Gladstone Capital Corp (GLAD) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Gladstone Capital Shareholders Call for the quarter ending June 30, 2018. (Operator Instructions) And 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.

All right. Thank you, Amanda. That's a nice introduction, and hello, and good morning to everyone. This is David Gladstone, Chairman, and this is the quarterly earnings conference call for shareholders and for our analysts for Gladstone Capital for the quarter ending June 30, 2018. Thank you all for calling in. We're always happy to talk to our shareholders and analysts and welcome the opportunity to provide you with an update on our company and the investment portfolio.

Now we'll start out with our General Counsel as we always do. He's also Secretary for the company, Michael LiCalsi. He's the President of Gladstone Administration, which is the administrator for all the Gladstone funds. Michael, go ahead.

Thanks, David, and good morning. Today's report may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. These forward looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable, and many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors on our Forms 10-Q, 10-K and other documents that we file with the SEC. Those can be found on our website, which is www.gladstonecapital.com, specifically the Investor Relations page at that website or always on the SEC's website, which is www.sec.gov. Now we undertake no obligation to publicly update or revise any of these forward-looking statements whether as a result of new information, future events or otherwise except as required by law. We ask that you take the opportunity to visit our website, once again gladstonecapital.com, sign up for our email notification service. You can also find us on Twitter. The handle there is @GladstoneComps or on Facebook, keyword Gladstone Companies. And today's call is simply an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday, for more detailed information. Again, those can be found on the Investor Relations page of our website.

With that, I'll turn the presentation back over to Gladstone Capital's President, Bob Marcotte. Bob?

Good morning, and thank you all for dialing in today. And without further ado, let's get into the results for last quarter and our portfolio performance and capital position, and I'll conclude with some comments on the outlook for the balance of our fiscal year 2018.

The highlights for the quarter ended June 30 include originations were $21 million for the quarter, including 2 follow-on investments and a smaller syndicated investment. As we had anticipated prepayments, they rose to $22 million during the quarter, which in addition to the usual amortization payments resulted in a $3.1 million decline in net investments, exclusive of any net investment appreciation in the quarter. Investment income rose 11.7% to $12.4 million as interest income increased 4% with the increase in average LIBOR rates, while prepayment and success fees rose to $900,000 and contributed about 2/3 of the increase in investment income compared to the prior quarter.

For the quarter, the overall performance portfolio yield on our investment-bearing -- interest-bearing portfolio increased to 11.8%, supported by the 33 basis point increase in LIBOR. Fee income lifted the annualized yield on the portfolio to 12.7% on the quarter. Net investment income rose 7% to $6 million or $0.22 per share as the net management fees rose with the elimination of any incentive fee credits, and interest expense was unchanged as the recently reduced bank line borrowing spread offset the increase in LIBOR rates. The net increase -- the increase in net assets from operations totaled $0.45 per share, up from $0.35 per share last quarter largely as a result of the $6.1 million of net portfolio appreciation, which also lifted the return on equity for the quarter to 20.3% and 14.8% for the trailing 4 quarters. Lastly, net asset value increased 2.8% or $0.24 per share to $8.86 with the net portfolio appreciation in the quarter.

With respect to the portfolio overall, the asset mix on the quarter was largely unchanged, given the modest portfolio movements as secured first lien loans continue to represent almost 50% of our investment portfolio and total secured debt totals almost 94% of our investments at fair value.

Improved operational and financial performance across more than a dozen credits was the primary driver of the $5.9 million of net unrealized portfolio appreciation for the quarter. Looking at these results in a broader context, this quarter's portfolio improvements bring the cumulative net realized and unrealized gains for the company over the past 5 years to $6.6 million. Certainly, we've seen some volatility over that period. However, I think these results are a validation of our ability to manage the credit exposures within our lower middle-market portfolio. You may also note that our oil and gas sector exposure remained elevated at 5.4% of our portfolio at fair value, which is up slightly from last quarter with the appreciation on the quarter. As referenced previously, about 2/3 of our exposure in this sector is attractively priced first lien investments at modest leverage levels. And given market conditions, we are expecting a significant portion of exposure -- this exposure to be refinanced in the near term. Our nonaccrual investments declined [on] the quarter with the recovery of ADC as referenced in our prior calls. The company is current on all interest payments, and the improved profitability and reduced leverage supported returning this investment to full accrual status. As of 6/30, we have one nonperforming asset, representing cost of $22.6 million in the fair value of $1 million or 0.3% of our portfolio at fair value. Since the end of the quarter, we've closed one small [add-on] investments of $4.5 million and received payoff of one syndicated investment in the amount of $3.7 million.

