Q4 2022 Gladstone Capital Corp Earnings Call

Greetings welcome to Gladstone Capital Corporation fourth quarter and year end earnings call. At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation.

If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad. Please note. This conference is being recorded I will now turn the conference over to David Gladstone Chief Executive Officer. Thank you you may begin.

Thank you Shari and that was a nice introduction and good morning, everybody. This is David Gladstone Chairman of the earnings Conference call Gladstone capital.

For the quarter and fiscal year, ending September 30 was 26.

Again, thank you all for calling in and we're always happy to talk to our shareholders and the analysts that follow us and we welcome the opportunity to provide an update on our company.

And now we'll hear from General Counsel, Michael let Kal say, who will make a statement with regarding to certain forward looking statements. Michael 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. 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 finding in our forms 10-Q, 10-K and any other documents we file with the SEC, saying you can find them in the Investor Relations.

Page of our website Gladstone capital Dot Com can also sign up for our email notification service. There. When you can also find them on the SEC's website, which is www dot FCC that G O V.

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 on today's calls an overview of our results. So we ask that you review our press release and Form 10-K issued yesterday for more detailed information again, you can find them on the <unk>.

The investors page of our website now I'll turn the call over to Gladstone Capital's President Bob Marcotte, Bob. Thank you Michael Good morning, all and thank you all for dialing in this morning I'll cover the highlights for last quarter and the fiscal year ended September 30, and conclude with some market commentary as we look forward into fiscal 'twenty three.

Before turning the call over to Nicole Shelton Brown, our CFO to review the financial results for the period, and our capital and liquidity position.

So beginning with last quarter's results originations for the quarter totaled 86 million, which included three new platform investments and included 26 million of add on investments to existing portfolio companies amortization and repayments were 22 million. So net originations were strong at $64 million for the quarter.

Interest income for the quarter rose, 24% to $15 6 million as the average investment balance was up approximately 47 million or nine 3% and the weighted average loan yield for the quarter Rose 120 basis points to 11, 2%.

In the absence of material exits prepayments fees and fee income declined to 400000. However, total investment income still rose by 16% to $15 9 million for the quarter.

Borrowing costs rose 700000, or 20% with increased bank borrowings and higher LIBOR rates as well as fees associated with the $50 million increase to our credit facility commitments. However, our net interest margin jumped by $2 3 million or 25% to a record 11.

$5 million for the quarter.

Administrative costs were largely unchanged. However, net management fees rose by 900000 to 3.4 million with the increase in assets higher incentive fees associated with the increase in investment yields and the absence of incentive fee credits compared to the prior quarter.

Net investment income rose 500000 to $7 5 million or 22 cents per share.

The net realized and unrealized losses for the port on the portfolio for the period came in at $2 4 million as loan depreciation on a couple of credits.

And the markdown of legacy equity valuation and anticipation of a subsequent exit outpaced the generally favorable operating performance of the portfolio.

As a result.

N. A V declined four cents per share to nine O eight as of September 30.

While we've only begun to realize the benefit of higher interest rates. We're pleased to report our cumulative net interest income generated a 10, 1% return on our net assets over the past year.

With respect to the portfolio our portfolio continues to perform well with generally modest leverage metrics and favorable liquidity and as such we did not experience any prepayments false last quarter.

Depreciation for the quarter totaled $2 3 million as the rise in a number of our <unk>.

As the rise in a number of our equity position.

<unk> was more than offset.

By yield driven discounts on seven several recently closed debt investments.

A reduction in the cumulative appreciation of our legacy common stock position and targets in anticipation of an exit and loan depreciation associated with soft operating performance at edge adhesives.

Since the end of the quarter notable portfolio events include the sale of the common equity investment in Targus and the liquidating distributions from a L. P investment in leads note Mark capital.

In reflecting on our fiscal 'twenty two performance and outlook for what is now our fiscal 'twenty. Three there are a couple of comments I'd like to leave you with.

During fiscal 'twenty two our origination increased is originations increased by 50% to almost $280 million, which lifted our net originations to $115 million for the year.

While still maintaining our focus on investing in growth oriented lower middle market companies today, our portfolio is over 50 companies and we've broadened our private equity network in the process.

We've maintained our underwriting rigor and are fortunate to have our portfolio heavily weighted towards senior secured loans, which have risen over the past year to 71, 4% of our investments.

Secured debt investments have increased to 89, 2% of total investments in the core portfolio continues to be modestly leveraged at under 3.3 0.5 times EBITDA.

Based on the cumulative asset gross the growth of the past year, we've elevated our balance sheet leverage to the target range of 90% to 110% of nap as we previously referenced and we will look to maintain our leverage in that range as we grow our assets going forward.

