Gladstone Capital Corp (GLAD) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Gladstone Capital Corporation's Second Quarter ended March 31, 2016, Earnings Call and Webcast. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder this conference is being recorded.

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

Alright. Thank you, Chelsea. Nice introduction and hello, everyone out there. This is David Gladstone, Chairman, and this is the second fiscal quarter earnings conference call; this is for the shareholders and analysts of Gladstone Capital. Common stocks traded GLAD and the preferred stock is GLADO. And again, thank you all for calling in. We're always happy to talk to our shareholders and analysts and welcome the opportunity to provide updates on our company, and the investment portfolio. As always an invitation is open to visit our offices here in McLean, Virginia, just outside of Washington, DC, and we also have some offices in New York and Los Angeles. The Gladstone team has grown to over 60 people now, a little under $2 billion in assets under management. So, now let's start out with our General Counsel and Secretary, Michael LiCalsi; he's also President of Gladstone Administration, which is the administrator to all of the Gladstone funds and some other related companies, and he'll make a statement regarding forward-looking statements and some other items. 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 this 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, should, will, 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 and our registration statement as filed with the SEC. All of these can be found on our website at www.gladstonecapital.com or the SEC's website 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 (technical difficulty) of future results. And we ask that you visit our website and sign up for our email notification service. You can also find us on Facebook, key word, Gladstone Companies and follow us on Twitter at GladstoneComps. You can read our earnings press release issued yesterday and also review our Form 10-Q for our second fiscal quarter ended March 31, 2016, which we also filed yesterday with the SEC. You can access both of those on our website gladstonecapital.com and also on the SEC's website sec.gov. And an audio presentation of this call will be archived on our website as well. And now we will begin hearing from Gladstone Capital's President, Bob Marcotte.

Thank you, Michael and good morning all. Before diving into the results for the quarter, I'd like to provide a brief review of Gladstone Capital. Gladstone, as we are commonly referred to lending fund within the Gladstone Companies family of publicly traded funds, 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 in EBITDA. Our target asset mix is for loans to represent approximately 90% of our portfolio with equity co-investments representing the balance. The majority of our assets 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. We target to make loans of $8 million to $30 million, but we'll 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 are aware, the middle market loan market for the quarter ended March 2016 was slow as is typical of the first calendar quarter of the year. While the broader loan fund outflows of the December quarter appear to have abated and there was some recovery over the quarter in the secondary trading levels of higher rated syndicated loans, new loan issuance on the quarter on the whole was down 19% compared to the prior year. Within the lower middle market we saw a significant uptick in deal activity on the quarter. However, they included a healthy dose of refinancings for underperforming companies and aggressively bid buyout financing opportunities which did not fit our leverage or pricing expectations.

For the quarter, we did close two new secured first lien investments representing a total of $18.5 million. Principal repayments on the quarter totaled $17.2 million, which included exits of our J. America investment and Legend Communication investment, and a partial paydown from United Flexible, which completed an acquisition and we migrated our investment to a higher yielding second lien debt. Including follow-on investments our net originations for the quarter totaled $3.6 million. While the magnitude of deals closed this last quarter was below our expectations, our current deal pipeline is strong as a result of some of the activities of last quarter, and we're optimistic we're on a path to get back to the investment volumes, consistent with the growth we experienced over fiscal 2015, and put some of our current available investment capacity to work. After the end of the quarter, the sale of Ashland resulted in an $8 million prepayment, as well as the realization of an associated success fee and small gain on our equity co-investments.

With respect to the portfolio overview and performance, the weighted average yield of our portfolio was largely unchanged from last several quarters at 11.2%. We've been able to maintain this yield while increasing our first lien secured investments, which rose to 62.2% of the total portfolio at fair value as of March 31, which is up from 58.6% at the end of December 31, 2015. Total (Technical Difficulty) consistent with our direct origination focus, our proprietary loans have grown to represent 88% of our portfolio would cost and syndicated loans have declined to 12% as of March 31, 2016.

For the quarter ended March 31, 2016, the net realized and unrealized depreciation in the portfolio totaled a disappointing $11.1 million. This depreciation is above our expectations and we believe represents a cumulative impact of several factors and is not indicative of the underlying health of the portfolio. The largest component of this depreciation are about 36% was related to the markdown of four syndicated loans, which reflect the conclusion of the targets restructuring and conservative valuations of several lower rated credits in the face of limited trading activity. The markdown on our energy portfolio represented an additional 29% of the depreciation, which was driven largely by external industry comparables and not the underlying credit performance, which I will comment on shortly.

