Gladstone Capital Q4 2023 Earnings Call Transcript

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November 14, 2023

There are 8 speakers on the call.

Operator

Greetings, and welcome to the Gladstone Capital Corporation Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Maxwell, Chief Executive Officer.

Operator

Please proceed, sir.

Speaker 1

Okay. Thank you very much. Latanya, this is, what, the 10th time we've talked with you on there. This This is David Gladstone, Chairman, and this is the earnings conference call for Gladstone Capital for the quarter end and also the Fiscal year end of September 30, 2023. Thank you all for calling in.

Speaker 1

We're always happy to talk with our shareholders and the analysts that Follow us and welcome an opportunity to provide

Speaker 2

updates with regards to the corporation.

Speaker 1

And now we'll hear from our General Counsel, Michael Kalsi will make a statement regarding certain forward looking statements. Michael?

Speaker 2

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. Certain 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 in the Forms 10 ks, 10 Q and other documents that we file with the SEC. You can find them on the Investors page of our website at gladstonecapital.com.

Speaker 2

While you're on there, you can also sign up for our e mail notification service. You'll find the documents on the SEC's website as well, 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. And just a reminder, today's call is an overview of our results, so we ask that you review our press release and Form 10 ks, Both issued yesterday for more detailed information. Again, go to the Investors page of our website to find them.

Speaker 2

Now, I'll turn the call over to Gladstone Capital's President, Bob Marcotte.

Speaker 3

Thank you, Michael. Good morning 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 commentary as we look forward into fiscal 2024. Before turning the call over to Nicole Schulte and Bren to review the details of our financial results for the period. So beginning with the last quarter results, originations last quarter below trend in total 27,000,000 to existing portfolio companies as we enter the quarter closely managing our overall leverage and with a cautious view on investment leverage levels in the face of Slowing price escalation and elevated interest rates.

Speaker 3

Prepayments have been modest this year. However, we did have one sizable prepayment from Oncor Dredging, which combined with the portfolio amortization, resulted in a $13,000,000 decline in our ending investment balance as of September 30. Short term SOFA rates increased 30 basis points on average over the quarter and were the primary reason the weighted Average yield on our investment portfolio rose to 13.8%. The average earning assets for the period also increased 3.7% and the 2 combined increased total interest income by 6.7% to $23,300,000 for the quarter. Borrowing costs rose slightly as average bank borrowings declined with the proceeds of the lower cost Glad V Baby Bond issuance in August.

Speaker 3

As a result, our net interest income rose $1,300,000 to $17,100,000 for the quarter. Deal closing and advisory fees fell with Originations and management fees rose by $1,500,000 given the reduced fee credits to $5,600,000 for the period. Despite the $2,100,000 decline in fee income and deal closing and advisory fee credits, net investment income came in at 11,000,000 or $0.28 a share for the quarter, which was down $700,000 from the prior quarter. The net realized and unrealized gains on the portfolio for the period totaled $2,100,000 which lifted our ROE for the quarter to 13.7% and 11.9% for the last 12 months. Consistent with our outlook for significant growth of private credit The lower middle market over the next couple of quarters, we elected to capitalize on significant investor demand into our common stock ATM program and issued 4,900,000 shares last quarter, which generated proceeds of $48,300,000 and increased our NAV to $409,000,000 or $9.39 per share.

Speaker 3

With respect to the portfolio, the portfolio continues to perform well With senior debt representing 73 percent of the portfolio and we ended the quarter with only 1 non earning asset representing $6,100,000 in cost or 0.4 percent of assets at fair value. We continue to prioritize Our portfolio monitoring in areas where revenue headwinds appear to be most prevalent, which seems to be mostly consumer facing sectors, which is a small portion of our overall investments. And thankfully, our couple of exposures to the auto segment were relatively unaffected by the recently settled strikes. Appreciation for the quarter of $2,100,000 was driven by the equity appreciation of our position in the manufacture of defense related electronics, which is partially offset by the depreciation of a handful of senior debt positions, most of which are private equity sponsored with significant underlying equity support. In reflecting on our 2023 performance and outlook for what is now our fiscal 'twenty four, there are Couple of comments I'd like to leave you with.

Speaker 3

While 2023 deal activity has been volatile, we've been able to grow our investment portfolio 10% to over $700,000,000 while still maintaining our focus on investing in growth oriented lower middle market companies and broadening our private equity network in the process. Today, our portfolio is comprised of over 50 companies And our core portfolio represents companies with an average EBITDA of approximately $11,700,000 We've maintained our underwriting rigor and are fortunate to have our Heavenly weighted senior secured loans with relatively low PIK and non earning assets. With the expectation of the continued growth opportunities Inside the portfolio and the growth of private credit market more broadly across the lower middle market, we've ended the quarter with a very conservative leverage position at just 74% of NAV and ample availability under bank credit facility. So we are very well positioned to grow our earning assets The primary driver of our net interest income growth and shareholder distributions in the coming year. And now I'll turn the call over to Nicole Schultenbrand, the CFO for Gladstone Capital will provide more details on the Fund's financial results for the quarter.

Speaker 4

Thanks, Bob. Good morning, everyone. During the September quarter, total interest income rose $1,500,000 or 6.7 percent to $23,300,000 based on the increase in short term rates an increase in earning assets. The weighted average yield on our interest bearing portfolio rose 30 basis points to 13.8 Percent with the increase in floating rates on the 89% of the investment portfolio that carries floating rates. The investment portfolio weighted average balance increased to $668,000,000 which is up $24,000,000 or 3.7 percent compared to the prior quarter.

Speaker 4

Other income declined $500,000 and total investment income rose $900,000 or 4.1 percent to $23,800,000 for the quarter. Total expenses increased by $1,600,000 quarter over quarter as net based management fees rose $1,700,000 with the reduced deal closing and advisory Net investment income for the quarter ended September 30 was $11,000,000 which was a decrease of $700,000 compared to the prior quarter for $0.28 per share, which exceeded the $0.265 per share dividends paid. The net increase in net assets resulting from operations was $13,100,000 or $0.33 per share for the quarter ended September 30, as impacted by the realized and unrealized valuation depreciation covered by Bob earlier. With respect to the full fiscal year, total investment income for 2023 was $86,400,000 which represented an increase of $23,300,000 or 37% over the prior year. The year over year increase is primarily due to the 21.2% increase in the weighted average principal balance of our interest bearing investment portfolio And the increase in the weighted average yield from 10.4% during the year ended September 2022 to 13.3% during the year ended 2023.

Speaker 4

Expenses increased $14,500,000 or 47.1 percent in 2023 as compared to the prior year. This increase was primarily due to a $7,900,000 increase in interest expense on borrowings and a $3,200,000 increase in the net incentive fee. Net investment income for the year ended September 30, 2023 was $41,000,000 an increase of $27,100,000 as compared to the prior year or $1.10 per share. The net increase in net assets resulting from operations was 42,700,000 or $1.14 per share for our fiscal year ended 2023 compared to $19,900,000 or $0.58 Per share for 2022. The current year increase was driven by net investment income and $12,700,000 in net realized gains, partially offset by $11,000,000 in net unrealized depreciation.

Speaker 4

Moving over to the balance sheet. As of September 30, total assets $311,000,000 and consisted primarily of $253,000,000 of senior notes, including the $57,000,000 of 7.75 Gladys Baby Bond due September of 2028, which we closed during the quarter. And advances under our $223,000,000 line of credit Declined to $48,000,000 as of the end of the quarter. As of September 30, net assets rose by $50,700,000 from the prior quarter end with the net proceeds from common share issuance under our ATM of $48,000,000 and our undistributed earnings. NAV rose From $9.27 per share at the end of the prior quarter to $9.39 per share as of September 30.

Speaker 4

Our leverage as of September 30 declined with the common stock issuance and debt reduction to 74% of net assets. And subsequent to September 30, we closed an $11,000,000 secured 1st lien debt and preferred equity investment in Quality Environmental. With respect to distribution, in October, our Board of Directors declared monthly distributions to common stockholders of $8.825 Per share per month for October, November December, which is an annual run rate of $0.99 per share. The The Board will meet again in January to determine the monthly distribution to common stockholders for the following quarter. At the current distribution run rate for our And with the common stock price at about $9.98 per share yesterday, the distribution run rate is now producing a yield of about 9.9%.

Speaker 4

And now I'll turn it back to David to conclude.

Speaker 1

Thank you, Nicole. Nice presentation. And Bob, not a good year. Michael did a nice job too presenting things that will help our analysts and stockholders Understand who we are and what we've been up to. In summary, it was another solid quarter and a solid fiscal year for Gladstone Capital.

Speaker 1

For the year, the company delivered some impressive results, 25% growth in average earning assets, 27% growth in net investment income, 11.9% return on equity And 22% increase in the common stock distribution rate, very nice numbers. While the fiscal year 2023 Results were good. The company also is very well positioned for the coming year as the portfolio is in good shape and Modest leverage and very low non performing assets has a strong balance sheet today to support further growth, and I think we'll get good growth for this new year fiscal year 2024. In summary, the company continues to stick with its strategy Investing in growth oriented low middle market lower middle market businesses with good management. Many of these investments are in support of midsized private equity funds that we have been friends with for many years, And they are looking for an experienced partner to support their acquisition and growth of that business, which they've invested in.

Speaker 1

This gives us an opportunity to make attractive interest paying loans to support our ongoing commitment to pay cash distributions to shareholders. We live to pay dividends, and I love that since I'm a shareholder. And I'm going to turn it back over to our The lady who is handling this, Latoya, and we'll get the operator to tell callers how they can ask for questions.

Operator

Thank you. We will now conduct a question and answer session. One moment while we poll for our first question. Our first question comes from Robert Dodd with Raymond James. Please proceed.

Speaker 5

Good morning and yes, congratulations on the quarter and a good year. Bob, can you give us I have some color about pipeline or anything like that. I mean, you sound very confident and Positioned the balance sheet to capitalize on some significant onboardings Of new deals potentially. So can you give us any color about, is that hopeful or is it Already showing up in the pipeline and the kind of deals given Q3 was pretty light obviously.

Speaker 3

Thank you for calling, Robert. I guess a couple of observations. We went through last quarter with almost $30,000,000 of core growth in existing portfolios. So we're finding our existing businesses that we feel good about are certainly in looking for solutions to continue to grow. I I would expect over the near term to see continue to see a significant investment on that front.

Speaker 3

Secondly, we've been very judicious in pursuing new activities. We've already closed 1 this quarter and there are definitely a few On the horizon, I will say, not all of those are necessarily private equity buyout situations. The Complexion of the marketplace today is, there are lenders and investors that are withdrawing from the market given the capital limitations The availability of capital more broadly. So we're finding businesses that The existing lenders are not able to step up and support the growth of the businesses as well as certainly some selective buyout activity. But at current marginal rates, there's no doubt that the overall volume of private equity buyout activity has come down a bit.

Speaker 3

So I think the idea of seeing flow and picking up from where we were in Q2 when we frankly took on no new assets Is part of why I'm relatively bullish. The unknown, Robert, is prepayments. Our portfolio continues to mature. We have roughly a little more than 50% of the portfolio With EBITDA north of $10,000,000 And so depending upon where interest rates are and how the liquidity returns to the market, We may see a pickup in prepayment activity, but that's a tough one to call at this point. I think our view is rates are staying high and The banks currently aren't aggressively pursuing refinancing activities.

Speaker 3

So we're seeing those assets probably stick around longer. A number of our portfolio companies have considered refinancings and been somewhat challenged based on the market reception. The last thing that I would also say is, consistent with that private equity market is Businesses are not selling and private equity is not necessarily raising a ton of new funds today. So a lot of portfolio companies and sponsors Are looking to extend the life of their investment horizon. So you're seeing a tremendous amount of continuation funding, Dividends and recapitalization activities because they can't necessarily sell the assets at the multiple they expected given the current interest rate environment.

Speaker 3

So Overall, we feel like the markets there, it's just slightly different pockets of activity. It's not all buyout activity. It's coming in a variety of different forms. And I think the idea of us Being able to put out an average of roughly $50 plus 1,000,000 a quarter, which is what we've been averaging for the most part On a normalized quarterly basis is the reason why we've created the capacity we have on the balance sheet. Just for round numbers, we'd need to put out another $100,000,000 in order for us to get to close to one to one leverage.

Speaker 3

That's currently what I would say is the target. And if we can do that over the course of the next 2 to 3 quarters, I think that's really the plan of why our balance sheet is currently as strong as it is.

Speaker 5

Thank you for that. That was really helpful color. Second one, if I can, on credit quality. I mean, to your point you earlier, but one on a call, the only thing the consumer You mentioned consumer headwinds in the consumer sector, but you don't have a lot of exposure. Any other areas Where maybe margins are moving the wrong way or anything like that where there's an emergence of perhaps Credit concerns or

Speaker 2

is it just the consumer right now?

Speaker 3

I will say we're going into year end. And in the past couple of years, year end has been a Market where some of the industrial companies, if we are in a metal bending, metal processing, Precision Manufacturing Business, their end customers will be large industrial manufacturers. Order visibility and order momentum is a little soft. Nobody wants to be stuck with year end inventory more than they otherwise would given the current rates and the current liquidity profile in the marketplace. So we're definitely seeing a tick down In some order flows for those, we tend to look at those as year end Related matters, it happened last year, it's happened in the prior years.

Speaker 3

I think at this point, the businesses are solid. They're not looking to source it overseas. They're not chasing alternative suppliers. This is not about pricing. This is about managing their order flows and maybe getting a little leaner.

Speaker 3

So Some of the metal processing industrial businesses, I think, are going to be down single digits in their revenue profile over Over the course of Q4, and we'll have to see what the beginning of Q1 next year looks like.

Speaker 5

Lovely, lovely. Helpful. And I mean, kind of following on to that, I mean, at this year end. I mean, have you had Pardon me, or you've gotten any feedback from portfolio companies about expected budgets for 2024 or maybe it's too early in that cycle. I mean, by the sound of it with the industrials, that's what you're hearing.

Speaker 5

Any other general Expectations, I mean, are people budgeting for a recession next year or just a more moderate economy?

Speaker 3

I don't think anybody is budgeting recession. For most of our businesses, it's about has the market moved, where do they need to be going, diversifying their underlying customers. As you may appreciate, when you started a lower middle market business, you tend to have a limited set of core customers that drive the business. And depending upon the selection of customers you've got or the diversity, there may be sectors that are not as robust. And so part of the challenge is broadening the horizon to grow the underlying business.

Speaker 3

At this point, I would say, I think people are cautiously optimistic. I think they know they're going to have to work harder. They know they're going to have to diversify more. They're going to have to broaden the funnel of deal opportunities to build on to 'twenty four volume, but we're still focusing on the core. Most domestic businesses are still reassuring.

Speaker 3

They are still looking for capable Lower middle market or middle market businesses that can support and be more flexible in their supply chain on fulfilling their production needs. And so, we don't feel like the market's moving away from us and it's certainly not about pricing. It's about diversity and stability of the customer base and we feel pretty good about this. It's not about Price for the most part, I was down visiting one of our smaller companies in the electronic Because people don't want to be dealing with foreign suppliers and It's created a resurgence in flexibility for those folks that are capable and responsive to their underlying customers. So At this point, it's not a recession horizon.

Speaker 3

It's about continuing to continuously improve the business And diversify the businesses that we're most focused on.

Speaker 5

Got it. Thank you very much.

Speaker 1

Thanks for calling in. Okay, Latanya.

Operator

Our next question comes from Mickey Schleien with Ladenburg. Please proceed.

Speaker 6

Yes. Good morning, everyone. Bob, I realize these are not particularly large investments, but I wanted to ask you about the prospects for DKI Ventures And eighth Avenue Food, just asking in relation to their valuation.

Speaker 3

Taking the reverse order, 8th Avenue Food is a large syndicated position in a bio business That is in the grain and commodity processing. It is Affiliated with what used to be the old Post Foods. It had a tough couple quarters, but it has consolidated its manufacturing and is reasonably solid In the foodservice business, as a second lien loan in this marketplace, things don't trade very well. And I think that one's probably trading at a relatively low point compared to its enterprise value. Frankly, I'm not terribly worried by that.

Speaker 3

That is actually a position that is owned by Apollo and they have Have significant capital invested in that business. So foodservice tends to go through some cycles But it tends to have a long term horizon to grow. That's one that don't really spend a ton of time on. I'll give you a little color on that one. In terms of DKI, DKI is a It's an environmental kind of a restoration company, kind of like a Balfour type of business, where it deals with Events such as flood, storm damage, fire, restoration type of obligations, The business has gone through a bit of a transition.

Speaker 3

It used to be a franchise business with local operations. It that franchise platform has Morphed to a services more of a TSP platform. They've recently hired some additional resources to expand and grow It's a network of property owners and managers that they service. The business has a core Supply GPO underlying it, which also produces a fair bit of profitability. Because of the current Events, whether it's climate change or otherwise, we seem to have plenty of occasions for that kind of support.

Speaker 3

And then given what's going on in the property market, we see large property managers desperately in need of a consolidated outsource Provider to service those particular incidents when they arise in their managed properties. So the underlying performance of the business has probably trailed what I think is the broader marketplace. We've repurposed the marketing side of the business and feel like it's in pretty good shape. And the underlying sponsors in this case And the founders of the business are continuing to fund money into the business to support the transition that's ongoing. So It's a business we are working hard on, but we think the long term fundamentals supporting the business The equity ownership is supportive of the business and feel like it's a small business that has a reason to continue to grow and come out of the situation it's in.

Speaker 6

Bob, just a follow-up to that explanation. Does Quality Environmental, the new investment you made, operate in the same space?

Speaker 3

It actually does not. Quality Environmental is an asbestos abatement firm focusing on certain segments of the healthcare and In the educational sectors. So it's more about curing environmental problems that exist, not fixing problems that have Heard, unfortunately.

Speaker 6

I understand. Those are all my questions. Appreciate your time. Thank you.

Speaker 3

Thanks for calling in Mickey.

Operator

Our next question comes from Kyle Joseph with Jefferies. Please proceed.

Speaker 7

Yes. Hey, Bob. Good morning. Thanks for taking my questions. Just wanted to pick your brain.

Speaker 7

Obviously, the portfolio is seeing some good yield expansion on rates, Kind of give us a sense for what Spread's been doing and the outlook for yield into 'twenty four given the forward curve?

Speaker 3

Thanks. Rates are a tough one, Kyle. Thanks for the question there. When you look at current market, the sulfur 7 type pricing puts Put rate at 12 low 12s. That starts to sound like traditional mezz or subordinated debt.

Speaker 3

And what's happening is there's a little bit of a convergence and blurring of the categories. If it is a good Solid business, you'll get you'll tend to get a little bit more pricing compression and we've seen Good sized businesses attract large capital sources and maybe that what might have been in the high 6s And the spread over SOFR can be bid down to maybe 6 over. So there's been about 50 plus basis points of compression For the better credits, and so they're clearing probably closer to the in the 11s As opposed to other places where it might have been a recapitalization and it might have been a slightly wider. So I think what's happening today As buyouts of good credits, good companies are getting a little bit more aggressive if they're upsize. And so what we're finding is, we wouldn't expect spreads to widen from where they are today.

Speaker 3

In fact, I probably suspect they will start to contract slightly, and we'll see less of that in the lower middle market. It's the large funds where they've got capital on the balance sheet that they need to be put to work, Where we're seeing the most amount of price compression, and that's not the average for us. What we're seeing is for us is It's still in the SOFR7 range for us. So I would not expect that compression to hit us. Some of our larger credits, we do have a fair number that I said average over 10.

Speaker 3

We may see some compression, but we'll see significant upsides in those situations. So if somebody if one of our credits happens to be very Because of growth, if we want to recapitalize that business or fund an acquisition, we may see that compression Come through slightly, but we'll get the upside associated with the additional volume. So in the lower middle market, I think you're going to see Slight compression in the larger credits. I think we're seeing at least 50 basis points in tightening, just because of competition.

Speaker 7

Got it. Very helpful. Thanks for taking my questions.

Speaker 1

Do you have any additional questions?

Operator

Mr. Gladstone, there are no further questions at this time. I'd like to turn it back to you for closing comments.

Speaker 1

Okay. Well, thank you all for calling in. We certainly appreciate those Questions from the analysts. They help us continue to go forward and explain where we are and what we're doing. We'll stop for now.

Speaker 1

We'll see you again next quarter. That's the end of this call. Thank you.

Operator

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

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Key Takeaways

  • Gladstone’s Q4 weighted average yield rose 30 bps to 13.8%, driving a 6.7% increase in interest income to $23.3 M and net interest income up $1.3 M to $17.1 M.
  • Originations totaled $27 M in Q4 as the company managed leverage amid slower price escalation and elevated rates, with portfolio amortization and a large prepayment reducing the ending investment balance by $13 M and keeping non-earning assets at only 0.4%.
  • The company issued 4.9 M new shares through its ATM program, raising $48.3 M, which boosted NAV to $9.39 per share while reducing leverage to 74% of NAV.
  • For fiscal 2023, Gladstone grew its interest-bearing portfolio by 21%, lifted total investment income by 37% to $86.4 M, and delivered net investment income of $41 M ($1.10/share), achieving an 11.9% ROE and raising its common dividend rate by 22%.
  • With senior debt at 73% of the portfolio, minimal non-performing loans, and ample undrawn bank credit, the company enters fiscal 2024 with a conservative leverage profile and capacity to capitalize on private credit growth opportunities.
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Earnings Conference Call
Gladstone Capital Q4 2023
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