While our asset growth may moderate with our leverage profile, we do expect our net interest income to rise with the full quarter impact of the current interest rates as well as the increased spreads and more conservative leverage metrics of the currently tighter credit environment with our floating rate investments as CD.

Our floating rate liabilities by approximately $400 million in the current floating rates on pace to be up about 125 basis points for the quarter. We would expect our net interest margin to be up in the range of 1.25 million this quarter.

Based on the portfolio performance and as the net interest income is realized we expect to be in a position to consider increasing the shareholder distributions in the coming quarters and now I'll turn the call over to Nicole Shilton, Brad the CFO for Gladstone capital to provide some more details on the fund's financial performance for the quarter Nicole Thanks, Bob Good morning.

During the September quarter total interest income rose $3 million or 23, 6% to $15 6 million based on an increase in both earning assets as well as prevailing rate the investment portfolio weighted average balance increased to $553 million, which was up $47 million or nine 3% compared to the June 30th.

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The weighted average yield on our interest bearing portfolio rose 120 basis points to 11, 2% with the increasing floating rate on the 89% of the investment portfolio that is carried at floating rates and other.

Other income declined by 800000 to 400000, However, total investment income still rose by $2 2 million or 15, 6% to $15 9 million for the quarter.

Total expenses rose by 1.6 million quarter over quarter as interest expenses increased 600000, and we had a 900000 dollar increase in net management fees driven by higher average assets increased yield and reduced incentive fee credit.

Net investment income for the quarter ended September 30th was seven 5 million, which is an increase of 500000 compared to the prior quarter R 22 cents per share and covered more than 100% of our shareholder distributions.

The net increase in net assets, resulting from operations was $5 1 billion or 15 cents per share for the quarter ended September 30th as impacted by the realized and unrealized valuation depreciation cover it by Bob earlier.

Moving over to the balance sheet as of September 30th total assets rose to $660 million, consisting of $649 million in investments at fair value and $11 million in cash and other asset.

Liabilities increased to 345 million and consisted primarily of $150 million of five and eight senior notes due January 2026, 50 million of three and three quarters senior notes due may of 2027 and as of the end of the quarter advances under our line of credit were $142 million.

As of September 30th net assets rose by $2 6 million from the prior quarter end with the realized and unrealized valuation depreciation which was offset by common share issuance under our ATM program of $4 5 million now.

<unk> declined slightly from $9 12 per share as of June 30th two $9 eight per share as of September 30th.

Leverage as of the end of the year rose with the increase in total assets, 210% if not at <unk>.

During the quarter, we amended our line of credit to increase the facility commitments to 225 million at quarter end, we had an excess of $60 million of current borrowing availability under our line.

Following the end of the quarter, we added another bank to our facility and bringing the total commitment to $245 million.

With respect to distributions.

Our monthly distributions to common stockholders increased to seven cents per share effective for the months of October November and December which is an annual rate of 84 cents per share. The board for me in January to determine the monthly distribution to common stockholders for the following quarter.

The distribution rates are Aman stocking with the common stock price at about $10.04 per share yesterday. The distribution run rate is now producing a yield of about eight 4% and now I'll turn it back to David typically Oh. Thank you I'm, Bob Nicole you did a good job of putting our shareholders know what's going on at the company and Michael.

I appreciate your comments as well in summary.

Just another solid quarter for Gladstone capital.

Which capped a stellar year for the company as well.

The company closed 86 million of new and add on investments in existing portfolio company, which lifted the total investments to 649 million, which represents an increase of 92 million or 17% over the last year.

Interest income that is for the quarter was up 25% based on higher interest rates and the company's favorable capital structure.

We expect the current rates to sustain this momentum and support potential increases in our common distributions.

How many quarters.

In summary, the company continues to stick to our strategy of investing in growth oriented lower middle market businesses with good management. Many of these investments are supported by midsized private equity funds and they're looking for an experienced partner to support the acquisition of growth of the business.

Over the time that they are invested this gives us an opportunity to make an attractive interest paying loans and support our ongoing commitment to pay cash distributions to shareholders.

I'm going to stop now and ask the operator to come on and now we'll get some questions from the analysts and other people that are on the line.

Sherry.

Thank you.

Like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue.

And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

Our first question is from Mickey Schlein with Ladenburg Thalmann. Please proceed.

Yes. Good morning, everyone. Excuse me are Bob you mentioned, the portfolio's average leverage.

Which which is an attractive figure could you discuss the trends in revenues and margins at the portfolio and.

Whereas the cash interest coverage ratio lies and and your sense of your borrow either borrowers abilities to service their debt is LIBOR and so forth climb.

But as you as you.

Point out you know the average leverage is is less than three and a half turns there are certainly you know some some above that.

