Gladstone Capital Corp (GLAD) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Gladstone Capital Corporation's first quarter ended December 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 call may be recorded. I would now like to turn the conference over to David Gladstone. You may begin.

Nicole, thank you for that nice introduction and hello everybody. This is David Gladstone, Chairman. And this is the first quarter earnings conference call for shareholders and analysts on Gladstone Capital. Our common stock is traded under the symbol GLAD and the preferred stock is traded on the symbol GLADO. Thank you for calling in. We're always happy to have these calls with shareholders and analysts and welcome the opportunity to provide an update on our Company and the investment portfolio. And always, I say it every time, you have an open invitation to come by our offices here in McLean, Virginia; we're outside of Washington DC; and say hello. The Gladstone team is here. We've got about 60 people with a little under $2 billion in assets under management.

So, now let's turn over to the General Counsel and Secretary, Michael LiCalsi. He's also President of Gladstone Administration, which is the administrative for all the Gladstone funds and related companies, and he'll make some statements regarding forward-looking statements and some other things. Michael, go ahead.

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. And 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. And 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 the factors listed in our Form 10-K, 10-Q filings and our registration statement as we file with the SEC. All these can be found on our website www.gladstonecapital.com or the SEC's website www.sec.gov. This 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. And please also note that past performance and 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 can find us on Facebook, key word The Gladstone Companies, and follow us on Twitter at Gladstone Comps. You can read our earnings press release and Form 10-Q for the December 31 quarter, which was issued and filed yesterday with the SEC. You can find the press release and 10-Q on our website gladstonecapital.com and the 10-Q on the SEC's website at sec.gov. And an audio presentation of this call will be archived on our website as well. And now we will begin by hearing from Gladstone Capital's President, Bob Marcotte.

Thank you, Michael. Good morning and thank you all for dialing in today. As a reminder for any new callers, Gladstone Capital is the lending fund within the Gladstone Companies family of publicly traded funds. And our core strategy is to provide cash flow based loans to privately held US based lower middle market businesses with $3 million to $15 million of earnings before interest and taxes. We target to maintain a minimum of approximately 90% of our investments in debt investments and the majority of which 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. The majority of our loans carry floating rates tied to LIBOR and our net investment income should generally rise with interest rates.

With that introduction, let's get into the results for last quarter. Last quarter, the combination of a modest improvement in middle market M&A deal volumes and an increase in sponsor refinancing and recapitalization activities resulted in a healthy flow of deal opportunities. While some of the elevated deal flow was opportunistic and in response to improved market liquidity, we were generally pleased with the overall quality of the deal flow. Of the deals we pursued, we did see some increase in competitive pricing pressure. However, we were able to close on three new investments in the quarter. Between new deals and follow-on investments, total originations in the quarter were just over $20 million and we carried over a $10 million proprietary secured second lien investment which we kick closed last week.

As announced previously, we also experienced two large exits last quarter associated with the sale of RBC Reliable and Barron's. And while they were great outcomes, they lift the total proceeds on the quarter to $50.5 million and had the impact of reducing our investment portfolio by $29.4 million on the quarter. That said, between the recently announced deal closing and the pending transactions and relatively few material liquidity of repayments on the horizon, we expect to rebuild these balances and show a net increase in the portfolio in short order. With respect to the portfolio overview and performance, the weighted average yield of our portfolio was up slightly from the last several quarters to 11.3% as we've been successful in putting on new investments at accretive yields and exiting lower yielding legacy investments.

With the significant liquidity events on the quarter and the new origination mix, our first lien secured investments dipped to 54.2% of the fair value of the portfolio as of December 31 and second lien investments increased to 39.6% of the portfolio at fair value at the end of the quarter. For the quarter ended December, we experienced net realized and unrealized depreciation on the portfolio of $4.5 million or approximately $0.17 per share primarily due to a $3.8 million reduction in the valuation of FDF, a $1.9 million valuation reduction to reflect the final proceeds after transaction costs and working capital adjustments from the exits of RBC and Barron's, and depreciation of two equity investments in Lignetics and Defiance, which we view to be as temporary given the underlying performance of the companies.

