a factor for us. All of these businesses, we typically get in the growth mode, and for the most part, there’s a multi-year period of growth and expansion. Remember, most of our investments start as transition from founder or family-run type businesses that private equity are buying with the intention of professionalizing, enhancing, and growing. They tend to come in at lower multiples, and there tends to be a multi-year period in which to expand those businesses. I think the bigger question is around the types of businesses or the sectors tend to run in streaks. I can tell you, for example, right now, I’ve seen more dental deals in the last 60 days than I’ve seen in several years.

We will be mindful of that. As I commented earlier, there’s obviously stresses, and we’re seeing probably more restaurant deals than we would have seen, obviously, for a variety of reasons. The way we would approach that is, obviously, we’re pretty selective. We only close about less than 5% of the deals we look at. We, in those cases, if we see multiple deals, we’ll pick the best of them, and maybe we’ll raise the bar as we see more in that particular sector, but the prospect of us closing more than one deal in a given sector in a relatively short period of time tends to be very, very low, unless there’s something unusual. Now, I will say we also continue to have pretty good visibility into the defense sector and some of the defense electronics, given our ARA exit, and we will probably see some additional investments in that sector as well, given what’s changing.

We will monitor the sectors probably much more closely than the vintage. For us, the challenge is we get into these newer, smaller deals, and the beauty is we have the opportunity to continue to invest and grow those businesses. As I said in my comments, 100% of last quarter’s fundings were additional growth to businesses that we were already invested in. That’s the beauty of the vintages that we’re going after, or the growth profile that we’re going after. So, interesting question. We certainly think about it. I don’t think it’s an issue for the portfolio. I think we’re just living through the hangover of companies that survived through COVID and had to take a couple of quarters to get their operations stabilized before they came back out to the market.

Robert Dodd: Very, very helpful. Thank you.

Operator: With no further questions, I would like to turn the conference back over to Michael for closing remarks.

Michael LiCalsi : Thanks, Sherri, and thanks for everybody for calling in. We’ll see you next quarter.

Operator: Thank you. This will conclude today’s conference. You may disconnect your lines at this time, and thank you for your participation.