Gladstone Capital Corp (GLAD) 2011 Q1 法說會逐字稿

Good day and welcome to the Gladstone Capital first-quarter shareholders' conference call and webcast. All participants will be in a listen-only mode. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to David Gladstone. Mr. Gladstone, the floor is yours, sir.

Well, thank you, Mike. Thanks for the nice introduction, and hello and good morning to all of you. This is David Gladstone, the Chairman, and this is the quarterly conference call for shareholders and analysts of Gladstone Capital, trading symbol GLAD.

Again, we thank you all for calling in. We are so happy to have the time with shareholders. We wish there was more of these, but we only do them once a quarter. We hope all of you take the opportunity to visit our website at www.gladstonecapital.com, where you can sign up for e-mail notices so you can receive information about us on a timely fashion.

And please remember that if you are ever in the Washington, DC, area, you have an open invitation to stop by and see us here in McLean, Virginia. We are here in the suburbs of Washington, DC, and I think if you'll stop by, you will see some of the finest people in the business.

Now I need to read a statement about forward-looking statements. This conference call may include statements that 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 that, even though they are based on our current plans, we believe those plans to be reasonable. There are many factors that may cause our actual results to be materially different from any future results that are expressed and implied in these forward-looking statements, including those factors listed under the caption "Risk Factors" in our 10-K and 10-Q filings and in our prospectus that has been filed with the Securities and Exchange Commission. And all of those can be found on our website at www.gladstonecapital.com and on the SEC website.

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.

As always, we start with our President, Chip Stelljes. Chip is also the Chief Investment Officer for all the Gladstone companies. He will cover a lot of ground, so, Chip, why don't you start off, please?

Thank you, David, and good morning. We are still finding the economics and small business lending climate to be difficult, but it is getting better. We are seeing some new investment opportunities and have a number of proposals out to companies.

We did close five new investments during the quarter for an aggregate amount of $9 million, and we invested $2.8 million in existing portfolio companies in the form of additional investments or draws on revolver facilities.

During the quarter, we received repayments of approximately $13.2 million due to payoffs, normal amortization and paydowns of revolvers. This included the full payoff of Puerto Rico Cable of $7.1 million and Interfilm Holdings of $2.4 million. So in total, we had a net production decrease in our portfolio of about $1.4 million for the quarter. We used the net proceeds to pay down our line of credit.

Since the end of the quarter, we made about $2.7 million in additional investments in existing portfolio companies. Additionally, after the quarter, we received $11.4 million in repayments, which included amortization in $9.4 million payoff from one company, which was Pinnacle Treatment Centers. At the time of this call, the amount we owe on our line of credit is $6.6 million.

As for the pipeline and outlook, we continue to see new investment opportunities. We have availability on our line and are actively seeking to make new investments.

At the end of the December quarter, our investment portfolio was valued at approximately $253 million versus a cost basis of $297 million. So the value based on our valuation of the portfolio is approximately 85% of cost.

At the end of the quarter, we had loans with six companies on nonaccrual, and a number of companies experiencing problems that may prevent them from making timely payments in the future. We've taken operating control of several of these companies, including taking control of our largest portfolio company, Sunshine Media Holdings, by purchasing the majority of the common stock in January 2011 for $1.5 million. We are working hard to fix the problems and improve profitability of all these companies.

On a dollar basis, the loans classified as nonaccruing had a cost basis of $30.4 million or about 10.3% of the cost basis of all loans in our portfolio. From a fair value perspective, the nonaccruals' fair value represents 3.2% of the fair value basis for all loans.

We continue to have a high concentration of variable-rate loans, so that we should have higher income when interest rates begin to increase. And while our rates are variable, they often have a minimum interest rate or a floor so that declining rates are mitigated. Approximately 84.7% of our loans have floors. However, 5.6% of our loans do not have floors, and with short-term floating rates at all-time lows, we are generating less income. The remaining 9.7% of our loans have fixed rates.

