Gladstone Capital Corp (GLAD) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Gladstone Capital Corporation first-quarter earnings call and webcast.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to hand the conference over to David Gladstone, Chairman. Please go ahead, sir.

Okay. Thank you, Karen. It's a nice introduction. Hello, everyone. This is David Gladstone, Chairman. This is the first fiscal quarter earnings conference call for the shareholders and analysts of Gladstone Capital. The common stock's trading symbol GLAD. The preferred stock's trading symbol is GLADO. Thank you all for calling in.

We're always happy to talk to all of our shareholders and analysts and welcome this opportunity to provide an update on the Company and our investment portfolio. As always, an invitation is open to all of you visit us. Well, not all at the same time. All of you to visit us at our offices in McLean, Virginia outside of Washington, DC. We also have some offices in Chicago and New York and Los Angeles. Those are primarily loan production offices.

We were founded in 2001 and the team has grown to about 65 people across four different Gladstone funds. And today, we represent just under $2 billion in assets under management. So we've grown very nicely during that period.

Now, we'll hear from our General Counsel and Secretary, Michael LiCalsi. He's also President of Gladstone Administration, which is the administrator to all the Gladstone funds and related companies. He'll make a statement regarding forward-looking statements. Michael?

Good morning, everyone. This conference call may include 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 and other factors, even though they are based on our current plans which we believe to be reasonable. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar expressions.

There are many factors that may cause our actual results to be materially different from any future results that are expressed or implied by these forward-looking statements, including those listed under the caption risk factors in our Form 10-K filing and our registration statement as filed with the SEC, all of which can be found on our website at www.GladstoneCapital.com or the SEC's website at www.SEC.gov. 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 except as required by law. Please also note that past performance or market information is not a guarantee of any future results.

We ask that you visit our website and sign up on our email notification service. You can also find us on Facebook key word, The Gladstone Companies, and follow us on Twitter at Gladstone Comps. You can read our earnings press release issued yesterday and also review our Form 10-Q for our first fiscal quarter ended December 31, 2015, also filed yesterday with the SEC. You can access the press release and the 10-Q on our website, GladstoneCapital.com, and on the SEC's website as well. An audio presentation of this call will be archived on our website.

We would like all of you to visit us for our annual stockholder's meeting. We will be having that meeting on Thursday, February 11, just 2 days from today at 11:00 AM Eastern Time at our headquarters which is at 1521 West Branch Drive, and we are in Suite 100. That's our main office in McLean, Virginia. If you are not coming to the meeting, or even if you are, please vote your shares using your proxy so that we get enough votes in to ensure a quorum. There are four ways you can vote before the meeting. One is by mailing in your proxy card. Two is by calling 800-690-6903. However, if you do call in, you will need your proxy card with your proxy control number to give it to the operator or by going to www.proxyvote.com and voting online. At that point, you will need your proxy control number, as well. You can also call your brokerage firm and they can help you get your vote in. Now, we will begin by hearing from Gladstone Capital's President, Bob Marcotte.

Thank you, Michael. Before diving into the results for the quarter, I would like provide a brief review of Gladstone Capital. GLAD, as we are commonly referred to, is the lending fund within the Gladstone Companies. We provide cash flow based loans to privately held US based lower middle-market businesses which we generally define as having $3 million to $15 million of earnings before interest and taxes. Our target asset mix is for loans to represent approximately 90% of our portfolio with equity co-investments representing the balance. Our loans are used to provide private equity buy-outs, make acquisitions, or to provide flexible capital solutions to grow a business.

As David mentioned previously, GLAD was one of the first BDCs focused on lending to the lower middle market, and our experience in continuing focus on this sector is a core part of our value proposition. The majority of our investments are senior secured loans to growth oriented or recession resistant businesses. Our investments are generally made in concert with private equity sponsors or owner-operators with significant equity at risk and may include an equity co-investment. We target to make loans $8 million to $30 million but will opportunistically consider smaller positions in broadly syndicated loans from time to time.

With that introduction, let's get into the results for the quarter. As many of you may be aware, the middle market loan market for the quarter ended December 2015 was slow. In fact, the volume of all middle market loans closed dropped in excess of 70% compared to both the prior quarter and the prior year according to Standard & Poor's. In the face of this weak demand and mixed deal quality, we only approved one deal last quarter and the closing slipped into early January. As a result, we did not make any new investments in the quarter. While new originations were slow, we did have a very active quarter of liquidity events across the portfolio, including recognizing a sizeable capital gain.

