Gladstone Capital Corp (GLAD) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Gladstone Capital Corporation Fourth Quarter and Year Ended September 30, 2019, Earnings Call and Webcast. (Operator Instructions) Please be advised, today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your speaker, David Gladstone. Please go ahead, sir.

Good morning, everyone. Good to have you on the phone with us. This is David Gladstone, Chairman, and this is the quarterly earnings call for Gladstone Capital for the quarter ending and the fiscal year ending September 30, 2019. Again, thank you all for calling in. We're certainly happy to talk to our shareholders and some of the analysts, and we welcome the opportunity to provide an update on the company and the investment portfolio.

And now we'll hear from General Counsel, Michael LiCalsi, who will make some statements regarding forward-looking statements. Michael?

Thanks, David, and good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and 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. 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 in our Forms 10-Q, 10-K and other documents that we file with the SEC. You can find these on the Investor Relations page of our website, which is www.gladstonecapital.com. You can also sign up for e-mail notification service or you can find these on the SEC's website at www.sec.gov.

And 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.

As a reminder, today's call is simply an overview of our results. So we ask that you review our press release and Form 10-K, both issued yesterday, for more detailed information. Again, you can find them on the Investor Relations page of our website.

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

Good morning, and thank you all for dialing in this morning. I'll focus the bulk of my remarks on the results for the last quarter and conclude with some summary comments on fiscal 2019 and the outlook for fiscal 2020.

The headlines for Gladstone Capital for the quarter ended September 30, 2019. Originations on the quarter were $24.7 million, which included 1 new investment and 2 add-on investments to the existing portfolio companies. Exits and prepayments on the quarter totaled $28.8 million, the majority of which were associated with the sale of our interest in ADC, which yielded proceeds of $18.3 million, and included the repayment of our debt position at par, a realized equity gain of $8.7 million as well as deferred interest and success fees. While the total investments on the quarter fell slightly, earning debt investments actually increased by approximately $7 million before any valuation movements.

Interest income on the quarter rose almost 6% to $11.8 million over the prior quarter with the collection of approximately $900,000 of previously deferred ADC interest. Excluding the ADC impact, the average yield on our interest-bearing portfolio declined slightly to 11.6% with the approximate 30 basis point decline in LIBOR in the quarter as the average outstanding investment balance was largely unchanged.

Prepayment fees, exit fees and dividend income declined to $900,000 from $1.7 million last quarter, which was the primary reason the total investment income for the quarter fell slightly to $12.7 million.

Borrowing costs fell slightly on the quarter as lower average borrowings and LIBOR rates more than offset higher unused facility commitment fees on the quarter.

Net investment income rose to $6.4 million or $0.21 per share as operating expenses were unchanged, and net management fees declined $200,000 compared to the prior quarter as incentive fee credits increased slightly.

The net assets from operations declined to $5.4 million or $0.18 a share as a result of $1 million of net portfolio depreciation on the quarter and NAV dropped $0.01 to $8.22 per share at September 30.

With respect to the portfolio, the asset mix as of the end of the quarter shifted slightly with the portfolio activity and the exit of ADC, resulting in earning assets increasing 2% to 90% of the overall investment portfolio at fair value while we maintained an almost equal split between senior secured assets and second lien assets. For clarification purposes, our senior secured assets do not include any assets where we have sold off a first-out position in the investment, which is consistent with how these assets are classified for collateral purposes under our credit facility.

The largest contributor to the portfolio appreciation on the quarter was the additional $3.3 million realized gain on the exit of ADC while positive bookings and strong operating results lifted the valuation of our Defiance and Targus investments. Detracting from this momentum were the headwinds experienced with the energies -- within the energy services and auto parts sector, which resulted in the depreciation of our investments in FES Resources and Meridian.

During the quarter, there was no change in the status of the 2 nonearning investments in the portfolio, which represent an aggregate cost of $8.5 million or 2.2% of debt investments at cost, which, as of September 30, have largely been written down to a fair value of only $100,000.

Since the end of the quarter, we've closed on an additional $17 million of additional debt investments, including one new proprietary investment, and repayments or exits on the quarter have totaled $2.4 million. So our earning assets are up about $15 million as of today.

In reflecting on the overall results for the fiscal year, there were a couple of points of note. Over the course of fiscal 2019, we successfully stepped up our origination activities, closing on $147 million of new and follow-on investments, which was up 38% over fiscal '18. However, repayments and exits nearly doubled on the year to $131 million, which limited our fair value growth during the period to approximately $13 million.

