David Gladstone – Chairman of the Board & Chief Executive Officer
George Stelljes, III – President, Chief Investment Officer & Director
Gresford Gray – Chief Financial Officer
Troy Ward – Stifel Nicolaus
Vernon Plack – BB&T
Gladstone Capital (GLAD) F4Q2010 Earnings Conference Call November 23, 2010 8:30 AM ET
Good morning and welcome to the Gladstone Capital Corporations fourth quarter and year ending September 30, 2010 shareholders conference call. [Operator instructions.] I would now like to turn the conference over to Mr. David Gladstone. Sir, please go ahead.
All right. Thank you, Amy for that introduction, and hello and good morning to all of you out there. This is the quarterly conference call for shareholders and analysts for Gladstone Capital, NASDAQ trading symbol GLAD. Again thank you all for calling in. We love these times we have together and we’re so happy to talk to shareholders about the company. We wish we could do it monthly but quarterly is probably enough.
We hope all of you take the opportunity to visit our website, www.GladstoneCapital.com, where you can sign up for email notices and you can receive current information about us in a timely fashion and we promise not to send you out junk email and just send you out stuff about our company.
Please remember that if you’re in the Washington DC area and you have a little time to spare you can come by here in McLean, Virginia, our suburb and come by and say hello to all of us here. You’ll see some of the finest people in the business.
Now, let me read the statement about forward-looking statements. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and Securities Exchange Act of 1934, including statements with regard to the future performance of the company.
These forward-looking statements inherently involve certain risks and uncertainties, even though they are based on our current plans and we believe those plans to be reasonable. There are many factors that may cause our actual results to be materially different from any future results that are expressed or implied by these forward-looking statements, including those factors listed under the caption risk factors in our 10-K and 10-Q filings and our prospectus that’s filed with the Securities & Exchange Commission and those can be found on our web site at www.GladstoneCapital.com, and also on the SEC Web site.
The company undertakes no obligation to publically update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.
Before we start, I want to thank those of you who called in or emailed in to say we had a typo in the press release. We did not put in one of the numbers under other expenses. The total actually added up, it just had a zero in other expenses and that number was left out. It was a dash mark or zero when in reality it should have been about $361,000. Again, the totals were correct and all the rest of it seems to be correct but that was our mistake. We did issue another press release last night and putting it out. Something out this morning. Sorry to confuse you if you were loading your model up last night and found that. We appreciate you calling us and letting us know that it slipped through all of our network of reviewing the press release.
We’ll start the discussion with our president, Chip Stelljes. Chip is the Chief Investment Officer for all of the Gladstone Companies as well as the President of this company and he’ll get us started. Chip?
Thanks David, and good morning. We'll still finding economic and small business lending climate to be difficult but it is getting better. We're seeing some new investment opportunities, and have a number of proposals out to companies. We hope to be telling you about more new investments soon.
We closed one new investment during the quarter ended September 30 of 10 million. In addition, we funded $4 million to the existing portfolio companies in the form of additional investments or draws on their revolver facilities.
During the same quarter we received repayments of approximately $26 million as a result of loan sales, payoffs, normal amortization, and pay downs of revolvers, including two payoffs of $14 million in total. So in total we had a net decrease of our portfolio of about $12 million for the quarter. We used the net proceeds to pay down our line of credit.
Since the end of the quarter we closed three new investments totaling $7 million and made about $1.4 million in additional investments in existing portfolio companies. Additionally, after the end of the quarter we received $1.8 million in additional repayments. Currently, the amount we owe on our line of credit is $19.6 million.
We continue to see new opportunities. We have availability on our line of credit and are actively seeking to make new investments.
We also continue to explore ways to increase the yield on our existing investment portfolio by refinancing lower yielding senior loans with third-party lenders while trying to maintain a higher yield in junior debt.
At the end of the September quarter our investment portfolio was valued at approximately $257 million versus a cost basis of $298 million. So approximately 86% of cost.
At the end of the quarter we had loans with six companies on non-accrual and a number of companies that are still experiencing problems that might prevent them from making their payments in the future. We have taken operating control of several of these companies and are working hard to fix the problems and improve profitability.
On a dollar basis, the loans classified as non-accruing have a cost basis of $29.9 million, or about 10% of the cost basis of all loans in the portfolio. From a fair value basis perspective, the non-accruals fair value represents 3.4% of the fair value basis of all loans.
We continue to have a high concentration of variable rate loans so that we should participate if interest rates begin to increase, and while our rates are variable they typically have a minimum interest rate, or a floor, so that declining interest rates are mitigated. Approximately 82% of the loans have floors. However, 8% do not have floors and the short-term floating rate is at all-time lows. We are generating less income. The remaining 10% of our loans have fixed rates.
One measure of the quality of our assets is our average loan rating for the quarter that just ended. Our risk rating system attempts to measure the probability of default for the portfolio by using a zero to ten scale. Zero represents a high probability default and ten represents a low probability.
Our risk rating system for our non-syndicated loans showed an average rating of 6.1 at September 30, 2010, compared to 7.1 at September 30, 2009. The average risk rating for unrated syndicated loans was 7.0 at September 30, 2010, which was unchanged from September 30, 2009. Our rated syndicated loan had an average rating of B2 at September 30, 2010, compared to CCC+ or CAA1 at September 30, 2009.
In addition to the quality of assets, the quality of the income continues to be good. We do not intend to generate substantial income from paid in kind or original issue discount structures as we discussed in the past. These generate non-cash income for us, which has to be accrued for book impact, but is not received until much later and as we all know, sometimes not at all. This income is subject to our 90% payout requirement, so the company does not receive the cash but has to pay off the income.
As for the marketplace, the senior and second lien debt marketplace for larger middle-market companies continues to improve. At September 30 we had a cost basis of approximately $18.3 million senior and second lien syndicate loans.
The marketplace for loans to companies at the lower end of the middle market in which we invest most of our capital is seeing more competition. Most banks continue a policy of tightened credit standards, especially for companies at the lower end of the middle market. Currently most banks are making asset-based loans, although we are seeing an increase in non-bank lending. Net of all these conditions – we still feel we have market opportunity.
Our loan request pipeline is still full and we should be able to show you some good investments over the next six months. Our goal, again, is to be a strong, profitable company rather than the largest company. And with that I’ll turn it back over to David.
Okay, thank you Chip. That's a good report. Now let's turn to the financials and for that we'll hear from Gresford Gray, our Chief Financial Officer. Gresford?
Thanks David, and good morning. Before I go through the financials, I’d like to highlight a few key points for the quarter.
First, as of September 30 we had investments in 39 companies, which decreased from 40 as of June 30. During the quarter we had one new investment and exited from two investments.
Second, on the statement of operations we reclassified the excess fees from interest income to other income and updated the prior period amounts for comparison purposes.
Third, at the time of this call, we have about $19.6 million borrowed on our line, so the availability on the line gives us the ability and flexibility to deploy more capital for the right opportunities.
And fourth, yesterday on November 22, we amended our credit facility and, as of that amendment date, advances under the credit facility bear interest at LIBOR, subject to a minimum rate of 1.5% plus 3.75% per year with a commitment fee of 1.5% per year on undrawn amounts when the facility has drawn more than 50%, and 1% per year on undrawn amounts when the facility has drawn less than 50%. In addition, we are no longer obligated to pay an annual minimum earnings shortfall fee to the committed lenders and as of the amendment date the company paid $665,000 in fees.
Now for the details. I’ll start with the balance sheet. As of September 30, we had about $271 million in assets, consisting of $257 million in investments at fair value, and $14 million in cash and other assets. We borrowed about $17 million, cost basis, on our line of credit, and had about $249 million in net assets. As such, we are less than one-to-one leverage, and this continues to be a very conservative balance sheet for finance companies like ours, which are, as compared to others which are leveraged much higher. We believe that our overall risk profile is very low.
In regards to the income statements for the September quarter, that investment income was $4.4 million versus $4.2 million for the same quarter last year, an increase of about 5%. That increase was primarily due to higher transaction fees paid by portfolio companies, which are credited against our base management fees.
We are continuing to look for new investment opportunities with pricing and structures that are attractive, especially with the capital on our line of credit. On a per-share basis, net investment income for the quarter was at $0.21 per share, as compared to $0.20 for the same quarter last year. This was a per-share increase of about 5%, which again was caused by the changes in our balance sheet.
Let’s turn to realized and unrealized gains and losses. First, realized gains and losses come from actual sales or disposals of investments. Unrealized appreciation and depreciation come from our requirement to mark our investments at fair value on our balance sheet. But the change in fair value from one period to the next has been recognized in our statement of operations. Our unrealized appreciation and depreciation is a non-cash event.
For the quarter ended September 30, we had no realized losses but had unrealized depreciation of $1.2 million over our entire portfolio, primarily from our control investments.
As of September 30, our entire portfolio was fair-valued at 86% of cost and the cumulative, unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders. However, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution.
During the quarter, we had another component of unrealized depreciation, which related to our credit facility. And for the quarter ended September 30, 2010 we recorded an unrealized appreciation of $0.6 million based on estimates of value provided by an independent third party.