Principal repayments totaled $41 million during the quarter, which included exiting two syndicated loans, AmeriQual and FAPS, for $11.4 million, repayments or unscheduled prepayments of $26.8 million from Funko, Allison, J. America, and TWS, and we exited a small legacy non-accrual investment of Heartland at our fair value. The sale of Funko as previously announced also generated a net realized after-tax gain on our equity of $17 million. In total, the combined portfolio proceeds and repayments on the quarter were a lofty $61.2 million and resulted in net contraction of our investment portfolio to just under $300 million at fair value as of the end of the quarter.

The one new investment we closed in early January was an $8.5 million secured first lien debt investment to support the acquisition of LCR Contractors by a private equity firm. LCR is a Dallas based spray fire proofing and thermal installation subcontractor. While the middle-market deal flow last quarter was light, our current pipeline of new deal opportunities has recovered very quickly. Today, the volume of attractive sponsor deals in our pipeline are well in excess of the portfolio proceeds received last quarter and more consistent with the growth we experienced over FY15. Recognizing the long-term opportunity for non-bank financing in the middle market, our elevated leverage at September 30, and the uncertainty of some of the liquidity events referenced earlier, we also elected during the December quarter to issue 2.3 million shares of common through an overnight offering in October raising an additional $19.7 million in gross proceeds. When you aggregate the liquidity events of last quarter, we were able to reduce our net borrowings by 55% by the end of the quarter. This leverage reduction has significantly boosted our available investment capacity at what we believe to be a very opportune time in the financing markets.

With respect to the portfolio overview and performance, the weighted average yield on our portfolio was unchanged from the last several quarters, 11.3%, when excluding non-accrual and reserves. We have been able to maintain this yield while increasing our first lien secured investments, which rose to 58.6% of the total portfolio at fair value at the end of the quarter, which is up from 56.5% at September. The total secured debts rose to 93.9% of the portfolio fair value from 89.4% at September as a result of the sale of our Funko equity position, which also started to reduce the preferred and common equity investments to 6.1% of the portfolio from 10.6% at September 30. Consistent with our direct origination focus, our proprietary loans have grown to represent 86% of the portfolio at cost, and syndicated loans have declined to 14% as of the end of the quarter. We currently have 44 companies in the portfolio, which is down from 48 the prior quarter end. And our portfolio remains highly diversified by industry classification with 20 different industries and headquartered in 20 different states.

For the quarter ended December 31, 2015, the net realized and unrealized depreciation of the portfolio was higher than expected at $13.5 million. A large component of this depreciation, or about 34%, was related to the markdown of our syndicated loan and proprietary loan portfolio based on the movement of the broader loan market valuations. The markdown of our energy portfolio represented an additional 26% of depreciation, and the balance represented a combination of factors related to the portfolio. The restructuring of Reliable Biopharma in anticipation of bringing in an experienced investor group to lead the business going forward, a markdown of our equity on Defiance Stamping which recently underwent a successful migration to a new production facility which we expect to recover as the business rebuilds their backlog, a significant markdown related to the impending restructuring of Targus, which is one of our syndicated loan positions, and soft operating results of one of our legacy media credits, Sunshine Media.

With respect to our oil and gas exposure, we continue to monitor our three positions closely. Net of the markdowns on the quarter, the fair value of our industry exposure totals $47.6 million or 15.9% of our entire portfolio, which is up slightly based on the contraction of the total portfolio. With respect to the performance of the three underlying oil and gas credits in the portfolio, I'd like to reiterate several points mentioned on previous calls. All three companies are service related companies and not directly exposed to commodity prices. To be more specific, SPL provides independent lab, measurement, and field metering services related to the production of liquids. WadeCo provides production well chemicals and services necessary to maintain frac well production in the prolific Permian Basin. And Francis Drilling is one of the largest fracking material logistics companies in the US, which is expanding into a variety of related services. FDF has benefited from its scale and ability to serve as the larger operators as their revenues have held up better than average for the drilling sector.

All three companies have and are continuing to address sector headwinds by cutting cost and continue to be profitable at this time. Each credit is backed by experienced private equity sponsors committed to the sector and who have contributed additional equity capital to fund attractively priced acquisitions to strengthen and deleverage the businesses. The majority of our sector exposure, 63% of the fair value today, has low leverage with debt averaging under 3 times of current cash flow.

