Gladstone Capital Corp (GLAD) 2022 Q2 法說會逐字稿

Greetings, and welcome to Gladstone Capital's Second Quarter Earnings Conference Call. (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, Chief Executive Officer. Please go ahead, sir.

Thank you, Peter, and hello, everybody. This is David Gladstone, Chairman. And this is the earnings conference call for Gladstone Capital for the quarter ending March 31, 2022. Thank you all for calling in. We're always happy to talk to our shareholders and analysts and welcome the opportunity to provide an update on the company. Now we hear first from our General Counsel, Michael LiCalsi, who will make a statement regarding certain forward-looking statements. Mike, go ahead.

Thanks, David, and 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 risk factors in our Forms 10-Q, 10-K and other documents we file with the SEC. You can find them on the Investors page of our website, www.gladstonecapital.com. Could also sign up for e-mail notification service there. You'll also find the documents on the SEC's website, which is 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. And 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, you can find them on the Investors page of our website.

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

Thank you, Michael. Good morning all, and thank you all for dialing in this morning. I'll cover a couple of highlights for the last quarter and provide some comments on the state of the portfolio and the market outlook before turning the call over to Nicole Schaltenbrand, Gladstone Capital's 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 were below our historical run rate; however, that is not unusual for the first quarter of the year, especially after such a robust fourth quarter and generally appear consistent with the broader market activity levels. For the period, originations came in at $11 million, which included a couple of small add-on investments to existing portfolio companies.

Exits and repayments for the period, however, came in at a total of $51 million. So net originations were a negative $40 million for the period. However, investments, which closed after the end of the quarter, made up much of this runoff, which I'll cover later. Just over half of the exits for the period was the repayment at par, the large senior loan to NetFortris, a middle-market telecommunication services business. This exit was anticipated and in addition to generating $3.2 million of success fee income for the period and reducing our PIK interest exposure going forward.

We retained a small residual interest in the acquirer. Interest income for the quarter rose slightly to $13 million as the average outstandings and weighted average loan yields were largely unchanged. Other income increased to $4.3 million for the period, which was up $1 million over the last quarter with the NetFortris proceeds, and supported the 7% increase in total investment income to $17.3 million. As you may note, fee income has been very strong for the past couple of quarters, which we would expect to moderate on the future quarters.

Borrowing costs were unchanged and administrative costs also largely unchanged. However, net management fees rose by $1.7 million to $4.3 million as the new deal closing fees remitted to the management company and credited against the base management fees declined materially compared to the December quarter. While the increase in total expenses outpaced the higher investment income, net investment income came in at a strong $8.7 million or just over $0.25 per share or 130% of the distributions for the period.

Net of a small net unrealized portfolio depreciation, the higher NII also contributed to a $0.05 per share increase in NAV to $9.49 per share as of March 31. Despite our modest leverage, we're pleased to report our cumulative return on equity since December 2019 before the onset of COVID is now at 18.9%, and we believe compares favorably to our peers.

With respect to the portfolio, our portfolio continues to perform well. We did not experience any payment defaults last quarter. That said, we do expect the pending interest rate increases and potential economic headwinds may impact certain businesses within the portfolio, and we will continue to proactively engage each of our investments to anticipate the challenges and limit any negative impact. In addition to the NetFortris exit, improving operating performance at several energy-related businesses supported the reduction in the depreciation of these investments and the bulk of the unrealized depreciation for the period.

The largest contributors to the unrealized depreciation for the quarter were a couple of equity positions in modestly leveraged business -- businesses, which experienced isolated revenue shortfalls, and we expect to recover over the balance of 2022. As of the end of the quarter, the asset mix continued to shift in favor of first lien loans, which rose to 70% of assets at fair market value.

Looking over the balance of fiscal '22, there are a couple of comments I'd like to leave you with. We funded 2 new proprietary investments totaling $26.4 million since the end of the quarter and anticipate several others to close in the near term. In addition, we expect near-term prepayment activities to decline with none realized yet this quarter, supporting higher net originations and portfolio growth going forward.

We're well positioned to benefit from the impending increase in short-term rates, given 90% of our investment portfolio are subject to floating rates, and over 90% of our debt is at fixed rates. With LIBOR expected to rise above the average LIBOR floor in the portfolio this quarter. And as outlined on Page 60 of our 10-Q, we are anticipating net interest income to increase by approximately $5.2 million per year or $0.15 per share for a -- should LIBOR rise 200 basis points over the 45 basis points applicable as of March 31.

