Gladstone Capital Corp (GLAD) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Gladstone Capital Corporation's Third Quarter ended June 30, 2020 Earnings Call and Webcast. (Operator Instructions) Please be advised that today's call is being recorded. (Operator Instructions)

I would now like to turn the call over to David Gladstone. Please go ahead.

All right. Thank you, Michelle. Nice introduction, got us all warmed up. This is David Gladstone, Chairman. And the quarterly earnings call that we normally do every quarter, and this is the third quarter for this company. It's year ending at September 30th and really thank you all for calling in.

We're always happy to talk to shareholders and analysts and welcome the opportunity to provide an update on the company and its investment portfolio. It's really hard today to give you much determination on which way winds are blowing, the government gets to decide almost everything and you've got the state government, the county government, the national government, and it's really hard to figure out which way the winds are blowing. But we'll start out here, the way we always do, General Counsel, Michael LiCalsi, who will make some statements regarding forward-looking statements.

Thanks. David, and good morning everybody. Today's report may include forward-looking statements under the Securities Act of 1933, 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 that we listed on our Forms 10-Q, 10-K, and certain other documents that we file with the SEC. You'll find these on the Investor Relations page of our website, which is www.gladstonecapital.com. On that website, you can also sign up for our e-mail notification service. You can also find our information on the SEC's website and that's at 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. Remind everybody that today's call is an overview of our results. So we ask that you review our press release and Form 10-Q, again both issued yesterday for more detailed information. These can be found on our website Investor Relations page at www.gladstonecapital.com.

Now I will turn the call over to Gladstone Capital's President, Bob Marcotte. Bob?

Thank you, Michael. Good morning and thank you all for dialing in this morning in anticipation of what we might have a few more COVID related questions this quarter. Let's get into the summary for the results, for the Gladstone Capital for the quarter ended June 30. Originations on the quarter totaled $56.5 million including 2 new proprietary investments. Repayments in proceeds on exit totaled $17.1 million and included the exit of 3 smaller positions, so net originations for the period were $39.4 million. Interest income rose on the quarter to $11.6 million or up 6% over the prior quarter with the increase in average investments as the portfolio yield was unchanged at 10.9% as most of our investments are well below the applicable LIBOR floors. Prepayment and dividend income was nominal. So the investment income overall was up slightly to $11.7 million. Borrowing and administrative costs fell in the period with lower LIBOR rates in unused commitment fees, however, net management fees, rose by $900,000 with the reduction of an incentive fee credits, resulting in net investment income of $6.1 million or $19.5 per share.

Net assets from operations rose to $15 million or $0.48 per share, which included $9 million of net unrealized portfolio appreciation on the quarter, as the reduction of market-based spreads and strong performers more than offset the weakness in our energy and auto-related investments. For the period NAV rose to $0.28 per share or 4% to $7.27 per share as of June 30.

With respect to the portfolio. As we discussed last quarter on our call, we were fortunate that our portfolio diversity limited our exposure to the consumer, retail where travel service sectors most impacted by the COVID-19 pandemic. That said much of last quarter was focused on working with our companies to make sure appropriate actions were instituted to adjust cost and bolster liquidity to weather any disruptions, including supporting their access to PPP funding. For the period we did not experience any payment defaults in our one non-accrual investment. Our non-accrual investments decline to 1.5% of the portfolio at fair value. You will note that we did move one investment to pick for the next couple of quarters in connection with the PE sponsor contributing new equity to bridge the disruption in order flow from the auto manufacturers it serves. From a valuation perspective, the top 3 companies that increased were driven by improved operating performance and they were closely followed by a number of our broadly syndicated investments that recovered on average about 60% of the last quarter's depreciation with the reduction in applicable market spreads, much of the unrealized depreciation this quarter can be attributed to our auto and energy sector related exposures.