The weighted average yield on earning assets rose to 12.3% on the year from 11.8%, aided by the $800,000 in deferred interest received from ADC exit and approximately 55 basis point rise in LIBOR over the year, which more than offset any general market spread compression. While we were disappointed at the performance of select credits, their depreciation was largely offset by appreciation elsewhere, and our net book value was largely unchanged on the year.

We ended the year with our core proprietary investment portfolio conservatively leveraged at approximately 3.88x EBITDA on a weighted average basis.

Over the last year, we have successfully improved our capital position by raising $17 million of common equity at well above our NAV under our ATM program, and as of September 30, our debt-to-equity stood at 71%, well below most of our peers.

After the end of the quarter, we called our 6% Series 2024 Term Preferred Stock, GLADN, which was refunded with $38.8 million of 5-year debt, GLADL, at a yield of approximately 5.375% and additional bank borrowings. In addition to the small interest savings achieved, this refunding removes the final hurdle to permit GLAD to take advantage of the higher permitted BDC leverage going forward.

Turning to the outlook for 2020. We've been able to source a healthy level of new deal opportunities in the past several months, which is not unusual for this time of year. That said, competitive pressures have also increased, particularly for senior unitranche investments where margins are inching down in spite of the downward movement in LIBOR since midyear. However, between GLAD's long term -- long-standing focus and relationship within the lower middle market and management's singular focus and alignment with GLAD's performance, we're confident we will overcome these near-term competitive pressures.

Given our current investment backlog and near-term pipeline, we expect to be able to continue to outpace the anticipated portfolio liquidity events. However, it will likely take a number of quarters to prudently deploy the nearly $70 million of incremental investment capacity we have as of today just to approach a 1:1 debt-to-equity ratio.

In conclusion, we believe we're well positioned to take advantage of our strong capital position and leverage relief to grow our investments and generate incremental cost efficiencies and enable us to improve our returns to our shareholders going forward.

And now I'd like to turn the call over to Nicole Schaltenbrand, our CFO of Gladstone Capital, to provide some additional details on the fund's financial performance for the quarter and fiscal year. Nicole?

Thanks, Bob. Good morning. During the September quarter, total interest income rose 6% to $11.8 million as the ADC deferred interest more than offset the 30 basis point decline in the average yield on the investment portfolio. Other income recognized during the quarter of $900,000 was largely associated with success fees received upon the exit of ADC. Other income declined by $800,000 compared to the prior quarter mainly due to a decrease in prepayment penalties received. Total investment income declined $200,000 or 1.3% to $12.7 million in the quarter. Total expenses for the quarter declined by $300,000 as financing expenses fell slightly by $100,000 to $3.1 million. Also, net management and incentive fees declined by $200,000 for the period as net base management fees rose by $200,000 with fewer credits associated with the lower level of originations. And incentive fees declined by $400,000 with an increase in adviser fee credit. Other expenses were unchanged in the quarter at $800,000 or 75 basis points on average assets. For the quarter ended September 30, net investment income was $6.4 million or $0.21 per share and covered 100% of our distribution.

Moving over to the balance sheet. As of September 30, 2019, total assets were $426 million, consisting of $403 million in investments at fair value and $23 million in cash and other assets. Our cash balance was elevated at the end of the year to support the funding of a new investment, which closed shortly after the end of the quarter. Liabilities rose by $8 million to $177 million as of 9/30 and consisted of $67 million in borrowings on our credit facility, $55.7 million of 6 1/8% senior notes in 2023 and $52 million of Series 2024 Term Preferred Stock. Net assets rose by $3.1 million since the prior quarter end with $1 million of net realized and unrealized portfolio depreciation and common stock issued under our ATM program, which generated net proceeds of $4.1 million for the quarter. Specifically, we issued 442 common shares at an average price of $9.49 per share or 115.5% of NAV. The accretive ATM issuance offset a portion of the portfolio depreciation and NAV per share dropped by only $0.01 per share from $8.23 as of June 30 to $8.22 as of September 30, 2019. Our leverage as of September 30 was up slightly from the prior quarter end at 71% of net assets with the increase in assets for the period. As of the end of the quarter, we had an excess of $100 million of current investment capacity and availability under our line of credit. Following the end of the quarter, we completed the call of our Series 2024 Term Preferred Stock at par in the amount of $52 million, which was refinanced with the issuance of $38.8 million of 5 3/8% notes due 2024 and the borrowings under our line of credit. As of today, the availability under our line is approximately $90 million of the $110 million unused.