Regarding our capital position and the outlook for the balance of the year. We were successful in materially improving our capital position compared to the end of the prior quarter with $6.9 million of net proceeds from common stock issued under ATM program and as a result of the $6.1 million of net portfolio appreciation. As of June 30, our debt-to-equity has declined to under 70%, providing us additional capacity to originate new investments in the near term.

Regarding the outlook for the balance of fiscal 2018. We're expecting prepayments to remain elevated over the next couple of quarters. However, we're cautiously optimistic that we'll be able to deliver net originations sufficient to offset these prepayments, as we did this quarter and lift our current investment levels consistent with our growth in our NAV and our overall leverage limitations. That said, we are seeing a fair bit of competition, especially on unitranche deal opportunities where some commercial banks are stretching above the traditional 3x leverage EBITDA level or from large private debt funds coming down market. We're continuing to reiterate our focus on growth-oriented, lower middle-market businesses where we have a strong track record and which also come with healthy level of follow-on investment opportunities as we experienced this last quarter.

And now I'll -- I'd like to turn the call over to Nicole Schaltenbrand, our CFO for Gladstone Capital, to provide some details on the fund's financial results for the quarter.

Thanks, Bob. Good morning, everyone. During the June quarter, total interest income increased by $400,000 or 4% over the prior quarter due to the 33 basis point increase in average LIBOR rate as the weighted average principal balance of our interest-bearing investment portfolio was largely unchanged since the prior quarter. Other income increased due to success fees and prepayment fees received associated with the payoff of one of our large debt investment.

Total expenses rose by $900,000 to $6.4 million for the quarter. Total financing expenses were unchanged since the prior quarter at $2.6 million as slightly lower average borrowings and the full effect of the bank credit line pricing reset last quarter more than offset the average LIBOR increase. Net management and incentive fees rose $1.1 million as the incentive fee increased with a higher yield in the quarter, and incentive fee credits were eliminated as net investment income covered all distributions.

Other expenses declined slightly in the quarter in the absence of onetime expenses associated with the amendment of the bank line that we recognized in the prior quarter. For the quarter ended June 30, net investment income was $6 million or $0.22 per share and covered 105% of shareholder distribution.

Moving over to the balance sheet. As of June 30, we had approximately $415 million in total assets consisting of $405 million in investment at fair value and $10 million in cash and other assets. Liabilities declined slightly to $170 million and consisted primarily of $117 million borrowings on our credit facility and about $52 million of Series 2024 term preferred stock at liquidation value. Net assets increased by $13.2 million since the prior quarter end with a $6.1 million of net portfolio appreciation and $6.9 million of common equity raise under our ATM program. For the quarter, we issued approximately 763,000 shares of common stock at a weighted average price of $9.13 per share.

NAV per share increased by $0.24 to $8.86 as of June 30 compared to $8.62 as of March 31. Thus far in fiscal 2018, net assets are up 11.5% to $245 million, with net asset appreciation and ATM share issuance contributing to approximately 45% and 55% of the increase, respectively. Looking forward, we continue to be well positioned to benefit from any upward movement in interest rates as 90% of the portfolio is tied to floating rate investment. The weighted average LIBOR floor on these assets is 1.3% and with floating rate assets of $375 million and only $117 million of floating rate debt, a 100 basis point rise in LIBOR should generate an approximate 5% increase in net interest income. Inclusive of the growth and our net asset value of the past quarter, our leverage position declined to just under 70% at June 30, and we ended the quarter with $73 million of unused commitment under our line of credit and current availability of approximately $67 million.

And now, I'll turn the call back over to David to conclude the presentation.

All right. Thank you, Nicole and Bob and Michael. All of you did a great job of informing our stockholders and analysts that follow the company.

In summary, Gladstone Capital had a good quarter, delivering strong financial results while enhancing the capital base and continuing to grow over the balance sheet of 2018 and beyond. The fund invested about $21 million in 2 -- one new investment and several follow-ons. Investment income rose by about $1.3 million. This is really from 2 sources: the increase in LIBOR and also some fee income associated with the prepayment. I always hate to see prepayments come, but it's nice when they come, and we get the extra money coming in. That one yielded about 17.6% so very nice investment. Net investment income was $6 million. That's about a 7% increase, which has more than covered our dividend for the quarter of $0.21. And with the net portfolio gain of $6.1 million, the quarter increase in net assets from operations totaled $12.1 million. It's about $0.45 a share. As a result of the $6.1 million, our net portfolio appreciation on the quarter, and the return on equity will continue the trend upward and stands at 14.8% for the last 4 quarters, which is near the top of all the BDCs in our peer group. Net asset value increased 2.8% or $0.24 per share to $8.86. We're not seeing a material impact to our borrowers regarding the tariffs that are being imposed that may come in the next round. We think the tariff discussions are going to be over, hopefully soon and as we see those countries coming to the table to remove some or all of the tariffs.

I do read my Twitter account every morning to see what the man who sets tariffs for the United States is saying, and so far, there doesn't seem to be a large impact to our borrowers. I'm hopeful that, that continues that way. My guess is the economy will continue to roll along. All the tariffs had been disadvantaged U.S. sellers of goods in other countries, and if that comes out, we'll be on top of a lot of things if those tariffs get removed.

In July, the board declared a monthly distribution to common stockholders of $0.07 per share for July, August and September. That's a run rate of $0.84 per share per year. And through the date of this call, we've now made 186 sequential monthly or quarterly cash distributions to our common shareholders. It's about $317 million. We've never missed a distribution, and that's about $11.46 per share for shareholders outstanding at June 30, 2018. Current distribution rate on our common stock and with the common stock price at $9.35 yesterday, the distribution run rate is producing a yield of about 9%, which continues to be a very attractive rate compared to other opportunities in the lending area. Our monthly distribution is 6% on our preferred stock, which translates to $1.50 annually. And the term preferred stock trades under the ticker symbol GLADN closed yesterday at $25.58. It's also a terrific yield for such a safe -- very safe security.

In summary, the company seems to be improving its position in private businesses and our midsize businesses with good management. Many of these are owned by middle-sized buyout funds which are looking for experienced partners like our group. And we lend those businesses money, and sometimes we get a little part of the equity but not that often. This gives us a chance to make attractive interest payment -- interest-paying loans which support our ongoing commitment to the cash distribution to stockholders. We've got a strong team in place capitalized on this market. And now we'll have the operator come on, and we'll take some questions from those of you who have dialed in.

(Operator Instructions) Our first question comes on the line of Mickey Schleien of Ladenburg.

I wanted to start by asking about leverage. It's been a few months since the board approved the lower asset coverage ratio, and I realize that that's work in progress. But I'd like to understand whether you started talking to your banks regarding the credit facility, and what sort of feedback they're giving you at this time?

Mickey, as we discussed last quarter, we have 2 things to deal with: one is, we've got quite a window of time before it becomes effective for us for a variety of reasons; and two, let's say, we're not a big BDC, and the broader BDC markets in the banks are going to be a part of setting how that evolves. What we've been told and continued to reiterate to us is that collateral drives the bank's leverage determination. The quality and performance of our portfolio continues to support the advance rates and the risk profile that the banks are concerned about and that all likelihood, the overall leverage is not going to be the issue, it's the collateral advance rates. And we do not expect a change in the collateral advance rates against our current portfolio. All that means is I suspect we will get relief on leverage limitation and continue to be held to the current performance advance -- the collateral advance rates that we could have in our existing agreement.

Okay. I understand. That's very helpful, Bob. I'm curious also whether you've changed your target leverage. And if you haven't, could you just remind us what that number is?

We have not changed our target leverage. We obviously continue to focus on the 200% test. At this point, we've got a fairly significant cushion to that 200% test, especially given our capital base and our net asset value movement. So I think as we get within a 10% cushion, a 10% benchmark to that net asset coverage test, we obviously begin to moderate and manage our originations as well as our liquidity events. So as we start to get -- dip below 220% coverage, you start to see us begin to manage our assets and capital base accordingly. So to get to that point, we've got a fair bit of capacity today. And as I said, we probably see some prepayments in the near term, which are good and bad. One is it'll generate, in many cases, fee income. But the yield on new assets may or may not be above where our historic yields have been.

Okay. I understand. And my last question is a little bit more housekeeping. I noticed on the Alloy Die restructuring, you meaningfully lowered the coupon on the debt, but you didn't receive any additional preferred or common equity. I was interested in understanding why you didn't get more equity in return for the lower coupon.

I think as it stands today, ADC is entirely controlled by GLAD and GAIN since this is a co-investment, so getting more equity when you already own the vast majority of the company doesn't really move the needle. The only one you're diluting in that case is management. We've introduced a new management team to grow that business, and they've done a remarkable job in improving their financial performance. So not unusual to kind of hold your position in that kind of a situation.

(Operator Instructions) Our next question is from the line of Christopher Testa of National Securities.

Bob, I appreciate your honesty on the private debt funds and others coming down market. A lot of people are kind of covering their eyes and pretending that's not the case. Just curious how you've seen -- how much of an impact, in your opinion, that's kind of had on terms and structures in your part of the sandbox and what you've seen?

Chris, we've seen some larger deals -- we typically will see $5 million, $7 million, $8 million EBITDA businesses, and we'll also see things that are approaching $10 million of EBITDA. We've obviously seen a much more acute competitive dynamic on the larger transactions. And in many cases, those are deals where the market multiples are elevated, and there's a significant pressure on free cash flow to continue to grow those businesses. And so what happens is the unitranche becomes a more attractive vehicle because of the low amortization requirements. And so where a private debt fund can put in $30 million to $50 million, it gets pretty, pretty aggressive. Obviously, as you go upmarket, above $10 million to $20 million, you talk about 6-ish -- 6 turns of leverage and 6.5 over LIBOR as being a benchmark. Obviously, if they can come down and do 4.5 turns of leverage or 5 turns of leverage at [6.5%] to [7%], that's a good yield for them. So we typically are seeing the differential in leverage and the differential in pricing impact transactions where there's $30 million to $50 million of potential investment opportunity. That's not our core market, but it does affect some transactions that we would otherwise look to participate with others in. So it's not our core, but it does affect our opportunities.

Got it. Okay. Now that's great color. And you had mentioned also some banks getting involved a bit in some of those transactions. Are these predominantly the kind of smaller community banks and regionals? Or at least some of the large banks actually participating here?

Mostly, in our experience, regional. These are $10 billion to $30 billion banks looking to grow their C&I loan portfolio. They've got deposit basis that they are seeking to put to work. And when we see a deal that might be 3.5 or 3.75 leverage, maybe it's got some collateral but not fully collateral coverage. It's got the right logos and sponsor. There are definitely situations where we have lost out in those cases to banks willing to take on that exposure.

Got it. Okay. That's very helpful. And how much of your senior secured book just approximately would you consider unitranche?

I don't know that we calculated that.

I would think...

I'm just -- we should qualify it. So how much of that would be over 5x leverage?

Oh, gosh. You have to go back to the portfolio. The average leverage for our entire portfolio is about 3.8 or thereabouts last we looked. So the vast majority of our senior loans are well under 4. I think we go into our -- we go into the deals really focused on a unitranche approach. A number of them might be 2 turns of leverage, and we call it a unitranche. Others might call it senior secured. So I would focus on the aggregate overall leverage, and the vast majority of them are well under 4.

Okay. All right. Now that's fair and extremely conservative. And I know that Mickey had asked you guys about balance sheet leverage and appreciate the detail. Are there any thoughts on -- if you don't necessarily choose to use the optionality of going about your current target leverage, is there any thoughts on potentially just increasing the economic leverage of GLAD through a joint venture or through obtaining an SBIC, which it seems that your lending would be perfect for. I'm just curious how the discussions on those who have been relevant to -- excuse me, those have been related to the increased ability to take on debt.

Two fairly broad-based questions there. I think the first, and the easiest answer is no. We're not anticipating pursuing an SBIC in the near term. We've kind of covered that in the past. Regarding joint ventures or elevating leverage, while that might hype the returns, I think we look at the overall risk portfolio. And I don't think it's our interest to increase leverage on the smaller credits that we invest in. And frankly, I think, given the economic -- where we are in the economic cycle, I think we're -- been fairly conservative at approaching our leverage levels and using off-balance sheet leverage to do that. I don't think it's consistent with where we are in the marketplace. So while we were looking at that previously, I think we're focused on building the balance sheet leverage, given the increased flexibility that we'll have in 2019 to address any issues about increasing the operating leverage for the benefit of the shareholders. So at this point, no, we're not actively seeking an off-balance sheet structure.

And just so you know about leverage for us, there was some talk about increasing the leverage from the banks. I think, at some point in time, rather than bank short-term debt would be more in line with long-term debt, that might have a variable rate that would match what we're doing. We're not in the business of leveraging up on short term and going along with loans. So just think about the leverage part that you've been asking [on --] questions. It's something that we talk about every day, but we're not quite ready to go in deep on leverage at this point.

Following on David's comment, Chris, we need to build enough scale inside of the BDC to be able to cost effectively access the broader institutional capital markets. So for us, fragmenting our leverage capital structure to create a sidebar fund works against creating the scaled issue and do more than just bank deals and very expensive baby bond transactions.

Got it. No. That makes perfect sense, guys, and appreciate your thoughtful answers. Last one for me, if I may. Congrats on turning around Alloy Die Casting. That's great. Just curious, did you receive the full benefit of the interest payment from that back on accrual for 6/30? Or should we expect the full interest income to be recorded for the 9/30 quarter on that?

The company is current on what was due for the quarter. You are astute in assessing there are -- there is accumulated deferred interest that will be recovered over time as the company's cash will support that. We have not finalized as and when that may come through, but that is a potential benefit on the horizon.

Thank you. And at this time, I'm showing no further questions. I'd like to turn this conference back over to Mr. David Gladstone for the closing remarks.

All right. Thank you all for calling in and listening, and we'll see you next quarter. That's the end of this call.

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