Gladstone Capital Corp (GLAD) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Gladstone Capital Corporation's third quarter earnings call and webcast. (Operator Instructions)

As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mr. David Gladstone. Please go ahead, sir.

All right, thank you, Kristi. Nice introduction. Hello, everyone. This is David Gladstone, Chairman, and this is the third fiscal quarter earnings conference call for shareholders and analysts of Gladstone Capital. Our common stock is traded on symbol GLAD and the preferred stock is trading on a symbol GLADO. Thank you all for calling in.

We're always happy to have these shareholder calls with shareholders and analysts and welcome the opportunity to provide updates on our Company and the investment portfolio. As always, the invitation is open to visit us here in McLean, Virginia. We're just outside Washington, DC. The Gladstone team has grown to about 60 people and a little under $2 billion in assets under management.

And now, we'll hear from our General Counsel and Secretary, Michael LiCalsi. He's also President of Gladstone Administration, which is the administrator of all the Gladstone funds and some other related companies and he'll make some statements 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 Company's future performance. 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 in our registration statement as we file with the SEC. All of those can be found on our website, 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 that past performance or market information is not a guarantee of any future results.

We also ask that you visit our website and sign up for our email notification service. You could also find us on Facebook, key word, The Gladstone Companies, and follow us on Twitter at Gladstone Comps. And please read our earnings release issued yesterday and also review our Form 10-Q for our third fiscal quarter ended June 30, 2016, also filed yesterday with the SEC. Those can be accessed on our website, GladstoneCapital.com, and the SEC's website as well, SEC.gov. And an audio presentation of this phone call will be archived on our website.

And please note that we will begin our presentation today by hearing from Gladstone Capital's President, Bob Marcotte.

Thank you, Michael. Before diving into the results for the quarter, I'd like to summarize Gladstone Capital's core investment strategy as the 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 define as having $3 million to $15 million in 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. The majority of our investments are senior secured loans to growth-oriented or recession-resistant businesses, which have the revenue visibility and cash flow profile to support a leveraged capital structure.

Our investments are generally made in concert with private equity sponsors' investments or owner-operators with significant equity at risk. We target to make loans of $8 million to $30 million, but we will opportunistically consider smaller positions in broadly syndicated loans from time-to-time.

With that introduction, let's get into the results for last quarter. As many of you are aware, the M&A stats were down last quarter, however, the broad leveraged loan market improved compared to the prior quarter. From our perspective, the lower middle market deal flow was healthy as we evaluated a similar number of deals as we did in the prior quarter. However, we did notice a notable improvement in the quality of the companies, which translated into an uptick in our originations and near-term investment pipeline.

For the quarter ended June 30, we closed two new investments totaling $32 million. Principal repayments totaled $20.4 million during the quarter, including one proprietary and two syndicated loan exits. Including follow-on investments, our net originations for the quarter totaled $14.1 million. Going into the current quarter, we anticipate new originations to remain strong based on our current deal pipeline, which included four deals in due diligence and documentation. Net of several pending repayments expected in the quarter, new deals are expected to result in net asset growth similar to what we've experienced last quarter while maintaining our investment discipline and portfolio yields.

Consistent with these comments, after the end of the quarter, we closed on the new proprietary secured second lien investment in the amount of $10 million, which was included in our earnings press release of yesterday. If you roll forward the total amount of investments on the quarter and the recent investment announced yesterday, we have invested $42 million and companies with less than three turns of leverage at an average rate of approximately 12%, 70% of which was senior secured loans.

The weighted average yield on our loan portfolio was down slightly on the quarter compared to the last several at 10.9%. While we did -- we have been successful in maintaining our new origination yields, the small decline was caused by prepayments as well as the impact of a non-accrual asset. It should be noted that while we have successfully maintained this yield while reducing our portfolio risks, as first lien secured investments have grown to 61% of the fair value of the portfolio as of June 30, 2016.

Second lien investments represent the balance of our loans and, in total, secure debts represent 93% of the portfolio fair value at the end of the quarter. For the quarter ended June 30, the net realized and unrealized appreciation in the portfolio totaled $600,000, which is a significant improvement from the last several quarters and we feel is more indicative of the underlying health and diversity of the senior secured portfolio.

While there have been a number -- while there were a number of individual investment valuation movements, we experienced offsetting appreciation and depreciation within our energy portfolio and a couple of other proprietary investments in the process of undergoing management transitions. It's not uncommon for us to face some management retooling over the duration of our lower middle market investments, and we hope to be able to report depreciation recoveries from some of our recent portfolio actions.

