Gladstone Capital Corp (GLAD) 2005 Q2 法說會逐字稿

Later we will conduct a question and answer session and instructions will follow at that time. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's conference, Mr. Gladstone, Mr. Gladstone, you may begin your conference.

This is the second quarter call for Gladstone Capital. Since this is a conference call, I need to read the warning about forward-looking statements. This report that I'm about to give may include statements and may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities 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, even though they are based on the Company's current plans and are believed to be reasonable as of today. There are many factors that may cause the Company's actual results to be materially different from any future results expressed or implied by such forward-looking statements, including the factors listed under the caption "Risk factors" of the Company's 10K filing, as filed with the Securities and Exchange Commission and can be found on our Website at www.gladstonecapital.com. The Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Well, the quarter-ending March 31, 2005 was a good quarter for our Company, but it could have been better. Loans and investments, we had a good quarter. In terms of loan closings, we invested about $44 million in new loans during the quarter to ten companies, so, production was good. During the quarter, we got repaid, however, by $34 million and after the end of the quarter, we invested in three loans, about $16 million and were paid back about $400,000 after the close of the quarter. We all hate getting these payoffs from good companies but it does give validation to our program and shows that we've picked some pretty good companies. Love those prepayment fees and success fees, but assets - - the asset now has to be replaced. For the record, we've had about 17 companies pay us off since inception. Average return from those loans and investments have been about 19%.

No losses to date and don't see any on the horizon. So, the program we set up seems to be working. So, no reason to change the plan. March 31, 2005, we had about $178 million in loans versus 146 million six months ago. The numbers for the quarter ending March are fine. The quarter ending June is off to a good start. Net investment income, which is before appreciation, depreciation, gains or losses for the quarter ending March 31, were about $4.4 million versus 3.1 million for the quarter last year. Net investment income was about $0.38 per share.

So, we continue to grow and just need to put a few more loans on the books to grow the earnings faster. I'm pleased to remember here, that we're talking about weighted average diluted common shares when we use these per share numbers. For the six months ending March 31, our net investment income was 9.1 million versus 6.1 million for the six months last year. So, for the six months we had about $0.78 per share in net investment income. So, it's been a good first half for earnings. Net investment income is the number that we use to pay out our dividends and distributions to shareholders. So it's the most important number to look at from that standpoint.

Now I'm switching to unrealized and realized gains. This is the mixture of appreciation, depreciation, gains and losses. This total was down by 155,000 for the three months but up for 112,000 for the six months. Not much to talk about on such a size portfolio that we have. Companies are paying as agreed and we believe there is no reason to worry about payments to date. That we have only one loan that was written down and - - by Standard and Poor's. That was Finn and we accepted that S&P valuation.

Another one written down as of December was Inca. It was down by about 250,000 but that loan paid off during the quarter ending March 31. So, we got all of our money back there plus interest. And this is not a slam at S&P, they're a good conservative group, their valuations of their loans are quite detailed. It just is to say that they're using a market test based on the loans that they see, they follow some 20,000 loans and that's what they thought it would sell for. And we were lucky enough to get it paid off and that's all out of the way now. The bottom line is that this term they call, net increase in shareholders equity from operation and this term is a combination of net investment income, appreciation, depreciation, gains and losses. And for the six months number, this was $9.2 million versus 4.2 million versus last year at this time.

So, this year we're at $0.82 per share versus last year's $0.42. So, it was a good six months. Our portfolio and the valuation, all our companies are paying on time as agreed. The portfolio keeps getting stronger as the economy gets better. The value of our one loan that was a little lower stayed about the same from this quarter versus last quarter. We're not happy about that devaluation, but I think that company, called Finn, is now looking much better. And when you have a group as prestigious and as strong as S&P, you hire them to value your portfolio, you need to accept all the values, not just the ones you like or don't like. Our Board has accepted all the values that S&P has put forward so far the Board is in agreement with Standard and Poor's. One note here, S&P values our loans at what they think they should sell for, based on their analysis of our loans. And on the other hand, our warrants or other equity kickers are valued based on what we think someone would pay us for that security. And that is, in turn, based on what the business would sell for.