The auto plant shutdowns and subsequent ramp-up of order flow has hampered the recovery of our 2 investments in those sector -- in this sector, which represents about 4.2% of our investments at fair value. However, as both companies are on attractive high profile vehicle platforms and they are continuing to win business and have ample liquidity. We expect these companies to improve in the next couple of quarters. With respect to our energy sector exposures, the pricing volatility in severe production contraction last quarter impacted our investment in an oilfield chemical distribution business. While we've been through energy swings with this company before and the team has adapted managing their cost structure. The speed of the production curtailment in the Permian was unprecedented. Fortunately, many of the shut in wells have already restarted with the improved crude prices and we expect their revenues to have bottomed in May and trend up this quarter.

Lastly, the extreme price swings disrupted the volume of energy property and lease sales last quarter, which negatively impacted our investment in the leading broker of government and auction services for these properties.

The company has taken significant cost reductions, bolster liquidity, and is well-positioned to benefit from postponed government sales and auctions of distress and restructured operator properties.

The asset mix at the end of the quarter was relatively unchanged based on the net originations as first lien loans dropped to 47% of cost and second lien loan exposure increase to 43% of cost.

Our only non-earning asset is our $7.2 million debt investment in B&T, a wireless engineering and contracting business, which represents 1.5% of assets at fair value. B&T is well-positioned to recover with the increase in wireless 5G expenditures, which we are beginning to see. Since the end of the quarter, our investment in Survey healthcare of approximately $14 million was prepaid at par, plus a prepayment fee of $300,000. We also sold a $6 million piece of our second lien exposure to the Lignetics at par, which represents a significant gain over where this position was marked last quarter.

Turning to the outlook for the balance of 2020. Despite the unprecedented challenges of COVID-19, we feel we weathered much of last quarter's challenges and our portfolio composition and diversity, underwriting discipline and active company management has affirmed our lower-middle market investment focus and positioned us well to grow.

On the new deal front, we are being cautious regarding any lasting COVID included related financial impacts and we have recently seen a pickup in the level of deal inquiries. Given the current market dislocations and more limited competitive conditions, we expect these opportunities to carry more modest leverage levels and improve yields. We intend to continue to proactively manage our investment capacity and sell existing assets to support these new investments. Excuse me, sorry. We intend to sell existing assets to support our new investments to maintain our targeted leverage level while enhancing our net interest income.

And now I would like to turn it over-- the call over to Nicole Schaltenbrand, the CFO of Gladstone Capital to provide an update on the details of the actual financial performance -- performance for the quarter.

Thanks, Bob. Good morning, everyone. During the June quarter, total interest income increased $600,000 or 5.7% to $11.6 million primarily due to an increase in the average balance of our interest-bearing investment. The investment portfolio weighted average balance increased by $24.7 million or 6.1% to $429 million compared to $404.3 million for the quarter ended March 31. The weighted average yield on our interest-bearing portfolio was unchanged at 10.9% compared to the prior quarter. As the decline in LIBOR had a minimal effect given interest rate floors and effect in our predominantly floating-rate assets. Other income decreased by $400,000 compared to last quarter with lower prepayment fees and dividends, resulting in the total investment income for the quarter increasing $200,000 or 2.1% to $11.7 million. Total expenses increased $700,000 or 4.2% quarter-over-quarter, primarily due to a $900,000 decrease in the incentive fee credit granted by the Adviser and small reductions in interest expenses and fees and other expenses.

As a reminder, we continue to credit closing fees received directly to the manager, which were $675,000 last quarter and we continue to provide a credit to reduce the management fees on broadly syndicated investment to 50 basis point which was $92,000 last quarter. Net investment income for the quarter ended June 30, 2020 was $6.1 million, a decrease of 7.1% as compared to the prior quarter, or $19.50 per share and covered 100% of shareholder distributions. The net increase in net assets resulting from operations was $15 million or $0.48 per share for the quarter ended June 30 compared to a decrease of $27.8 million or $0.89 per share for the prior quarter. The current quarter increase was driven primarily by $9 million of net portfolio appreciation, as Bob covered earlier.