Another measure of the quality of our assets is that our average loan rating for the quarter that just ended remained relatively unchanged. Our risk rating system attempts to measure the probability of a default with a portfolio by using a zero-to-10 scale, zero representing a high probability of default and 10 representing a low probability.

Our risk rating system for our nonsyndicated loans, which constitute over 92% of our loans, showed a weighted-average rating of 6.5, up from 5.9 during the prior quarter. As for our rated syndicated loans, they had a weighted average rating of B/B2 for this quarter, down slightly from a B+/B2 during the prior quarter.

In addition to the quality of assets, the quality of the income continues to be good. As we discussed before, we try to avoid income generated from paid-in-kind or original-issue discount structures. These generate noncash income which has to be included for book and tax, but is not received until much later, and as we all know, sometimes not at all. This type of noncash income is subject to our 90% payout requirements, so we would be paying out cash that we had not yet received.

The senior and second-lien debt marketplace for larger middle-market companies continues to improve. At December 31, we had a cost basis of approximately $18.7 million in senior and second-lien syndicated loans.

The market for loans to companies at the lower end of the middle market in which we invest most of our capital is seeing more competition. Most banks continue a policy of tight credit standards, especially for the companies at the lower end of the middle market. Currently, most banks are making really asset-based loans, although we are seeing an increase in nonbank lending.

Net of all these conditions, we still feel we have a market opportunity. Our loan request pipeline is still full, and we should be able to show you some good investments over the next six months.

And with that, I will turn the presentation back to David.

All right. Thank you, Chip. That was a great report. Now let's turn to the financials, and for that, we will hear from David Watson, our Chief Financial Officer. David Watson, go ahead.

Thank you, David, and good morning, everyone. Before I go through the financial statements, I'd like to highlight a few key points for this quarter.

First, during the quarter, we made five new investments and exited from two investments. Our goal is to continue this increased investment activity.

Second, on November 22, 2010, we amended our credit facility. In effect, the interest rate, subject to a 1.5% LIBOR floor on advances, went from 6.5% to 5.25%, a decrease of over 19%. The undrawn commitment fee is between 0.5% and 1%, depending on how much is outstanding at any given time.

Additionally, we are no longer obligated to pay an annual minimum earnings shortfall fee to the committed lenders, which resulted in the reversal during the current quarter of $0.6 million in estimated shortfall fees previously accrued in prior quarters. We paid a 0.5% amendment fee on the commitment.

Third, at the time of this call, we have $6.6 million borrowed on our credit facility, so the availability on our line gives us the ability and the flexibility to deploy more capital for the right opportunities.

And now for the details, I will start with the balance sheet. As of December 31, we had $275 million in assets, consisting of $253 million in investments at fair value and $22 million in cash and other assets. We borrowed $25.3 million on our line of credit and had $247 million in net assets. Therefore, we are less than 1-to-1 leveraged.

This is a conservative balance sheet for a finance company, which are usually leveraged much higher. So we believe that our overall risk profile is low.

Moving over to the income statement, for the December quarter, net investment income was approximately $4.6 million versus $4.4 million for the same quarter last year, an increase of 4.7%. The increase was primarily due to lower interest expenses because of lower borrowings outstanding and the reversal of related fees during the current quarter, as previously discussed, partially offset by a decrease in interest income resulting from the reduction in the size of the Company's investment portfolio subsequent to December 31, 2009.

On a per-share basis, net investment income for the quarter was $0.22 per share as compared to $0.21 for the same quarter last year.

Let's turn to realized and unrealized changes in our assets. Realized gains and losses come from actual sales or disposals of investments. Unrealized appreciation and depreciation come from our requirement to mark our investments to fair value on our balance sheet, but the change in fair value from one period to the next may be recognized in our income statement. Unrealized appreciation and depreciation is a noncash event.

For the December 2010 quarter end, there were no realized gains or losses. For the December 2009 quarter end, there was $0.9 million in realized losses related to the sale of two syndicated loans.

From an unrealized standpoint, for the December 2010 quarter end, we had net unrealized depreciation of $2.9 million over our entire portfolio. The decrease was primarily due to depreciation and the debt of certain of the Company's portfolio investments, most significantly Sunshine Media Holdings.