Syndicated investment valuations represented a net positive swing on the quarter, as we got paid out at par on two positions. However, several other second lien investments in the syndicated portfolio experienced large valuation swings relative to their underlying leverage profile, due to limited trading interest in these lower rated credits.

During the quarter, Vertellus, one of our smaller syndicated investments, was added as a second non-accrual loan, as the company filed bankruptcy in anticipation of a near-term sale of the company. Nonaccrual investments at the end of the quarter totaled $6.5 million or 2.3% of our portfolio at fair value.

We currently have 43 companies in the portfolio, which is down one from the prior quarter and our portfolio remains highly diversified by industry classification with 20 different industries and headquarters in 20 different states.

With respect to the portfolio yields and income, for the June quarter, total interest income was down by 4.8% compared to the prior quarter based on a small decrease in the average interest earning assets and the weighted average yield. Other income, consisting mostly of success fees received, increased $800,000 over the prior quarter to $1.6 million and lifted total investment income in the quarter by 4.1% to $9.8 million. Fees and expenses were largely unchanged for the prior quarter, and excluding a small incentive fee waiver by the Adviser, we're happy to report that GLAD generated a return on equity of 11.5% for the quarter.

With respect to the investment outlook and backlog, based on the deal flow of the past quarter and our current pipeline of deal opportunities, we believe we're well positioned to continue to achieve measured asset growth to drive our net investment income and support stockholder distributions. In addition to our growing earning assets, the team is committed to proactive management of our portfolio with a goal to maintain our net asset value and demonstrate a consistent return on equity commensurate with our predominantly senior secured investment portfolio.

While we are optimistic regarding our investment outlook and current backlog of opportunities, we're also mindful of the volatile trading swings of our common shares over the past quarter. Accordingly, early in the June quarter, we used a portion of the $7.5 million repurchase plan and were able to purchase just over 41,000 shares at an average cost of $6.95 per share for a total cost of $288,000.

And now, I'd like to turn it over to Nicole Schaltenbrand, our Chief Financial Officer, who will provide an update on the fund's third fiscal quarter financial results.

Thank you, Bob, and good morning. Let's start by reviewing the income statement. For the June quarter, total interest income was $8.3 million, which is down by 4.8% or $400,000 compared to the prior quarter. This is driven primarily by the decrease in average interest earning assets, as the majority of our new originations closed later in the quarter, as well as a slight decrease in our weighted average yield.

Other income consisting mostly of dividends and success fees received increased quarter-over-quarter from $800,000 to $1.6 million and lifted total investment income to $9.8 million. Interest-related fees and expenses on the quarter were unchanged, and as a result, total net interest income on the quarter declined by $400,000 to $6.3 million.

Non-financing costs, excluding management fees, decreased by $100,000, compared to the prior quarter, to $900,000 due to a decrease in shareholder-related costs and professional expenses incurred. Gross management fees for the quarter were unchanged at $2.2 million. However, the net management fee increased as the Adviser fee credit declined to $200,000 in the current quarter.

For the quarter ended June 30, 2016, net investment income was $4.9 million or $0.21 per share and covered 100% of shareholder distributions. As we have demonstrated over the last several years and in the most recent couple of quarters, our Adviser remains committed to crediting its fees so that annual net investment income covers our shareholder distributions.

Moving over to Gladstone Capital's balance sheet. As of June 30, 2016, we had approximately $326 million in total assets, consisting of $308 million in investments at fair value and $18 million in cash and other assets. Liabilities totaled approximately $140 million and consisted primarily of $73.3 million in borrowings on our line of credit, and $61 million in our Series 2021 term preferred stock.

Our net asset value increased slightly by $0.03 per share quarter-over-quarter with a decrease in the cumulative net unrealized depreciation on the quarter, bringing the NAV per share to $7.95 as of June 30, 2016, compared to $7.92 per share as of March 31.

Inclusive of all of the liquidity events of the past quarter, we are well positioned going into the balance of our fiscal year 2016 to grow our investment portfolio and net investment income with about $24.5 million in aggregate cash and availability on our $170 million credit facility to fund additional new investments.

And now, David will conclude the presentation.

Thanks, Nicole. You and Bob and Michael all did great presentations to inform the shareholders and I think the stockholders should feel pretty good about the progress of the Company.

