Q1 2023 Gladstone Capital Corp Earnings Call

Speaker 2: Greetings. Welcome to the Gladstone Capital Corporation's first quarter of earnings call. This time all participants are in 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 from your telephone keypad. 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. Now, 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're here from our General Counsel, Michael LaCalsie, who will give a statement regarding certain forward-looking statements.

Speaker 3: Next day, good morning, everybody. Today's report makes the American Statements on the Security SACs of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. And these forwards looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable.

Speaker 4: Many factors may cause our actual results to be materially different from future results. Express or imply by these forward-looking statements, including all risk factors, or forms 10Q, 10K and other documents we followed the SEC. Find them on the Investors page of our website, www.gladstonecapital.com

Speaker 5: You can also sign up for email notification service. You can also find the documents on the SEC's website, that's scc.gov. Now we undertake no operation. We update orderifies any of these photos and statements, whether as a result of new information, future events, or otherwise, except as required by law. Today's calls and overview of our results, so we ask the...

Speaker 6: 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 Schultenbrand, our CFO , to review our financial results for the period in our capital liquidity position.

Speaker 7: 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.

Speaker 8: 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.

Speaker 9: The income rose on the period 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.

Speaker 10: Borrowing costs increased $900,000 or 22% with higher SOFA rates. However, our net interest margin also rose 1.9 million or 17% to a record 13.4 million for the quarter.

Speaker 11: Administrative costs were largely unchanged. However, net management fees rose by 1.2 million to 4.6 million, or 2.9 percent 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.

Speaker 12: came in at $3 million. And as a result, NAV declined $0.02 per share to $9.06.

Speaker 13: 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.

Speaker 14: Based upon the portfolio performance and increase in net interest income, we recently announced a monthly dividend increase to 7.5 cents or 90 cents annually and will consider further increases in the coming quarters. With respect to the portfolio, the portfolio continues to perform well.

Speaker 15: 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.

Speaker 16: 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.

Speaker 17: Notable portfolio exits for the period included the sale of a couple of equity investments in Targus and Leeds' Novomar capital, which generated realized gains of 10.3 million, and the repayment of R2I, which is a highly leveraged credit.

Speaker 18: and contributed to the 35% drop in PIC income for the quarter.

Speaker 19: In reflecting on our outlook for the balance of 23, I'd like to leave you with a couple of comments.

Speaker 20: 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 the coming quarters.

Speaker 21: 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 to 100 million over the balance of the year as we did last year. Just recently in January , we closed a new deal, NeoGrap.

Speaker 22: to senior secured loans, which at present represents 72% of our investments.

Speaker 23: which at present represent 72% of our investments. And secured investments.

Speaker 24: have increased to 91% of the total investments with a modest overall leverage of under 3.5 turns.

Speaker 25: 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 of the quarter, we would expect our net interest margin to be up in the range of 750,000 in the quarter. And now I'd like to turn it over to Nicole Shelton-Brand.

Speaker 26: Thank you, Bob. 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.

Speaker 27: The weighted average yield on our interest-bearing portfolio rose 110 basis points to 12.3 percent with the increase in floating rates on the 91 percent of the investment portfolio that carries those floating rates. The investment portfolio weighted average balance increased to $590 million which was up 37 million or 6.7 percent compared to the...

Speaker 28: $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.

Speaker 29: Net investment income for the quarter ended December 31st was $8.7 million, which was an increase of $1.2 million compared to the prior quarter, or 25 cents per share, which exceeds the 21 cent per share dividends paid, and supported the increase to 22.5 cents per quarter announced in January . The net increase in net assets resulting from operations was $5.7 million.

Speaker 30: that fair value in 18 million in cash and other assets.

Speaker 31: Liabilities declined to $315 million at the end of the quarter and consisted primarily of $150 million of 5 and 8 senior notes due 2026.

Speaker 32: $50 million of 3 3?4 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. We have declined slightly from $9.08 for share as of September 30.

to $9.06 per share as of December 31st. Our leverage as of December 31st 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 7.5 cents per common share effective for the months of January , February , and March, which is an annual run rate of 90 cents per share. The board will meet in April to determine the monthly distribution to common stockholders for the following quarter.

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.

The company didn't close much last quarter, but it did a good job of exiting some assets and leveraging 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.

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 good management. Many of these investments are support of mid-sized private equity funds that we partner with, and they are looking for experienced partners to support the acquisition and growth of the business in alright.

questions about the company.

Thank you Mr. Gladstone. To ask a question at this time please press star 1 from your telephone keypad and a confirmation tone will indicate your line in the question queue.

You may press star 2 if you would like to withdraw your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

One moment please, so we pull for questions and once again that's star one. Thank you and our first question is from the line of Mickey Shine with Madden Burke. Please continue with your questions.