So, there's almost two different approaches going on here. One, there is a valuation system for loans and one for equity. As you can imagine, loans and equity do need to be valued differently. Since about 98% of all the assets we hold are in loans, it's pretty much a moot point about what the valuation policy is for our equity positions. If you look at the way we look at our loans today: If the business was sold, our loans would be paid in full. So, if we use the sale price of the business to value our loans, then all our loans would be valued at par. But we don't own these companies so the value of the note has to be set by the marketplace as interpreted by S&P. However, when we value the equity, the value is set by the marketplace but that value implies a value of the entire business, less some discount for minority position. And we look at that value of the business in order to determine the value of our warrant or success fees, what we call our equity.

And that's how we go about the mechanism of doing that small amount of equity that we have in these companies. Our loan ratings on our portfolio remain the same, 7.2 for this quarter, versus last quarter. This is our risk-rating system that we set up with the help of a number of groups, including S&P. The feeling here is that our portfolio has not changed in risk profile. The probability of default is still relatively low at 7.2. We're quite happy with the portfolio, both the existing loans and the new ones that are coming on. All are paying on time and we don't have any defaults. We only had that one loan that gave us some worry last quarter and that was Inca and it paid off. And so our portfolio, as far as we're concerned, is much better today.

The marketplace, well, since I talked to you, the senior and sub-debt marketplace for large and middle market companies has continued to be very strong. The larger loan marketplace is capital markets run by Wall Street. The money just keeps flowing into that marketplace and companies that are getting ratings from the rating agencies have continued to get good financing. Seniors syndicated loans of $200 million or more, rates continued to be strong at 2% or 3% over LIBOR. LIBOR is the London interbank rate in a bank rate, which is recognized as a leading indicator of short-term rates. And LIBOR today is about 3.2, 3.3%. So, when you add that to the 2.5% spread that bars having to pay, they're getting money at about 5.8%, which is pretty cheap money by historical standards. We all know that that's going to change and it will go back and LIBOR has traditionally been 5%, 6%. So, businesses probably in the next year or so will start to pay 7%, 8% for their money, which is in line with historical standards. And that's all for the larger companies that we help finance sometimes.

The smaller companies that we are heavy in, their loans are a world of difference from the syndicated loan marketplace. There's no pressure from syndicated loans there, it's hard to syndicate anything less than $100 million. And we're making loans in the range of $5 to $15 million. So we don't see a lot of competition from any of the major capital marketplaces. Some of the banks are beginning to look at the marketplace but given the regulatory environment, we don't think we will see them there. We are avoiding fixed rate loans and are concentrating on variable rate loans. We don't want to get hurt by the Federal Reserve when they increase interest rates.

As many of you know, we nut place an interest rate cap in place to cover these fixed rate loans. Some people call this a derivative and it does show up on our income statement as a change in value of the derivative. So, our fixed rates are capped. Our new loans are variable. So, we don't worry a lot about what Mr. Greenspan may do with interest rates. We just hope that he doesn't increase them so fast and so high, like he did last time, that he'll kill the economic recovery that we've got going so well right now. From the standpoint of our portfolio companies, what we worry about, what we continue to worry about, the cost of oil. It has a rippling effect all through the economy. We see it in other commodities, as well, such things as copper and cement are all creeping up in price. So, there is inflation coming in the economy. And that's worrisome.

Also, the amount of money being spent on the War in Iraq is certainly hurting our economy and one thing that we rail against a lot is the pork barrel spending by Federal and State Governments. It's just over the top these days and when you have a war like the one we have in Iraq, we'd expect Congress to be fiscally responsible but they continue to spend. And all of this excess money that they're creating goes to T-bills and dollars and there are just too many dollars chasing buyers out there today. And given the number of buyers for the dollar, it continued to decline. It's just less desirable currency and it's going to continue to sink. From our standpoint, that's relatively good for some of our small businesses that don't have to buy from outside the United States but have some sales to customers outside the United States. That means that their prices are lower and so, as a result, they get a little bit of pickup from that. But that's not enough to put a lot of money on.

The trade deficit with China and Asia, in particular, is just terrible. It's hurting a lot of the small businesses. China, of course, is not letting its currency float in value and, therefore, they continue to subsidize their industries with this artificial currency conversion that they have. I don't expect it will be easy for them to let go of that, but it's just a killer right now. I'm sure there are large retail giants in the United States, are lobbying Congress not act on this. Retail giants get 80% of their products from China and Asia. So, they don't want to see the cost of goods rise. If China does let the currency exchange rise, it would encourage retail giants to buy from American manufacturing companies like the small businesses that we finance. So, we're hopeful that our Congressmen and Congresswoman will get some backbone up and stand up to the lobbyists and jaw bone the Chinese to let that currency float. It would be very good for the American marketplace.

Our marketplace, on the other hand, loan demand is strong. We see lots of people in the marketplace for the larger loans like hedge funds and bond funds. Good loans are still hard to come by. We've seen a little bit of crack in that marketplace as some of them begin to move out of the marketplace. I think demand will recede for - - and therefore it will be good for us in the senior and second loan marketplace. The small loan marketplace, which we're also heavy in, see some competition from banks but as I mentioned, it's not a lot. Small loans have a risk profile that most banks are not interested in. And giving our expertise in underwriting these small loans, we can compete very favorably with them. The mezzanine loan, there are about 100 mezzanine funds out there and we see them scrambling for loans, as well. And so we are competing with them from time to time. And we don't have a lot of problem competing with the mezzanine loan funds for a good, strong loan.

Our pipeline alone it's just very strong today but we don't reduce our criteria for loans. We're very fixed on fundamentals that we use to analyze these businesses. And we certainly don't intend to change our standards in order to make our loan production volume greater. Our goal is to be the strong and profitable Company, not the biggest Company and so we will continue to stick to our knitting on that. The industrial base for the U.S. is continuing to get stronger. We see it every day in the small businesses out there. They've kept their costs low and their profits are getting better. They're not full at all in terms of capacity. They're hiring people, they're building backlog. 2005, I think when we look back at it, will be one of the strongest years in - - that we've seen in a long time.

Just so you know, we will be updating our shelf offering. I don't need any money today. We don't need it for the immediate future, but we like to keep that thing updated so you will probably see that filing go in the next couple of months. Securitization: We have engaged our lawyers and told them to put together the securitization documents so that we can use that as a mechanism for financing. I hope that will happen this fall. So, stay tuned on that front. And you can keep up with things that are going on by going to the Website and signing up for our e-mail notification. We don't send out any junk mail, we don't sell your name to a junk mail users. So, sign up there and you can keep up with us.

In summary, I believe 2005 is going to be a good year for this company. We've increased the monthly dividend from $0.12 to $0.13. That's an 8.3% increase. So, our run rate is now $1.56 a share. Those who purchased the stock back at the offering date are now enjoying a - - about a 10.4% return on the stock and it's trading at about 22. So, not bad for a start-up in the middle of a terrible recession. We just need to hire more people and grow the assets. With that comment, I'll turn it back to get us on the question and answer. Go ahead.

Thank you, Mr. Gladstone. [ OPERATOR INSTRUCTIONS ] Our first question comes from Joel Houck of Wachovia.

Thanks, good morning, David.

Good morning, Joel.

My question really has to do kind of with the new fund you're starting up, Gladstone Investment Corp. and how - - is that going to be different than what we have here? Are there going to be different aspects of the markets you're going to tackle? And then in kind of a follow-on on that, David, is you guys have done a good job in terms of investment performance in credit quality, but repayments have obviously been pretty high. Does that mean, in conjunction with the new fund, that perhaps you wouldn't raise more equity for Gladstone Capital and just kind of leverage the business and run it more like an annuity until, you know, the environment gets better and more conducive?