Moving over to the balance sheet. As of June 30 total assets were $458 million consisting of $447 million in investments at fair value and $11 million in cash and other assets. Liabilities rose to $231 million as of June 30th and consisted primarily of $133.5 million in borrowings on our credit facility. $57.5 million of [6.8%] senior notes due 2023 and $38.8 million of 5.38% senior notes due 2024. Net assets rose by $8.9 million from the prior quarter-end with $9 million of net realized and unrealized portfolio appreciation. The NAV rose from $6.99 per share at March 31st to $7.27 per share as of June 30th. Our leverage as of June 30th increased from the prior quarter-end to 102% of net assets from 86% with the net originations for the period.

As of the end of the quarter, we had an excess of $53 million of current investment capacity and availability under our line of credit. In April, we successfully extended the revolving period ending on the credit facility by 6 months to July 15, 2021. Our overall leverage continues to compare favorably, and we believe we have sufficient levels of liquidity to support our existing portfolio companies as necessary and selectively deploy capital in new investment opportunity.

With respect to distribution, Gladstone Capital has remained committed to paying its shareholders a cash dividend. And in July, our Board of Directors declared monthly distributions to our common stockholders of $0.065 per common share per month for July, August, and September, which is an annual rate of $0.78 per share. The Board will meet in October to determine the monthly distribution to common stockholders for the following quarter. At the current distribution rate for our common stock and with a common stock price at about $7.31 yesterday. The distribution run rate is now producing a yield of about 10.7% which continues to be attractive relative to the extraordinary low yields generally available in the market today.

And now I'll turn it back to David to conclude the presentation.

Super, Nicole, very nice and good presentation. Bob and Mike keeping us all up to date. It's a challenging quarter for the participants in leverage lending marketplace these days and Gladstone Capital is no exception, but we did well in delivering numbers on this good company originated $56 million. We had about $17 million in paydown. So we ended up with about $39 million increase in our assets and hopefully, all of those will produce some good income over the next 6 months and we will be able to report to you some good things on that as well -- run as well.

We are working hard with our portfolio of companies trying to keep the non-performing assets where they are today, about 1.5% and then have the total investments higher assets drove a nice increase in the company's core net interest income of about $8.9 million and we've maintained a strong balance sheet, including existing assets making additional capital available to provide for more loans to middle-market businesses. That's the business we're in, it's the original business that I started out in many years ago.

In summary, the company continues to invest in mid-sized private businesses with good management, many of these situations are supported by private equity funds, so we hang around with those guys to provide the debt that they need to buy something. This gives us an opportunity to make attractive interest-paying loans and supportive ongoing commitments to pay cash distributions to shareholders.

As I mentioned at the beginning, forecasting today is very difficult because quite simply, we have no way of knowing which way the state and local governments as well as the national governments, are going to do to what's going on. If you walk down some streets in Washington D.C. you see them all boarded up and we wonder how that's going to un-button at some point in time. We've given the government the power to do most anything in the name of COVID-19 and it has some good things and bad things with it. But let's stop here and have the operator come on.

If you would, Michelle, come on and tell people how they can ask some questions.

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

Yes, good morning everyone. First of all congratulations on what's -- what appears to me to be a very strong quarter given how difficult the environment is, so well done. I see that your investment activity was much higher in that quarter than over the last several quarters. And I'd like to understand how much of that was from deals in the pipeline that perhaps you've been working on for a while and simply came to fruition now versus opportunistic investing during a period of high dislocation?

Good morning, Mickey. Both of those investments. It takes a while for these deals to come to fruition. I mean, so both of them actually pre-dated the quarter and were adjusted modestly as a result of the quarter activities but feel very comfortable as both of those deals are relatively low leveraged more like 2s versus 4s times turns of leverage. So we're happy with those investments, nice yields, but lower risk exposures.

