Title

Presentation

Operator: Greetings and welcome to the Gladstone Capital Corporation First Quarter 2024 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 conference is being recorded. I would now like to turn the conference over to your host, Mr. David Gladstone, Chairman and CEO of Gladstone Capital Corporation. Thank you. You may begin.

David Gladstone: Thank you very much and good morning everyone. And this is David Gladstone and this is the earnings conference call for Gladstone Capital for the quarter ending December 31st, 2023. Thank you all for calling in. We’re always happy to talk to with you and share information about this company and your company. And we’ll get started, of course, and hear from our Assistant General Counsel, Eric Helman. And he’ll tell you some stuff that you need to know before you listen to Bob. Go ahead, Eric.

Eric Helman: Thank you, David and good morning. 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. 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 we file with the SEC. Those can be found on the Investor Relations page of our website at www.gladstonecapital.com, where you can also sign up for our e-mail notification service or on the SEC’s website, at www.sec.gov.

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-Q, issued yesterday for more detailed information. Again, those can be found on the Investors page of our website. Now, I will turn the call over to Gladstone Capital’s President, Bob Marcotte.

Bob Marcotte: Good morning. Thank you all for dialing in this morning. I’ll cover the highlights for last quarter and some comments regarding the outlook for the balance of fiscal 2024, before turning the call over to Nicole Schaltenbrand to review the details of our financial results for the period. So, beginning with our last quarter’s results, originations last quarter rebounded and totaled $58 million, including one new portfolio company and several existing portfolio companies. Prepayments — repayments continue to be modest, which combined with portfolio amortization totaled $22 million, so net originations were $37 million for the period. Short-term SOFR rates unchanged, so the weighted average yield on our investment portfolio was also consistent at 13.9%.

Average earning assets for the period declined slightly, resulting in a 1% decline in our total interest income to $23 million for the quarter. Borrowing costs declined with lower average bank borrowings, given our equity issuance in the September quarter and debt placement. As a result, our net interest income rose 2.3% to $17.5 million for the quarter. Higher net interest income improved originations and advisory fee credits lifted the net investment income by 8.6% to $11.9 million or just over $0.27 per share. The net realized and unrealized gains in the portfolio for the period totaled $8.1 million, which lifted our ROE for the quarter to 19.4% and 14.9% for the last 12 months. With respect to the portfolio, our portfolio continues to perform well with senior debt representing 73% of the portfolio, and we ended the quarter with only one non-earning asset, representing $6.1 million of cost or 0.4% of assets at fair value.

We continue to prioritize our portfolio monitoring in areas where revenue headwinds compare to be most prevalent, which seem to be mostly consumer facing sectors, which is fortunately a small portion of our portfolio. Appreciation for the quarter of $8.1 million was led by the broad-based depreciation of our debt investments, which totaled $6.3 million, while the net appreciation of our equity co-investments contributed additional $1.6 million. And reflecting on our first quarter of fiscal 2024 performance and our near-term outlook, a few comments I’d like to leave you with. Last quarter’s deal activity certainly demonstrated the benefit of our incumbent position is supporting growth oriented businesses across a variety of industry sectors in an otherwise slow deal environment.

PE sponsors are dealing with extended hold periods and continuing to see ways to creatively grow or capitalize their investments and supporting performing businesses we know well is a low-risk way to grow our assets. That said, deal flow has improved, and we expect new originations to increase along with potential prepayment activity over the balance of the year as short-term interest rates are expected to decline and PE sponsors are expected to bring more — their more seasoned investments to market to generate liquidity events for their investors. We ended the quarter with a conservative leverage position at just 83% NAV and ample availability under bank line — our bank credit facilities. So we’re very well-positioned to grow our earning assets and fee income to continue to support our shareholder distributions over the balance of the year.

And now I’ll turn the call over to Nicole to review detail — the fund’s detailed financial results.