Since our last call, I'm sure you've all noted the announcement of the increase in our annual dividend to $0.81 per share per year. And while the increase is well supported by recent earnings results, we will continue to assess the outlook for portfolio growth and net interest income increases to sustain any future increases to the shareholder distributions.

And now I'd like to turn the call over to Nicole Schaltenbrand, the CFO for Gladstone Capital, to provide some additional details on the fund's -- financial results for the quarter and the call. Nicole?

Thanks, bob. Good morning all. During the March quarter, total interest income rose $100,000 or 1% to $13 million. The investment portfolio weighted average balance increased by $20 million or 4% to $514 million compared to the prior quarter. The weighted average yield on our interest-bearing portfolio declined slightly by 10 basis points to 10.2%. Other income rose at $1 million to $4.3 million, drove a 7% increase in total investment income to $17.3 million for the quarter. Total expenses rose by $1.6 million quarter-over-quarter, driven by an increase in net management fees associated with the decline in new deal origination fee credits this quarter. Net investment income for the March 31 quarter was $8.7 million, which was a decline of $500,000 compared to the prior quarter or $0.25 per share and covered 130% of shareholder distribution.

The net increase in net assets resulting from operations was $8.3 million or $0.24 per share for the quarter ended March 31 compared to $12.1 million or $0.35 per share for the prior quarter. The current quarter increase is driven by the increase in earnings and small net unrealized portfolio depreciation covered by Bob earlier. Moving over to the balance sheet. As of March 31, 2022, total assets declined by $548 million, consisting of $538 million in investments at fair value and $10 million in cash and other assets. Liabilities declined to $223 million as of the end of the quarter and consisted primarily of $150 million of 5 1/8 senior notes due 2026, $50 million of 5 3/4 senior notes due May of 2027. And as of the end of the quarter, advances under our line of credit were only $17.4 million.

As of March 31, net assets rose by $1.6 million from prior quarter with the net earnings in excess of distribution. NAV rose from $9.44 per share at December 31, $9.49 per share as of March 31. Our leverage as of the end of the quarter declined slightly with a decrease in total assets and currently stands at 68% of net assets. At quarter end, we had an excess of $130 million in current borrowing availability under our line of credit, the revolving period of which ends in October of 2023.

With respect to distribution, we have remained committed to paying our stockholders with cash distribution. And in April, our Board of Directors declared monthly distributions to our common stockholders of $0.0675 per common share per month for April, May and June, which is an annual rate of $0.81 per share. The Board will meet again in July to determine the monthly distribution for the following quarter.

At the current distribution rate for our common stock and with a common stock price at about $11.80 per share yesterday, the distribution run rate is now producing a yield of about 6.9%. Distributions in addition to the NAV growth over the past year of $1.38 per share have resulted in a total return of $2.16 per share or 27% over the past year.

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

All right. Thank you. Very nice presentation, Nicole and Bob. Good work. And Michael, same to you. It's great job as always. Company closed $11 million in add-on investments to support the growth and diversification of the businesses, while at the same time, rebuilding the pipeline of investment opportunities, which yield about $26 million in new investments closed.

But after the end of the quarter, the company successfully exited one of the largest investment positions which generated a nice income lift for the quarter, an attractive overall return of approximately 16% for the 5-year investment period. So very nice deal. I hate to see it go, but we cashed it in. The company earnings over the past couple of quarters has clearly outpaced the common dividend based on the team's outlook to sustain an asset level and the interest income. We're pleased to lift the dividend, as Bob mentioned, $0.81 per share, now going at $0.0675 per share, and we began that in April.

So the company is on a good strong run rate now and continues to invest in growth-oriented middle market businesses with good management. And many of these investments are supported by midsized private equity funds that are always looking for an experienced partner to support the acquisition and growth of the business they're investing in.

This gives us the opportunity to make attractive investments. And these investments are interest-paying loans and they support the ongoing commitment to pay cash distributions to our shareholders. In summary, it's a good quarter. Looking forward to some more good quarters and months.

I'll now ask the operator come on, please, and tell people how they can ask a question.

(Operator Instructions) Our first question is from Robert Dodd with Raymond James.

Congratulations on another excellent quarter. In terms of restocking the outlook if we can. I mean, obviously, NetFortris this quarter, an excellent exit with a very large success fee. You've had a number of those over the last, call it, 18 months. What are the structures -- are you confident that the structures you're seeing in the market to date than your originations or what's in the portfolio can produce the same kind of levels of success fee or total economic return. It doesn't matter if it's success fee per se. As you've seen over the last kind of 18 months going, is that basically sustainable going forward?

Thanks for the question, Robert. My -- the structure of the NetFortris situation included a fairly healthy amount of PIK or success income as the company was growing. So it was a little bit unusual. So I would not expect that in the norm. However, if you look back, most of the other overall returns that you're referencing were largely associated with small equity co-investments that we made in certain of our businesses. I think that, that strategy continues to be intact. As I mentioned on my commentary, we have a number of equity co-investments in small growth-oriented businesses.

We tend to go into them at modest levels of enterprise value and through our credit facilities and the business strategies, those companies tend to grow. And as they get closer to $10 million or more than $10 million of EBITDA, there's a natural lift that comes from the scale of the underlying business. We have a number of those situations that we have been percolating and supporting. So we are happy to continue to invest, and even in this quarter, added some investments to existing portfolio companies. So the combination of the equity, investments, funding the continued growth and the scaling of those businesses we feel are positive.

I do think that the timing may be somewhat erratic because certainly, in an upward rate environment, you may have less market buoyancy to support the sale of those companies. It's been a pretty good run over the course of 2022. But we still feel that our selectivity and the opportunities that we've seeded in the co-investment side of our business are still going to produce above-average returns.

So a long-winded way of saying, we've got some in the kitty that we're going to continue to expect to manage and monetize on a go-forward basis. And certainly, we're not -- we're looking forward to and anticipating some of the interest rate income increases given our position in floating rate assets and fixed liabilities in the interim to support some of that return escalation as well.

I appreciate that very detailed response. I mean one of the things you mentioned there was obviously upward rate environment. You mentioned in your prepared remarks that there are -- the rate environment, the economic environment could hurt some businesses potentially within your portfolio. How big a segment of the portfolio do you have elevated concerns or concerns about, is it 5%, 2%, 10%? And are there any particular industries that you think are particularly vulnerable in the current economic volatility in rising rates and inflationary environment.

Well, I think there's probably 2 general sectors that I would be concerned about, but not necessarily a meaningful percentage of our portfolio. The 2 that I would point to is some of the basic commodity businesses, where in the course of the last 12 months, we've seen dramatic escalation of prices, and in some cases, escalation beyond reason and the result is volume slow. And the closest point that I would reference there are things like aluminum marketplace where the price skyrocketed in last quarter, the volume started to fall since the buyers started to push back. So my biggest concern is escalation beyond reason that causes the markets to contract. We don't have much in the way of commodity businesses in the portfolio. So that is not a big concern, but it does ripple through the industrial platform, and we do have some manufacturing-related businesses that have to deal with metal prices, but they've generally been successful and passed through most of those commodity changes.

The other more significant concern is the impact of inflation and the perception that some of the consumer-related businesses may start to see pullback. Obviously, there's a much more complicated formula that we would see there. But anything that's directly consumer-related would obviously be a concern as inflation increases, whether it's housing or other forms of price points that are creating pressure for some of those producers. We have very few consumer-focused businesses that doesn't have the kind of revenue visibility that we would normally expect to put our leverage behind. We do have a restaurant or 2 in the portfolio. Both of those situations are extremely lowly leveraged and have had both long-term growth and very defendable interest margins or margins on their business -- their operating margins and our sponsored deals. So we obviously have a deeper capital base below us. So it's the consumer side of the business that we're obviously monitoring as to whether a pullback will be a problem. Certainly, those businesses are seeing significant food price increases. They are seeing significant labor shortages and labor cost increases. And it is pressuring their margins a bit, but we're not concerned about the companies we currently have in the portfolio.

I appreciate that detail as well. Thank you, Bob. And yes, congratulations on the quarter, again.

Thank you, Robert.

Ladies and gentlemen, there are no further questions at this time. And I would like to turn the call back to Mr. David Gladstone for closing remarks.

Well, thank you all for attending this meeting, and we look forward to seeing you again next quarter, and that's the end of this meeting.

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