With respect to distribution, Gladstone Capital has remained committed to paying its shareholders a cash dividend. In October, our Board of Directors declared a monthly distribution to our common stockholders of $0.07 per common share per month for October, November and December, which is an annual rate of $0.84 per share. The Board will meet in January to determine the monthly distribution to common stockholders for the first calendar quarter.

At the current distribution rate for our common stock and with the common stock price at about $10.25 yesterday, the distribution run rate is now producing a yield of about 8.2%, which continues to be attractive relative to most yield-oriented alternatives.

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

Thank you, Nicole. You did a good job. Bob, Michael, you both did a good job of informing our stockholders and analysts that follow our company.

In summary, Gladstone Capital had a good quarter, which capped a solid year, originated $25 million for the quarter in new investments and the total investments for the year of $147 million to more than offset the elevated levels of prepayments that continue to grow and continue to grow our assets. We reported $12.7 million of investment income for the quarter and cleared $50 million for the investment income for the year, which was up 9.8%. Generated an 8.3% return on equity, net of all the portfolio gains and losses, while maintaining a very conservative leverage balance sheet. Maintained a strong balance sheet, which signified dry powder and given the recent regulatory leverage relief. So we've got plenty of room to grow the investments at attractive, lower middle market businesses that we finance.

So in summary, the company sees an improving position in the private businesses that are midsized and with a good management team that we like to finance. Many of these are owned by midsized buyout funds. We follow them around and finance their acquisitions that they're always looking for experienced partners, and they know if they get us involved, that will carry our weight there in terms of doing due diligence and financing the leverage over their equity. This gives us a chance to make an attractive interest-paying loan, which is supported by our ongoing commitment to pay cash distributions to stockholders. We have a strong team in place to capitalize on this marketplace and think we'll do a good job for the next year that will end in 2020 -- in September of 2020.

Now, operator, Sydney, would you come on and tell our callers how they can ask some questions?

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

Yes. A question for Bob. So there's been a good deal of stress in the more liquid loan markets, and I think some of that weakness there is due to the outflows as a result of declining LIBOR. But I also think the market's realizing that deal terms have been too aggressive and fundamentally deteriorating, especially for some business models. There's also been increased bifurcation between good credits and those that are perceived to be weaker. So in the past, you've nibbled at the more liquid credits in your portfolio. And given the volatility we're seeing there, are there areas of that market where you're seeing interesting opportunities that perhaps you think the market is mispricing?

Mickey, it's an interesting question. There -- you're exactly right, we've been somewhat opportunistic where illiquidity has created opportunities. At the moment, I agree with you, LIBOR is part of it, but I think the other part is most of the syndicated loan marketplace falls in the single B category. And the CLOs, which are the biggest buyers of those assets are pretty overweighted single Bs. In concern of potential downgrades and what it might do to their buckets and the required liquidations, I think people are holding off. So you're not seeing a whole lot of issuance in the single B category these days. We've seen very little coming to marketplace through the syndicated banks. So we really have not seen any particular opportunities.

I will also note that if you follow the -- some of the other bigger BDCs and private funds pools, last week, there was an announcement of 3 underwriters took on a $1.6 billion syndicated loan with 3 BDC participants. So what you're starting to see is a migration of some large assets that would have otherwise been syndicated to the large commitment capabilities of some of these bigger BDCs.

The other thing that's noteworthy that I think is beginning to filter is, I think the investor marketplace is beginning to recognize that buying syndicated loans given the documentational elements of those transactions are not very attractive or protective in a downward environment and they are opting to invest more through private debt funds run by professional managers. So I think you're also seeing folks who are looking for surety on execution and the marketplace that's looking for professional managers to run those assets beginning to shift some of those opportunistic situations in favor of private debt-funded alternatives. So we're not particularly optimistic at the moment on having syndicated opportunities that we might find attractive in the marketplace today.

Okay, I understand. That's interesting, Bob. I appreciate that. Just one follow-up question in terms of the portfolio structure. I did notice that the allocation to second lien increased quarter-to-quarter. But as you've said in the past, that includes last-out pieces of unitranche, which as we know, some other BDCs would label as first lien. So could you give us a sense of how much last-out unitranches in the portfolio? And was that what drove the increase quarter-to-quarter?