Nicole Schaltenbrand: Thanks, Bob. Good morning. During the September quarter, total interest income fell $300,000 or 1% to $23 million based on the small decline in average earning assets. The weighted average yield on the interest-bearing portfolio was consistent at 3.9%, and the investment portfolio weighted average balance declined to $658 million, which was down $11 million or 1.6% compared to the prior quarter. Other income declined by $300,000 and total investment income fell by $500,000 or 2.3% to $23.2 million for the quarter. Total expenses declined by $1.5 million quarter-over-quarter as net management fees declined $1.2 million with higher deal closing and advisory fee credits and $700,000 in lower financing costs from the reduction in average bank borrowings.

Net investment income for the quarter ended December 31st was $11.9 million, which was an increase of $900,000 compared to the prior quarter or $0.274 per share, which exceeded the $0.2475 per share dividends paid. The net increase in net assets resulting from operations was $20 million or $0.46 per share for the quarter ended December 31st as impacted by the realized and unrealized valuation depreciation covered by Bob earlier. Moving over to the balance sheet. As of December 31st, total assets rose to $767 million, consisting of $750 million in investments at fair value and $17 million in cash and other assets. Liabilities rose with net originations to $349 million as of December 31st, and consisted primarily of $253 million of senior notes.

And as of the end of the quarter, advances under our $234 million line of credit were $85 million. As of December 31, net assets rose to $418 million from the prior quarter end, with investment appreciation and undistributed earnings. NAV rose 2.3% from $9.39 per share as of September 30 to $9.61 per share as of December 31. Our leverage, as of the end of the quarter, with the asset growth — rose with the asset growth to 83% of net assets. Subsequent to December 31, we had a small $3 million prepayments of a syndicated second lien debt investment. With respect to distributions, our monthly distributions to common stockholders of $0.0825 per common share was announced for the month of January, February and March, which is an annual run rate of $0.99 per share.

The Board will meet in April to determine the monthly distribution to common stockholders for the following quarter. At the distribution rate for our common stock and with a common stock price at about $10.30 per share yesterday, distribution run rate is now producing a yield of about 9.6%. And now, I’ll turn it back to David to conclude.

David Gladstone: Thank you very much. Nicole, you did a great job, and so did Bob and Eric, and you all did a good job. So they’ve informed our stockholders and analysts that follow the company. So, with your report that you got the 10-Q filed yesterday to shareholders in this call that we’re making, it pretty much brought up to-date about everything going on. So in summary, it’s just another solid quarter. Sometimes that’s pretty boring, but it’s pretty nice when we have borrowing profitable quarters. They increased the net investment income by 8% over the prior quarter. That’s really good. That gives good coverage over the current common distributions. Strong portfolio performance and generating net portfolio appreciation increased the net asset value by 2.3% from the last quarter.

I love it when that goes up every quarter, and it helps us pay our dividend. For 2023, the whole Glad achieved returns on equity of 14.9%, which compares very favorably with the other business development companies in our peer group. The company is also very well positioned for the coming year as the portfolio is in good shape with modest leverage and very low non-performing assets and a strong balance sheet to support further growth. In summary, the company continues to stick with its strategy of investing in growth-oriented lower middle market businesses with good management teams. Many of these investments are supported by midsized private equity funds that are looking for experienced partners to support via acquisition and growth profile of that business, which they are invested in.

This gives us an opportunity to make an attractive investment paying loans to – on these paying loans that support our ongoing commitment to pay cash distributions. I’m going to stop now, and ask the operator to see if there’s anybody that has a question for the Group here today.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Kyle Joseph with Jefferies. Please proceed with your question.

Kyle Joseph: Hey, good morning. Thanks for taking my questions. Bob, just kind of want to get your thoughts in terms of where spreads have been going in the lower middle market. Obviously, we tracked public credit markets have been very strong. Obviously, your markets tend to be a little bit more insulated or lag, but just get a sense for spreads you’ve been seeing on new deals?

