Gladstone Capital Corporation (GLAD) Earnings Call Transcript & Summary

Greetings, and welcome to the Gladstone Capital Corporation's Third Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I'll now turn the conference over to David Gladstone, Chairman. Thank you, David. You may begin.

Well, thank you for bringing all these things together, and good morning to everyone out there. This is the earnings conference call for Gladstone Capital for the quarter ending June 30, 2026. Thank you all for calling in. We're always happy to talk to our shareholders and analysts and welcome the opportunity to provide some updates on our company that's doing very well. And before we get to the last quarter's results, Catherine Gerkis, Director of Investor Relations, will provide a brief disclosure about certain regulatory matters. Catherine, go ahead.

Thanks, David, and good morning, all. Today's call may include forward-looking statements, which are based on management's estimates, assumptions and projections. There are no guarantees of future performance, and actual results may differ materially from those expressed or implied in these statements due to various uncertainties, including the risk factors set forth in our SEC filings, which you can find on the Investors page of our website, gladstonecapital.com. We assume no obligation to update any of these statements unless required by law. Please visit our website for a copy of our Form 10-Q and earnings press release for more detailed information. You can also sign up for our e-mail notification service and find information on how to contact our Investor Relations department. Now I will turn the call over to Gladstone Capital's CEO and President, Bob Marcotte.

Good morning. I'll cover the highlights for the quarter and a few comments on the near-term outlook for the company. Beginning with last quarter's results, fundings last quarter totaled $82 million and included four new investments totaling $67 million and $15 million in advances to existing portfolio companies. Exits and repayments came in at $40 million, so net originations were $42 million for the quarter. Interest income for the period rose 4.7% to $24.3 million on higher average assets as our weighted average debt yield of 11.8% was unchanged for the period. However, other income declined from the large prepayment fee received last quarter, so total investment income declined $1.5 million to $24.5 million. Interest and financing costs rose $700,000 with increased borrowings, which included the $60 million December 2029 note issued in the period. However, net management fees declined $1.1 million with the increased origination fee credits. Net investment income declined by $800,000, largely on lower onetime prepayment fees to $11 million or $0.49 per share for the period. Net portfolio appreciation came in at $3 million, driven by unrealized portfolio appreciation as our gainers outnumbered the decliners by a 2:1 margin. With respect to the portfolio, the investment portfolio composition is largely unchanged with first lien debt and total debt investments at 71% and 91% of the portfolio at cost, respectively. We're pleased to report that the leverage and return profile of our new debt investments last quarter were all first lien and with weighted average leverage under 3x EBITDA and an average 7% spread over SOFR. Our health care and education sector concentration declined as we elected to exit Giving Home Health Care and redeploy the capital to higher returning investments. As of the end of the quarter, our non-earning debt investments increased to 5 with a cost basis of $46 million or $26.7 million or 3.1% of our debt investments at fair value. The credits added are Lone Star, a Texas-based printed circuit board contractor and Eegee's, an Arizona-based quick-serve sandwich chain. Both credits are GLAD-controlled investments and have recently undergone senior management changes and are in the process of developing additional revenues and expense reductions to return them to earning asset status. As far as the outlook is concerned, since the end of the quarter, received an anticipated prepayment of Imperative totaling $12 million, which will eliminate our exposure to the oil and gas sector, and we anticipate a slightly larger prepayment this week, which should reduce our PIK interest income in coming quarters. Our committed investment pipeline is well more than the recent repayments and includes several attractive follow-on investments in existing portfolio companies, which are continuing to scale. Between upsizing existing credits and new investment yields, we are not expecting our weighted average yield to be negatively impacted by these reinvestment activities. Our leverage position ticked up at the end of the quarter with net debt at a modest 100% of NAV, and we expect to continue to use our floating rate bank facilities to support our near-term investment activities. And now I'll turn the call over to Nicole Schaltenbrand, our CFO, to provide details on the fund's financial results for the quarter. Nicole?

Thanks, Bob. Good morning, everyone. During the June quarter, total interest income rose $1.1 million or 4.7% to $24.3 million as the average earning assets rose $28.4 million or 3.6%, while the weighted average yield on our interest-bearing portfolio was unchanged at 11.8% for the period. Total investment income was $24.5 million as dividends and prepayment fee income declined from the large onetime payments in the prior quarter. Total expenses declined $700,000 or 4.7% versus the prior quarter due to a decrease in net management fees of $1.1 million and higher closing fee credits and other expenses also fell $300,000, mainly due to lower legal expenses. These factors were offset by a $700,000 increase in interest expense. Net investment income for the quarter fell to $11 million or $0.49 per share or 109% of cash distributions per common share. The net increase in net assets resulting from operations was $13.3 million or $0.59 per share for the quarter ended June 30 as impacted by the unrealized valuation appreciation covered by Bob earlier. Moving over to the balance sheet. As of June 30, total assets rose to $970 million, consisting of $953 million in investments at fair value and $17 million in cash and other assets. Liabilities rose $32 million since the prior quarter to $439 million, with the decrease in LOC borrowings funded by the new $60 million 7% note issue due in December of 2029. The remaining balance of our liabilities consists primarily of the $149.5 million of [indiscernible] convertible debt, $50 million of 3.75% notes due May 2027 and $45 million of 6.25% schedule preferred stock. As of June 30, net assets rose $3.1 million to $485.7 million, and NAV per share rose from $21.36 to $21.50 as of June 30. Our gross leverage as of June 30 rose to 100% of net assets. With respect to distributions, monthly distributions for August and September will be $0.15 per common share, which is an annual run rate of $1.80 per share. The Board will meet again in October to determine the monthly distributions to common stockholders for the following quarter. At the distribution run rate for our common stock and with the common stock price at about $19.35 per share yesterday, the distribution run rate is now producing a yield of about 9.3%. And now I'll turn it back to David to conclude.