In summary, Gladstone Capital has delivered on a number of key metrics for the quarter. We made two new loans totaling $32 million and then there was a transaction after the quarter end as well. We used our stock buyback program to respond to the stock price dropping to really unwarranted low prices. That always keeps things in line and we paid dividends on our common and preferred stocks. That's a key indicator of our strength and our net asset value per share is pretty much the same, up or down a little bit every quarter.

I do believe this Company continues to be well positioned to grow the earnings and support our dividends. Our goal is always to protect the dividend distributions and then increase it when we see the strength in the earnings and the outlook is favorable.

Right now, we're looking at the future and all mindful of the recent economic trends, which might show that the economy is slowing down. And some of the middle market businesses that we lend to still have great strength. And here's some of the things, though, that we worry about. The credit markets are still unsettled. There's weak cash flows going into the syndicated loan marketplace, which we've used in prior years but not much recently. I think this will turn around because the buyout funds have plenty of capital and should be out buying businesses and giving us an opportunity to help them in the buyouts.

Lower oil and gas prices, they're always positive as an impact on the rate of inflation, keeping inflation down. Also, it impacts the income of many oil and gas producing states and companies in those states, and uncertainty of the future prices have already negatively impacted the capital investment activity in that business. We do have three energy-related companies. All of those are downstream. We're not out poking holes in the ground looking for oil, so we're not expecting to have any repercussions to our loans due to oil -- low oil prices.

Recent impact of Britain leaving the EU, that vote really had an impact on bond yields and made a lot of things unsettling, and we still are uncertain about the Federal Reserve and their move on interest rates; just one more unknown out there. And we like all the businesses. We hate uncertainty and I always ask myself, how am I supposed to plan if you have a few people in Washington, DC, that can make rates go up and down if they're -- whenever they want it to do. So it's really hard sometimes to figure out what cost is going to be in the future.

Federal and state regulations impacting many of the private companies that we lend to; I know all of them and as well as were here in our office, the businesses are just feeling the crushing burden of paperwork on reporting to the government. It's become overwhelming. Distributions, despite the economic trends, we believe Gladstone Capital will continue to make good loans and it will be growing as well as if there's a recession coming. I think our businesses are pretty much recession resistant, so we feel comfortable about that.

We are selective in everything we do just to be safe and as you may know, middle market businesses continue to be an important part of the US economy. They are the primary creators of economic growth and certainly creating jobs, and we like lending to these businesses. We've developed a great credit rating system that's a good predictor of the future operations of these borrowers and it's held us well in the past and I think it will in the future as well.

Gladstone Capital is and will remain committed to paying shareholders' cash dividends. As a large shareholder myself, I like dividends, and in July, our Board of Directors declared the monthly distribution on our common shareholders of $0.07 per common share per month for July, August, and September. They also declared the dividends for the preferred stocks. They'll look at the dividends again in early October and I think things look fine there for the dividend as well.

Through the date of this call, the Company has made 162 sequential monthly or quarterly cash distributions on the common stock. That's almost $273 million, and the Company has never missed a distribution. That's about $11.70 per share on the shares outstanding at June 30, 2016.

Current distribution rate on our common stock with a common stock price at about $8.07 yesterday; the distribution run rate is now producing a yield of 10.4%. It's pretty much in line with the BDCs in the marketplace today. That percentage rate is above historical norms and we're above most yield-oriented alternatives. It is an incredibly good buy, I think, right now if you want something with a great yield. A monthly distribution of 6.75% on our preferred stock gives $1.69 per share annually. That preferred stock had a closing market price yesterday of $25.46 on NASDAQ under the symbol GLADO. That's another terrific yield buy, about 6.6%, very safe stock to hold as an income producer.

In summary, this Company, Gladstone Capital, is in good shape for -- phone went off. Oh, maybe we're missing -- okay, I got a phone call. I thought that was because we were off the air, but we're not. So and to the end, we have continued to strengthen the companies and borrowed money from our -- for those companies that have borrowed money from us, and we have a strong team.

Thank you all very much, which you'll come on now and we'll talk about some questions.

(Operator Instructions) Our first question is from the line of Andy Stapp of Hilliard Lyons. Your line is open.

Could you talk about the pricing environment for new investments compared to quarter and a year ago?

Bob, why don't you take that? You're on the line every day.