Our entire portfolio was fair valued at 85.1% of cost as of December 31, 2010. The cumulative unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders. It does indicate that the value is lower and there may be future realized losses that could ultimately reduce our distributions.

During the quarter, we had another component of unrealized depreciation, which related to the fair value of our credit facility. For the quarter ended December 31, we recorded an unrealized depreciation of $0.4 million, primarily based on estimates of value provided by independent third party. On our balance sheet, as of December 31, we had a cumulative net unrealized appreciation on the line of credit of $0.7 million, down from $1.1 million at September 30, 2010.

Our bottom line is the net increase to net assets from operations. This term is a combination of net investment income, unrealized net appreciation or depreciations, and realized gains and losses. For the December 2010 quarter end, this number was an increase of $2.1 million or $0.10 per share versus an increase of $6.3 million or $0.30 per share in the prior year's December quarter.

The year-over-year change is primarily due to the $2.9 million in unrealized depreciation in investments in the current quarter when compared to the $2.6 million in unrealized appreciation recorded in the prior-year quarter.

While we believe our overall investment portfolio is stable and continues to meet expectations, with continued investor uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of the portfolio.

And now, I will turn the program back over to David.

All right. Thank you, David Watson; that was a very good presentation.

I do hope all of the listeners out there will read our press releases and also obtain copies of the Quarterly Reports, called a 10-Q. And we just filed that yesterday with the SEC. And you can access all of that, plus press releases and the 10-Qs, on our website at www.gladstonecapital.com and also on the SEC website.

I think the big news for this quarter is we continue to make progress with our portfolio companies. They are getting stronger as the economy gets better. We also added a few new investments to the portfolio of our loans. And some of these were syndicated loans.

You'll note from the presentation that one of these last syndicated loans that was purchased before the recession paid -- had paid off in full, and that was Puerto Rico Cable. It was valued at about 80% of par in September 2009 and then 90% of par in September 2010, and now it is paid off in full at par.

I think this exit demonstrates the ability to pick good investments. And we all still believe that if Deutsche Bank had renewed our line of credit, we would've been paid back with interest, and just from our syndicated loans, and like the example above, rather than having to sell them at a loss in the spring of 2009 and pay off Deutsche Bank line.

It was also reported that the US Federal Reserve purchased $280 billion of poor loans at par from the Deutsche Bank to keep them afloat during the recession. So while the US taxpayers were bailing out Deutsche Bank, that bank still felt the need to liquidate our line of credit, caused us to have a big loss in the sale of our syndicated loans.

It's really too bad the Fed wouldn't buy some of our loans and bail us out the way they bailed out the bank in Germany, the Deutsche Bank. But we've recovered from all of that. That's the end of a very bad chapter for us. And we are finished with that and looking for positive now. And the positive I think for this quarter is that our backlog of opportunities to lend money is increasing. It seems to be increasing every month, and I think it will continue through this year.

We do have plenty of room to borrow on our line of credit. We only owe $6.6 million, have $127 million, so we should put $50 million, $75 million on the books before we need to raise equity or debt or some kind of long-term credit. So there's really plenty of room to grow, and we are dependent on Chip Stelljes and his team to put those deals on the books.

Our biggest challenge today is long-term debt. The long-term debt marketplace for our Company is not good. We are a small business compared to many of the big borrowers.

We have a line of credit with supportive lenders. They are great lenders on our line of credit, and it's working fine, and we believe it will be sufficient for the near term. But we're going to have to find long-term solutions for our Company. In order to make a lot of long-term loans and investments, we're going to need to raise long-term debt or long-term capital such as the issuance of preferred stock.

Our new investments that are long term are going to need to be matched up with long-term liabilities. We just can't rely on the short-term lines of credit for our Company.

So we are talking with some very interesting insurance companies. And we are not there yet with them. And even though this problem hasn't been solved -- that is, the long-term debt problem hasn't been solved -- we will continue to look for solutions. And I feel very confident that we are going to find a long-term debt solution in the near term.

