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Operator: Greetings, and welcome to the Gladstone Capital Corporation’s Second Quarter Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Gladstone, Chief Executive Officer. Thank you, sir. You may begin.

David Gladstone: And thank you, Latoya, for that 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 March 31, 2023. We’re here in, McLean, Virginia. It’s a cool 45 degrees. We’re outside of Washington, D.C., but Bob and Nicole will come on a minute and warm you up with a good report. Thank you all for calling in. We’re always happy to talk to our shareholders and the analysts that follow us and welcome the opportunity to update you about this fine company. Now we’ll hear from our General Counsel, Michael LiCalsi, who will make a statement 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. These forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. Now 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 listed on our Forms 10-Q, 10-K and other documents that we file with the SEC. You can find them on the Investors page of our website at gladstonecapital.com. Now while you’re there, you can also sign up for our e-mail notification service and you can 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. We remind everyone that 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, those are found 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 some of the highlights for last quarter and conclude with some comments on the outlook for the balance of 2023, before turning the call to Nicole Schaltenbrand, our CFO, to review our financial results for the period and our capital and liquidity position. So beginning with our last quarter results. Originations for the quarter rebounded to $64 million for the period, which included $16 million of add-on investments to existing portfolio companies. Amortization and repayments were modest to $10 million, so our ending investment balance rose by $54 million for the period. Higher short-term rates lifted the weighted average yield on our investment portfolio by 80 basis points to 13.1%, and were the primary driver behind the 7% increase in total investment income.

Borrowing costs increased on the quarter as well, up $300,000 with higher SOFR rates. However, our net interest margin rose $900,000 to $14.3 million for the quarter. Net management fees were unchanged at $4.6 million or 2.7% of assets as new deal closing fee credits offset higher incentive fees associated with the increase in investment yields. Net investment income increased 10% to $9.6 million or just over $0.26 per share for the quarter. The net realized and unrealized gain on the portfolio for the period came in at $2.4 million, which combined with undistributed earnings and accretive share issuance under our ATM program combined to lift NAV per share by $0.13 to $9.19. The combination of the increased net interest income and equity appreciation lifted our ROE for the quarter to 11.6%.

Based on the portfolio performance and increase in net interest income, we recently announced the monthly dividend increase $0.08 or $0.96 annually, which last quarter’s earnings covered by an adequate margin of 110%. From a portfolio perspective, our portfolio continues to perform well with generally modest leverage metrics and favorable liquidity profile, and we ended the quarter with only 1 nonearning and debt investment, representing $6.1 million in cost or 0.4% of assets at fair value. The appreciation for the quarter of $2.4 million was primarily related to the net move in several equity co-investment positions as net depreciation on the debt investment portfolio was nominal at under $1 million. In reflecting on our outlook for the balance of 2023, I’d like to leave you with a couple of comments.

While the broader market deal flows have moderated, we’re continuing to see attractive investment opportunities within the lower middle market and expect follow-on investments within our portfolio will continue. And in total, these should outpace repayments and support further growth of our investment portfolio. We’ve maintained our underwriting rigor based on these interest rate escalations and continue to focus on our investment activity on lower risk, senior secured loans, which have grown to 74% of our investments. And today, the weighted average overall leverage for the portfolio is under 3.5x EBITDA, which helps mitigate any potential debt service issues and the yield erosion associated with nonearning assets. We continue to actively manage our balance sheet leverage within our modest leverage target range and market conditions permitting, plan to continue to issue equity under our ATM program to support further growth of our investment portfolio.

With our floating rate investments exceeding our floating rate liabilities by just over $412 million, and the current floating rates on pace to be up at least 40 basis points for the quarter, we would expect our net interest margin to be up an additional $400,000 this quarter. And now I’d like to turn the call over to Nicole Schaltenbrand to provide some details on the fund’s financial results for the quarter. Nicole?

Nicole Schaltenbrand: Thanks, Bob. Good morning all. During the March quarter, total interest income rose $1.2 million or 7% to $19.6 million based on the increase in prevailing floating rates and an increase in earning assets. The weighted average yield on our interest-bearing portfolio rose 80 basis points to 13.1%, with the increase in floating rates on the 91% of the investment portfolio that carries the rates. The investment portfolio weighted average balance increased to $604 million, which was up $14.4 million or 2.4% compared to the prior quarter. Other income was largely unchanged at $1 million and total investment income rose $1.3 million or 7% to $20.6 million for the quarter. Total expenses rose by $400,000 quarter-over-quarter with higher interest expenses as that management fees were unchanged with new deal closing fee credits offsetting the higher incentive fees.

Net investment income for the quarter ended March 31 was $9.6 million, which was an increase of $900,000 compared to the prior quarter or $0.263 per share, which exceeded the $0.225 per share dividend paid and supported the increase to $0.24 per share per quarter announced in April. The net increase in net assets resulting from operations was $12 million or $0.33 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 31, total assets rose to $700 million, consisting of $679 million in investments at fair value and $21 million in cash and other assets. Liabilities rose to $358 million as of March 31 and consisted primarily of $150 million of 5 and 1/8 senior notes due 2026, $50 million of 3.75% senior notes due May of 2027.

And as of the end of the quarter, advances under our line of credit rose to $153 million. As of March 31, net assets rose by $17.5 million from the prior quarter end with the net proceeds from common share issuance under our ATM program of $13.8 million and unrealized gains in undistributed earnings. NAV rose from $9.06 per share as of December 31 to $9.19 per share as of March 31. Our leverage as of the end of March — as of the end of the quarter rose with the increase in assets to 105% of net assets. With respect to distribution, Gladstone Capital’s monthly distributions to our common stockholders was increased to $0.08 per common share effective for the month of April, May and June, which is an annual run rate of $0.96 per share. The Board will meet again in July to determine the monthly distribution to common stockholders for the following quarter.

At the current distribution run rate for our common stock and with a common stock price at about $9.42 per share yesterday, the distribution run rate is now producing a yield of about 10.2%. And now I’ll turn it back to David to conclude.

David Gladstone: Well, thank you. And Bob and Nicole and Michael, all of you did a great job of informing our shareholders and analysts about our company. In summary, another solid quarter at Gladstone Capital. We’re doing it now for about 20 years. It’s a good company. Company delivered net investment income originations of about $54 million for the quarter, which lifted the net asset growth of the company to over $150 million in the past 12 months. Portfolio is in good shape with modest leverage and very low nonperforming assets. Net interest income, 7% to — rose to 7% from $14.3 million. The higher rate and support the 7% increase in the monthly common distributions to $0.08 per share. This is just terrific. I love it when Bob and Nicole raise the dividend, and we get up to, well, it’s a 10.2% yield.

I’m not sure you can find anything better out there in the lending area. In summary, the company continues to stick to its knitting and its strategy of investing in growth-oriented lower middle market businesses. These have good management teams. Many of these investments are supporting midsized private equity funds that are looking for experienced partners to support the acquisition and growth of the business, which they are investing. This gives us an opportunity to make attractive interest-paying loans to support our ongoing commitment to pay cash distributions to shareholders and being a large shareholder, I get great joy when raises the dividend. And now operator, Latoya, if you’ll come on and let’s talk to some of the callers and answer their questions.

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

Mickey Schleien: Bob, we obviously saw how weak U.S. GDP growth was in the first quarter and the decline in consumer inflation certainly seems to be pointing towards material deceleration in the economy. With that in mind, what trends are you seeing in your portfolio companies’ revenue and EBITDA? And how concerned are you about their ability to continue to service their debt in terms of cash interest coverage?

Bob Marcotte: That’s a mouthful, Mickey, but I’ll do my best. I’ll start with the premise, you understand that most of our companies are not consumer-facing businesses. When we look at growth-oriented businesses, we’re focused on businesses that have competitive positions and revenue visibility, and those don’t tend to be consumer focusing — focused businesses. So we start with revenue visibility and commercial relationships, industrial relationships that are generally sustaining. The second piece is we do start with a very low leverage profile. And I’ve commented on this on prior quarters, we’re well under 3.5 turns of overall leverage. And you have to understand that our investment strategy, when we start with lower middle market businesses, they tend to be growth-oriented businesses that we are providing flexible capital to expand.

And so when you look at our profile of businesses, while we may start small, oftentimes the portfolio will grow fairly quickly. And as it does, it organically deleverages. And to give you some metrics on that, at the moment, as of the end of March, 55% of our portfolio on a weighted average basis has EBITDA of greater than $10 million. So these are not very small companies. They’re reasonably sized companies, and the overall leverage there is very attractive. The balance of the portfolio, less than half has under $10 million of EBITDA and for the most part, has a very similar leverage profile. So when we track, we’ve got bigger companies for roughly half of the business, and the smaller companies, we obviously have invested in are earlier in their growth profile and oftentimes, are growing organically.

And so that is where — while they may not grow at the same rate we originally expected, we’re not terribly concerned. These are businesses that might be health care, might be industrial, might have technology or competitive differentiation. Not really concerned about where those are from a current performance basis. We’ve seen negligible deterioration from our third-party evaluations of all of those businesses, as I indicated in my comments. So again, further affirmation of where we are. The last 2 pieces that I would add, our PIK income on the portfolio is very low today. It’s under 5% of our interest income. So if we were seeing stress, the logical scenario for this growth business portfolio would be to accrue some income. Our PIK has not even gone up.

It’s, in fact, going down at the moment. And obviously, as we’ve commented in the past, our nonearning assets are effectively unchanged from the prior quarter. So at this point, not terribly concerned. We’re not seeing the kind of liquidity pressures. And if you run the math, at 3.5 turns of leverage, even at today’s interest rates, you’re going to have net fixed charge coverage unless you have a material deterioration of the business. And for the most part, we are not seeing that.

Mickey Schleien: Bob, I appreciate that in-depth answer, it is really helpful. And I’d like to understand how that philosophy applies to your aerospace segment, which is 1 of your largest allocations. And more specifically, obviously, everybody is watching the government negotiate the budget given the debt limit issues. How exposed are your aerospace investments to these discussions in terms of a potential for a cutback in military spending?

