Q2 2024 Gladstone Capital Corp Earnings Call

Participants

David Gladstone; Chairman of the Board, Chief Executive Officer; Gladstone Investment Corp

Michael Licalsi; General Counsel, Secretary; Gladstone Capital Corp

Robert Marcotte; President; Gladstone Capital Corp

Nicole Schaltenbrand; Chief Financial Officer, Treasurer; Gladstone Capital Corp

Mickey Schleien; Analyst; Ladenburg Thalmann & Co Inc

Sean Adams; Analyst; Raymond James Financial Inc

Presentation

Operator

Greetings, and welcome to the Gladstone Capital Corporation second quarter earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. David Gladstone, Chief Executive Officer. Thank you, sir, you may begin.

David Gladstone

Thank you, Latoya. That was a nice introduction and hello everybody. This is David Gladstone, Chairman, and this is the earnings conference call for Gladstone Capital for the quarter ending March 31st, 2024. Thank you all for calling in. We're always happy to talk with our shareholders and analysts and welcome the opportunity to provide updates to the company. I hope we have some good questions today, but we're going to start off first with our General Counsel, Michael McQuigg. He's going to make a few statements regarding forward looking statements. Michael?

Michael Licalsi

Thanks, Dave, and good morning. Everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and Securities Exchange Act of 1934, including those regarding our future performance that these forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable 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 our Forms 10-Q, 10-K and other documents that we file with the SEC, and you can find them on our investors page of our website, gladstonecapital.com.
And while you're on there, you can also sign up for our e-mail notification service can also find the documents on the SEC's website, which is w.w.w.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 that today's call is simply 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, you can find them on the investors page of our website.
With that, I'll turn the call over to Gladstone Capital's President, Bob Marcotte.

Robert Marcotte

Thank you, Michael. Good morning and thank you all for dialing in this morning. I'll cover the highlights for last quarter before turning the call over to Nicole to review the details of our financial results for the period. So beginning with our last quarter results fundings last quarter were modest at $45 million given the traditionally slow first quarter and limited new deal buyout activity in the market. And like recent quarters, about two thirds of the fundings were add-ons to the existing portfolio investments.
Pre-payments and amortization totaled $15 million. So net originations were $30 million for the period, so for rates were unchanged. So the weighted average yield on our investment portfolio was largely unchanged at 14%. However, average earning assets for the period rose 3.5%, resulting in a 3% increase in our total interest income to $23.7 million for the quarter.
The combination of increased interest costs from higher average bank borrowings and an increase in non earning assets offset the increase in earning assets and net interest was unchanged at $17.5 million for the quarter. Management fees rose five to $5.7 million in the absence of new deal advisory fee credits and net investment income declined by 9.7% to 10.8 million. However, net realized gains rose to $2.2 million and the combination totaled $0.298 per share or 120% of dividends for the period.
In the aggregate, net realized and unrealized gains on the portfolio totaled $12.9 million, which lifted our ROE for the quarter to 22.3% and 17% for the last 12 months.
With respect to the portfolio. Our portfolio continues to perform well, with senior debt representing 71% of the portfolio. And we ended the quarter with two non-earning debt investments, which represent $20.4 million at cost or 1.8% of assets at fair value. Depreciation for the quarter of $12.9 million was led by the appreciation of five equity positions driven by strong underlying operating performance or preferred share liquidation preference amounts and a $1.9 million realized gain related to residual interest associated with the sale of a former investments.
Regarding our near term outlook, I'd like to leave you with a couple of comments. We continue to benefit from our incumbent position, supporting growth oriented businesses across a variety of industry sectors and with PE. sponsors facing extended investment hold periods. If they have not hired a banker to sell, they are continuing to seek ways to creatively grow and recapitalize their investments and supporting these performing businesses.
We know well is a low risk way to grow our assets. The syndicated loan market for larger, well-established credits improved significantly last quarter, which has led to some spread compression for these companies, which we expect will trigger an uptick in prepayment activity for some of our larger positions over the balance of the year. We ended the quarter with conservative leverage position at just below 89% of Nav and ample availability under our bank credit facility. So we're well positioned to grow our earning assets and fee income to continue to support our shareholder distributions in the coming year.
I'd now like to turn the call over to Nicole Schaltenbrand, the CFO of Gladstone Capital to provide some more details regarding the Fund's financial performance for the quarter.

