GLAD

Business Context and Reporting Period

Company: Gladstone Capital Corporation (GLAD)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2013
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.

Key Financial Metrics

Material Changes vs. Prior Comparable Period

• Investment Income: Total investment income decreased 14.2% for the three months ended June 30, 2013, compared to the prior year period, primarily due to a reduction in the weighted average principal balance of the portfolio caused by early payoffs. For the nine-month period, income decreased 11.5%.
• Net Realized Losses: The company recorded a net realized loss of $2.39 million for the quarter, driven largely by a $2.9 million loss on the sale of Kansas Cable Holdings, Inc. (KCH). For the nine months, the net realized loss was $5.41 million, including losses from the sale of Viapack, Inc. and the write-off of Access Television Network, Inc.
• Unrealized Depreciation: Net unrealized depreciation of investments was $4.70 million for the quarter and $7.45 million for the nine months. This was partially offset by reversals of prior period depreciation upon the realization of gains/losses on sold assets.
• Expenses: Total expenses net of credits decreased 18.7% for the quarter and 16.8% for the nine months compared to the prior year, largely due to reduced interest expense from lower borrowings and incentive fee waivers.
• Portfolio Composition: The portfolio contracted slightly, with 46 companies as of June 30, 2013, compared to 55 in the prior year. The fair value of the portfolio was 72.2% of cost, reflecting cumulative net unrealized depreciation of $98.5 million.

Guidance, Outlook, and Risks

• Management Commentary: Management notes that while economic conditions are improving slowly, the recovery remains protracted. The company continues to see investment opportunities consistent with its objectives but faces competitive pressure in the BDC marketplace.
• Recent Developments:
  • Credit Facility: Extended the maturity of its $137.0 million revolving credit facility to January 19, 2016, and removed the 1.5% LIBOR floor on advances.
  • Interest Rate Cap: Entered into an interest rate cap agreement in July 2013 for a notional amount of $35.0 million to limit interest rate exposure on a portion of borrowings.
  • Investments: Made new investments in AG Transportation Holdings, Allen Edmonds Shoe Corporation, and Funko, LLC. Sold investments in Viapack, Access TV, and KCH.
• Risks and Contingencies:
  • Non-Accrual Status: Three portfolio companies were on non-accrual status as of June 30, 2013, representing 15.9% of the cost basis of debt investments.
  • Liquidity: The company's ability to make new investments is dependent on external financing due to RIC distribution requirements and the illiquidity of its portfolio.
  • Valuation: All investments are valued using Level 3 inputs (unobservable), involving significant management judgment and estimates.
• Distributions: The company declared monthly distributions of $0.07 per common share and $0.1484375 per preferred share for the quarter ended June 30, 2013. The tax characterization of distributions for the fiscal year ending September 30, 2013, will be determined at year-end.

Important Facts for Investor Verification

• NAV vs. Market Price: Verify the current market price of GLAD common stock relative to the reported NAV of $8.60 per share, as the stock has historically traded at a discount to NAV.
• Non-Accrual Assets: Review the specific portfolio companies on non-accrual status (aggregate cost basis ~$53.7 million) and the likelihood of recovery or further impairment.
• Realized Losses: Confirm the impact of recent realized losses (Viapack, KCH, Access TV) on the company's cumulative earnings and ability to sustain distributions.
• Fee Waivers: Note the voluntary waivers of incentive fees by the Adviser to ensure distributions are covered by net investment income; verify if these waivers are sustainable.
• Credit Facility Covenants: Monitor compliance with the Credit Facility covenants, specifically the asset coverage ratio (currently 287%) and minimum net worth requirements.