During the quarter, we did address two of our more challenged assets by exiting Heartland, which had been in non-accrual for some time with net proceeds of $1.5 million and a realized loss of $2.4 million. We also restructured our Legend exposure in anticipation of refinancing with the pledge of additional collateral provided by the Legend guarantor. With the exit of Heartland in October, the non-accrual investments as of the end of the quarter were down to one company representing fair value of $4.6 million or 1.6% of our December 31 portfolio value.

With respect to yields, for the December quarter, the total investment income on the portfolio was $10.1 million, which was down 1.1% or $100,000 compared to the prior quarter based on the decrease in the average interest earning assets as the weighted average yield was unchanged at 11.3%. Other income, consisting mostly of success fees received, increased slightly quarter over quarter to $900,000, which represented 9% of the total interest investment income on the quarter. Our debt portfolio is well positioned for any interest rate increase with 84% of the portfolio in floating rate investments and 16% in fixed rate investments. Our floating rate investments typically have a minimum LIBOR floor, and the weighted average floor on the variable rate loans was 1.7%, while the weighted average margin is 9.2% as of December 31, 2015. With the dramatic reduction in our floating rate debt on the quarter, our sensitivity to further increases in one-month LIBOR has shifted to the positive as our portfolio net interest income as of December 31, would rise by $100,000 and $1.5 million, assuming an additional 100 basis point and 200 basis point increase in LIBOR, respectively.

With respect to the investment climate, backlog of loan opportunities and outlook. With the exception of last quarter, we've averaged about $30 million of originations per quarter and based on our current pipeline of deal opportunities, we believe we're well-positioned to [redeploy] our current investment capacity and drive investment income and shareholder distributions over the next few quarters. Our confidence is found in the continuing attraction of the lower middle market to private equity sponsors and the increasing value of unitranche financing solutions in the face of more turbulent financing market conditions. At the same time, we're mindful of the current expectations in the broader market. The credit spread should increase further to fully reflect the recent movement in the syndicated loan market, and leverage levels are expected to trend down.

While we are optimistic regarding our investment outlook, we're also mindful of the volatile trading environment for our common shares and the extreme discount to net asset value that's reflected in the current trading price of our shares. Certainly, we feel this volatility and discount are unfounded and our shares represent a compelling investment opportunity based on the stability of our portfolio and our track record and commitment to supporting the common distribution. Accordingly, we have announced in January, a $7.5 million share repurchase program which we believe should address some of these issues while still providing ample capacity to support new investment opportunities. This repurchase program will become effective shortly after the expiry of our current blackout period; however, the program in no way obligates the Company to acquire any specific amount of stock.

The team's priority is to continue to be proactively manage our portfolio, generate attractive senior secured proprietary loan originations, and to drive investment income and enhance the return to our shareholders. And now, our Chief Financial Officer, Melissa Morrison, will provide an update on the funds' first fiscal quarter financial results.

Good morning, everyone. Let's start by reviewing the income statement. Interest income on our debt investment decreased quarter over quarter by $200,000 or 2.3% to $9.2 million with a large number of paydowns and exits during this past quarter. Other income increased slightly on the quarter to $900,000 or 8.7% of total investment income. However, interest expense decreased by $300,000 or 28% quarter over quarter as the weighted average balance outstanding on our line of credit decreased significantly during the December quarter resulting in an increase in net interest income of $200,000.

Non-financing costs, excluding management fees, increased by $300,000 compared to the prior quarter to $1 million as a result of the increase in professional and shareholder related expenses, typically associated with our year-end expenses. Our gross management fees declined on the quarter consistent with the decline in average assets and recent management fee reduction. However, the decrease in the amount of the management fee credit compared to the prior quarter resulted in the total non-financing costs increasing to $3.2 million.

For the quarter ended December 31, 2015, net investment income was $4.8 million or $0.21 per share. As we have demonstrated over the last several years and in the most recent two quarters, our advisor remains committed to crediting its fees so that annual net investment income covers our shareholder distribution. The low net investment income on our income statement is where we reflect realized and unrealized changes in the fair value of our portfolio, all non-cash transactions. During the quarter ended December 2015, the combined net realized gains of $15.4 million were primarily due to our sale of Funko, which generated a net after-tax gain of $17 million, and we recorded net unrealized depreciation excluding reversals of $15.7 million on investments, which Bob covered previously.

Moving over to Gladstone Capital's balance sheet. As of December 31, we had approximately $328 million in total assets consisting of $300 million in investments at fair value and $28 million in cash and other assets. Liabilities totaled approximately $132 million and consisted primarily of $57.5 million in borrowings at cost on our line of credit, $61 million on our series 2021 term preferred stock, and $9.6 million in tax liabilities related to our exit of Funko. During the quarter ended December 31, we closed on a common stock offering for 2.3 million shares for gross proceeds of $19.7 million, inclusive of the over allotment. This offering was at a 5.6% discount to the $9.06 September 30, 2015, NAV before issuance expenses. Based on leverage restrictions and the uncertain timing of certain liquidity events at that time, we felt this small issuance, even though slightly below NAV, was in the best interest of the fund and its shareholders.

Our net asset value decreased quarter over quarter by $0.10 per share as a result of the October share issuance, and the increase in the cumulative net unrealized depreciation on the quarter totaled approximately $0.58 per share bringing the NAV per share down to $8.38 per share as of December 31 compared to $9.06 per share as of September 30. Inclusive of all the liquidity events of the past quarter, we are well-positioned going into the balance of our FY16 to grow our investment portfolio and net investment income with about $81 million in aggregate cash and availability on our $170 million credit facility to fund additional new investments. And now, David will conclude the call.

Okay, Melissa, Bob, Michael, all three gave good reports. And in summary for Gladstone Capital, the sale of Funko generated a nice capital gain of about $17 million on its equity investment which can be reinvested now yielding additional interest income to enhance the shareholder distributions. Funko, which was a co-investment with our affiliate fund Gladstone Investment Corporation traded as GAIN, was a very successful investment. We sold a non-accrual loan during the quarter. It was listed at fair value, so that was nice to put that one out of the way. And we restructured another unperforming loan in anticipation of a full recovery. I think we will get all of that money back. Significantly paid down our line of credit so that we improved our asset coverage ratio required by the government. We see this quarter as one of setting up the Company for a strong performance in the balance of the fiscal year ending September 30, 2016. After the quarter end, we were able to make a new loan in January of this year that should get us off to a good start in the three quarters that we have left in this fiscal year.

And as we look to the future, we're mindful of recent economic trends and indications which suggest potential further slowing of the economy. The financial marketplaces are in turmoil. The sell-off of syndicated loans means fewer people are making loans; this reduces the capital available to small and mid-sized businesses. This really hurts the job creation ability of the economy because more of the jobs are created by small business than any other category.

Recently, the volatility and the share price of many companies like ours and like all of our competitors will likely curtail the ability to raise additional capital, and since we pay out all of our income, or most of it, which is required by the government, we can only grow by selling new shares or triggering some kind of capital gain. That's why this last capital gain was so good for us. The fall in price of oil and gas is having a positive impact on the rate of inflation. However, the lower prices are impacting the income of many oil and gas producing states. Given the size of the oil and gas market, big and small businesses will have to cut their capital investments and long-term growth in investments, and I just think that's going to have a big impact on the economy.

For most of our Companies, the lower energy costs are a welcome relief from the high energy costs they have been in past. We have three energy related companies that are doing fine today, so we are not expecting to have any repercussions due to the energy prices. Uncertainty around the Federal Reserve -- excuse us for that noise; a fire truck just went by. The uncertainty around further Federal Reserve moves on the interest rates in the next several months is another unknown. Planners like us and all business people really hate uncertainty. And there is no good indicators that the Fed -- what the Fed will do at the next meeting that they have. Anyway, we will hold our breath until they make the next decision.

Global economic growth is still unknown. No one knows the real economic situation in China because their statistics are always suspect. There seems to be a lot of concern there as capital is leaving China, and that's certainly not a good signal. While we do not invest directly in any of the foreign companies and certainly not in China, the global economy does affect us because it affects all the companies that we invest in, in some way. The US continues to grow the federal debt faster than the economy with a federal deficit now over $18 trillion. It will probably hit $19 trillion this year. That's very scary as we continue to run up a tab on our credit card, if you want to think about it that way.

Federal and state regulations around many of the private companies like those we invest in, most of those people running those businesses feel that there is far too much regulation that's hindering their ability to grow. There are thousands of pages of regulations every year produced by the governments, and this year was probably the largest one in history in terms of the number of pages, the regulations that came out.