Right now, I think there's definitely been some compression at the upper end of the marketplace. In the lower middle market, we're really not seeing that. As I mentioned earlier, we're still closing deals south of three turns of leverage and continuing to generate a mix of senior assets at roughly two-thirds of our investments and second lien assets at one-third, generating a blended yield, which is very similar to where our current weighted average yield is.

Obviously, moving up to the higher credits in the syndicated loan market, leverage can approach 6 and the rates are probably just south of double-digits. That's certainly not where we are going to be investing the majority of our funds.

Kristi, if you'll come on, something's wrong with the phone. We're getting a lot of feedback.

It should be fixed now.

Okay. Well, let's get the next question.

Our next question is from the line of Christopher Testa of National Securities. Your line is open.

Just on the investment flow, I notice you had some transfers out of the senior debt and concomitantly into senior sub-debt, and also into unsecured debt. Can you just give some color on why there was those transfers?

There were really two transactions that drove that. I think as we described a couple of quarters ago, we did a unitranche for a sponsor called United Flexible, which was an investment as a unitranche. They put on a couple of add-on investments and given our comfort level in the add-on investments, we actually transferred from a unitranche to a second lien investment as the companies grew and it made acquisitions and the EBITDA in that particular business has grown substantially. So we've chosen to migrate our position to a second lien investment, which obviously we're getting a far more improved yield on it.

Secondly, the only unsecured asset that you're referring to is the outgrowth of a restructuring that was associated with one of the syndicated loan assets. I believe the entirety of the -- it was PLATO, right? PLATO, which is an educational related asset restructured about two quarters ago, I believe.

In participating in that restructuring, our second lien investment was migrated to an unsecured investment in the recapitalization of that company. That was not an origination.

Okay, great; that's great color. Just shifting gears kind of looking at your capital and -- as well as dry powder. So you're up to 72% debt to equity, but in the past you guys have done up well past 83 times and all the way up to the top of the (inaudible). How should we think about this given you guys are trading at a slight premium to NAV? Would you be looking to opportunistically raise capital now to pay down debt balances? Or would you rather let that run above 0.8 times, 0.85 times?

That's a fairly involved question, Chris. I guess what I would say is a couple of things. One, as we start to look at the outlook of where the investment flows are, if we have strong investment flows and are expecting a reasonably decent net asset growth, we obviously have to sort that into our capital stack and our longer term opportunities. As I mentioned, we do anticipate a fair number of prepayments over the course of the next quarter to two. So that will certainly fund a portion of it, but we do expect net asset growth above those prepayments.

We do have capacity under our current lines and so certainly, we have that dry powder. As you speak to the underlying equity capital, I think there's a couple of considerations; one, we feel pretty good about where the portfolio is today. So if we feel that there are certainly some reductions in some of the depreciation, our capital base is going to be strengthening. We've got more ups and downs. Certainly that will affect it and there are some things in the works that we hope to announce in the near term that would be positive in that respect.

That being said, given what we believe to be the long-term opportunity and the consistency in performance and yields, we would certainly be prepared to opportunistically look at equity capital raises as the market continues to recognize, but certainly feel given where we're performing, given the proportion of senior secured assets, and given our current yield, that there is certainly an upside in our current shares, and be mindful of when and how we go raise capital.

We do have some capacity and, frankly, it's part of the process that we're continuing to evaluate. I don't know if you have anything to add to that, David.

One of the things that we do have is a co-investment with our sister company, Gladstone Investment, and they are preparing one of the companies to be sold. It could be sold in the next 90 days and if it is, it would trigger pretty substantial capital gains based on the indications of interest we're seeing. But I don't want to start down that trail -- about, I want to say last year, I started talking way early when one of them was coming up and it took us nine months to get it to the altar and get it sold.

So just keep that in mind as that would produce a pretty substantial amount of opportunity for the Company to reinvest it and that's like free equity.

Okay. That's great color, guys. Thank you. And just last one from me would be the lower middle market; it seems that M&A has been down substantially from the first calendar quarter into the second. Just what are you seeing quarter to date in LMM sponsor opportunities? And do you see this picking up?

As I laid out in my comments, we looked at about 120 deals each of the last two quarters. Obviously, we did not do much with the first quarter. The second quarter, some of them carried over and certainly, the flow of what we're seeing is affecting our current outlook and pipeline. So I would say the level of activity is consistent. I think the quality of deals have improved and, in part, I think they've improved because companies, good operators have got solid numbers, have completed their audits for 2015, and the outlook for interest rates and the attraction of the domestic market as opposed to the international market is providing a very favorable opportunity for some of these companies that hadn't been public or hadn't come out to be sold to come out.

And you're obviously seeing a buoyant market in enterprise valuations. At the upper end of the market where it's a little bit more noticeable, your enterprise value multiples are approaching 11 or north of 11. So I think what you're seeing is a market that's attractive for new companies to come and I think we saw that in the second quarter whereas in the first quarter, I think there was a fair bit of companies that were desperate for refinancings in anticipation of what was thought to be a potential increase by the Fed over the course of the next couple of quarters in rates.

So the profile and character has changed more than the actual flow of opportunities.

Got it. That's great color.

And, Chris, as you know, this marketplace that we're in is very similar to the syndicated loan marketplace, which is down about 32% versus last year's transactions. But it picked up substantially in the past quarter and I think this quarter is going to be a good one. But I don't think we'll get back to what it was last year. That first quarter just about stymied everybody in terms of putting new deals on the books.

The other thing that's affecting it, Chris, a little bit is the proportion of deals in the M&A environment that's going to strategics continues to increase. I think the last stat I saw was up to 64% of the M&A activity was being driven by strategic buyers. So obviously, those are M&A transactions that we're not going to participate in. So you definitely have a lot of things moving, but frankly, a lot of that does not affect the lower middle market. You don't have a ton of strategics coming down and buying companies with $3 million to $10 million in EBITDA.

Right, right. All right, that's all for me. Thank you, guys, for the great detail on those questions.

Thank you for calling in.

Next question.

Thank you. Our next question is from Bob Brown, a private investor. Your line is open.

Two questions. One is just an investor relations kind of question. What is the attitude on announcing investments? Because I know it seemed like in prior years you've gone towards announcing investments pretty much as they happen. And in the last two quarters, it seems like you've gone away from that. And then last Friday, you announced the most recent investment. And we're just wondering how should we think about in terms of what you're going to be looking at going forward in terms of how and when you announce during the quarter?

We will continue to announce investments as close to when they occur as possible. As you may recall, we did not close any new investments in the first quarter so there was a bit of a hiatus there. The investments closed last quarter were late in the quarter and because they are private companies, we take some time to negotiate what the terms of those releases were. And so they were a little slow as a result of that.

So the policy has not changed. It's just the timing of the transactions make it appear as if it was a little bit more of a hiatus between the last time it might have happened. And as you saw, we did announce yesterday a deal that closed earlier this week as part of our Q press release, a transaction we just closed. So you will continue to see investments as they occur.

Okay, thanks. And the second question is more just in terms of how we should think about the net asset value and in terms of going forward, it seemed like the high yield debt market has, at least publically, has seemed to have rallied over the last little bit, especially since the whole Brexit issue, et cetera. And I didn't know if I should have expected or thought -- expected a little more increase in net asset value as a result or in terms of our securities. Or is that something that as the companies report more their own year-end financials, it tends to adjust more at that point in time. I just didn't know how to think about going forward.

Well, there's two factors in that one, Bob. The proportion of investments that we have in syndicated loans has come down dramatically. We're now under 10%. So no matter what happens, it's not going to be a big mover. Secondly, the majority of our syndicated loan investments are probably at the second lien but probably lower rated securities. I think the majority of the recovery that you're citing has been with the securities down to probably mid-single Bs. We have a number of securities that may be a little bit lower than that in rating, but we're comfortable given the underwritings and the industries that they're participating in.

My comment in my remarks is those investments that might be in the CCC range tend to be the least liquid in the marketplace. They are not as broadly marketed and I think if you were to look at the general CCC index, that's a portion of the high yield market that has not yet recovered. I would expect it to recover. At the end of the day, it is probably the single highest yield opportunity in the range, both domestic and international, of yield opportunities. But at this point, it's been relatively soft. Between BDCs and CLOs there's not a tremendous amount of investment capacity right now. And so it has been a weaker part of the market and the result is they have not necessarily performed as strongly.

We would expect those ultimately to improve, but as you can see from the remarks in our Q, a number of those positions were down this quarter despite the market environment because of some liquidity and particular credit issues. I hope that helps.

Yes, thank you.

Next question.

(Operator Instructions) I'm not showing any further questions. I would like to turn the call back over to Mr. David Gladstone for any further remarks.

All right, thank you all for calling in. We appreciate the time with you and that's the end of this call.

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