Well, in summary, again, it was just another solid quarter for Gladstone Capital. The team is doing an excellent job of sourcing attractive private equity-backed lower middle market investment opportunities. So again, Bob, you're on top of the world again, the team continues to deliver strong earnings performance driven by healthy increases in net interest margins. And bolstered net investment income to more than cover the current shareholder dividends. That's 9.3% for a great little company. The company has a strong balance sheet, ample borrowing capacity to grow our investment portfolio and continue to support our shareholders with dividends. We love dividends here, and we love paying them out to our folks. So I'm going to stop now and call on the operator to tell people how they can ask some questions, and we'll try to help you out there.

[Operator Instructions] Our first question comes from the line of Erik Zwick with Lucid Capital Markets.

And Bob, I think you may have touched on this a little bit in talking about the expectation for the portfolio yield to remain kind of relatively consistent. But just curious if maybe you could give a little bit more detail in terms of the investment pipeline today, one, in terms of the size of the pipeline relative to maybe 3 months ago and then also the spreads that you're seeing today and how they compare to the existing portfolio yield?

Sure, Erik. The pipeline is pretty strong. Most of our investments are looking for acquisitions. In this marketplace, strategic add-ons to the small credits have huge equity appreciation opportunities. So we are seeing, I don't know, anywhere half dozen plus or minus of additional add-ons to the portfolio. So I would expect that to be a meaningful percentage of the pipeline on a go-forward basis as it was last quarter. In addition, I would say the opportunities are not slowing down. In fact, we're probably raising the bar given where we are in our leverage profile. And the result is $75 plus or minus million a quarter in originations is a relatively easy mark. It's consistent with what we did last year. We're also seeing fewer repayments. The repayment velocity has slowed down a fair bit given what's gone on in the marketplace. So $35 million to $50 million of repayments and exits a quarter put us in a position where we could see fairly consistent net asset growth. Obviously, that's tempered by where we are in our leverage profile. So I will say we would expect to continue to grow modestly. And in light of those competitive dynamics; leverage yields in and around the high 6s, low 7s, I think, is where we would expect to continue to participate. And as a result, we really wouldn't see an effective yield degradation to where we are today at 11.8% as the average. So that's obviously excluding any increases in underlying rates were that to happen. So I think it's pretty much the same as we experienced this quarter. I will say that the one thing that we continue to see is the lower middle market, there's a lot of deal opportunities. It's really finding the ones that fit our credit profile and the organic growth that we're looking for. I think some of our peers are continuing to see similar flow of volume opportunities. So it continues to be a strong market for us.

That's great color. And second question for me. Just kind of bigger picture, as you look across your portfolio, very diverse from an industry perspective and kind of end customer. There's a lot of talk about kind of a K-shaped growth in the economy and the lower-end consumer having some difficulty to some degree. And I know you don't have a whole lot of exposure there, but just thinking maybe about Eegee's and maybe other things. Are you guys seeing any kind of real signs that there's kind of this bifurcation or separation in the growth of the economy? And if so, how are you managing that and thinking about the growth that you just mentioned going forward?

Well, traditionally, we have not done a ton of consumer-facing businesses. It doesn't provide the same revenue visibility that we typically look for to support the cash flow leverage that we put on these businesses. We do have a few. You mentioned Eegee's. So we have a couple of restaurants. Obviously, facing a variety of pressures. I don't think there's any doubt that consumer spend has softened. Tractions, check size and costs are a challenge in a business like that. But that's a very small snippet of our portfolio. I will say we have other consumer-facing businesses that we have gone through adjustments and are seeing strong momentum, positive movement in some of the other restaurants that we're invested in, positive movement in the apparel business that we have that's called Xcel, which is a wet suit type business. So structured appropriately, I think we are seeing decent momentum in some of the consumer sectors, but that's a very small portion of our overall portfolio. Most of our businesses are industrial, precision manufacturing, suppliers to large-scale companies, including aerospace and defense type businesses. And the backlogs are strong and continuing to grow. The only thing that I would add in that category is in prior quarters, we talked about the ability to bring production back to the states. We are still seeing some of that, but I would also add tariffs and commodity prices are disrupting some of that because to source it domestically given some of the steel, copper and other commodity prices, it's still extremely expensive and domestic manufacturers are hesitating in moving as much production back to the U.S. in the face of very expensive commodity prices. So we're still seeing a fairly robust demand, but it's tempered by some of the tariff-related impacts on some of the raw materials. So I guess what I would say is the manufacturing businesses are strong. And we are looking at, obviously, businesses where there's a high degree of automation to improve operating efficiencies and cost structure.

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann.

On a follow-up to Erik's question, you mentioned leverage in the high 6s, low 7s, which seems to be a little bit above some of the other BDCs I cover. Is that really a function of their focus on long contracts, so you have a better view in terms of what the cash flows are and so forth?

To be clear, that was spread, not leverage. Our leverage portfolio last quarter, as I mentioned, was an average of 3x EBITDA. Our spreads are typically in the high 6s, low 7s.

Okay. That was my misunderstanding. But are you -- on your comments that you're seeing a lot of opportunity for -- in the lower middle market, do you view it as more of a buyer's market? And what does that say about where private equity is in terms of their growth pace?