Bob Marcotte: Good morning, Kyle. Spreads really have not moved consistent with the overall yields. I would say, as we commented last quarter, there’s definitely a lot of capital upmarket from us. And in sponsor-oriented deals, where there’s reasonable size, we occasionally will see some pricing compression in the 50 basis point range. But for the most part, in our initial investments, which tend to be $10 million to $20 million and grow, we don’t, at this point, see that level of compression. Certainly, that leaves interest rates at a relatively high level. So, deal flow is not exactly as robust as we’d like, but we’re really not seeing much in the way of spread compression today. That’s just not where the market is right now. People are obviously expecting those rates to come down. But at this point, we’re not seeing that pricing compression.

Kyle Joseph: Got it. Very helpful. And then on credit performance, obviously, non-accruals were stable in the quarter, but just to get a sense for top line growth margins, EBITDA growth and how you’re — the companies continue to do well in the face of higher rates and ongoing inflation.

Bob Marcotte: Well, it’s obviously a mix. As I said, we definitely increased investments in some performing assets on the quarter, which was a big part of our fundings. And those higher performers are probably looking at 10% to 15% EBITDA lifts. There’s certainly some, where there’s a little bit more headwinds. If you look at the portfolio overall, EBITDA roughly was down slightly at low single-digits, 3% to 5%. There are definitely some sectors where there’s more challenge. Those challenges would be in places like consumer-facing business, anything in the restaurant business, anything in discretionary healthcare, certain sectors are more exposed in those cases. I will say that those tend to be – there are smaller sectors.

And where there is some level of headwinds, as I’ve said in the past, our second lien exposure, which is where it would be most impacted tends to be the larger credits. And on average, our leverage in our second lien portfolio is significantly below our average for the portfolio. Our second lien leverage average is something under three. So where we see headline pressure, it tends to be in the smaller credits where we control the credits as the senior lender. So, overall, I would say, we’re still modestly defensive on the consumer side of the businesses, expecting things to improve. But most of those cases, we are the senior lender and in pretty good shape to manage the underlying portfolio risk profile. The overall leverage for the portfolio still runs at just under four turns of EBITDA.

So we’ve got some cushion in those cases relative to enterprise value.

Kyle Joseph: Got it. Very helpful. Thanks for taking my questions.

David Gladstone: Thank you. Next question.

Operator: Thank you. [Operator Instructions] Our next question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.

Robert Dodd: Good morning, and congratulations on another excellent quarter. If I can Bob on the — can you give us some more color on the characteristics of the originations? I mean, you had $47 million, two existing portfolio companies. And I think those were quite chunky in general. I mean like Zupas was over $10 million — there are several others that were quite large. So I mean, can you give us any color, was that add-on acquisitions by those portfolio companies, recapitalization, anything else. It’s a handful of big add-ons rather than sometimes we see more – a large number of small ones. So any color you can give us about what the drivers were that the size of those follow-on?

Bob Marcotte: Well, the follow-on for the most part were somewhere in the $10 million to $12 million range. I think the big ones, Zupas went actually up and down. I mean we — the company is continuing to grow and expand. We had to bring in another lender since it was getting so large. And once we brought in the other lender, there were additional fundings that happened on the quarter. So it actually today is still below where we were in the prior quarter. There are two other credits that we were in. One was ALS went up and Leadpoint went up. In both of those cases, leverage had gotten very low. In fact, leverage was approaching well under two. And sponsors looking to take a distribution, looking to reposition and manage their extended whole periods were part of it.

One transaction decided not to sell with a very escalated valuation and our loan-to-value in that case is well under 30%. So most of those were probably positioning on the part of the sponsor. Those were the only notable ones. There were a couple of others that were in the couple of million dollar range. But it turns out that I think there was total six investments in the portfolio at that point of any consequence above $1 million that was represented most of the total dollars of those fundings. It just happens to be a case where strongly performing assets were — we were opportunistic in putting out additional capital to those companies. Nobody wants to take their company to market when the interest rates are where they are and some of the buyers are on the sidelines right now.

Robert Dodd: Got it, got it. Understood. I mean that goes on to the follow-on. I mean, you mentioned it in your prepared remarks as well, like deal flow is you’re improving, you’re expecting there’s going to be more activity later in the year. And you also position for portfolio growth over the rest of the year. What’s your comfort level that the portfolio is going to be up from here by year-end given you talk about maybe prepayment activity accelerates as well. I mean, can you give us some more thoughts on how you think the increase in prepayments, combined with increase in deal flow, how that’s going to work out to ballpark what your portfolio could look like at year-end up flat. Any color there?

