GLAD

Business Context and Reporting Period

Company: Gladstone Capital Corporation (GLAD)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2017
Business Overview: Gladstone Capital is an externally managed, closed-end, non-diversified management investment company operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The company invests in debt and equity securities of established private businesses in the United States, primarily targeting lower middle-market companies.

Key Financial Metrics

Material Changes vs. Prior Comparable Period

• Net Income Improvement: Net increase in net assets resulting from operations improved significantly to $4.66 million for the three months ended March 31, 2017, compared to a net decrease of $6.14 million in the prior year period. This was driven by a reduction in net unrealized depreciation.
• Expense Reduction: Total expenses, net of credits, decreased by 24.3% to $3.43 million for the quarter, primarily due to increased fee credits from the Adviser and lower professional fees.
• Realized Gains/Losses: The company recorded a net realized gain of $45,000 for the quarter, a stark contrast to the $5.52 million net realized loss in the prior year period, which was impacted by the restructuring of the Targus investment.
• Portfolio Composition: The portfolio consists of 44 companies. The five largest investments represent 32.8% of the total portfolio at fair value. Debt investments comprise 95.1% of the portfolio at fair value.
• Non-Accrual Status: As of March 31, 2017, loans to two portfolio companies (Sunshine Media Holdings and Alloy Die Casting Corp.) were on non-accrual status, representing 7.2% of the cost basis of all debt investments.

Guidance, Outlook, and Risks

• Capital Raising: The company completed a common stock offering in October 2016. As of May 2, 2017, the stock traded at a premium to NAV. The company did not seek stockholder approval to issue shares below NAV at its February 2017 annual meeting; future issuances below NAV would require such approval.
• Liquidity: The company maintains a $170.0 million revolving credit facility with $81.4 million available as of March 31, 2017. The facility matures in January 2019.
• Distributions: The Board declared monthly distributions of $0.07 per common share for April, May, and June 2017. The company aims to maintain its RIC status by distributing at least 90% of investment company taxable income.
• Risks: Primary risks include interest rate fluctuations, the credit quality of portfolio companies, and the ability to raise capital if the stock trades below NAV. The company is subject to asset coverage requirements under the Investment Company Act of 1940.
• Subsequent Events: In April 2017, the company invested $22.0 million in secured second lien debt to a new portfolio company.

Investor Verification Checklist

• Fee Credits: Verify the sustainability of the significant fee credits ($1.52 million for the quarter) from the Adviser that reduced net expenses.
• Non-Accrual Loans: Monitor the status of the two portfolio companies on non-accrual status (Sunshine Media Holdings and Alloy Die Casting Corp.) and potential write-downs.
• Unrealized Depreciation: Review the drivers of the $0.75 million net unrealized depreciation for the quarter, specifically the declines in Alloy Die Cast and LWO Acquisitions.
• Capital Availability: Confirm the company's ability to deploy capital given the $81.4 million availability on the credit facility and the current market price of its stock relative to NAV.
• Preferred Stock Obligations: Note the mandatory redemption of Series 2021 Term Preferred Stock in June 2021 and the associated dividend obligations.