David Gladstone - Chairman Michael LiCalsi - General Counsel Bob Marcotte - President Nicole Schaltenbrand - Chief Financial Officer

Greetings! And welcome to Gladstone Capital, Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A Question-and-answer session will follow the formal presentation. [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 are always happy to talk to our shareholders and analyst and welcome the opportunity to provide an update on the company. Now, we’ll 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 Securities Exchange Act of 1934, including those regarding our future performance. So these forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. Though 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 the other documents that we filed with the SEC, you can find them on the Investors page of our website, www.gladstonecapital.com. You could also sign up for our email notification service there. You can 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. 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, 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 a 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 [inaudible] was anticipated and in addition to generating $3.2 million of success fee income for the period and reducing our pick interest exposure going forward, we retained a small residual interest in the enquirer [ph]. 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…

Thanks Bob. Good morning all! During the March quarter total interest income rose to $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 and drove the 7% increase in total investment income to $17.3 million for the quarter. Total expenses rose by 1.6x quarter-over-quarter, driven by an increase in the 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 distributions. 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 an increase in earnings and small net unrealized portfolio depreciation which was covered by Bob earlier. Moving over to the balance sheet, as of March 31, 2022 total assets declined to $548 million, consisting of $538 million 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 5.125% [ph] senior notes due 2026, $50 million of 5.375% senior notes due May 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 in prior quarter, with the net earnings in…

Alright, thank you. Very nice presentation Nicole and Bob, good work, and Michael same to you, great job as always. The 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 five year investment period, so a very nice deal. 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 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 right now and continues to invest in growth oriented middle market businesses with good management, and many of these investments are supported by mid-sized private equity funds that are always looking for an experienced partner to support the acquisition and growth of the business they are investing in. This gives us the opportunity to make attractive investments and these investments are interest paying loans, and they support their 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 to come on please and tell people how they can ask a question.

Thank you. [Operator Instructions] Our first question is from Robert Dodd with Raymond James. Please go ahead.

Good morning! Congratulations on another excellent quarter. In terms of restocking the outlook that we can, I mean obviously NetFortris this quarter, an excellent exit with a very large success fee. We’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, the new 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 [inaudible] per say as you’ve seen over the last kind of 18 months. Is that basically sustainable going forward?

Thanks for the question Robert. My – the structure of the NetFortris situation included a fairly healthy amount of pick 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 the 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 in 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 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 many details response from – thank you on that. I’ve been wondering if you mentioned this obviously, upward late environment you mentioned in your prepared remarks. The late environment and the economic environment could hurt some businesses potentially within your portfolio. How big a segment of the portfolio do you have elevated concerns at all or concerns about? Is it 5%, 2%, 10%, and whether they are in any particular industries that you think are particularly vulnerable in the current economic volatility and rising rates and inflationary environment.

Well, I think there's probably two general sectors that I would be concerned about, but not necessarily a meaningful percentage of our portfolio. The two that I would point to is you know 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 is low and the closest point that I would reference there are things like aluminum market place, where the price skyrocketed and 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 pass 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 pull back. 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, you know 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 two in the portfolio. Both of those situations are extremely lowly leveraged and have had both long term growth and very dependable interest margins; margins on their business, their operating margins and our sponsor 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 – it is pressuring their margins a bit, but we are not concerned about the companies we currently have in the portfolio.

I appreciate that detail as well. Thank you, and yeah, congratulations on the quarter again.

Thank you, Robert.

Next question?

Thank you. 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.