Well, despite all of these economic trends, we believe that Gladstone Capital will continue to make good loans to growing and certainly recession resistant businesses but one has to be extremely selective. Small businesses continue to be an important part of the economy, and they are the primary drivers of economic growth in terms of job creation in the United States, and we certainly like investing in these small businesses. The entrepreneurs, they are a great fun to work with.

Gladstone Capital has remained committed to the shareholder dividend. And in January 2016, our Board of Directors declared a monthly distribution on our common stock of $0.07 per common share per month and the regular distribution for our preferred shares for the month of January, February, and March 2016. The Boards are going to meet again in April to consider and vote on the monthly distributions for April, May, and June. So, we will see about those. I don't see any reason that we won't be able to do that. Through the date of this call, we have made 156 sequential monthly and quarterly cash distributions to our common shareholders; that's almost $263 million worth of distributions. Never missed a distribution. That's about $11.22 per share of the outstanding shares at year end.

From a debt perspective, BDCs are required to main $2 for $1 in terms of assets coverage. And this means its assets, primarily the loan portfolio, must cover the total debt, including the bank borrowings and even the term preferred for at least 2 times. Today, the Company has an asset coverage that's about 262%, which means that our loan portfolio would have to decline more than 62% to have any impact on the preferred stock. Even worse than the 2008 crisis, BDC loan portfolios didn't come anywhere close to that type. So in light of the recent volatility and the market, our Board approved a common stock repurchase plan of $7.5 million, which we'll implement soon hopefully, and we'll see what that does. The current distribution rate on our common stock with the common stock price at $6.20 yesterday, distribution run rate is now producing a yield of about 13.5%, which is above the BDC industry median now. It used to be a little lower. The yield on the industry is about 12.2% currently. Just remember our net asset value is $8.38; so for a $1, you can buy $1.35 worth of assets of our Company.

Our monthly distribution of 6.75% on a preferred stock translates into about $1.6875 annually. Term preferred has a closing market price yesterday of about $22.50; that's about a 7.5% yield. You can buy that stock under the symbol GLADO. So all of the stocks are down. It's a shame because we are so strong today and hopefully some people will see the light and start buying again.

In summary, the fund is strong. It's in a strong position to go through the rest of 2016. We set up to capitalize on the improvements in the marketplace in the coming months. We are hopeful to build our asset base and interest earning investments over the course of the year and provide dividend growth to our shareholders. This has been the shaky start to 2016 for just about everybody, including this Company. And the marketplace is weathering many similar storms in the past, but I don't know when this one will come to a recession or not.

Now, I'll turn it back over to the operator, and we'll take some questions from our good analysts and shareholders.

(Operator Instructions)

I do show a question from the line of Bob Brown, a private investor.

Yes. First, with regard to the advisor credits in order to maintain the -- help maintain the dividend. I know in the past years, sometimes you do it at the end of the year. Sometimes you do it quarterly. What are the thoughts on that going for 2016?

Sure. The idea for the year ending September 30, 2016, is that we do it at the end of the year. What had happened in the past unfortunately for us is that when we give a credit, we don't ever get it back so there's no way, if you give a credit in the first quarter and then have bounty for the rest of the year, that you can reclaim that credit. And so as a result, we decided to hold everything until the end of the year and make that credit. It doesn't mean it's any more difficult for the management company to do, but it's just as a way of analyzing things and working in favor of the management company not having to give a credit when a credit is really not due for that year.

So in this first quarter then the management -- the $0.21 reflects the full payment of the management fee?

Melissa, why don't you answer what the numbers are.

Sure. We did end up crediting -- it was about a $300,000 credit in the quarter ended December 31. It is at management's discretion. And you are correct; it has been quarterly or annual, but definitely on that annual run rate our NII will cover distributions. Management has remained committed to that.

Got it. Thank you. And you mentioned in terms of the repurchase plan, when does the blackout period end that the -- at least the theory the Company could start making purchases under the plan?

Three days from now. We usually wait three days for the marketplace to absorb the information that's in the 10-Q that's been filed.

Got it. Thank you. Okay. Thank you very much.

Can we have another question, please?

I see no additional questions from the queue at this time. I would like to turn the conference back over to Mr. Gladstone for any additional comments.

Well, that's disappointing. We'd love to have some more questions but we understand that. I guess we've done a great job in explaining what's going on. So that will end this, and we thank you all for calling in and we'll see you again next quarter.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now log off and disconnect. Everyone, have a good day.