Well, as you can imagine, Joel, I can't talk at all about the new fund until we become - - and we will probably have a press conference just like this so we can introduce the new fund and talk about it with regard to Gladstone Capital. So, I'm going to skip that question if you don't mind and talk about Gladstone Capital. And Capital doesn't have any intention of slowing down. It's in a different marketplace than the investment Company. And so, as a result, there is really no overlap and we should be able to grow the assets at the same pace that we projected. As far as being flat and running it like an annuity, I can't imagine doing that. That would be the antithesis of what we do. As far as credit quality; I think the credit quality, because we're so overwhelmingly oriented toward high credit quality, it does predict repayments. Because if you have good credit quality, a good company after a couple of years of paying our higher rates, can usually find somebody at a cheaper rate and that's to be expected. We have had an extraordinary amount of repayments based on our original projections. But I think the repayments just validate our whole concept of what we're doing. So, from our standpoint, the credit quality, we're not going to lower it in order to grow the assets faster. Nor are we going to sit back and sort of watch the assets perform. We're going to continue to add to it. And I would expect the asset growth to be pretty strong over the next six months, certainly the next year. Sorry I can't answer about the new fund.

I understand. You mentioned a 19% return to date, I guess, on your investments. Is that like a compound IRR?

Yes, that's exactly what it is. We do an IRR analysis every time we exit one of these and then we average it out. We've done very well.

That is good. Okay, thanks, David.

Okay, next question, please?

Our next question comes from Richard Shane of Jefferies and Company.

Hi, David. This is actually Dan Fannon. I wanted to talk about - - you mentioned hiring additional employees; I wanted to see, what that meant for infrastructure and what that meant for deal activity going forward? Are these going to be more senior-type level people that are going to help bring in the transactions or more junior people to kind of build out your infrastructure?

Well, it's really both. We moved from the old location where we were pretty much constrained about a month or so ago. And we're in a new slot now. We've got room for about 60 people here. We've only got 25 in the Company today. We just hired -- signed up two new analysts during the quarter. And the - - one of those - - one is already started and the other is starting on Monday. And we are interviewing managing directors as we call them and - - who are deal doers. We have a couple of those folks who are - - I guess we are pretty far along in having them come on board. So, the idea is to bring on more people, build the Company up over the next couple of years so that the amount of new deals getting done every quarter is double where it is today and continues to grow the asset base. So, that's our goal, Dan.

Okay, great. Thank you.

Next question?

Our next question comes from Vernon Plack of BB&T capital markets. Hey, good morning.

Most of my questions have been answered, just one follow-up. Is there any flexibility - - do you see any flexibility, perhaps, into having higher prepayment fees given the level of repayments that you're seeing?

Yes, it's always a fun thing to renegotiate, is prepayment fees. We have prepayment fees and they're relatively high, compared to the marketplace and we stand pat on that. And we get - - these payments come - - and these payoffs come and the prepayment fees are very nice to have. But if you're paying somebody 7, 800 over LIBOR and you can refinance yourself with the bank you've already paid down, it's just good business for them to do that. So, I just don't think over the next six months we're going to have as many prepayments as we've had in the past. But you just can't count on that. We will just continue to play it the way it's rolled out to us. And yes, prepayment fees are lovely and we get nice fees but they still get prepaid. You can't really tell somebody they can't pay you back when they're paying the rates that they're paying. So, we make it expensive to repay but it doesn't stop the prepayments.

Thank you.

Any other questions?

[OPERATOR INSTRUCTIONS] I'm showing no other questions at this time, sir.

All right, one last question, anybody have one last?

I'm still not showing any other questions.

All right, well we'll end the conversation right here. We thank you all for tuning in and hopefully we will be talking to you in another three months. Bye-bye.

And again, ladies and gentlemen, if you would like to listen to the replay of this call, you can dial 1-888-266-2081. The code is 694148 and it will be available May 10, 2005 at 12:30 p.m. until June 9, 2005, 11:59 p.m. Thank you and this concludes our conference. You may disconnect.