Yes, good morning everyone. Bob, first a high-level question. Can you give us a sense of what's going on in the market that prevented you from closing your new originations during the quarter?

Good morning, Mickey. As you may recall, we had a couple of 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 were going to support the significant step up in rate. I think we are being very careful about not only rates, but also the

but what's the economic headwinds are going to affect the revenues in the underlying portfolio. So while we saw a number of credits that were not clearing, you know, we were a little bit more conservative. I think the fact that we've already closed one in January and there are numbers 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.

points of fed tightening. So how do you see that potentially impacting the portfolio's ability to service its debt?

Yeah. Let me give you a couple of quick stats and we 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 has 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 leverage under two and a half.

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 3.1 times.

So, an 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,

You know, 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.

the face of the escalating interest rates is well positioned. I understand that 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?

So we placed it on nonacrull effective October 1st and we did reverse one month. So the September of 2022 month of interest, which was...

Less than 75,000 of interest was. Okay, that's it for me this morning. I appreciate your time. Thanks, Mickey.

than less than 75,000 of interest was. Okay that's it for me this morning I appreciate your time thank you. Thanks Mickey.

Thank you. As a reminder, to ask a question today, press star 1. The next question is from the line of Robert Dodd with Raymond James. Please receive your questions.

Hi and congratulations on the quarter and also thank you for that detailed answer to Mickey's question on the interest coverage and the leverage by kind of...

sized here. That's really, really helpful. On the pipeline if I can, in response, you prepared the mark in response to these questions. You talked about, obviously it was a little – you had originated a lot, so it kind of emptied the pipeline and started to refill again. I mean how would you rank the pipeline in terms of looking for –

you want to underwrite in this kind of economic uncertainty period? It's an interesting question. I would say there's probably a couple of different nuances there, Robert.

First off, I think if you read some of the recently released reports, tightening credit conditions has squeezed a lot of folks out of the marketplace today. A lot of the regional banks, a lot of the larger banks, and capital constraints in a number of places. There

have really moved all of the borrowers to the private capital markets. So being open as we are today, we're getting to see an awful lot of stuff.

And so for us, the good news is, as time goes on, we're seeing current numbers, we're seeing current 23 outlooks and budgets, and if people start to negatively trend to their plan, two things typically happen. Sponsors don't buy them because they're not going to hit their targets. And two, they are not going to give us the profile to de-leverage the risk that we were expecting. So there's a natural, the deal falls away because the visibility or the sponsors don't think they can make the valuations work. For us,

Today, you know, we do have a number of things out there, but it's all based on trends that we are seeing continued Deleveraging obviously, you know, because we do deal with smaller credits There are pockets where things are doing very well and Our you know focus in those is really just the

sustainability of those businesses. So if we're investing in something that might be positively impacted by electrical vehicles or energy consumption or things like recycling or closed loop or other things that are

might bring for the wider swath of credits that we're seeing. I appreciate that color. I mean, the private capital market, as you say, I'm still open. Are you seeing any increase in competition in your end of the market? Given to your point, there's probably somewhat fewer businesses that actually meet everybody's kind of...

Not just yours, but others underwriting parameters in this environment. Is it resulting in more crowding for the deals that are getting done? Don't seem to be, right? I don't think so. I think the idea of we're a consistent player, we've got an established position.

More often than not, we're getting calls from sponsors who the banks flaked on them or some lender that was relying on the CLO market to support their business or insurance company to back them isn't there, and we'll certainly get those calls.

and have preferential opportunities. And the thing in today's marketplace that I would say is, there's no reason for us to stretch.

I mean, given our traditional pricing, you know, use a benchmark, 7 over or something like that, today that's going to generate senior returns in excess of 11%.

There's no reason to stretch for extra credit risk. We have said we have had situations where the senior is approaching what would traditionally be subordinated or second lien returns There's no reason to stretch the current level of interest rates and the current demand for private capital is giving us a tremendous opportunity to put money out as senior risk.

as long as it's in the right business. It's generating great returns for us. I appreciate that really clear answer. Thank you. Thank you for calling in.

Thank you. At this time we've reached end of the question and answer session. I'll now turn the floor back to Mr. Gladstone for closing.

Okay, thank you all for calling in. I would mention that there's a lot of junk in the marketplace today. A lot of banks have been out of the market and just closed their door to new loans. I guess the regulators are beating on them pretty hard.

Anyway, we're in great shape to keep moving forward. I expect this quarter that we're in now that began in January is going to be a strong quarter for us. And that's really the end of this presentation. We'll see you next quarter. So thank you all for calling in. rob

Thank you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.