David Gladstone: You know, pre-payment is probably the toughest thing to predict. I mean, at this point, there’s, probably two or three decent-sized investments that we see likely to prepay. And if those prepayments come in, it’s somewhere between $10 million to $25 million, maybe $30 million, the pace of growth originations we are visually going to be pressed to outpace that. I think in the past, we’ve generally targeted to grow somewhere in the range of $20 million to $25 million a quarter. So, if we’re seeing similar amounts of prepayments, it’s going to take two or three deal closings a quarter to get that number back up. That’s not unheard of in the market where we’re playing. When you’re dealing with Unitranches, in the range that we’re talking about, $20 million to $25 million deals are normal and two or three deals a quarter, is also fairly normal.

So, I think if you look back at our origination history when the deal market was running, doing 200 to 215 million in gross originations per year is certainly doable. So, I think putting on 25 net — 25 net conservative — is a conservative number for us to continue to grow the assets. Is that going to happen every quarter? I’m sure it’s not. But I will also say, we’re feeling pretty good where we are and given our current capital base. We tend to slot in above the SBICs, which cap out around $20 million for the most part. And we tend to slot in below the large-scale billion-dollar funds which really don’t want to put out anything less than $40 million. So, if it’s a zip code of $20 million to $40 million, we are in pretty good shape to be competitive on that profile.

And there’s obviously a few other guys that are out there, but that’s the size deal that we are, I think, pretty well-positioned to continue to originate. And the mix may change a little bit. I expect with rates coming down, we may look at a little bit more second lien paper, which will negate some of the compression in spreads likely to happen as rates come down. But for the most part, I think $25 million plus or minus in net asset growth a quarter is still a track racer that we’ve averaged and a track record, I would expect for the balance of 2024.

Robert Dodd: I appreciate that color. Thank you very much.

David Gladstone: Thank you. Next question.

Operator: Thank you. Our next question comes from the line of Mickey Schleien with Ladenburg Thalmann. Please proceed with your question.

Mickey Schleien: Good morning everyone. Bob, following the common share issuance in the September quarter, the balance sheet leverage has been running a little bit below your target level. Is that purposeful because of your view on the economy or something else? Or do you expect your leverage to climb towards your target level as you invest your liquidity?

David Gladstone: Good morning, Mickey. I think there’s, two factors there. One, we were flattered to have institutional buyers come into the stock in the volumes that they did. We’ve always had a long-term strategic objective to increase the institutional holding and the float in our shares, and when they showed up, we felt it appropriate to take that advantage. And you will note that our institutional share counts probably doubled as a result of that issuance. So, strategically, it was good for the investor base and the flow in the stock market for us, we took advantage of it. I think the second is, we wanted to be in a position where we were strong relative to our capital base. Bank market conditions were a little unsettled in the summer.

So we felt going long, and the equity gave us a little bit more strength in that viewpoint. Lastly, I would say, yes, we are going to increase our leverage as the spreads probably start to contract with interest rates coming down. We’re obviously, skewed very much towards the fixed cost of capital right now. Having a strong equity base will allow us to put on assets and optimize our capital structure, and allow us to continue to maintain the level of dividend coverage that we’re going to look for to try to continue to maintain the dividend level at or above where it is today. So, we’ll grow into that leverage level with higher assets over the course of the next 12 to 18 months.

Mickey Schleien: That’s very helpful. Thank you, Bob. That’s it for me this morning.

Bob Marcotte: Thank you.

David Gladstone: Next question?

Bob Marcotte: No.

Operator: Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I’ll turn the floor back to Mr. Gladstone for final comments.

David Gladstone: Okay. Thank you very much. I appreciate you all calling in. Wish we had a few more questions. We like it when you ask questions, but we’ll wait for next quarter to get some more questions. That’s the end of this conference call.

Operator: Thank you. This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation.