Gladstone Capital Corp (GLAD) 2004 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the glad stop capital quarterly report conference call. At this time all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference please press star 0 on your touch-tone telephone. As a reminder this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. David Gladstone. Mr. Gladstone, you may begin your conference.

Thank you, [Holly] since I'm making public statements here I need to read the obligatory warning about forward-looking statements.

This report may include statements that may constitute forward-looking statements within the meaning of the Securities Acts of 1933 and the Security Exchange Act of 1934, including statements with regard to the future performance of the company. These forward-looking statements inherently involve certain risks and uncertainties, and although based on the Company's current plans and we believe to be reasonable, that is as of today. Factors that may cause the Company's actual results to materially differ from future results expressed or implied by such forward-looking statements include among other factors those listed in the risk factors of the Company's 10-K for the fiscal year ending September 30th, 2003, as filed with the Securities and Exchange Commission on December 11th, 2003. By the way you can get that report on our web page as well. So the Company also doesn't undertake to publicly update or revise any of the forward-looking statements whether as a result of new information, future events, or otherwise.

Well, the quarter that ended December 31st was okay, had some disappointments, but we do think we can do better. The marketplace is changing. The numbers, of course, were okay. Investment income was up from 3.2 million to 4 million, versus the quarter ending last year, that's about a 25% increase. Net investment income was up from about 2.4 to 2.9 million this year, 29 cents versus 24 cents. Not as good as we wanted to be and certainly behind our original plan.

Invested assets were the disappointment of the quarter. We had 109 last year this time and we're only at 19 this period this year. We had some payoffs and paydowns and that's what you said caused us to be behind. We started out this quarter with about 119 on the books. That's down from the 147 that we put on the books from the inception of the company, so we've seen some significant pay-office and pay-downs, companies like our [Cozy Shack] have paid off completely, but we picked companies that had good cash flow and strong earnings and that has been shown in their ability to pay off and pay down the loans. Just out of cash flow we haven't seen so much from refinancing although the ARI loan that got paid off was paid off out of the refinancing.

On the valuation front Standard & Poor's didn't like the numbers generated by [Fin] for the quarter. They reduced the value from about 10.5 to 9.1. This is the company that sells landscaping equipment. They, that is S & P, see the company as working its way through a difficult period but we think the values shouldn't have been lowered that much but we have to abide by what they put up. I didn't see it so bad because the spring is when they sell a lot of their equipment, so we'll see more as when the cycle begins. S & P only had the numbers during the fall, so they haven't seen what we're seeing. But we'll see if they increase the value as we come along. By the way, Fin has never missed a payment. They're current, and while we were disappointed we think that will change. Fin is the dominant company in the market with market shares of 60 to 80% on a lot of their product lines and they are owned by great LVO group that we've known since 1979, and we think they're great, and they certainly have done great work with their portfolio.

[Markel] was recapitalized. They had another $1 million injected into the company. They've made the cost cuts that they probably should have made a year ago. The cuts should bring them back to profitability that they saw before the 9/11 downturn, and they suffer from the general problem in the marketplace of all paper products, that is strong supply and weaker demand. One of the demand areas that has been weak for them has been the hotels. The hotels are large users of paper products, and hotels are still at about 60% occupancy rather than the 85 or so they were in the past, and Markel has suffered some because of that, but I think all of this recapitalization, reorganization of their operations will do great things for them. Markel has made their payments. Again, good company from that standpoint.

Rest of the portfolio is doing fine. Wing Stop, our chain, I'll just mention this, something interesting, Wing Stop, a chain of take-out fresh chicken wings sold about 2 million chicken wings on super Sunday for the Super Bowl. Just an incredible period of time. I guess drinking beer and eating wings is a great thing to do for the Super Bowl. They continue to open new stores and are doing quite nice.

I know all of you always ask me questions about the economy and what we see going on. Since October we've watched this senior and sub-debt marketplace for large middle market companies jump dramatically. These are companies that do syndicated loans and large financings, 200, $600 million, it's a marketplace that we're not in but we watch it because it tells us what's going on in the debt marketplace at that level. In essence, any company that can get a risk rating out of S & P or Moody's can get a securitization done these days, and those that want to get financing have seen a significant jump in the number that are coming through.

The senior syndicated loan marketplace is usually $150 million and more, so we don't see it in our marketplace but we watched interest rates drop there, that the banks and others are charging. It's gone from about 4.5% over LIBOR, about 5.5% to about 3 percentage points over LIBOR, about 4%. So it's come down dramatically, and we've watched demand for the product grossly outstrip supply by 2 or 3 to 1. For example, a $600 million syndication that's going on now will draw $2 billion worth of requests, so huge demand for loan products these days, primarily from insurance companies and pension funds.

None of this has come down to impact the smaller loan marketplace, and most likely will not. I only saw it come down once, and that was in 1989, '88 time period. Usually they just don't syndicate loans under $150 million because there's not liquidity for it afterwards. So what we're watching now is that the larger industrial-based companies and a lot of the service business is getting financing and the industrial base of the U.S. is coming back in the smaller business are coming back so we're seeing some strength now and a recovery from the over building that went on in the late 1990s. There are more loan requests now.

Many of them still have some difficult stories, and we have to decline those, but we're seeing a tremendous pickup now. We're hoping our first loan that we're going to use our debt to draw down will close next week. It's about $14.5 million. We think that one will close. The folks at CIBC and Key Bank that are providing us with our line of credit have done a great job, and -- in staying with us, and we're very happy to be with them. So all in all the quarter was not a good one for us. That we'd like to see, but, on the other hand the world does seem to be changing pretty dramatically, and we're expecting to do a bang-up for this quarter and we think the summer is going to be pretty strong.

We are updating our shelf offering. I think a was filed last night. Don't want to scare anybody but we do uptake that shelf from time to time in case we need to raise equity capital, so don't be alarmed by that.

Our belief at this point in time is that 2004 will be a good year for Gladstone Capital. We think we'll come back pretty strong in terms of this quarter and we think we'll make the numbers that we originally had the street indicating, and so we're still on target to do a good job, but a little bit behind for the December quarter. And we should expect -- we do expect to increase the dividends again this year even though it wouldn't look like it at this point in time.

With that in place, I'll open it up for questions. Would you please give them the instruction on how to do that, Holly. Well, I haven't heard Holly, so I'm hoping he's on.

Thank you, Mr. Gladstone.

Yes, go ahead, Holly.

If you have a question at this time, please, press the 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from queue please press the pound key. If you are using a speaker-phone, please lift up the handset.

Any questions?

Our first question comes from Joel Houck of Wachovia.

Good morning David. Couple more conceptual questions. FIN corporation, as you mentioned S & P, Mark was below where you guys would have put it, but the warrant position is actually higher than the cost base. I'm just trying to understand how the equity value can be higher and, you know, then the debt value is lower. I just don't quite understand that.

The way it works is this, that the people at S & P mark to market of what they think they could sell the -- what the note would go for, and as a result of marking it to market, we're going to have gyrations in the value because they're marking to market as if it was going to be sold and looking at debts in the marketplace that they think would sell in a similar marketplace.

We, on the other hand, the old methodology, we sort of sat around and said what do we think we could sell this loan for today, and if it was close to par we pretty much marked it at par, but the guys at S & P will mark something up by one point. They'll go 101 on this one and 97% on this one, so when they took a rather dim look at.

On the warrant side we do have an accruing fee that's going to come through there, and as a result we're marking that I think at about one-third of the value of what that will actually be. Today, Fin could be sold for far in excess of its debt load plus this warrant would bare about three times what we valued it at today, so we're saying that if the company is sold this warrant is going to be worth a great deal of money, and since only one of the divisions at Fin is really far behind its original projections, the basic company that we put up money for is still strong and doing well, we just think that the warrant is still worth what we thought -- one-third of what the actual value would be if the company was sold.

I mean, I guess the follow-on to that is I applaud the company's efforts to have an independent third party to look at the company but a firm like S & P sounds like they don't necessarily, based on when you release results, take into account real-time information, and so, therefore, you know, someone looking at your December 31st statements, you know, this is kind of an understatement, if you will, of book value, and hence the third-party valuation concept just seems like a case where it didn't work that well.

Well, you know, I hear what you say. On the other hand the alternative would be for to us do it ourselves, and we've seen so many people out there, you're following many of them, get a lot of criticism for having a non-third-party or having it done inside, that we still feel it's the best thing to do. And you're going to see gyrations in our valuation that are going to go up and down every quarter by larger amounts and smaller amounts. It's just going to be market-driven as opposed to some kind of liquidation value. I know a lot of the guys that you follow use a liquidation approach. That is, if the company was sold today would I get all of my money back, and if the answer is yes, then they pretty much mark it to market. If it's some multiple of that or some minor amount then they mark it down, and if the equity is worth more, then they write it up. I'm not sure that either one of the ways of valuing these private equities are right, but this is the one that we chose, and we're going to live with it for awhile. I guess over time we'll see how it works. And if it works okay, then we'll leave it. If not, we'll have the choice of going back to our old ways.

Okay. Then, just kind of lastly, David, you mentioned, you stated dividend increase this year, right now implied quarterly rate of 33 cents is obviously a little ahead of the underlying operating income. Where does the improved earnings leverage come from? Is it just a bigger balance sheet with the improved deal flow? Is there margin expansion in the works later this year?

I don't think there's any margin expansion but there is the fact that every time you close a loan we get pretty substantial fees, and those fees come into income, and as a result, that will help drive the number as we close loans. We've been, unfortunately I've been saying this for sometime that we think the fee income is going to go up as we close these loans, so we haven't closed a lot so you haven't seen a lot, but there was about $255,000 worth of fees in this quarter from the two loans that we closed, actually only one of them paid a fee, the other small one did not, and as a result I think you'll see that driving and covering a lot of our costs, which, in essence, will drop things to the bottom line, so it's just loans on the books, and we're borrowing money at 1.5 over our LIBOR, which is what our interest rate is with the guys at CIBC. If you are lending it out at 10 or 12 or 13%, that's good spread, so that's what we're trying to do.

Ok, thanks a lot!

Next question.

Thank you, sir. Our next question come from Richard Shane of Jefferies.

Hey, Richard.

David, are you there?

I am now.

Terrific.

I'm not sure what's going on with our phones. Not good.

Okay. Couple questions. Can you talk specifically about what the originations were this quarter, where you put new money to work and also given that so much of the story is about anticipation of new loans coming on the books, what your pipeline looks like currently, what you sort of anticipate for this year, and maybe put that in a historical context so we can understand where you were maybe a year ago?

Yeah. We've been closing one or two loans a quarter, which is not what we need to do. We need to close three, four per quarter, so average loan size of 10 million or so, we closed two loans, the best one was Gammel. I don't know if any of you know people who are into quilting, but this is the largest manufacturer and seller of what can only be described as a long-arm sewing machine that you can do quilting with. It is the one that everybody wants called Gammel. I had no idea there were so many millions of people in the United States and all over the world practically that are into quilting but this is the number one company. We financed that buy-out with a nice loan of about $14.5 million.

We also saw a company called Burt's Bees, which manufactures the lip balm and other cosmetic items for those who want natural or unadulterated kind of cosmetics, and we like that deal a lot. Ame is a mean lender decided to take it all at the last minute, so we didn't get any, so we bought a little bit of the syndication. It's traded up to about.15 of its face amount, so we just took that down only because we had done some work on it and knew it was okay.

Those are really what we did, Rick, and the pipeline is strong as I've ever seen it. We have been extremely busy here. We've closed one loan is closing I guess Wednesday of next week is set up, and we have another one behind that for March, and hopefully we'll have a third behind that. So we'll get our three loans in this quarter. But it is been slow for us, and we apologize for that, but it's just industrial base in the U.S. has been quite rugged.

David, if those three loans close this quarter what type of volume would you be talking?

35, $40 million.

And how much -- how big do you need to get the balance sheet before you consider your first securitization?

Lots of debate about that. We worked with the guys at CIBC. Round numbers, $200 million would be the ideal. You can do it for less than that. American Capital's first securitization was, I think, 130, 140. So we're probably within striking range today except we need a little more diversification in our portfolio.

So realistically you're talking probably a fourth quarter event?

I think it will be this year.

Okay. Thank you.

Next question.

Our next question comes from Lee Carter of Oppenheimer.

Hey there. Two things. The main business that [inaudible], said to say hello to you.

I can't hear you. Can you get a little closer to the phone?

Can you hear me now? Kelly Green said to say hello, which spoke very highly of you, and she married a Frenchman, so she's going over to England to live. Anyway, I noticed the book value on Gladstone is about 13, the back on good is about 14. Are you able to cut some back some the commission costs, or what happened there? I thought that was pretty good.

Well, I don't know that it's that different. I haven't compared them recently but I think it's in the first year of glad we actually did a small return of capital, if I remember right, Harry. Is that right?

That's correct.

So that's why it went down a little bit in that first year. Remember, we were pretty aggressive, thought things were going to go gangbusters so we got cracking a little bit too ahead of time on our dividend.

The loans that you're making now are they running around 12, 13%?

Yeah, all in that same range. Some of them we've done a senior loan at about -- I'm trying to remember now -- I think it's about a minimum of but a variable rate, and so that -- but that's the first mortgage on everything, so did a small one of those of about $4 or $5 million.

Appreciate the answers. Thank you, David.

Okay. Lee, thank you. Next question, please.

Thank you. Our next question comes from [inaudible] of A.G. Edwards.

Good morning.

Good morning, David.

Quick question. I have been kind of hearing anecdotally that some of the pricing for some of the deals are getting done at pretty rich levels, seven or eight, maybe even nine times EBITDA. I was wondering if we were going back into a period of time when so much capital is coming into your market where the covenant trend is going against you and the amount of leverage getting put on deals is going against you and the pricing is getting high, kind of that irrational time period that we add few years ago. Can you comment on that at all?

Sure. I think if you look at the large middle market deals, the 200 million or, so you'd see rates, as I mentioned before, come down pretty dramatically. Also, the LBO funds are paying up. We're seeing those deals, not in our marketplace, the lower end, but the higher market we're seeing LBO firms pay six and eight times EBITDA which is relatively high compared to the last three years. Still not as high as the period of 1988, '89, when people were paying eight or ten times the earnings, the cash flow, the EBITDA, whatever you want to call it, and only putting up 10% of the equity in the deals.

Today's deals, I'm again talking about the very large transactions that might be at eight times EBITDA, they're borrowing through these syndicated loans and the high-yield marketplace, they're borrowing anywhere from four to five times EBITDA. We saw one the other day that was coming at 4.8 times EBITDA. We watched that marketplace trying to figure out what's going on in the larger marketplace as it may impact our marketplace.

Down in the lower end, people are still paying five times EBITDA, six times EBITDA in some cases. We just did one the other -- the one that we're trying to close on Wednesday where the LBO group is paying about 3.8 times EBITDA. So the deals in the smaller end are still reasonably priced but as we all know you a got to do a lot more of them. So the larger groups that are buying these large transactions are paying up pretty handsomely for deals at this point in time.

Now, it -- if somebody's paying six or seven times EBITDA and we'll still only lending at 3.5 times EBITDA that means they're putting about half of the dollars in, in equity, which is the case today. It's running although about 40% in the deals we're seeing, 40% from the equity guys. Now, I don't know how they plan to make a lot of money in terms of capital gins down the road, but we should be in good shape in terms of our lending multiples, and so from our standpoint, we're not taking any more risk than we did in prior years, but I think the L B O groups are now paying up because they've got so much money. Last estimate I saw was about a ten-year supply of equity in the LBO funds today and they keep raising more and more. I noticed Bonderman just raised $5 billion for his next fund, so lots of dollars out there. Texas Pacific is the name of that fund.

Lots of money out there chasing the larger deals, but thank goodness the small-deal marketplace hasn't exploded. It only exploded once before, and that was in 1989, just before the big crash, and then you had people reaching down to the smaller deals. We didn't see it in '89, '99 before this last crash came. We didn't see it coming down into the smaller vend the scale, and I don't expect to seat here, either.

Okay. Very good. One other question. I'll just kind of let you make a comment on this. I'm not sure if you saw where ISS came down on your proxy voting, and they had made a recommendation to withhold the election of John Outland, and it was related to the proportion of other fees relative to your audit fees. Could you just comment on that?

Yeah, David,'s a pretty sad thing. Our proxy was wrong. The fee amount was too much. It was a higher number than it actually was, and they were reacting to the fact that the typo was in there. Even though we sent them the correction and even though our lawyers looked at it and said, gee, it's not really a big major change in the proxy, so we'll see. Our shareholder meeting is today at 11:00. As soon as we finish here we're going to go upstairs and tell the same story to those ten shareholders who show up. So John Outland should not have been -- had ISS on top of him for that because it was a typo in the proxy, and we just missed it.

Okay. Thank you.

You're welcome. Next question, please.

Our next question comes from Henry Coffey of Ferris-Baker-Watts.

Couple of clarification points. Cozy paid off but you made a comment about ARI refinancing?

Yes, ARI paid off our original loan and then -- and the reason they paid it off is they had a merger between two companies, the one that was owned by the one large LBO group merged with one that was owned by another LBO group and the second group had very little debt on their company so the equity in the deal went up dramatically when the two merged, and after that merger, the senior lender, who was a very large, well-known finance company, decided that they would increase the loan and take out the subordinated debt, but they did leave in a small piece of last out traunche, as they call it, and we were invited back into that after it closed. It was about two months after it closed and we got paid off. We were invited back into take a small piece of that, so we ended up buying $5 million, a little bit of the senior, but most in that last in/last out traunche. That's how that came about. It came from a strengthening, a very much increased balance sheet and a strengthening of that company.

And you made a comment about outlook. Do you want to put in that terms of net investment income guidance or --.

No, we haven't been issuing any guidance. I think the street is pretty much on target, and our plans are to do a good job for you.

Thank you.

Next question.

Again, I'm going to go ahead and repeat the instruction. Again, if you have a question, please press the 1 key on your touch-tone telephone. I'm not showing any further questions, sir.

Well, that's great. Again, those of you who want to call and talk, we always try to do that for you, but I'm going to be leaving to go upstairs to our shareholders meeting in about 30 minutes, so I'll be out of pocket after that until after lunch. Thank you all for attending, and hopefully in next meeting we'll have some great news for you. Thanks again. Bye.

Ladies and gentlemen, thank you for your participation in today's conference. This now concludes the program. You may all now disconnect. Thank you, and have a great