Gladstone Capital (GLAD) - 2020 Q4 - Annual Report

Part I Item 1. Business Gladstone Capital is an externally managed BDC investing in U.S. lower middle-market debt and equity, aiming for current income and capital appreciation, with a $450.4 million portfolio as of September 30, 2020 - Gladstone Capital is an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a BDC and a RIC, investing in debt and equity securities of established private businesses in the U.S[15] - The company's investment objectives are to achieve current income through debt investments and provide long-term capital appreciation through equity investments in lower middle-market companies (EBITDA of $3 million to $15 million)[19][20] Investment Portfolio Composition by Security Type (at Fair Value, in thousands) | Security Type | September 30, 2020 (Fair Value) | % of Total | September 30, 2019 (Fair Value) | % of Total | | :--- | :--- | :--- | :--- | :--- | | Secured first lien debt | $213,468 | 47.4% | $178,213 | 44.2% | | Secured second lien debt | $196,986 | 43.7% | $181,541 | 45.1% | | Unsecured debt | $4,299 | 1.0% | $3,933 | 1.0% | | Total debt investments | $414,753 | 92.1% | $363,687 | 90.3% | | Preferred equity | $7,000 | 1.5% | $9,854 | 2.4% | | Common equity/equivalents | $28,647 | 6.4% | $29,334 | 7.3% | | Total equity investments | $35,647 | 7.9% | $39,188 | 9.7% | | Total Investments | $450,400 | 100.0% | $402,875 | 100.0% | - The company is externally managed by Gladstone Management Corporation (the Adviser) under an Advisory Agreement, which includes a base management fee of 1.75% of average total assets and a two-part incentive fee (income-based and capital gains-based)[17][56][61] - To maintain its RIC status, the company must distribute at least 90% of its Investment Company Taxable Income annually and meet specific income source and asset diversification requirements[78][80] - As a BDC, the company is subject to a 150% asset coverage requirement for senior securities, which impacts its ability to incur debt and pay distributions[100][101] Item 1A. Risk Factors The company faces economic, interest rate, and LIBOR transition risks, compounded by inherent lower middle-market investment risks, portfolio concentration, external management conflicts, and BDC capital raising constraints - Economic risks, including the COVID-19 pandemic, market volatility, and changes in interest rates, can negatively impact the business, financial condition, and the value of investments[114][118][125] - The planned phase-out of LIBOR by the end of 2021 creates uncertainty for the company's variable-rate debt investments and borrowings, potentially requiring renegotiation of loan agreements[129][131] - Investments in lower middle-market companies are extremely risky due to their limited financial resources, narrower product lines, dependence on key management, and lack of publicly available information, making them more vulnerable to economic downturns[142][143][144] - The portfolio is concentrated in a limited number of companies and industries; as of September 30, 2020, the five largest investments represented 28.9% of the total portfolio at fair value, and the top industry, diversified/conglomerate services, represented 20.6%[158] - The company is dependent on its external Adviser and its key personnel; the incentive fee structure may induce the Adviser to make speculative investments, and the company may be obligated to pay the incentive fee even if it incurs a net loss[190][197][198] - BDC regulations restrict the issuance of common stock below NAV without shareholder approval, constraining capital raising efforts, and require maintaining an asset coverage ratio of at least 150% on senior securities, which could restrict distributions if asset values decline[188][189] Item 1B. Unresolved Staff Comments The company reports that it has no unresolved staff comments from the SEC - None[248] Item 2. Properties The company does not own any real estate or other material physical properties, operating from premises leased by its Adviser, for which it reimburses costs under agreements - The company does not own any real estate; it occupies premises leased by the Adviser and reimburses costs pursuant to the Advisory and Administration Agreements[249] Item 3. Legal Proceedings The company is not currently subject to any material legal proceedings, nor is it aware of any material legal proceedings being threatened against it - The company is not currently subject to any material legal proceedings[250] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[251] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on Nasdaq under "GLAD," experiencing significant FY2020 volatility. It aims to distribute at least 90% of taxable income monthly, with estimated annual expenses at 14.75% of net assets before fee credits Quarterly Common Stock Price and Distribution Data (FY 2020) | Quarter Ended | NAV per Share | High Price | Low Price | Declared Distributions per Share | | :--- | :--- | :--- | :--- | :--- | | 12/31/2019 | $8.08 | $10.69 | $9.35 | $0.21 | | 3/31/2020 | $6.99 | $10.55 | $4.04 | $0.21 | | 6/30/2020 | $7.27 | $8.27 | $4.50 | $0.195 | | 9/30/2020 | $7.40 | $7.84 | $6.78 | $0.195 | - The company intends to distribute at least 90.0% of its Investment Company Taxable Income to stockholders through monthly cash distributions to maintain its RIC status[258] Annual Expenses (as a percentage of net assets) | Expense Category | Percentage of Net Assets | | :--- | :--- | | Base Management fee | 3.47% | | Loan servicing fee | 2.62% | | Incentive fee | 2.36% | | Interest payments on borrowed funds | 4.84% | | Other expenses | 1.46% | | Total annual expenses | 14.75% | - After applying all non-contractual, unconditional, and irrevocable credits from the Adviser, total annualized expenses for the quarter ended September 30, 2020, were 11.24% of net assets[274] Item 6. Selected Financial Data FY2020 reported $48.0 million total investment income, $25.2 million net investment income, and a $1.9 million net asset decrease from $27.0 million losses, with NAV per share at $7.40 and total assets at $459.2 million Consolidated Selected Financial Data (Years Ended September 30, In thousands, except per share) | (In thousands, except per share) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Statement of Operations Data: | | | | | Total Investment Income | $47,959 | $50,035 | $45,581 | | Net Investment Income | $25,163 | $24,580 | $23,088 | | Net Increase (Decrease) in Net Assets | $(1,873) | $19,869 | $18,648 | | Per Share Data: | | | | | Net Investment Income per Share | $0.81 | $0.84 | $0.85 | | Distributions Declared per Share | $0.81 | $0.84 | $0.84 | | Balance Sheet Data: | | | | | Total Assets | $459,177 | $426,069 | $399,508 | | Net Assets | $233,743 | $249,330 | $237,092 | | Net Asset Value Per Common Share | $7.40 | $8.22 | $8.32 | | Senior Securities Data (at cost): | | | | | Total borrowings | $128,000 | $66,900 | $110,000 | | Notes payable | $96,313 | $57,500 | $— | Other Unaudited Data (Years Ended September 30) | | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Number of Portfolio Companies | 48 | 53 | 50 | | Weighted Average Yield on Investments (excluding non-accrual) | 10.97% | 12.26% | 11.80% | | Total Return | (15.75)% | 12.55% | 9.53% | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations FY2020 saw a 4.1% decrease in total investment income and a 10.4% reduction in net expenses, leading to a 2.4% rise in Net Investment Income. A $27.0 million net loss from investments resulted in a net decrease in net assets, yet liquidity remains strong with a 202.6% asset coverage ratio - During FY 2020, the company invested $131.2 million in six new portfolio companies and $18.8 million in existing ones, receiving $78.8 million from exits and repayments, resulting in a net portfolio increase of $66.2 million at cost[299] Results of Operations Comparison (FY 2020 vs. FY 2019, In thousands) | (In thousands) | FY 2020 | FY 2019 | $ Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Total investment income | $47,959 | $50,035 | $(2,076) | (4.1)% | | Total expenses, net of credits | $22,796 | $25,455 | $(2,659) | (10.4)% | | Net Investment Income | $25,163 | $24,580 | $583 | 2.4% | | Net loss from investments | $(27,036) | $(4,711) | $(22,325) | 473.9% | | Net Increase (Decrease) in Net Assets | $(1,873) | $19,869 | $(21,742) | (109.4)% | - The $27.0 million net loss from investments in FY 2020 was primarily driven by $18.7 million in net unrealized depreciation, attributed to wider market credit spreads and discounts applied to portfolio companies impacted by the COVID-19 pandemic[331][332] - Net cash used in operating activities was $46.1 million in FY 2020, a shift from $9.3 million provided by operations in FY 2019, mainly due to lower proceeds from investment repayments and sales[360] - The company maintains a $180.0 million credit facility, with $128.0 million outstanding and $17.6 million available as of September 30, 2020; the revolving period ends July 15, 2021[379][562] - As of September 30, 2020, the company had outstanding $57.5 million of 6.125% Notes due 2023 and $38.8 million of 5.375% Notes due 2024[387][388] - The company's asset coverage ratio on senior securities was 202.6% as of September 30, 2020, comfortably above the regulatory minimum of 150%[310][386] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate fluctuations, with 78.1% of its debt portfolio in variable-rate loans. A 100 basis point interest rate increase would result in a $0.9 million net decrease in net assets from operations - The company's primary market risk exposure is to interest rate fluctuations, which affect the spread between investment income and borrowing costs[405] Debt Portfolio Composition by Interest Rate Type (as of Sept 30, 2020) | Rate Type | Percentage of Portfolio | | :--- | :--- | | Variable rates | 78.1% | | Fixed rates | 21.9% | | Total | 100.0% | Hypothetical Interest Rate Sensitivity Analysis (in thousands) | Basis Point Change | Net Increase (Decrease) in Net Assets | | :--- | :--- | | Up 100 basis points | $(914) | | Up 50 basis points | $(605) | | Up 25 basis points | $(320) | | Down 15 basis points | $190 | Item 8. Financial Statements and Supplementary Data This section presents the audited FY2020 consolidated financial statements, detailing investment valuation policies, related-party transactions, borrowings, and distributions. Total investments at fair value were $450.4 million, and total net assets were $233.7 million as of September 30, 2020 - The financial statements were audited by PricewaterhouseCoopers LLP, which issued an unqualified opinion[417] Consolidated Balance Sheet Highlights (in thousands) | | September 30, 2020 | September 30, 2019 | | :--- | :--- | :--- | | Total Investments, at fair value | $450,400 | $402,875 | | Total Assets | $459,177 | $426,069 | | Total Liabilities | $225,434 | $176,739 | | Total Net Assets | $233,743 | $249,330 | | Net Asset Value Per Share | $7.40 | $8.22 | - The company's investment valuation policy uses a combination of third-party inputs (from ICE), yield analysis for debt, and a Total Enterprise Value (TEV) approach for equity and certain debt investments; the Board of Directors has ultimate responsibility for determining fair value[481][484][487] - As of September 30, 2020, all investments were valued using Level 3 inputs, except for one investment valued with Level 2 inputs and one valued at NAV as a practical expedient[512] - For FY 2020, the Adviser received a gross base management fee of $7.6 million and a gross incentive fee of $5.3 million; after various credits, including a $3.0 million credit to the incentive fee, the net fees were significantly lower[540] Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[612] Item 9A. Controls and Procedures Management concluded that disclosure controls and procedures were effective as of September 30, 2020, with no material changes to internal controls over financial reporting during the fourth quarter - Management concluded that disclosure controls and procedures were effective as of September 30, 2020[613] - There were no material changes in internal control over financial reporting during the quarter ended September 30, 2020[616] Item 9B. Other Information This item is not applicable to the company - Not applicable[617] Part III Item 10. Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance is incorporated by reference from the company's definitive Proxy Statement for its 2021 Annual Meeting of Stockholders - Information is incorporated by reference from the 2021 Proxy Statement[620] Item 11. Executive Compensation Information regarding executive and director compensation is incorporated by reference from the company's 2021 Proxy Statement - Information is incorporated by reference from the 2021 Proxy Statement[621] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership of certain beneficial owners and management is incorporated by reference from the company's 2021 Proxy Statement - Information is incorporated by reference from the 2021 Proxy Statement[621] Item 13. Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships, related transactions, and director independence is incorporated by reference from the company's 2021 Proxy Statement - Information is incorporated by reference from the 2021 Proxy Statement[622] Item 14. Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's 2021 Proxy Statement - Information is incorporated by reference from the 2021 Proxy Statement[622] Part IV Item 15. Exhibits and Financial Statement Schedules This section lists the financial statements, financial statement schedules, and exhibits filed as part of the annual report. This includes the audited financial statements, the schedule of Investments in and Advances to Affiliates, and various corporate governance and financing agreements - This section lists all financial statements, schedules, and exhibits filed with the Form 10-K[624][625] Item 16. Form 10-K Summary The company has elected not to provide a summary of the Form 10-K - None[632]