As I indicated in my comments, Mickey, we don't classify last-outs in second liens. And at the present, we don't have any last-outs in our portfolio. We have sold off senior loans to participants on a straight-up basis not as a part of our existing facilities. So that is not part of the mix. I think more traditionally in the past, the unitranches that we've done have been larger dollar amounts because it's a deeper -- it's a larger multiple of the underlying EBITDA. So it's not uncommon for us to have prepayments of those unitranches given the market pressures, and it will cause some swings in our assets.

As my comments alluded, there's a lot more pressure in the senior asset category today. That's where most of the private debt funds are looking to put their money to work, and so it's a little bit -- been a little bit more challenging for us putting on assets in that category. The deal we closed after the end of the quarter was a unitranche, and a number of our current pipeline activities are unitranches. So I would not look at the shift as a permanent event. $20 million in a transaction can swing those numbers fairly easily, and we are committed to the continued roughly equal mix of first lien and second lien going forward.

Our next question comes from Henry Coffey with Wedbush.

It's always good to go after Mickey because he's so detailed and focused. So thank you, sir. Thank you, Mickey. But in more general terms, when you look at your portfolio companies, we've got 2 issues that you would both have the word volatility in them, obviously a lot of rate volatility which could affect how your business performs, and then a lot of sort of economic shifting going on, and then obviously, we're going into an election. When we -- if we just ignored all that and talk specifically to your companies, how are they doing? I mean what are their business -- their actual business outlook? What's it like out there in the field is kind of how I'm asking the question.

Henry, we're pretty diversified. So I think you have to recognize there are some sectors where things are going reasonably well. Domestic manufacturing is going reasonably well. Some of the service-oriented businesses are doing reasonably well. If it's got an international flavor to it or if it's got the tariff issues that they've had to manage around, those obviously have been more challenging. Most of the investments that we've been focused on have a core organic growth opportunity to them and well in excess of what the economic growth is today. And so they -- even if they are slow, they're still doing fairly well.

So if we looked at the sectors where we play today, it's pretty diversified. Diversified manufacturing, diversified services are pretty strong. But I would also say that we've steered clear of anything that's housing-related. We've steered clear of anything that's kind of retail-oriented given the continued consolidation and uncertainties of those marketplace. But overall, I think the majority of the movement that you're seeing in the portfolio appreciation or depreciation has more to do with our outside pricing service, which sets the price for a significant portion of our loans. And as you've seen, there's probably, typically in the recent market, 1 point to 1.5 points of depreciation because of just the general market trends and valuation levels. So I can't be more specific without drilling into individual names, Henry, and that's obviously not something we can do on this call.

And then when you jump to the other side of the discussion and look at just where rates are right now, we almost have a -- we've got a tweak of an inverted -- of a steepness in the yield curve. Nothing to get really exciting -- excited about. And then we have some recent increase in the 10-year. So -- and that's only over the last 5 days. So when you look at the current rate environment, how do you think the company is positioned in terms of spreads and margins, and what your investment rates will look like?

Well, look, I think a year ago, we were all thinking that LIBOR was going up and we were going to reap some lift on our cumulative margin and our modest leverage. I think in the current environment, it does not feel like the rates are going to go down much from here. So any decline, I would continue to point towards overexuberant competitive pressures, and frankly, that's not something that we're going to chase.

We are very focused on growth-oriented businesses that are looking for capital flexibility and follow-on investments to grow their companies. And ultimately, by giving them those flexibilities, they're able to compound the return and expand their equity appreciation, and that doesn't change because interest rates move 25 basis points. And so we are continuing to pursue those opportunities, that's the core of the marketplace.

I think from our perspective, yes, we refinanced some of our fixed-rate structured debt down a little bit. We've reduced the weighting on the fixed side a little bit. I would also venture to guess that there will be a discussion coming early 2020 with respect to the spread on our bank line. And all of those things, weighted together, will give us some incremental flexibility as it relates to the net interest margin. But our net interest margin has held fairly consistent, and we're going to be disciplined around that. So I don't think it narrows from here. But I also don't think in the near term, given the competitive pressures, it's likely to widen. I think we can make it work where it is. We'll just have to work a little harder to keep our costs low or lower them, and we will look to increasing our leverage slightly over what we experienced last year to enhance the returns to the shareholders.

I'm not showing any further questions at this time. I will now turn the call back over to Mr. Gladstone for any further remarks.

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

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect.