GLADSTONE CAPITAL CORP quarterly report, Q2 FY2024

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Gladstone Capital Corporation — Q2 FY2024 Form 10-Q

Reporting period: Fiscal quarter and six months ended March 31, 2024. Gladstone Capital is an externally managed business development company (BDC) and regulated investment company (RIC) investing primarily in debt and equity of U.S. lower-middle-market businesses.

Financial performance and condition

  • Investment income: $24.0 million for the quarter, up 16.7% year over year; $47.2 million for six months, up 18.5%. Interest income rose 21.1% and 23.1%, respectively, reflecting a larger average interest-bearing portfolio and higher yields.
  • Net investment income (NII): $10.8 million for the quarter, up 11.9%; $22.7 million for six months, up 23.7%. NII per common share was $0.25 for the quarter versus $0.26, and $0.52 for six months versus $0.51.
  • Operations: Net increase in net assets from operations was $23.6 million ($0.54 per share) for the quarter and $43.6 million ($1.00 per share) for six months. Results included unrealized investment appreciation of $10.7 million and $18.5 million, respectively; these valuation gains are not necessarily realized cash gains.
  • Portfolio and NAV: Investments at fair value were $791.6 million across 51 portfolio companies, versus $704.8 million at September 30, 2023. Net assets were $430.8 million and NAV was $9.90 per common share, up from $408.7 million and $9.39. At cost, the portfolio was 90.9% debt and 9.1% equity.
  • Cash flow and liquidity: Operating activities used $45.3 million for six months, primarily reflecting $102.7 million of investment purchases; financing activities provided $49.3 million. Cash, cash equivalents and restricted cash ended at $5.4 million. The revolving facility had a $243.7 million commitment, $117.2 million outstanding and $103.3 million reported availability, subject to borrowing-base constraints.
  • Debt and coverage: Notes payable had $257.0 million principal outstanding ($253.6 million net carrying value); the line of credit had $117.2 million outstanding. Facility weighted-average borrowing rates, including unused fees, were 9.9% for the quarter and 10.9% for six months. Reported asset coverage was 213.4% for indebtedness and 212.4% for preferred stock; the company reported compliance with facility covenants.
  • Distributions: Common distributions paid were $0.495 per share for the six months, versus $0.435 in the prior-year period. The board declared $0.165 monthly for April–June 2024, stated on the post-quarter reverse-split basis.

Material changes and notable items

  • Quarterly net expenses after Adviser credits rose 21.0% to $13.2 million, faster than investment income, primarily reflecting higher management fees and interest expense. For six months, net expenses increased 14.0% to $24.5 million.
  • Non-accrual debt exposure increased: Edge Adhesives and WB Xcel were on non-accrual at March 31, with $20.4 million cost basis and $12.9 million fair value, compared with Edge Adhesives alone at $6.1 million cost and $2.9 million fair value at September 30.
  • Six-month investment activity included $26.0 million invested in two new portfolio companies and $76.7 million of additional investments in existing companies. Major additions included Quality Environmental, ALS Education, Leadpoint and SpaceCo. Trowbridge was sold in part, generating $8.4 million net proceeds; CHA Holdings repaid at par for $3.0 million.
  • Unrealized appreciation was led by Antenna Research and Lonestar EMS for the six-month period; declines in FES Resources and WB Xcel partly offset gains. FES Resources filed for Chapter 7 bankruptcy in March 2024.
  • After quarter-end, Giving Home Healthcare repaid at par for $29.7 million net proceeds and a $2.5 million warrant-related distribution; Gray Matter Systems repaid at par for $14.0 million. The company also invested $7.3 million in Total Access Elevator in April.
  • A 1-for-2 reverse stock split became effective April 4, 2024. The reported March 31 NAV per share and period per-share figures precede that split. The company also began issuing Series A preferred stock; 70,044 shares were outstanding at quarter-end, with a 6.25% stated rate.

Outlook, risks and contingencies

  • The filing provides no specific quantitative earnings or portfolio-growth guidance. Management says inflation had not materially impaired portfolio companies’ debt-service ability to date, but warns that cumulative inflation effects could pressure some companies’ margins, sales and debt service.
  • Interest-rate movements are a key risk: 88.2% of debt investments were variable rate, while borrowing costs and investment income may respond differently to rate changes.
  • Most investments use Level 3 valuation inputs, making reported NAV sensitive to estimates of company performance, discount rates and valuation multiples. Management cautions that realized sale proceeds could differ materially from recorded fair values.
  • Other credit and portfolio risks include non-accrual exposures, PIK income that is not collected in cash when accrued, portfolio concentration, and the possibility of delayed or reduced principal repayments. Five largest investments represented 25.7% of portfolio fair value.
  • Undrawn portfolio-company lines, delayed draws and uncalled commitments totaled $54.1 million. The company reported no material pending legal proceeding and no established litigation reserves at March 31.
  • Related-party management and servicing arrangements, including fee credits, are material. The Adviser and Administrator are affiliates controlled indirectly by the chairman and CEO; the affiliated broker-dealer also acts as preferred-stock dealer manager.

Investor verification priorities

  1. Review the performance and recovery prospects of Edge Adhesives and WB Xcel, and the impact of FES Resources’ bankruptcy.
  2. Assess how much reported earnings and NAV growth depends on unrealized Level 3 marks rather than realized gains and cash collections.
  3. Verify sustainable cash earnings against common and preferred distributions, including the impact of PIK income and investment funding needs.
  4. Monitor borrowing availability, facility covenants, asset coverage and refinancing obligations, particularly the 2026–2028 note maturities.
  5. Confirm post-reverse-split share and per-share comparisons when evaluating the stated distribution rate and NAV.