Okay. That's helpful. Bob, I see that your weighted average risk rating on your proprietary investments improved, which certainly the trend I’ve been seeing generally in the sector. Were there some particular outliers that drove up the rating?

Some of those numbers are a little bit lagging since the financial results for the second quarter, are in the 9 -- the 6:30 numbers right. We don't have 6:30 numbers as of 6:30 for all of our company. So.

Right.

There is a little bit of lag in there. The second is, I would attribute mostly to the deals that were recently closed. When we put on deals that are leverage at less than 3 in that order of magnitude, it's certainly going to improve the rating.

And thirdly as per my earlier comments the appreciation of the top 3 performers had to do with improved performance. So we had 3 historical companies dramatically improve their financial performance which is going to wait up the number. So it may be a little bit of an anomaly given the timing but some good assets and improvement tons from core positions, I think I think where the result. But we will definitely go back and make sure we understand what that swing was.

I appreciate the color. That's really interesting. So Bob, your leverage at least in terms of debt to equity now is within your target range unless it which last time I looked, I think you mentioned it was 0.9% to 1.25% and it sounds like from your prepared remarks that you're not willing to go higher into the target range given the current market conditions. Is that correct?

I don't think that's. I think we are, we are floating around the 1 to 1 leverage net level now. We obviously had some subsequent prepayment, so it brought us back down I think gave us about $20 million in additional capacity based on pre-payments, we certainly will go back up on leverage, but we are going to, as we go up over 1 to 1 we are going to be looking at our existing assets closely to determine how much further we want to go. Obviously, we're going to maintain a cushion to deal with any portfolio-related matters. Once we get over a certain threshold we're going to keep an amount reserve. As you may recall before we move to our leverage multiple we typically didn't go much past 80% even though the rule was one to one. So we're going to -- we're going to keep a cushion to that 1.25 going forward. And I think the last comment that I would make is we also want to be very careful that between the line capacity and what's available in the marketplace, to make sure that the marginal funding cost, that we are using to fund those new assets is accretive. So again, it's going to be around or guard rails around the one to one leverage and we're going to closely manage on a go-forward basis.

I do understand that and appreciate it. And David Gladstone mentioned how difficult it is to make forecast right now and I realize that the decision to issue common equity takes many factors into account, but you've mentioned cushion several times and that decision to potentially issue common equity, obviously, we'll have to take into account the opportunity to put the capital to work. Simply put, do you have an appetite to issue common equity, given that the stock is trading above NAV?

That's a tough question Mickey. I got to say, we're going to have to have some really attractive continued investment opportunities. At a 10.7% yield on that stock today, when you factor in the marginal debt financing costs, which are probably higher than what's currently in our -- on our book today. It's going to have to be a pretty accretive investment opportunity to be able to cover that marginal funding cost and that marginal equity cost. Would we consider it? Yes, but it's not going to be a significant volume. We obviously believe that there is a path to which this stock is generating a very attractive yield and it should continue to appreciate. We continue to maintain the quality of the portfolio.

So backing up the truck today, it's probably premature.

I understand. So if I could summarize based on those last couple of answers, it sounds like the strategy would be more to just rotate the portfolio perhaps as repayments come in or from lower-yielding investments to higher-yielding investments as you find them while constraining leverage in the midst of all of this uncertainty. Is that a fair statement?

And so it's a good recharacterization, Mickey. It's a day-to-day situation that we're managing. I mean, the other thing that I would add is, when we think about issuing equity, we have to anticipate where the market is going. We're already beginning to see some price compression and some competition as the market normalizes. So I wouldn't want to issue a bunch of equity in anticipation of a particular spread in the marketplace and to see that get bid down, so we're certainly going to manage it very closely. And if we do anything, it may be a small amount under our ATM program as the market dislocation support.

Our next question comes from Henry Coffey of Wedbush.