Now let’s turn to net increase or decrease in net assets resulting from operations. Please note that we’re talking about weighted average fully diluted common shares when we use per-share numbers. For the September quarter we had net increase in net assets resulting from operations of $3.8 million versus a net increase of $3.4 million in the prior year period. This was $0.18 per share for the current quarter versus $0.16 for the prior year quarter. With the continued uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of the portfolio.
And now I’ll turn it back over to David.
All right. Thank you, Gresford. For more details on our financials, all the listeners please should read our press release. And also obtain a copy of our annual report called the 10-K, which we filed with the SEC yesterday. You can access the press release and the 10-Ks on our Web site at www.Gladstonecapital.com and also on the SEC's Web site, www.sec.gov.
I think the big news this quarter continues to be that we're now away from the destructive action of the recession and we’re actively looking for new investments. Starting to get a lot more letters out and we now feel confident enough to put some new investments on the books and build our incomes so that we can look forward to increasing our dividends somewhere down the road.
We have plenty of room on our line of credit to make new loans and with these three lenders that we have that are supporting us we feel confident that they are behind us in terms of the line of credit.
Also, we continue to make progress with our existing portfolio companies as they continue to work their way out of the difficult recession. Some of them are exploding in terms of growth and others are just bumping along and making good progress but at a slower pace.
I want everyone to know that this is probably the most optimistic I've been about the company in the past two years. Our goal for this fiscal year will be and that's the one that's ending September 30, 2011, is to have a good increase in the income and hopefully some dividend increase. That's our goal for this year.
Even though we have a nice new line of credit today, that line is of course short-term and we eventually need to change that short-term borrowing into long-term credit. To do that we're talking to a number of credit providers and I think that in the next six months or year, they could provide us with some long-term debt.
Our portfolio companies, we worry that they’re not going to be able to get lines of credit as well. They seem to be doing okay with lines of credit but the term loans that they need, there's a fair number of regional banks out there that make revolving lines of credit but primarily these are based on assets. And these asset-based lenders are certainly more plentiful than they were last year but we hope somewhere along the way that we can get long-term debt for both our portfolio companies and for ourselves.
The banks are still just making short-term loans, and while that's not very good for our portfolio companies it does give us an opportunity to lend long-term to some of these small businesses. I believe the next six months, certainly year, things will change and more long-term credit will be available to our company as well as our portfolio companies. But we still just have to wait and see when that time periods going to come.
We still have a lot of things to worry about in the general economy. Certainly oil prices continue to pick up a little bit and as the economy recovers oil prices probably will go up. We're watching the metal prices like copper and others. They just continue to go up and certainly the food commodities are very high levels now. And we're worried about inflation. The decision by lawmakers in Washington, DC to borrow and spend just will continue to put the pressure on everyone and you'll see inflation come along as a result of that.
Our federal government continues to spend and it's off the charts. and we can only hope that the new Congress that's coming in will slow things down. This things that's going on called Quantitative easing from the Federal Reserve is really nothing more than the government printing more money and spending it in the hopes of jarring the economy back to some kind of spending level. We do note that the States are a little bit less to spend these days because they don't have as much money but spending from the federal level continues to go forward. None of this seems to be helping small businesses and that's really a shame because the small business areas is where about 80% of the new jobs are created.
The amount of money being spent on the wars in Iraq and Afghanistan certainly hurt our economy as we continue to pour money into those places. And all of us, including everyone here at the Company supports our troops. They are the true heroes of this period in history and they risk their lives for us, and as a result we should treat them with great honor.
All this spending means more taxes probably from this congress and certainly this administration and I just don't see how people can pay more taxes. It'll just cause the economy to get much slower. The trade deficit with China continues to worry us. It's just terrible. China continues to subsidize their industries and their businesses to the disadvantage of our businesses. They're subsidies on oil prices are significantly higher than they have been in the past. This means our companies can’t compete with them and certainly jobs then leave the United States and go to Asia.
The downturn in the housing industry and the related disaster in home mortgage defaults continues to hurt our economy and I just don't know how many more home mortgages will ultimately fail but their estimates put that number in the trillions of dollars.
Despite all the negatives, the industrial base of the U.S. is not a disaster. The recession has had its impact on small businesses as well as our portfolio companies but thank goodness it's not been a disaster.
We're seeing improvement in many of our companies and we think the last quarter of 2010 will see much more progress.
We believe the downturn that began in 2008 will continue for the rest of 2010 and into 2011. However, I do believe the economy is on an upswing that is not going to get any worse. If that's true and it is on an upswing we can take advantage of it and we'll have a great time over the next two to four years to make loans and investments.