But the focus really is making sure the leverage profile and our line of credit and liquidity of the businesses are solid.

The interest coverage. Obviously is is in flux I would say right now the the folks that we're focused on most closely or anything related to consumer oriented businesses, where a pullback or.

End market demand might be impacted we are also seeing areas, where some of the business services are being impacted things that might be marketing oriented or or have.

Have discretionary spend on the part of those businesses.

But for the most part those are the only areas that we're seeing any issue.

Most of our business most of our investments are business to business in the end.

We are definitely seeing a nice sustaining growth in many segments, where domestic manufacturing is a priority.

That is a continuation of the trend of bringing back production to domestic manufacturers and managing the logistics associated with domestic.

So with respect to overall leverage you know obviously, we always have maintenance covenants in all of our deals which require interest coverage. That's typically one one to one two turns of coverage.

At this stage I don't think we have any particular covenant defaults or covenant issues in that regard. So we feel the pump. The portfolio has has plenty of coverage even at the leverage level that they are and we've also had very few draws against any of our associated lines of credit so.

Much like when we saw the P. P P situation and the onset of Covid we've.

We've seen very little draws against the liquidity of the businesses, they're managing their liquidity profile appropriately.

So at this stage interest coverage, we're not we're not concerned obviously, we're going to monitor it closely.

The increase in interest rates in the last quarter, obviously has to play through a few more quarters before we start to see significant change in those but but we're watching it closely.

I I don't anticipate that we have any material issues in the short term.

And as I've said in the past about 70% of our deals are sponsored deals. So we have equity investors and funds below us that obviously are in the process of managing those capital structures and in many cases support the underlying businesses did.

Did I leave anything out on that Mickey no no that was that was great. Thank you just one follow up Bob.

You just mentioned some comments about the market dynamics I'm curious how.

You view, you know supply and demand of private capital for the debt markets, where you operate.

Clearly everyone wants to.

Invest in software companies with recurring revenues are those deals are still highly sought after but overall when you think about the pipeline has the deceleration of the economy the rising rates.

You know.

Some concern about how the election would turn out has that slowed the demand for your capital and where do you see the most interesting risk reward in terms of industries and securities you know where their first lien second lien or other.

There's a lot in there, but the simple the simple framework is I think there are a lot less folks.

Coming down market, there's certainly plenty of opportunities upmarket given the discounts in the broader syndicated marketplace. So there's not a lot of big guys coming down the.

The commercial banks have paused, whether it's for regulatory or their own portfolio matters.

And you have folks that are you know aren't in a position to to raise additional capital or somewhat balance sheet constraints, so where it might've been a broad a competitive process, there's definitely hum fewer players on the.

Field at the moment to take up those opportunities. The second is we are seeing sponsors leaning into a growth oriented businesses, where they see an outlook for continued expansion you know it might be you know capital equipment, where automation and technologies or <unk>.

Proving performance or reducing labor requirements, those kinds of things and as a result, there's only a few folks on the field. What we're tending to see is people are more interested in getting their deals closed than shopping around knowing full well there aren't a lot of places to go and so from our perspective.

What that's enabled us to do is be more selective in terms of the business that we go after leverages, probably down and in select instances I think pricing is up but we are closing deals in what I would say are probably more defensive sectors contract manufacturing of food.

Products certain health care related segments that are certainly more defensive those kind of situations, where we're getting our attractive attractive rates and an attractive sectors with respect to how we're playing and where we're playing.

You know it is a trade off today, you know balance sheet leverage and in the framework a unit tranches chew up a lot of capacity for fundings. So we will selectively look at unit tranches or we may team up with other folks to pursue unit tranche type opportunities.

We did close a fairly large second lien asset in the quarter at a very attractive pricing.

So I think in certain instances, where leverages down and it's the right kind of sector.

We are going to pursue second lien and we may see that grow a bit in our portfolio, but that is highly dependent upon what's going on in the senior market. Because we obviously don't want to be taking undue risks that the senior lenders might inflict on the underlying business. So.

I would say right now, we're probably being more defensive getting the pricing that makes sense for us and and seeing fair bit of growth and some nice sectors to diversify the portfolio.

Thank you Bob that's really helpful. Those are all my questions I. Appreciate your time, thanks for dialing in Mickey.

Next question.

As a reminder, this star one on your telephone keypad, if he would like to ask a question. We will just pause for a brief moment to poll for any final questions.

Okay.

There are no more questions at this time, so I will hand, the conference back over to management for closing comments.

Thank you very much and thank you all for calling in I hope, you're having a good day to day and well see you next quarter.

That's the end of this call.

Thank you that will conclude today's conference you may disconnect. Your lines at this time and thank you for your participation.

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