Nicole Schaltenbrand

Thanks, Bob. Good morning, everyone. During the March quarter, total interest income rose $700,000 or 3% to $23.7 million. With the increase in average earning assets. The weighted average yield on our interest-bearing portfolio was largely unchanged at 14. The investment portfolio weighted average balance increased to $680 million, which was up $23 million or 3.5% compared to the prior quarter.
Other income was $300,000 in total investment income rose $800,000 or 3.3% to $24 million for the quarter. Total expenses rose by $1.9 million as net management fees rose $1 million with lower new deal closing and advisory fee credits and a $700,000 increase in interest expenses from higher bank borrowings.
Net investment income for the quarter was $10.8 million, which was a decline of $1.2 million compared to the prior quarter or $0.2475 per share. The net increase in net assets resulting from operations was $23.6 million or $0.54 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 $812 million, consisting of $792 million in investments at fair value and $20 million in cash and other asset. Liabilities rose of net originations to $380 million as of March 31st and consisted primarily of $254 million senior note and as of the end of the quarter, advances under our $244 million. Credit facility were $117 million.
As of March 31, net assets rose to $431 million from the prior quarter end with investment appreciation. Nevro's three platform from $9.15 per share as of December 31 to $9.90 per share as of March 31. And subsequent to March 31. And I think most of you are aware, we executed a one for two reverse stock split in our shares of common stock. And as a result, the approximate nag per share is $19.80, and the ongoing monthly distributions doubled to $0.165 per share per month.
Additionally, after the end of the quarter, we invested $7.3 million in a new proprietary investments, including senior debt and preferred equity. We also received the payoff of our second lien debt investment and giving home health, which included prepayment penalties of 900,000 and a distribution on our warrant position of $2.5 million. We also received the payoff of our second lien debt investment in gray matter systems, which included prepayment fees of $200,000.
With respect to distributions, our monthly distributions to common shareholders of $0.165 per common share were announced through the months of April, May and June, which is an annual run rate of $1.98 per share. The Board will meet in July to determine the monthly distribution to common stockholders for the following quarter at the current distribution rate for our common stock, the common stock price at about $21.77 per share yesterday, the distribution run rate is now producing a yield of about 9.1%.
And now I'll turn it back to David to conclude.

David Gladstone

Thank you. And you did a great job, Nicole and Bob earnings for that quarter. And Michael, you did a great job too in leading our stockholders know, and the analysts know that they're following our company and all of our recent performance highlights to me would be the Company continues to scale its investment portfolio and handbook clips. Now that $800 million last quarter, which is up over 37% in the past two years, while maintaining the lower middle market focus.
It's a different discipline than others might see, but this is a good yield for this kind of a company with such a good track record. While we saw a small uptick in the nonperforming assets, the investment team is on top of the situation and otherwise portfolio continues to perform well and they supported significant net portfolio appreciation again this quarter, which lifted net asset values, my share of 6.8% and between the higher rates in the portfolio performance.
Glad has achieved a return on investment of about 17% for the past year, which puts the Company in the top end of all the business development company peers that we compare ourselves to.
In summary, the company continues to be well positioned as a portfolio in good shape and strong balance sheet. And I think that will support us well for further growth, and hopefully the growth orientation will increase our dividends as well. Many of these investments are in support of midsized private equity funds that are looking for experienced partners to support their acquisition and growth of their businesses in which they have invested pretty substantial amount of equity.
This gives us an opportunity to make attractive interest paying loans to support our ongoing commitment to pay cash distributions to our shareholders. So now, Latoya, if you'll come on, we'll I get some good questions from the people that are called end of day. Latoya?

Question and Answer Session

Operator

(Operator Instructions) Mickey Schleien, Ladenburg.

Mickey Schleien

Yes, good morning, everyone. And Bob, according to LSEG. lower middle market, spreads have contracted about 50 basis points over the last year, but they're still above pre-COVID levels. So when you talk about the supply and demand for lower middle market capital and the health of the economy, what's your view and the outlook for loan spreads in your business?

Robert Marcotte

Good morning, Mickey. I think that indication of where the spread compression is coincides with what we're seeing. Obviously, that's a much lesser level than what is happening at the upper middle market from realm where frankly, you have broadly syndicated loans in the CLO market, red hot and driving spreads down. That doesn't generally apply to credits where deals started under $10 million of EBITDA.
You have to remember that most of our portfolio companies start under tenant EBITDA and grow over time. And it's only when they get to larger scale that we see that price compression. So we're expecting some in line in the range of what you're outlining. But just to give you an example, the prepayment that we just disclosed in our subsequent events was a very large credit that we were opportunistically invested in several years ago. And the Company's EBITDA was in the range of north of $100 million. Just for indicate purposes.
And when it went it, we repriced it priced at levels that just don't make sense for us. So we let that pay off now and going forward, we'll continue to focus in our market where we can think there's enough competition is less and the scale does not warrant the kind of price compression that that you're alluding to.

Mickey Schleien

I appreciate that. Thanks. Thanks for that explanation. But I realize they're relatively small investments, but could you give us a quick update on the outlook for DKI and BNTDKI?

Robert Marcotte

DKI is a restoration type business. It's a business that there's obviously a wide swath of players in that marketplace. And we're talking about storms, fires, some events like that, which obviously continue to happen fairly regularly. The business has been in transition going from a , a franchise oriented business to more of a TPA type of business that's required the business to alter some of its marketing and retool some of its cost structure. And it's in that it's in that process. We are we are working with the team to tried to expedite the matter.
And if we can't find a way to organically grow it, there's enough of there's enough players in the marketplace that we believe that there's a strategic exit alternatives that we would pursue. In the case of the case of B. and T. It's largely a engineering platform that has some unique advantages it's extremely experienced in the wireless engineering business. Unfortunately, there's only a couple of major players in that business that drive most of the revenues. It has the capabilities to outsource to offshore sources, which are more cost-effective to support some of that engineering capability.
The problem is in a business like that. And the CapEx cycles are very difficult to predict when networks get upgraded when cell sites and things get altered and when they spend money on spectrum, it can be up and down. We are going into a new cycle of spend in the telecommunications realm. We still have some 5G spend that's going on. And you have people like T-Mobile and Verizon spending on additional wireless capacity as an alternative on Internet service our offering.
And you also have a significant amount and they do this as part of their business, significant amount of broadband. It's money coming out of the Infrastructure Act, the administration signed into law. It's taken a few years to ultimately get it aligned and get it beginning to be deployed.
But I think if you look at this quarter, the amount of money per year. That's going to be put to move broadband to the rural markets as increased. It's almost doubled. I think the numbers that I've seen are somewhere between $8 billion and $10 billion per year are going to be spent extending other broadband services more broadly across the US. So we are beginning to see the relief of those amounts, and we're hopeful that that will be part of what will lift the engineering services that B&T provide.

Mickey Schleien

Yes, I understand, Tim. Thanks for that. That's really useful. Just a couple of housekeeping questions sort of trying to gauge the portfolio's risk and can you give us a sense of the current average EBITDA debt to EBITDA and cash interest coverage ratios?

Robert Marcotte

I think we cover the gamut, as I have alluded to in the past, in terms of overall EBITDA, EBITDA can generally start as low as $2 million to $3 million and Inrange upwards to $150 million of EBITDA. So an average is pretty distortive on a I think a simple average there just wouldn't be reflective and the vast majority of our credits start in sub $10 million of EBITDA and grow and grow from there.
In terms of overall leverage, I think the overall leverage profile is in the roughly four X range I think that's consistent where we were before. And interesting, there's probably a bit of a barbell, the businesses that have grown that we've been making additional investments in and are of size tend to be slightly lower leverage than early-stage credits where they're still in a growth mode and they tend to be slightly higher leverage.
But it's a it's still in the range of roughly four turns of debt to EBITDA. And for the most part that supports the kind of interest coverage that we typically would covenants. We generally had deals with at least two and mostly three covenants in the transactions. And most of those would require debt service coverage in the range of $110 million to $120 million.

Mickey Schleien

I understand those are all my questions. Thanks for your time this morning.

Robert Marcotte

Thanks for calling in and making next question.

Operator

Sean Paul Adams, Raymond James.

Sean Adams

Morning, guys. Could you add a little bit more color on the new nonaccrual WPX? It looks like it's only been on the books for about three years. So I'm wondering if there was any residual impact from the fires as well as providing a little bit more color on the origination outlook for the rest of the year?

Robert Marcotte

XL was one of the few credits that we some we have a little bit more consumer oriented exposure than I would normally expect in the portfolio of XL, if you don't know, is a premium brand in the wet suit market. The business was doing fairly well and we probably were a little bit more often optimistic about where it stood. Covid certainly lifted and the luxury and athletic activities that were going on in the marketplace and the and it was fairly robust.
And post COVID retail channels were reasonably full from the seasonality of those kind of offerings, combined with some consumer oriented pullback was more severe. And as a result, we put it on nonaccrual. The Company is in the throes of a a new line launch, which is lined up and expected to occur as the mid summer timeframe.
And I can say that we are very optimistic that the fall bookings are at a multiple of what they were last year. So we are we're positioned to restart it. But it was a little bit of a hangover situation between COVID, retail channels, consumer and a refresh on the brand that we are we are working through at the moment and we have stepped in with a more significant involvement and we've recruited external expertise to assist us in repositioning and taking advantage of the opportunity.
This is a global business. It is selling US selling international and so on sales, there's a lot of opportunity to go get in that business. And I think we've brought in some resources to help us with that process.
Picking up on the originations for the back half of the year. That's the challenge for us. I will say that we are, as I mentioned, expecting an uptick in prepayment activities and we are very much focused on it sifting through and finding good growth opportunities to redeploy that capital. I will say that once the business has grown and it's got $20 million, $30 million, $40 million of EBITDA on sales, our exposure tends to be a little higher.
And so when we restart the process and bring in earlier stage younger businesses in the lower middle market, the initial exposures tend to be smaller and it will take a period of time for those to grow and mature into credits of comparable size. So we are planting seeds today. I think the deal that we referenced that has been closed is a nice transaction that is intended to be a a rollup or a ad on our platform.
That is interestingly in the elevator repair business, it's a fragmented market that there are plenty of opportunities to grow, and those are the kind of situations we're currently working on to expand. So I think we will continue to see add-ons to some of the younger companies in the portfolio, and we'll continue to see opportunities at the lower end of the middle market where we'll see that come.
In terms of overall, I think the challenge will be to drive net growth over the course of the balance of the year.
I think given what could be, you know, $150 million-plus of pre-payments plus or minus if we can originate and stay ahead of that curve. I think that's a that's what we're currently we're currently kind of shooting for, but it's not going to be a ton of net asset growth, given what we're expecting to be refinancing activity because we're going to maintain our yield discipline and we can certainly scale up.
But our cost structure or returns. Just it doesn't make sense for us to do that. I don't know if that helps.

Sean Adams

Incredibly helpful. Thank you for the color. I really appreciate it.

David Gladstone

We have another question?

Operator

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

David Gladstone

Our shocks, we want to have more questions. So you guys are not working very hard. So we're not getting enough questions. We want to get some more questions. Of course, we don't have a lot of problems in the portfolio so I guess we're not going to get many questions at the end of this conference call, and we thank you all for calling and see you next quarter.

Operator

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