We are not considering issuing any common stock at this point of time in this company because the stock prices are still too low, but I expect the stock price to increase over the next year and because all of the investment activities that we are planning to do. Our dividend was declared at $0.7 per share for the month of October, November, and December. The distribution rated for October dividend with the stock price at about $11.33 at the close of yesterday, gives us a yield of about 7.4%
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In summary, as far as I can see, the economic conditions are improving. We’re getting better each day. We think the economy has certainly reached bottom and is beginning to gain some strength. We just don’t know how fast it will recover. It looks like it's going to be a very slow and high unemployment under recovery over the next two quarters, maybe three quarters.
Now please remember we are stewards of your money. We’ll stay the course and continue to be conservative in our investment approach. This next year should be much better, the year ending September 30, 2011 should be a good year for us and I'm really looking forward to that.
And with that Amy, I'm going to stop here and open up the lines for analysts and shareholders who want to ask some questions.
Thank you. We will now begin the question-and-answer session. (Operator instructions) Our first question is from Troy Ward with Stifel Nicolaus. Please go ahead.
Troy Ward – Stifel Nicolaus
Great. Thank you. Good morning, gentlemen.
Troy Ward – Stifel Nicolaus
Just a couple of quick questions on Gladstone portfolio, movement’s maybe we can expect in the fourth quarter? Looking through the portfolio, it looks like there's $8 to $10 million worth of cost value of loans that probably have matured at this point today? Can you just talk on whether or not those have been repaid and how that impact portfolio growth for the December quarter?
Chip, why don't you take that?
Yeah. We have a number of maturities that are coming up. We're in discussions with companies about either renewing the facilities. I would say we're not seeing a wave of refinancing coming at us. A number of these are good companies that are performing well and so we're interested in sticking with those credits but we're certainly not, I'm certainly not forecasting the wave of repayment that we saw through the quarter in December 30. I think most of those will be extended and hopefully on better terms than we had originally.
Troy Ward – Stifel Nicolaus
Then specifically on the precision investment which matured in October, do you anticipate that will stay on the books for the, you're going to redo that one?
Yeah, so we expect that one has as we have negotiated an agreement with them and are in the process of documenting that now.
Troy Ward – Stifel Nicolaus
That's great. On the liability side what are you seeing David, from the CLO market. I know we saw another CLO get done earlier this year that had kind of focused more on senior assets because that's kind of what's available from the CLO structure right now, which seems to fit your business model, maybe more than some other BDCs? How do you look at the liability side of the balance sheet beyond the credit facility?
Yeah. We haven't explored it to a high degree. Most of those CLO's that we've seen gone out have been very special CLO's. They've not been anything close to what we do. I think the one that you may be referring to was very similar to us and they went through a lot of pain and suffering to get that done. I don't think the marketplace has come back the way it was two years ago but I don't rule it out. I think in the next year you may see a lot more traction in that marketplace and if there is, we certainly will take a look at that and see if we can offload some of our loans to a cheaper borrowing base or CLO.
Troy Ward – Stifel Nicolaus
Okay and then finally, just a couple of quick questions on the credit facility? Are there any limitations to your credit facility regarding borrowing base or such, or today would you have full access to that facility?
Gresford, do you want to talk about that?
Yes. We have full access to the credit facility. It is based on our borrowing base so there are no limitations right now, Troy.
Troy Ward – Stifel Nicolaus
Okay and then one final one. What about the fees? Did you pay any upfront fees on this facility that will be amortized over the life of the facility? And if so, how much was that?
No, we paid the 655,000 that we paid in fees. That just rpresented one times fees that will not be amoritzed.
Those had already been accrued and so that was already in the P&L and unpaid so when we changed our line of credit, we paid what we had accrued. So you already had those in your histoircal numbers.
Troy Ward – Stifel Nicolaus
Thanks. You won't be accruing any new ones on the new facility?
No, that's correct.
Troy Ward – Stifel Nicolaus
Next question, please.
Our next question is from Vernon Plack with BB&T Capital Markets. Please go ahead.
Vernon Plack - BB&T
Thanks very much and Gresford, just a few other quick questions. Were there any non-recurring expenses from the quarter?
No, the most recent that I can think of would be the compensation expense that we recorded a couple of quarters ago, the 255,000 but during this quarter we did not have any non-recurring expenses like that.
Vernon Plack - BB&T
Okay and just a point of clarification. Once you borrow more than 50% or $63.5 million your unused fee on the total amount drops to 0.5%? Is that correct?
That's correct. If it's under 50% drawn it's 1%.
Vernon Plack - BB&T
Okay. All right. Great. Thanks very much.
Okay. Next question.
(Operator instructions) Mr. Gladstone, I'm showing no questions in the queue at this time.
All right. Thank you all for calling in. We certainly appreciate it and again we'll see you next quarter. That's the end of this call.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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