As for our portfolio companies, we worry, too, that they are not able to get long-term senior loans that they need. There's a fair number of regional banks around that make new loans based primarily on assets of the business. And these asset-based lenders are certainly more plentiful today than they have been in the last few years. And I think they will take care of all the short-term needs of our portfolio companies. But we do need long-term loans for them as well, senior debt. And I think the banks are going to come around this year. They are just not there yet.

We do still have the same worries that I mention on almost every phone call -- that is, oil prices going up. The prices have been going up over the last 90 days. And we are all worried about inflation. The politicians in Washington continue to expand the money supply, and that will probably cause a lot of inflation as time goes on.

The government is projected to issue trillions of dollars more in T-bills, and the government tends to be, right now, sopping up all the available lines of credit in order to finance its growth in the money supply.

Spending by the federal government is continued off the charts. The so-called stimulus packages, they are just filled with spending goodies for many of the supporters of the legislators. We are hoping that they will do away with some of this kind of stuff with the new legislation -- new legislators that we have on board.

The amount of money being spent on the war in Iraq and Afghanistan continues to hurt our economy. All of us here at the Company certainly support our troops; they are the true heroes. They lay down their lives and risk them every day for us, and we are hopeful of their safe return.

All of this spending will mean more taxes. And I just don't know how people can handle more taxes, given the situation that we are in today. It will certainly cause much more dislocation in the economy. And the government will have to sell much more debt to cause inflation. It's just going to continue as far as we can see.

The trade deficit with China and certain other nations is just terrible today. China continues to subsidize their industries to the disadvantage of our businesses. They have huge subsidies for oil and gas in their country. This means our companies can't compete with them for jobs, for products. And so the jobs leave the United States and go to Asia. And now I've been reading, for the last two months, China has even stopped buying our government paper.

The downturn in the housing industry and the related disaster in home mortgage defaults continues to hurt the economy. I don't think anyone knows how many home mortgages will ultimately fail, but some of the estimates put it in the trillions of dollars. And that was the main cause of the recession, and I think it's continuing to hold us back.

In spite of all the negatives that we run into, the industrial base and many of the small businesses out there today are certainly not in a disaster mode anymore. The lingering recession is having an impact on our portfolio company, but it's not the disaster that all of us expected. Like most companies, some of our portfolio companies have not seen an increase in revenue or backlogs. However, some of them are seeing tremendous good increases, and I think there's a lot of good news in the economy today.

We certainly believe that the downturn that began in late 2008 will continue into 2011. However, I think the economy has stabilized. And if that's true, I think we can take advantage of it, and this will be a great time for us over the next couple of years.

We are not considering issuing any common stock at this time because the stock price is still much too low. We've got plenty of room on our line of credit, probably $120 million worth of borrowing capacity on the line.

Just to turn now, our distributions are still $0.07 per share per month. We paid that in January, are going to pay it again in February and March. So that is in a good position. And at that distribution rate, the dividend, with the stock price at about $10.99 as it closed in yesterday, the yield on this distribution is now very high. It's at 7.6%. And with the NAV now at $11.74 -- we are trading at about 94% of NAV -- I just think this is an incredible buy, given that the Company is very underleveraged in terms of the amount of money that we have borrowed from the banks.

Please go to our website, www.gladstonecapital.com, and sign up for our e-mail notification service. We don't send out any junk mail, just news on your Company, so sign up if you would, please.

And in summary, as far as I can see, the economic conditions that we are looking at today have changed to the positive. We think the economy has reached bottom. We will start to gain strength over time.

I think the next two quarters will be very telling as to how fast it's going to change. And we are certainly stewards of your money, and we're going to continue the course that we are on today, which is to be very conservative in investment approach until we can get a better fix on which way the winds are blowing in terms of the economy.

We invite you all to come to our shareholders' meeting. It's on February 17 at 11AM at the Hilton Hotel in McLean, Virginia, 7920 Jones Branch Drive. If you are not coming, please vote your shares using your proxy so that we can get the votes in. You can vote by proxy, just mailing in the proxy card. You can also vote by calling an 800 number. It's 800-690-6903. But you'll need your proxy card in front of you at the time, because they're going to ask you for your proxy control number.

