Gladstone Capital Corp (GLAD) 2006 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Gladstone Capital December, 2005 quarterly call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference please press star, zero on your telephone keypad. As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman. Thank you. Mr. Gladstone, you may begin.

Thank you, Jen. This is the quarterly conference call for shareholders for Gladstone Capital. We thank you all for calling in. We love to talk to shareholders and give you all an invitation that if you're in the McLean area stop by and say hello and if you're at one of our offices go by and say hello to the folks there. You'll see a great team at work and I think they're the best in the business.

For those of you who are new this call is about Gladstone Capital. The Company has-- is a company that makes loans to small and medium sized private businesses. But before I begin let me read the forward-looking statement warning. This report that I am about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Security and 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 our current plans and we believe those to be reasonable. There are many factors that may cause our results to be materially different from any future results that are expressed or implied by these forward-looking statements including those risk factors listed under the caption titled "Risk Factors" in the 10-K filings, especially the one we just filed with the SEC. You can find those on our Web page at gladstonecapital.com and also on the Securities and Exchange Web page. The Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information or future events or otherwise.

The quarter ending December 31st was a very productive quarter for our Company in terms of strengthening the portfolio but poor in terms of the net loan originations. After the quarter end more loans closed but rather than summarizing let's dig into the details. Our loan production was below what we wanted for the quarter. We made loans of about 26.7 million in new loans and originations to four companies so our loan production was not what we wanted. During the quarter we spent a lot of time making the portfolio stronger and at the end of December our net asset value or our value increased in those loans by $4.9 million of unrealized appreciation so the time was well spent getting our portfolio in better shape.

During the quarter we did receive repayments of about $38.7 million of our loans and that includes normal amortization and prepayments and the sale of loans. There is some very good news in those payoffs and sales of loans. The loan we had to Finn Corporation had been marked down by Standard & Poor's as being only worth about $0.70 on the dollar or 70% of what we paid for it. During the quarter that loan was paid in full. The company is doing much better and their bank decided to advance more money so that Finn could pay us off. The IRR on that Finn loan was about 14%. We still have warrants to buy stock in Finn and we hope that that will be worth something in the next couple of years. I talked to management there a few days ago and they said they will probably do something with buying that warrant, not this year but maybe next year. That, of course, would drive up the total IRR for the total investment.

We sold our two loans in Marcal. We had a mortgage as well as a loan to the company. Marcal runs a large paper mill in New Jersey. We were in that with American Capital. They did not get paid off. They stayed in. We saw an opportunity to sell our position to another investment company and move on. We were just worried that the paper industry has so much capacity that if there's an economic downturn Marcal could have a problem. They seem to be doing fine now. We were happy with the situation but looking out in the future we're a little worried. The IRR on Marcal investment was 17.5%. That was a great deal for us and, as you know from the last call, we sold our note in ARI. We discussed that at the last meeting but that was a company that makes drive shafts and other under auto parts as they say. The IRR on that investment in the company was 12.3%. There was a series of loans. We had a much larger loan in the beginning. As they refinanced themselves and grew and bought other companies we were pared down to smaller and smaller position. Unfortunately we sold that loan at $0.72 on face value. While it produced great returns during the prior year, it yielded a loss in this quarter of about $1.2 million. The overall IRR on all those investments was 12.3% to us over the life of the investment. That was just about the worst deal we've ever had and quite frankly if all of our bad deals yield an IRR of 12.3% I'll be a happy man.

Payoffs and sale of some of our loans outpaced production and our portfolio did not grow but rather it was reduced by about $12 million for the quarter. At the end of the quarter our investments were about $192.6 million. That was the value and our cost was 192.2 so it's now our value is in excess of what we paid for them.

As you can see the portfolio has gotten very strong but after the quarter ended we did make about another $30 million worth of loans so the quarter ending March looks like it's off to a good start. We'll have to see how it ends up at the end of the quarter. For the record we've invested approximately $419 million since inception and have had exits or payoffs in loans in 22 companies. The average return on those paid off loans has been about 15%. That's before leverage at our Company so that's cash on cash. We certainly have never expected the amount of payoffs that we've gotten in these last few years. It has been quite a time to get so many payoffs that it has hurt our growth rate.

We have never had an investment that hasn't had a positive IRR and given the strength of the portfolio today we don't see anything on the horizon that would change that. Of course, there are no guarantees in life. Like everyone else these companies can develop problems. The program that we've set up on which we founded the Company of making good solid loans, first and second liens to companies, is working as we planned it. We don't feel the necessity to change our strategy at this point in time and for those people who want a very conservative portfolio of loans that perform very well over time this is the Company to own stock in.

Balance sheet is very strong today. We have approximately $55 million borrowed under our line of credit at December 31st. We have $155 million in equity so the leverage is less than one to one. Most finance companies are leveraged up two, three, or four to one and banks, of course, are ten or fifteen to one so it's a very conservative balance sheet.

Income statement, the numbers for the December quarter were behind our desired production level but we're building on strength now and I think the quarter ending March will show us some good results. For the December quarter, however, net investment income, which is the number before appreciation, depreciation, gains and losses and all those kind of things, that was about $4.4 million versus 4.7 million for the same quarter last year so we're a little bit behind because of all these payoffs. Net investment income is about $0.38 a share for the quarter and here we are talking about weighted average, fully diluted common shares and that we use in the per share numbers on our financial statements and that's what I'll be talking about as we go through these numbers.

Now I'd like to turn to unrealized and realized gain. This is a mixture of appreciation, depreciation and gains and losses. This is where we shine this quarter because the portfolio increased in value so much. For the quarter ending December unrealized and realized gains increased by about $3.8 million or $0.33 a share. This value is primarily determined by Standard & Poor's, which I feel is very conservative. I witness their depreciation of thin and then it getting paid off. Nonetheless, they do use a market test for what they think loans could be sold for and it's based on some 20,000 loans or so that they say they follow so even though they are very conservative, we still think they are very good in terms of doing our valuations. We are the only business development company that uses S&P on a direct basis to come in and value our loans. Other business development companies have various consultants like Duff and Phelps and S&P even and others like Houlihan Lokey, all good firms but they give some oversight to the valuation process as opposed to giving a specific value. S&P gives us an exact number for our loans and our Board has accepted the S&P number every time except one and that was the ARI situation, which we had sold before we filed the 10-K and so we made an adjustment down by a small amount. Shareholders I think do not have to worry about the inherent conflict of interest in our situation that is we're making the loans and then setting the value because we don't do that. S&P is the one that's setting the value for us so there that conflict of interest is completely removed in our Company.

Now turning to the bottom line, the net increase in stockholders equity from operation this term is a combination of net investment income and all of the appreciation, depreciation, gains and losses for the three months ending this number was $8.2 million versus 4.9 million last year at this time so this December quarter we are about $0.71 per share, per diluted share, versus last year's $0.43 per share. That's a very strong showing for the quarter.

Paid in kind interest, we continue to reduce that. It has declined down now so that we only have one loan that produced about $33,000 for the December quarter. I'm hoping to keep this at a very low number. We don't have any original issue discount income that runs through. Both of these are non-cash income items that we don't like to trigger. I know some other companies have large amounts of this but we are very comfortable having a very low amount of non-cash income. This is very important in our Company because all the BDCs that have non-cash income have to borrow money or raise equity in order to pay their dividend. We, on the other hand, are in a very conservative position that the money coming in is actually the money that we're using to pay out. All our companies are paying on time as agreed so the portfolio is very strong and money is flowing into our business that we can use to turn around and pay dividends and the value of our loans is now higher than the cost basis so this shows a tremendous amount of strength.

Our loan rating, this is our own internal system. The risk rating system used to set-- that we set on our loans was 7.1 for the quarter versus 7.0 for the last quarter. This risk rating system gives you a feeling of how we see our loan, our loan portfolio, versus the numbers that you see from Standard & Poor's and I think the risk rating here is relatively low compared to other situations we see out there.

The marketplace since I last talked to you the senior and sub debt marketplace for large middle market companies is continuing to be robust, a lot of money chasing deals. The large loan marketplace, which is run by Wall Street, money continues to flow in. Companies that can get a risk rating from one of the rating agencies have continued to get exceptionally good financing. Senior syndicated loans of 200 million or so are still getting LIBOR somewhere-- LIBOR plus 2% to 3% averaging probably 2.5 over LIBOR. LIBOR is running about 4.7% today and so if you add 2.5 to that they're borrowing on average at about 7.2% and debt money is very cheap for these companies and that's why the leveraged buyout marketplace continues to run. LIBOR traditionally has been 5% to 6%. We think it may move up to that range even if Alan Greenspan is out. It will probably move into that area and track and we hope it doesn't go up beyond that so companies will be paying 7.5-8% for their traditional financing. That's a wonderful rate and I think it will continue to show this economy the direction to go. It's a good marketplace out there right now.

The demand for loans in the big marketplace has continued to be strong and we see hedge funds continuing to do about 70% of all the transactions out there today so it's a solid loan marketplace. Equity marketplaces if they get stronger may pull some of that money away but right now we're not seeing it so demand for senior paper is high and demand for second liens is also very high. We continue to find a few loans there. I noticed one of the statistics that we haven't published any place so this will be the first time we announce it is that we looked at about 765 deals last year and ended up doing 50 in all across our Company so we saw a lot of transactions and that's quite a lot to take a look at.

The marketplace for small loans is continuing to see good growth. It's hard to find these good smaller loans but it's not as competitive as in the syndicated loan market place. Finding loans of $5 to $15 million continues to be a good place to be but also still competitive. The small marketplace, we really don't see the competition from banks. Where we see it is from the smaller lenders and investors that continue to step out and put money to work. There a number of mezzanine loans and small business investment companies that are out there in our space and our pipeline is very large. As I just mentioned the number of loans that we saw, at the same time there are still lots of people out there looking for loans so we continue to work hard to find the good loans to put on our books. We're seeing them. It's just that we're very picky in what we are willing to put on our books. We also are reluctant to do many fixed rate loans. We are still concentrating on variable rate loans. That way we can't be hurt by the Federal Reserve if they continue to increase the interest rates or if interest rates just go up in general. We're hopeful that the new head of the Fed will keep the rates lower but we are in a very strong position today. Currently we only have about $6.4 million of fixed rate loans. As most of you know, we have an interest rate cap in place today that will cover a small amount of our fixed rate loans. I think it's about $35 million in terms of the cap so we do have room to put some fixed rate loans on the books. We just haven't seen fit to do any of those. Hopefully we'll find a few more and put those on the books by say some time this summer.

Worries, we continue to worry about oil prices. They are still much too high. It's having a tremendous impact on the economy and we worry that that's going to stifle growth. And the money being spend on the war in Iraq is still hurting a lot of things. We support our troops in Iraq but the war is draining us tremendously and during this wartime we wish Congress would be a little bit more spendthrift in terms of the amount of money governments are spending today. Federal and state governments are just spending way too much money and it would be a good time to reduce spending but we haven't seen any action by Congress to act more responsibly in terms of reducing the amount of money that they're spending. All of this excess money that's being created is hurting the dollar and sometimes that's desirable. It does help our small businesses that are exporting overseas because it makes prices of our goods so much cheaper and helps some of the companies but most small businesses are not exporting so as a result it is not good for the small business in the United States.

The trade deficit with China continues to be just terrible. China continues to subsidize their industries to the disadvantage of our companies. We hope that somewhere along the way China will let its currency float and stop the subsidies and so as a result we'll have some ability to compete with some of the Chinese companies that have entered our marketplace in such strong numbers. Nonetheless the industrial base of the U.S. is continuing to strengthen. Small businesses have kept their costs low and profits are improving. Manufacturing facilities are not operating at full capacity and we see small businesses, most of them hiring people and building backlog so 2006 still looks strong.

We see a few cracks in the economy but they're not enough to worry about at this time. I do know that we're going to keep our shelf in place, our shelf registration. We anticipate that we'll update the shelf this year. We don't need money right now. Obviously we have lines of credit that we're using but we do like to stay prepared in case we need that.

Our dividend has remained steady at $0.135 cents per month. It's $1.64 run rate per year. Stock price is about a little over $20.50 yesterday so the yield is somewhere in the 7.9% range. It did trade down during the last quarter. We hate to see that doing-- that going on but as a result of some of the short sellers coming in and selling the stock I guess I should have expected it because after the call we got a flurry of phone calls from our friends in the business say that they were being asked to lend their stock. As you know, short sellers borrow stock before they short and we had a number of people coming in. The shorts borrowed stock way before several analysts called for shorting the stock and all that looks a little suspect. I've had several people ask me if that was really legal and as far as I know it is. It's just part of our free market system that shorts can come in and knock a stock down. The nice thing is that produces a great buying opportunity for shareholders today to buy the stock at a good price. And I would ask you please to go to our Web site and sign up for e-mail notifications. It will get information out to you and also we produce a little Newsletter. That Newsletter is on our management company's Web site or gladstonemanagement.com but do come to the Web site, gladstonecapital.com, and you will get information about the Company.

In summary I believe 2006 is going to be a good year for Gladstone Capital and I feel really good about the Board increasing the dividend again during this year. And with that, Jen, I will stop and I'll ask for some questions from our shareholders.

[Operator Instructions] Our first question is from John Maier with UBS.

Can you just talk about a little bit the credit of management fees which there was $550,000 and last quarter it was about 100,000? I realize it's hard to predict but maybe you could give me some insight into that?

Yes, what happens is we do charge structuring fees and those kind of fees come in and we had a good number come in during the quarter of things that we had raised money for and so as a result we credit those fees. The come into the management company, as you know, and we credit it against the management fee rather than having it into capital and going that route because management does-- the management company does do the work so we just had a lot more activity of things that we are doing and earned a lot more fees.

But there's no real way of predicting it so--?

No. I think as we get bigger, John, it will continue to increase but there's no way of sort of predicting that on a current basis. I know a lot of the other BDCs have huge amounts of those fees as they take fees out of these companies and I remember reading one that had as much as 20% of their income was from these kind of fees so they are hard to predict and certainly they are not reoccurring. They could stop altogether so that's the worry that we all have. Nonetheless it was a good quarter for fees.

Vernon Plack with BB&T Capital Markets.

One question as it relates to your new acqui-- your new companies. One is [Dillon Engles] and the other SCS Acquisition. Just curious, it shows that both of those companies in the description are in the chemicals business and I don't know if there's anything to be taken away from that in terms of a feeling for the industry or whether that's just a coincidence, just really interested in any color you would have on that?

No. No special color on that, they just happen to come in. One was a company that we liked. It was actually a company that just goes out and does nothing, a sponsor that does nothing but transactions in this area. We happen to work with them. They happened to find this one and we thought it was a great deal but you should not expect us to be a chemical company kind of investment strategy. It just happened to come at the same time. Next question please.

Rick Shane with Jeffries & Co.

Two questions, you'd given the statistics on where originations are quarter-to-date. Where are you in terms of prepayments quarter-to-date?

We don't have any unexpected prepayments in the sense that we've got regular amortization that comes in so we've got some amortization and it's relatively small. We don't-- most of our loans are low amortization kind of loans anyway so I'd say it's very little.

Got it and in your conversations with the portfolio companies are you expecting any significant prepayments in excess of amortization this quarter?

Well I have one company I know that is trying to get sold and so we'll get repaid on that one so expect at least one sort of normal sized, 5 to 10 million, but I don't have anything else that I know for sure is going to get done.

And is that loan being carried at par currently?

It is.

Got it and then the other question is in terms of the change to NAV due to the delta in unrealized gains and losses, how much of that was reversal of unrealized losses from previous quarters related to the sales you had this quarter? The total number was 4.9 million.

Right. Well, obviously the one at Finn was so that was one that had been depreciated so we got paid and that came back through and I think it's about 3 something-- 3.1 I think it is. We'll put that-- that's a good question and why don't we put that on the Web site under Q&A?

Okay great. Thank you very much.

[Operator Instructions] Scott Valentin with Friedman Billings Ramsey.

On the originations quarter-to-date so far, that 30 million, is there anything that carried over from the last quarter maybe that didn't close on time and as a result closed during the current quarter?

I think one of those was due to close at quarter end but I can't remember which one it is now. I know Dillon Engles got closed right at the end of the quarter but it seems to me there have been a few those that have over the-- Westlakes, one of the folks here sitting in the room with me says Westlakes was going-- that's right. Westlakes was going to close. I knew there was one. Westlakes was going to close in last quarter but closed in this quarter.

And secondly, with the shift in the management fee going to an externally managed structure can you talk about the cost impact on a go forward basis?

I don't think there is going to be any change and I've said that before. I think the base management fee is going to be about the same and you know we've talked about this in conversation that the big change here, of course, is the stock options will go away and so I think we've got about 12%-- maybe it's higher than that now-- of the stock under option so all of that overhang or possible dilution would go away. If you will remember in the proxy that was worth a very large amount over a period of time and in it's place will now go a sharing of the profit going forward and I just think that Company is going to be so much better off going down that route of not worrying about stock options, that stock options have become a big, big problem in terms of accounting and distribution and who gets them and how they are done. It just is a nightmare so we're very glad to go to the model that's used by Apollo and Aries and half a dozen others of the BDCs.

Mr. Gladstone, there are no further questions at this time.

Last chance for a question, anyone have one? All right, thank--

I had another question queue up from Henry Coffey with Ferris, Baker Watts.

Good morning. [Jason Phone] for Henry actually. We were wondering what trends you were seeing in any investment in loan quality?

Jason, it hasn't really changed that much over the last three or four years. The loan quality always is a function of multiples as well as operations and while operations have continued to get stronger over the period of time the multiples have gone up so the risk reward ratio hasn't really changed that much. What you've got is stronger companies that are borrowing more and that, of course, as you borrow more increases the risk but you've got more earnings for that so I would say our risk rating model that we use on a portfolio has changed very little. It's averaged in that 7.1-7.0, that same range over that period of time. That's our indication of what we think the risk rating would be and if you go back and follow that inside the Ks and the Qs, there's a chart that you can plot that on that plots close to what you'd see-- well I want to say S&P or Moody's would be in that range but we think we're similar to them, not exactly in any way exactly because they are a huge organization with a wonderful portfolio that they can measure things by and we're measuring ours based on our own understanding of our existing portfolio. But I think we're in that range and I think the risk rating that you'd see is very similar to what was in the portfolio even three years ago, four years ago.

There are no further questions in queue at this time.

All right thank you all. We appreciate it and, of course, we have Gladstone Investment tomorrow at 9:30 so people who want to hear about that one please dial in. Thank you all and this meeting is adjourned.

This concludes today's conference. Thank you for your participation. You may disconnect your lines.