Bob Marcotte: Well, I don’t know what your — aerospace and defense, maybe that falls into 2 separate categories. I think you’ve got NASA and you’ve got the Department of Defense. The 2 investments that probably represent the bulk of that exposure, 1 of them is when you typically talk about aerospace, there’s a mix of rocket-related pieces and then there are also missile-related pieces and armaments. And the majority of that exposure today is feeding the primes, which have significant order backlogs and in fact, that credit that you’re referencing is very large credit with record backlog at the moment. And if you were to look at the backlog for Northrop Grumman or Lockheed Martin or some of the larger missile and armaments business, they are doing extremely well today.

We are not concerned about that company. It also happens to be 1 of the largest companies in our portfolio with — it’s about $30 million of exposure, but we’re talking about a business with revenues approaching $300 million. So we’re not typically concerned about that. The other business that falls in that category was a strategic investment we made a number of years ago that was in the communications and radar technology space. And when you think about drones and think about incursions and monitoring activities, that business is doing extraordinarily well. Has more than doubled its EBITDA and is continuing to see significant revenue opportunities because the electronic components and the type of warfare we’re logically going to see in the next couple of years is not something that the government can turn down.

It has to be increased, and we are seeing that coming through in new order activities and new awards. So I guess the good news is we’re in sectors that are growing and we’re in sectors where there’s significant visibility in backlog, which obviously reduces the near-term concerns.

Mickey Schleien: No, I’m glad to hear that, Bob. Congratulations on another strong quarter.

David Gladstone: Okay, next question Latoya.

Operator: Our next question is from Robert Dodd with Raymond James.

Robert Dodd: Congratulations on another strong quarter. I do have 1 question on the liability side. Obviously, with T Bank. I mean, you pushed out the maturing — the revolving period on the credit facility to October from, I think, it was August before, but that still needs obviously to be addressed this year. Can you give us any color on what additional you’re doing on that front? Or should we expect you to just draw a lot of the capital on the revolver before the revolving period expires? Or can you give us any color there?

Bob Marcotte: Obviously, there’s a diversity of banks in that facility, Robert. And we have an arrangement under discussion with them today that we believe will extend the maturity on that facility. I would be remiss to say that we’re not going to consider alternatives in a way to diversify some of that exposure. It obviously is on the top of our list to address. I think at the current time, maintaining a conservative balance sheet, a clean portfolio, we continue to represent an attractive investment opportunity and we hope to conclude those discussions shortly, but we’ll, over the longer term, be looking to diversify our liability mix. So you’ve got any good ideas, we’re open to them. But we’re working it, and we’re not concerned at this point, given where our assets are performing and given where our stock is performing.

We feel we’re a reasonable performer in the sector, and we’ll be able to attract additional resources to continue to support that part of our liability structure.

Robert Dodd: Got it. Got it. And then if I can go back to the kind of following on to Mickey’s question, I mean to your point. I mean the weighted average leverage under 3.5. Even at where rates are currently, that probably means cash interest coverage, I can’t get fixed charge coverage ratio, but cash interest coverage is probably well north of 2 on a weighted average basis across the portfolio, even with where rates are right now. And PIK obviously is low. Like are there any elements of the portfolio where you’ve started to have discussions with sponsors? The weighted average portfolio is about 2, there’s got to be some that are weaker. But any color on this? Are there any emerging discussions there? Or is it just the portfolio is in great shape?

Bob Marcotte: There’s no isolated where I would say the economy is hurting. There have always been, in the smaller side of the market, idiosyncratic risks where a given customer — a given customer shifts and we have to replace that customer kind of thing. So whether it’s marketing, whether it’s pulling through additional awards, we haven’t seen a ton of that. And remember, most of these businesses are growth oriented. There are additional investments that they need to make in CapEx. There’s — so it’s not all EBITDA to interest expense. There’s reinvestments in businesses. We tend not to get involved in businesses where the maintenance capital expenditures are very high. You don’t see a lot of trucking businesses and those kind of platforms because the amount of free cash flow out of that business is very limited.

At this point, I’ll give you 1 example. We have a restaurant in the portfolio. You would think that’s atypical for us. That restaurant portfolio is a very large restaurant chain. It has essentially leverage under 2 and is continuing to grow their underlying businesses. Are they making the free cash flow that they were? No, it’s a little tighter, but the leverage is extremely low. And at some point, they just slowed down their investments in new locations. So they can manage their leverage and their fixed charge coverage based on how fast they want to continue to expand their platform. So we’re not seeing any systemic issues that are causing concern for us at this point.

David Gladstone: Latoya, would you come on and see if there’s anybody else who wants to ask us a question?

Operator: There are no further questions in queue at this time. I would like to turn it back to management for closing comments.

David Gladstone: That’s a shame. We had such a good quarter. We expected a lot of good questions, but we’ll wait until next quarter and maybe you’ll dream up some good questions for us. Thank you all for tuning in, and that’s the end of the program.

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