Good morning and just kind of following up on Mickey's questions. When new loans are put in front of you, what -- who is looking for capital in this market and or is it just people looking not for capital for growth, but for capital to survive? What is the nature of the beast that comes walking in the door, looking for capital right now?

Henry, there is a fair amount of folks that are looking to recap out existing lenders. Folks that are under stress, folks that have come to the end and have had enough probably had a bump in the road and have reached their 5-year hold period, so those are tough situations. We generally are not -- we're generally somewhat skeptical in those situations that they've had 5 years and can't deleverage to work our payout. It's certainly a telltale sign that we should be careful.

There are certainly some new transactions going on. Folks are beginning to think about how to due diligence in a COVID environment. Travel is starting to work and folks are even thinking about doing due diligence calls with the management teams. But those transactions are just beginning to percolate. They've been pretty much on hold for the last 3 to 4 months. Where we see additional opportunities coming on are also in some add-ons and folks that are in the business and have the opportunity to acquire accretively. But for the most part, it's still sponsored financing transactions albeit, the overall flow is certainly only beginning to re-emerge.

You also talked about spreads tightening, I don't want to characterize the comment, but what is the correlation right now between actual real live trends in businesses and trends in quote bond values and spreads and loan values. How are those 2 lining up or is there a disconnect there in your opinion?

I only -- I think about it 2 ways. The one is in the broadly syndicated marketplace, we have a number of those investments in our portfolio. They are still marked well below where I would expect them to be and I think that's indicative of the leveraged loan market has not fully re-related, you know CLO market conditions, investor funds flows have not bid up the syndicated marketplace as much as I would expect. You still have assets trading in the '80s not necessarily in the '90s and, but I think you're also talking about higher levels of leverage and instruments that don't have quite the same controls and covenants in them and protections that we would require in the current environment.

So that's more of a macro funds flow issue that it's going to take longer to resolve that as I mentioned, of the comments we're only back at about 60% of where we marked it down last quarter.

In the direct origination front, where proprietary investments, senior funds continue to proliferate, we're talking about insurance companies and plenty of folks, looking for yield in the current market environment. And to be able to put a unitranche piece of paper on your investment portfolio and talk about an L-plus 7, 8 or more, that's a very attractive yields relative to the marketplace and the leverage levels are probably half of what some of the syndicated levels are. We are seeing a more active investment activity there. I mean, without sharing names major insurance company pools in 4, 5 guys and opens up the checkbook for $750 million fund last quarter. I mean, take advantage of the marketplace recognize there is some dislocation and putting on paper with poor protections that is going to yield almost high single-digit rates. That's a good return for that investors. So we're definitely seeing more interest in the direct proprietary investments than we are the market inflating or reflecting the leverage finance syndicated loan market.

And is that going to be -- is that then create a challenge for you in terms of wanting to put out money because you've got an insurance company bid to compete against or is that an opportunity because you'd rather be involved in a more liquid dynamic situation as a no-bid market can be very scary, as we all know?

Yes, well, if you've got a $750 million fund you got 4 people, you're not going to see the market, your brand new, you don't have a reputation, you don't have the flexibility. So we're still going to compete pretty well in that situation and we are focused on the lower-middle market. They're not going to want to touch of business at least initially, that might be sub $10 million EBITDA.

So the competitive barriers for that company getting into where we play is still meaningful. They are potential participants as that company grows. So if we go in and do a unitranche and the business grows, we will, may need a partner or we may decide such a good business that will bring in a lower cost seeing you as part of building a business. So if it starts at $8 million and the acquisition or too later is $20 million of EBITDA, we're very happy to start in that transition, grow the business and go from a unitranche player to sub debt player in that situation and make money, over the entirety of our, the duration of our investment. So I'm not worried about it. I will think that it will drive down the margins at the upper end of the size range initially and that's what we're beginning to see.

Okay. There are no further questions.

No further questions.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.