The balance of the portfolio performed well and was aided by the influx of capital into the broader leveraged loan market, which lifted syndicated loan prices relative to the prior quarter. While its book value decline hit our ROE for the quarter, it is in part due to a reversal of the $15.7 million appreciation reported in the 9/30 quarter. And if you evaluate our ROE over the last four quarters, our improved net interest income and net appreciation has lifted our ROE to 10.7%. Regarding FDF, the company is one of our remaining energy related investments. The company provides fracing logistics and other services to many of the largest service companies and oil producers in the southwest. While it's been a challenge for the company to adapt their operations to the level of drilling activities over the past two years, they've maintained profitability and more recently have experienced an uptick in revenues for the past two quarters.

Last quarter, the company's debt facilities were amended to provide additional liquidity and working capital availability. In conjunction with these amendments and the sponsors' contribution of additional equity, we agreed to modify our interest to PIK interest through December 2017. Net of the depreciation on the quarter, our FDF debt position is now valued at $9 million or 40% of cost. In other portfolio movements on the quarter, we recognized a $5 million realized loss associated with the depreciation of our Sunshine Media investment largely for tax purposes. And the restructuring of our syndicated loans to [Vertalis] was completed when we received a note representing $1.1 million in second lien debt and common equity for our position. At the end of the quarter, we had one investment on non-accrual representing a cost of $19.1 million in fair value of $3 million or 1.1% of our total portfolio of fair value.

We currently have 44 companies in the portfolio, which is down 1 from the prior quarter and our portfolio remains highly diversified across 21 industries. For the December quarter with respect to portfolio yields and income, total interest income declined $500,000 or 5.3% compared to the prior quarter as lower average interest earning assets more than offset the improved weighted average yield. Other income consisting mostly of success and other fees associated with the RBC and Barron's exits increased by $700,000 from the prior quarter to $1.3 million. As a result, the total income on the quarter rose slightly to $10 million as the increases in other income more than offset the dip in interest income. Fees and expenses were largely unchanged from the prior quarter and inclusive of a small incentive fee waiver by the advisor, GLAD generated net investment income of $5.2 million, which represented 10% return on assets on the quarter.

With respect to the outlook backlog for the Company. Based on my market comments earlier and our current pipeline of deal opportunities, we anticipate getting past the near-term reinvestment challenges in short order. We have significant untapped borrowing capacity and believe we are well positioned to continue to achieve measured net asset growth while maintaining our investment discipline and portfolio yields. In addition to growing our earning assets, the team remains committed to the proactive management of our portfolio with the goal to maintain our net asset value and demonstrate consistent return on equity. And now I'd like to turn the call over to Nicole Schaltenbrand, our Chief Financial Officer, who will provide an update on the fund's first fiscal quarter financial results.

Thank you, Bob, and good morning everyone. Let's start by reviewing the income statement. For the December quarter, total interest income was $8.6 million, which is down 5.3% or $500,000 compared to the prior quarter. This was driven primarily by the 11.7% decline in our average interest earning assets offset by a slight increase in our weighted average yield. Other income consisting mostly of success fees and dividends received increased quarter-over-quarter from $600,000 to $1.3 million and lifted the total investment income to $10 million. Interest expenses on the quarter declined by $300,000 mitigating most of the decline in interest income. However, total net interest income on the quarter declined by $200,000 to $6.8 million.

Non-financing costs increased by $200,000 compared to the prior quarter and net management fees in the quarter were unchanged at $2 million. For the quarter ended December 31, net investment income was $5.2 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 advisor 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 December 31, we had approximately $305 million in total assets consisting of $288 million in investments at fair value and $17 million in cash and other assets.

Liabilities totaled approximately $91 million and consisted primarily of $28 million in borrowings on our line of credit and $59.5 million in our Series 2021 Term Preferred Stock, which is now disclosed net of deferred financing costs as mandated by the adoption of FASB Accounting Standards Update 2015-03. Our net asset value declined by $0.26 per share quarter-over-quarter. The NAV decline was primarily driven by the net realized and unrealized depreciation that Bob covered earlier, which equates to $0.17 per common share. In addition, as discussed previously, the price realized on last quarter's common stock offering was at a small discount to net asset value and reduced our NAV by an additional $0.09 per share.

As of December 31, NAV per share was $8.36 compared to $8.62 as of September 30, 2016. Looking forward, we continue to be well positioned to benefit from any upward movement in interest rates as 91% of the portfolio is tied to floating rate investments. The weighted average LIBOR floor on these assets is approximately 1.4% and with only $28 million in floating rate debt, 100 basis point rise in LIBOR should generate an increase in NII of approximately 5%. Inclusive of all of the liquidity events of the current quarter, we are well positioned with a strong capital position with low debt to equity of approximately 43% and approximately $80 million of availability on our credit facility to fund additional new investments. And now, David will conclude the presentation.

Thank you, Nicole. And it was a very nice presentation, Bob did a good job and Michael too. So, we're doing a good job I think of informing our stockholders and analysts. In summary, Gladstone Capital had a strong quarter. Team made new loans of about $20 million, that was $17.2 million to new companies and $2.8 million to our existing portfolio. We also had that one that moved over and should have been closed in the past quarter, but it was $10 million so it gets us a good start in this quarter that we're in. Company has maintained its concentration of loans in mid-size US companies, these are all private companies, and continues to have a good yield on these loans. And continued concentration of most of our loans was senior loan positions that gives us a great deal more safety than in second lien and continued to improve the capital position of the Company such as the strong position to continue to grow this Company.

We raised $17,300 in new cash, but after all of the deductions we had $16.4 million to us. So, we're looking to the future now. We're mindful of shifting political environments and the effects that they have on the economy as well as the business we lend to today. The credit markets are quite active. This is one of the strongest marketplaces I've seen. There's been significant cash inflows into the syndicated loan marketplace and private loan funds, all of these are focused on the middle market. This may lead to reduction in interest rates that we can charge borrowers as competition continues to cut rates. We haven't seen much of that yet, but I'm sure it will happen if money keeps coming rolling in. We may also see some of the lenders lend more money to a single company in order to win the loan.

At this point, it doesn't seem to be a problem. They're not lending six times or seven times the EBITDA number so we are still in good range. Now the recent election has triggered a jump in optimism in businesses, the index of optimism that we've seen out there. The survey show that small and mid-size businesses, the optimism is very high. This is really good for us. It will increase demand on the loans and businesses striving for growth will borrow more money. However, the increased demand for loans may be pushing interest rates up as we are all able to charge a little more. Have to wait and see how those two trends are going to affect our future. We also note that the Federal Reserve keeps indicating that they're going to increase their rates further.

Given most of our loans are variable rate, it should be positive to our shareholders and we expect that most of our customers should be able to pay a small increase in interest rates. The fed's only raising rates by 0.25%. These are not big movements so most businesses should be able to pay that. We are optimistic that increasing federal and state regulations, which have been a burden to so many middle market businesses that we lend to, may be shifting and they may see some needed relief. There's been a Presidential order that for every new regulation the government seeks to impose on businesses that they must at least two regulations that are removed. I think time will tell us whether they eliminate any of the regulations that bother so many of our borrowers.

And of course there might be a replacement for the Affordable Care Act that has caused so many businesses, especially small businesses, to lay off or move employees from full time to part time. I hope Congress can fix this so that that gets out of the way of growth. And despite these economic trends, we'll continue to be selective in making good loans to grow. I know these are hard times to believe that there could be another recession, but that happens from time to time and of course we are very well suited for a recession. We've got a good strong position today. As you know, middle market businesses continue to be the important part of the US economy that helps us grow the number of jobs out there. Small businesses are primary creators of economic growth and job creation. The new administration wants to create jobs.

If they do, then lower middle market business is what they need to stimulate. We like lending to these businesses and have developed a good credit rating system that is a good predictor of future operations of our borrowers. Now Gladstone Capital has remained committed to paying shareholders a cash dividend and in January, our Board of Directors declared a monthly distribution to our common stockholders of $0.07 per common share per month for each of the months of January, February, and March. This is a good run rate of $0.84 per share per year. Recently about 12 BDCs, I can't remember the count exactly, have cut their dividend and that's a big negative in the marketplace. But as we sat today and looking at the future, we don't expect there to be any reasons to believe that we need to ever cut our dividend. This Company is very strong today so don't put us in that category. Through the date of this call, we paid 168 sequential monthly or quarterly cash distributions to our common stockholders, that's about $283 million. We've never missed a distribution.

It's about $11.10 per share on our shares outstanding at December 31, 2016. Current distribution rate of common stock with the common stock priced at $9.91 on the close yesterday. The distribution run rate then is about 8.5%, which continues to be very attractive relative to the most yield oriented alternatives out there. Our monthly distribution of 6.75% on our preferred stock translates to $1.69 annually and the term preferred stock that we have is about $25.45 on NASDAQ so the ticker symbol of GLADO, which gives terrific yield at 6.6% on a very safe stock to hold for income purposes. So in summary, it seems to be improving in the marketplace where we can make interest paying loans and use that interest to pay the cash distributions to our shareholders. It's a very simple business model.

We have a strong team in place to capitalize on the market and the system has been developed over the last 25 years that we're using to determine which loans are the best ones to go into. In short, I feel very strong about this Company today. And now I'll turn it back to the operator to take any questions from the good people that are out there that have called in. Come in, Nicole.

Thank you. (Operator Instructions) Andy Stapp, Hilliard Lyons.

Just wondering how your pipeline for new investments compared to quarter and a year ago?

Bob, what you got in your pipeline?

Andy, the pipeline is roughly the same I would say. We typically see anywhere between 6 and 10 transactions that we have indications out on and are fairly confident that those proprietary investments will move forward. Obviously M&A environment bounces up and down. There is some measure of competitive dynamics. So, we would typically see a number of those fall away. So when we handicap, we typically look for two to three, maybe in a good quarter four investments to close. At this point, I would say the only added point that I would have is I think our pipeline is probably skewed a little bit more second lien today because of some of the yield and some of the competition for the unitranches is really driving some of those pricing down. So probably where we used to be maybe 70%-30% unitranche to second lien, we're probably close to the 50%-50% today; but ultimately these are second liens with modest leverage attachment points. We are not looking at things that are closer to the more syndicated loans where leverage attachment for those instruments could be approaching [5%s and 6%s].

Okay. And I was a little confused about the amount of investments you made in existing portfolio companies. I think the earnings release referenced $2.8 million, the Q said $3.9 million. Am I missing something?

I think the difference in there, Andy, is there was $2.9 million of new money putting in that was really one investment that was a secondary buy on a small syndicated position that we made that was most of that. The additional amount that you're referring to is probably the amount of capitalized interest because we do have PIK interest on a number of our investments. So, there's roughly $1 million plus of PIK interest that increased the total amount and that would have come through the cash flow statement that I suspect you're looking at.

Okay. And you enjoyed a pickup in the yield on your debt investments. To what extent do you think you can continue to lift the yield?

I don't think that I would expect a lot of that. We continue to target new originations, they're accretive. 11.3% is a pretty heavy rate in the current rate environment that we're experiencing. To do that, we probably have to skew our investments much more second lien and I don't think we want to do that at this point in the credit cycles. So, I think today we're probably about as high as we are short of an interest rate increase in LIBOR on where we are likely to be. I also wouldn't see it go down much at this point. We're not looking to compromise our origination yields just to put money to work.

Christopher Testa, National Securities Corporation.

Just dwelling on your comments on the competition and pricing, just wondering if you could give us some color on how the competition has changed the structure of the new investments you're seeing particularly in second lien. I know Bob, you had said that there was modest attachment points, just wondering if you could give us some more detail there?

I think if you read a number of the brokerage or banker kind of summaries of the capital markets, I think what you're seeing is the unitranche leverage range has probably inched up what used to be roughly 3 turns on unitranche in the middle market is probably pushing in many cases upwards of 3.5 turns or 4 turns. So, that is putting some pressure on do you go a bifurcated senior second lien or do you just do a unitranche structure? So, today we're probably seeing a little bit more unitranche reaching in the 3 turns or higher and so those are transactions that we're probably not going to see.

The incremental benefit of doing a bifurcated structure, which is more complex doesn't justify when the senior lenders are looking to go a little bit deeper. So what we're seeing would typically then be a deal where the banks would still do roughly 3 turns of leverage on the first, a little bit more competitive pricing, and then we would take the last turn to 1.25 turns or something like that in second lien. So all in, our leverage is probably still in the same range but it's predominantly where the banks are strongest and there is an efficient senior lender in front of us as opposed to a unitranche competition. Did that help?

Just looking at your capital structure, I know as of June 30 you were able to redeem the preferreds. Is there any inclination to potentially do this and have a baby bond offering and just lower your cost of funds?

I think we have a priority right now of getting the investments back up. I would say that that is on the horizon, Chris. There's a bit of a dance that we will have to work through. We have to move the maturity date on that preferred issue out, which would probably require a refunding of it. In part because the maturity date of that is also linked to our credit facility. So the first move will obviously be taking that out, extending that maturity, and we will then open up the line which has a maturity date in I believe January of 2019 timeframe. So, we're coming up on the scenario where we probably have to begin to move that dance to extend our maturities.

And just the $3.9 million or so out of the first lien into the second lien comment, I might have missed that I'm sorry, which company was that?

You're talking about the overall movement of first to second lien? A large portion of the RBC Reliable Biopharma exposure was senior loans. We were the only lender. We were largely the equity owner since we had taken that over. And when the proceeds of that came in, which aggregated a little over $36 million in the aggregate, that was such a huge move on our senior debt paydowns that it naturally popped our second lien up as a percentage. The second liens went up slightly, but it was more a result of the senior loans going down than anything else.

(Operator Instructions) Bob Brown, Private Investor.

First of all, you've been talking about the mix of first lien and second lien. If you could talk about what your thinking is in terms of loaning along with an equity sponsor versus totally proprietary going forward. And the second question is related to some possible equity kickers. I know in the past couple of quarters David had mentioned there may be one company that might be getting some type of event where we could get some equity kicker and I was wondering if that's still out there and/or what's it looking like this year in terms of in that issue?

On the topic of sponsored versus unsponsored, there definitely has been a slight increase in the non-sponsored activity. Sponsors are certainly being pressured based on the valuation multiples to push leverage up and to push pricing down. That's obviously not something that we're chasing. I think I commented on some of the opportunistic refinancings that are going in the marketplace today. The $100 billion or whatever of refinancing activity in the broader syndicated market, the vast majority of that was repricing. So, it's gotten a little bit more competitive in the sponsor side so I would say our mix right now is probably roughly 50-50 of sponsored versus unsponsored. We're very cautious about the unsponsored activities, but that's roughly the proportions today and I think that's just the nature of the market. We're looking for good quality assets at reasonable leverage and yields.

With respect to kickers, I think the recollection was that we had Barron's on the Q to be sold for a number of quarters. It was closed in the last quarter and we did realize approximately I think a $2.5 million gain on the equity interest there. So that was factored in, but like anything else, that had been marked up and was reflected in our 9/30 valuation. We just happen to have realized on that appreciation in the cash that came in on the quarter. That's the unusual piece. All of our exits were already recognized as of 9/30 and that's why we had $15.7 million of appreciation in the 9/30 quarter. So, you have to kind of look at it over the totality of the year to see where those little kickers kind of come in because when the yield is recognized in the book and when the cash is actually recognized are oftentimes different time periods.

In terms of looking out this year, anything in particular we're thinking about that looks promising or are there things that look promising?

I think the couple of things that I would focus on is we don't have a ton of anticipated liquidity events on the year. We've obviously taken a few big slugs in the last quarter. There are one or two companies that are in the marketplace today. One of them may be in our energy related portfolio and if that were to clear, it would probably would be a positive. Beyond that, I don't really see a ton of equity interest. I would say that we do have upside opportunity in appreciation in a number of our equity interests that have been written down. I commented on two in my comments where we think that the pipeline and the momentum are stronger and will result in appreciation, but I don't think there is an envisioned liquidity event associated with those situations. We're working the equities hard, but obviously it takes quarters and operating performance and those don't move very quickly. So, we're focused on the operating performance not necessarily the liquidity events right now.

(Operator Instructions) And I'm showing no further questions at this time, I'd like to hand the call back over to David Gladstone for any closing remarks.

Thanks so much. And thank you all for calling in. We love these questions, hopefully we get a lot more next time. And we'll see you in another quarter. Bye.

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