Another way to vote is to go to a website called www.proxyvote.com. There you can vote online by using your proxy control number again. Also, if you need to vote, you can call your broker, and your broker can help you make that vote as well.

I know you all know this, but I want to mention it again. Recent regulation changes made voting of shares a very difficult matter. The government now requires that shareholders of a stock actually vote the shares, and your broker can no longer vote the shares for you, so you have to do the duty of voting your shares.

As a result to your fund, to round up the votes by calling all of you is very costly today. And it takes a lot of time and attention. And so please vote your shares so that we can move this along. It just takes away dollars that we could pay out in dividends to shareholders to go through this.

And, oh, before I forget, some of the folks have been asking if I'm buying shares in this Company, and the answer, of course, is yes. But I buy them through the dividend reinvestment plan, or as it's known as the DRIP. And that doesn't show up in the quarterly filings.

So we are now filing at the end of each year an update to my holdings each year. For example, we filed a Form 4 last week showing that I had purchased during the year 23,326 shares of Gladstone Capital during 2010, now, using the DRIP plan again, and that had a value of about $250,000.

So, yes, I keep buying the stock. I'm just buying it through a way that doesn't show up in the data that's out there today.

So, okay, let's stop here and open it up, if, Mike, you'll come on, and we will have some questions from analysts and shareholders.

(Operator Instructions). Troy Ward, Stifel Nicolaus.

I'm going to ask a couple questions, and if the operator could put me on mute afterwards, because I've got a lot of background noise at my location. Just real quick, two topics, David, on Sunshine Media and then on the syndicated loans.

Can you just give us an update on Sunshine Media? You had made the comment that you bought the equity in January of '11. And just talk about the valuation as of December 31. I'm assuming all of that was kind of already baked into that valuation. Obviously, the pieces are going to change.

And then also, on the -- it looks like you have two pieces of senior term debt. One of them is a last-out senior. Is it only behind the other piece that you hold? I guess how much other senior debt is in front of that last out, other than what I see on your balance sheet?

And then secondarily, on the syndicated loans, can you just talk about the opportunities you are seeing? I mean, it seems a little counterintuitive, based on where the high-yield market has gone and kind of the running of the assets, that you are finding your best opportunities in syndicated loans versus smaller, one-off kind of deals.

So if you could address those, I would be grateful. Thank you.

All right, Troy, thank you for the question. Chip, you want to answer that question on Sunshine?

Sure. Sunshine Media, there's a couple questions in there. First of all, the situation itself was one where we got a strong management team. It was a company that was already in a business model transformation. As you may recall, this company had some advertising exposure or revenue exposure and had some real estate advertising exposure.

So this business model was changing anyway. We got a very strong management team there. And quite frankly, we just felt that the Company would do better in our hands. And so we bought out the existing shareholders and now really are in partnership with management to continue that transformation.

So, the devaluation you mentioned is reflective of the fact that the company has had some difficulties. It's got two pieces of the business, one of which is very strong, the other of which is the transformative part that I discussed or the one that has more issues to it.

But we've got good confidence in what we are doing there. We just felt that the company would succeed better if we had control of the business. So we moved to do that in January, and the valuation is reflective.

To your other question about the debt, we are the sole debt holder in that company at this point. So there is -- all the securities you see that all are senior to the last-out tranche are on our balance sheet and they are ours.

And let me just pick it up from there. On the senior syndicated loan side, you are certainly right, the marketplace has changed. I think the senior debt side, senior syndicated loan debt side now has changed, and it's more like 2006.

We have not been buying much recently, obviously, because prices have come in so tight to the marketplace today. But the few that we've picked up we thought were good investments. But I'm not sure how much more you're going to see us do in that area, mainly because the marketplace has changed so much.

There's huge demand that's gone into that marketplace. These are the senior loan debt funds that are filling up as shareholders bail out of government securities and go into these variable-rate loan funds that have been set up by many of the brokerage houses. And right now, the amount of money pouring into those funds is far outstripping any kind of loans that are coming to marketplace.

And as a result, you are seeing all of the -- well, I won't say all of the crazy things, but you're seeing a lot of the same things that you saw in 2006. So, Troy, I wouldn't put too much emphasis in your projections on us doing a lot of senior syndicated loans, but we will keep trying and see if we can find some good ones.

Yes, I would also say, Troy, we're not focused just on syndicated loans. I will tell you, for the record, while we didn't book a lot of proprietary direct loans during the quarter, we had two that were signed up and in the due diligence phase, both of which fell apart during the quarter. So we will continue to focus on proprietary investments as well.

Okay, next question, please?

Mark Hughes, Lafayette Investments.

Just a quick question here on -- I've heard you say several times in the last year that the period when the economy is coming out of a recession should be kind of your sweet spot for making new loans. And here we are, seems to be coming out of the recession, and we don't seem to be making many new loans. You just mentioned two that fell apart that you thought you were going to make, but they didn't get done. Meanwhile, your better old loans are paying off, it looks like, at a fairly decent clip. But there hasn't been any growth in the portfolio. In fact, the opposite is happening.

And I'm trying to figure out why we're not putting more loans on the books. And nobody wants you to make loans just to make loans, but it seems like there's a lot going on out there, but Gladstone is not participating, and deals aren't getting done. And I'm trying -- I'm very frustrated and trying to figure out why this is happening. And maybe you are just a quarter or two away from showing some real growth, but can you tell me something about why things aren't getting done and maybe why you think that will change over the next year?

Well, I can tell you that we are perhaps much more conservative and always have been than some of the other players in the marketplace. We also won't extend credit to people that we feel uncomfortable with. And that's not a reflection, perhaps, on them personally, but just on the business or where they are in the economic cycle.

Up until this fall -- I would say maybe the summer, but certainly this fall -- I, and I think many of the people here, were not very convinced that the economy was as strong as others believed it to be. And I'm really not sure that we are all that strong today.

So we are perhaps more cautious and going slower than others. I think you'll see some good deals done this year, but again, that's a projection I can't back up with anything other than we've got a very nice pipeline and we work on deals, and we're going to continue to be conservative, because who knows what the next six months will bring or the next year will bring?

And I just can't -- Mark, I can't really put my finger on it other than to say that this is a time in which the winds are blowing in both directions. One day you get a nice, strong breeze from the back and your sails fill up and you feel like you're going to go forward, and then the winds reverse and you get a lot of negative news and you feel uncomfortable with it.

But we are working hard here to put this Company forward, and I can only say that that's where we are today. I can't really give you a projection beyond that.

But, I mean, couldn't you argue that you make your best deals when there is uncertainty in the world? Because when times are good, there's too much easy money out there, and there's other places for people to go for their money than to Gladstone. I would just think some uncertainty -- we seem to be past the point of systemic failure, which we might have faced in 2008 and 2009. You know, I would think a little bit of uncertainty isn't bad for you all for making good loans.

Well, if there was just a little bit of uncertainty, I would be on your side. I'm not as convinced as perhaps you are that that much uncertainty has been taken out of the economy. We still see very dramatic things going on with the government printing $1.5 trillion worth of paper, which has an impact on every single company that we look at. We are watching oil prices spike up one day and come down the next.

So I went through a lot of things that are on our minds here. And when you bake all of those into projections for any small business, it makes the uncertainty range go much higher than perhaps you are listing it on your scale. We are just being conservative, and I can't do any better than that, Mark, in answering why we are where we are.

Okay, good luck.

Next question, please?

(Operator Instructions). Mr. Gladstone, gentlemen, it appears that we have no further questions at this point.

All right. Thank you very much, Mike, and thank you all for calling in. Again, we'll do our best to make you some profits this year, and we will just have to see where it goes, and that's the end of this conference. Thank you all.

And we thank you, sir, for your time. We thank you all for attending today's conference call. The conference has now concluded. At this time, you may disconnect your lines. Thank you.