The balance of the unrealized depreciation represented the net movement of a variety of positions, including our markup of several of our equity co-investment positions, including bearing in the markdown of several positions, including our equity investment Defiance Stamping, which as we commented earlier, we expect to recover as the business rebuilds their backlog.

With respect to our oil and gas sector exposure, we continue to monitor our three positions closely. This quarter's marks bring the cumulative unrealized depreciation on these three credits to $10 million or 18% of the total investment cost, and our fair value of our industry exposure is down to $43.9 million or 15% of our portfolio. With respect to the performance of the three underlying oil and gas credits in the portfolio, I would like to reiterate several points mentioned on previous calls. All three companies are service-related companies and are not directly exposed to commodity prices. All three companies have and are continuing to address sector headwinds by cutting cost and continue to be profitable despite last quarter's dipping crude prices or drilling-related activities. All three companies are current on all scheduled debt service payments and in compliance of all applicable covenants. And each credit is backed by experienced private equity sponsors committed to the sector and have contributed additional equity capital to fund attractively priced acquisitions to strengthen and deleverage the business. During the quarter we concluded three significant portfolio actions, including the closing on a deal to inject additional management and equity resources into reliable biopharma, and we are already assuming to see results of that transaction. In addition, we participate in the prepackaged restructuring of targets and exited at par a legacy underperforming radio investment in Legend Communications. The non-accrual investments as of the end of the quarter are largely unchanged and consisted of a portion of an investment in one company and represented a fair value of $4.8 million or 1.7% of our March 31, 2016, portfolio fair value.

We currently have 44 companies in the portfolio, which is consistent with the prior quarter, due to the two investments made during the quarter offset by the two payoffs that incurred. Our portfolio remains highly diversified by industry classification with 20 different industries headquartered in 19 different states. With respect to the portfolio yields and income, for the March quarter, the total interest income was $8.7 million, which was down 5.6% or $0.5 million compared to the prior quarter, based on the decrease in the average interest earning assets as the weighted average yield was largely unchanged to 11.2%. Other income consisted mostly of success fees received declined slightly quarter-over-quarter to $800,000, which represented 8.3% of the total investment income for the quarter. Our debt portfolio continues to be well positioned for any interest rate increase as the percentage of floating rate investments has increased slightly to 85% of the portfolio. The majority of our floating rate investments continue to have LIBOR floors, and the weighted average floor on the variable rate loans was 1.6%. And the weighted average margin is 9.3% as of the end of March. With the reduction of our floating rate bank debt in the prior quarter, our sensitivity to further rate increases in one-month LIBOR has shifted to the positive as our portfolio net interest income would rise $100,000 and $1.4 million assuming an additional 100 basis point or 200 basis point increase in one-month LIBOR, respectively. With respect to what we're seeing going forward in the outlook, with the exception of the last quarter, calendar of 2015, we've averaged about $30 million of originations per quarter. And based on our current pipeline of deal opportunities, we believe we are well positioned to get back on that pace and deploy some of our current investment capacity to drive net investment income and shareholder distributions over the next three quarters. And while we are optimistic regarding our investment outlook, we're also mindful of the volatile trading environment for our common shares and the extreme discounts to NAV that impacted our shares in the last quarter. Certainly, we feel this volatility in discount are unfounded and the yields on our shares represent a compelling investment opportunity based on the stability of our portfolio and our track record and commitment to supporting the distributions.

Accordingly, we announced and implemented a $7.5 million share repurchase program last quarter. From the effective date of that program, which was February 12, through the end of the quarter, GLAD shares aided by the general market resurgence rose from $5.73 a share to $7.45 a share for a gain of 30%. During this rapid movement, GLAD was able to purchase just under 46,000 shares at an average cost of $6.17 a share for a total cost of $283,000. The team's priorities continue to be proactively managing our portfolio, generated attractive senior secured proprietary loan originations to drive a net investment income and enhance the return to our shareholders.

And now, I'd like to introduce you to our recently appointed Chief Financial Officer, Nicole Schaltenbrand, who will provide an update on the fund's second fiscal quarter financial result.

Thank you, Bob and good morning, everyone. Let's start by reviewing the income statement. For the March quarter, total interest income was about $8.7 million, which is down by 5.6% or $500,000 compared to the prior quarter. This was driven primarily by the decrease in average interest earning assets, as the weighted average yield was largely unchanged since the prior quarter at 11.2%. Other income consisting mostly of dividends or success fees received declined quarter-over-quarter to $800,000 or 8.3% of total investment income for the quarter. Interest expense on the quarter decreased slightly with a lower average balance outstanding on our line of credit. However, total net interest income on the quarter declined by 5.9% to $7.5 million.

Non-financing costs excluding management fees increased by $100,000 compared to the prior quarter to $1 million due to annual [meeting] costs and other shareholder-related costs and professional expenses incurred. Net management fees declined by $700,000 compared to the prior quarter due to an increase in the amount of the management fee credit, which resulted in total non-financing costs declining to $2.6 million.

For the quarter ended March 31, 2016, net investment income was $4.9 million or $0.21 per share and covered 100% of shareholder distribution. As we have demonstrated over the last several years and in the most recent couple of 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 March 31, 2016, the net realized loss of $5.5 million was primarily due to the restructuring of our investment and target. In total, we recorded net realized and unrealized depreciation of $11.1 million across our portfolio, which Bob covered previously.

Moving over to Gladstone Capital's balance sheet. As of March 31, 2016, we had approximately $311 million in total assets, consisting of $293 million of investment at fair value and $18 million in cash and other assets. Liabilities totaled approximately $126 million and consisted primarily of $57.3 million in borrowings that cost on our line of credit, and $61 million in our Series 2021 term preferred stock. Our net asset value decreased quarter-over-quarter by the increase in the cumulative net unrealized depreciation on the quarter, which totaled $0.46 per share bringing the NAV per share to $7.92 as of March 31, 2016, compared to $8.38 per share as of December 31, 2015. Inclusive of all the liquidity events over the past quarter, we are well positioned going through the balance of our fiscal year 2016 to grow our investment portfolio, and net investment income with about $70 million in aggregate cash and availability on our $170 million credit facility today to fund additional new investments.

And now, David will conclude the presentation.

Oh, great. Nicole, Bob, Michael, you all did a great job informing our stockholders and the analysts that follow our company about what's going on. Just to summarize again, Gladstone Capital has delivered several key metrics, and we made two new loans of $18.5 million, we restructured or got out of three underperforming loans that should enhance our future earnings growth. We used our stock buyback program just a little in order to respond to the stock price dropping to unwarranted low prices, and we've continued to build on our strength that we have here and work hard to make the loans to small businesses. I believe this Company continues to be well positioned to grow, we have funds to grow, we're well within the government regulations that keeps companies like ours from growing sometimes. So, we are in a position to grow the investments in earnings, this should give us some earnings that we need to increase our dividend to stockholders. Our goal is always to protect the dividend and distributions that we have to stockholders to increase it when we see the strength in our earnings; I talk to Bob almost every quarter about raising the dividend. We continue to strengthen our balance sheet, the time is coming when I'm hoping that we can look at our earnings to increase the distribution to stockholders. As we look to the future, we're mindful of recent economic trends, which might slow the economy and some of the small businesses we lend to. Here are some of the things that we're worrying about still, credit markets are still in turmoil, there are very weak cash flows into the syndicated loan market and this means that fewer loans from us to buy in that marketplace. Lower oil and gas prices have had a positive impact on the rate of inflation. However, lower prices also impact the income of many oil and gas producing states and companies of course, and uncertainty in future prices have already negatively impacted the capital investment activity of many of these companies. We have three energy related companies in our portfolio; they are doing fine. So we're not expecting to have any repercussions on these low oil prices -- because of these lower oil prices.

I think uncertainty around the federal reserve's moves on interest rates in the next several quarters is just another big unknown, and we like all the other business people who are looking to the future just hate uncertainty. I ask myself many times, how do you plan to -- how do you make plans if you have a few people that can make rates go up or down at any time they want to, it's very disconcerting. Federal and state regulations continue to impact many of the private companies like those which we make loans to. Many of them feeling crushed by the burden of paperwork and reporting to the government or virtually everything that they do. It is very difficult for many businesses that are small to keep up with all their regulations. So despite these economic trends, we currently believe Gladstone Capital will continue to make good loans to just growing businesses that I think most are recession resistant. We are very selective as you know, smaller businesses continue to be the important part of the economy. They are primary creators of economic growth and job creation, and we love lending to these smaller businesses that are aggressive in growing. Gladstone Capital has remained committed to paying shareholders a cash dividend. In April, our Board of Directors declared a monthly distribution to common stockholders of $0.07 per common share per month for April, May, and June. The Board will meet again in July to consider the vote on the monthly distributions for July, August, and September 2016. Through the date of this call, we made 159 sequential monthly and quarterly cash distributions to our common stockholders, that's almost $268 million, we've never missed a distribution and that's about $11.47 per share on the shares outstanding at March 31, 2016.

Currently, the distribution rate on the common stock with the common stock price being about $7.44 yesterday, distribution run rates now producing a yield of 11.3%, it's above the historic norm for almost all the yield-oriented alternatives out there, it's an incredibly good buy for those wanting great yields and good upside. The monthly distribution of 6.75% for our preferred stock, it's $1.69 annually, term preferred that we have outstanding at a closing price of $24.85 on NASDAQ under the ticker symbol GLADO, which gives a terrific yield and extremely safe position since you're in a preferred stock.

Well, just summarizing, Gladstone Capital is in a strong position to capitalize on the improvements in the marketplace in the coming months. We seek to build asset based interest paying loans and provide dividends to growth and our stockholders, market conditions at the start of the year were a bit shaky to say the least, but appeared to have settle down now. We've got a great team in place here today to capitalize on the market.

So, now the operator will come on and take any questions from the good people who want to call in and ask us few questions.

Certainly. (Operator Instructions) Andy Stapp, Hilliard Lyons.

Good morning.

Good morning.

Good morning.

You mentioned the pipeline for new investments was strong. How does the pipeline compare to year-end?

Much better.

Okay.

I think going into year-end, there is always a bit of an [exhale] of deal closing and timing and there's a very little that actually carried over. We had one deal that closed the first week of the year, but that was just a delay from Q4. As you know, there was a massive outflow in the high yield marketplace, and there are a very few people looking to conclude leverage financing at the end of the year. As the markets normalized and the outflow ceased, I think the deal activity picked up over the course of the quarter and built over the progress through the first three months of the year.

Okay. And would you provide some color on any change in the trends of the overall health of your underlying portfolio companies, such as revenue and profitability growth?

The year-end, because of the natural lag between when folks report and we value them, some of what you're seeing in the portfolio results is really coming from the December, January time frame of when these results are generated, so year-end activity was a little soft given some of the volatility in the credit markets. I will say it's pretty clear, the economic growth in the more traditional, industrial, manufacturing-oriented businesses is challenging, but those are certainly businesses that -- we're not exposed to mining, for example, but those kind of businesses towards the end of the year and the beginning of this year were very tough, that said those kind of businesses are slow. So, developing those and growing those are certainly more challenging. Overall, I would say it's probably below where we would expect, but we don't look at them in whole, we actually look at on an individual-by-individual basis, and focusing on driving those results. For the most part, the key focus that we're working with is the private equity behind them driving the business, and we have adequate equity cushion below us to absorb any potential disruptions or pause in the growth rate of those underlying businesses.

Okay. Do you expect share buyback activity in coming quarters to be similar to the Q2 pace?

I think when we put the buyback in place, we were responding, I think when we talked about it last quarter we were responding to what may have been a little bit of a unique situation, a large amount of institutional selling across the BDC complex, which created a natural imbalance in the share loads. I think it's our position that we put this in place; one, to respond to that extraordinary market circumstance. We're not obviously one of the more broadly held shares in the institutional marketplace, so I'm not sure that we would expect much of that on a go-forward basis. But to the extent that the discount became more significant, I think, you will see more at the current price. I'm not sure that whereas if active as I suspect some of the others that have recovered as much as we have are probably not as active in building that share buyback.

Okay. That makes sense. Thank you.

Next question?

Thank you. (Operator Instructions) And I'm not showing any further questions at this time, I would now like to turn the call back to Mr. David Gladstone for closing remarks.

Okay. Thank you, Chelsea and thanks to all of you for calling in, a few good questions, wish we had more questions, but now you have to hold those questions until next quarter, but we appreciate you dialing in and see you next quarter. That's the end of this conversation.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.