Gladstone Capital (NASDAQ:GLAD)
F1Q2011 Earnings Call
February 8, 2011 8:30 a.m. ET
David Gladstone – Chairman of the Board & Chief Executive Officer
George Stelljes, III – President, Chief Investment Officer & Director
David Watson – Chief Financial Officer
Troy Ward – Stifel Nicolaus & Co.
Mark Hughes-Lafayette Investments
Good day, and welcome to the Gladstone Capital first quarter shareholder conference call and webcast. All participants will be in a listen-only mode. (Operator instructions.)
I would now like to turn the conference over to David Gladstone. Mr. Gladstone, the floor is yours sir.
Well, thank you, Mike. Thanks for the nice introduction, and hello and good morning to all of you. This is David Gladstone, the Chairman, and this is the quarterly conference call for shareholders and analysts for Gladstone Capital, trading symbol GLAD.
Again, we thank you all for calling in. We’re so happy to have the time with shareholders; wish there was more of these, but we only do them once a quarter. We hope all of you take the opportunity to visit our website at www.GladstoneCapital.com, where you can sign up for email notices so you can receive information about us on a timely fashion.
And please remember that if you’re ever in the Washington D.C. area you have an open invitation to stop by and see us here in McLean, Virginia. We are here in the suburbs of Washington, D.C., and think if you’ll stop by you’ll see some of the finest people in the business.
Now, I need to read a 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 that 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, implied in these forward-looking statements, including those factors listed under the caption “risk factors” in our 10-K and 10-Q filings and in our prospectus that has been filed with the Securities & Exchange Commission. And those can be found on our website at www.GladstoneCapital.com, and also on the SEC website.
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.
As always, we start, with our President Chip Stelljes. Chip is also the Chief Investment Officer for all of the Gladstone Companies. He’ll cover a lot of ground. So Chip, why don’t you start off please.
Thank you, David, and good morning. We’re still finding the 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 did close five new investments during the quarter for an aggregate amount of 9 million, and we invested 2.8 million in existing portfolio companies in the form of additional investments or draws on revolver facilities.
During the quarter, we received repayments of approximately 13.2 million to payoffs, normal amortization and pay downs of revolvers. This included the full payoff of Puerto Rico Cable of 7.1 million, interfilm holdings of 2.4 million. So in total, we had a net production decrease in our portfolio of about 1.4 million for the quarter. We used the net proceeds to pay down our line of credit.
Since the end of the quarter, we made about 2.7 million in additional investments in existing portfolio companies. Additionally, after the quarter we received 11.4 million in repayments, which included amortization and a $9.4 million payoff from one company which was [Inaudible] Centers. At the time of this call, the amount we owe in our line of credit is 6.6 million.
As for the pipeline and outlook, we continue to see new investment opportunities. We have availability in our line and are actively seeking to make new investments. At the end of the December quarter, our investment portfolio was valued at approximately 253 million versus a cost basis of 297 million. So the value based on our evaluation of the portfolio is approximately 85% of cost.
At the end of the quarter we had loans with six companies on non-accrual and a number of companies experiencing problems that may prevent them from making timely payments in the future. We’ve taken operating control of several of these companies, including taking control of our largest portfolio company, SunShine Media Holdings, by purchasing the majority of the common stock in January 2011 for 1.5 million. We’re working hard to fix the problems and improve profitability of all these companies.
On a dollar basis, the loans classified as non-accruing have a cost basis of 30.4 million or about 10.3% of the cost basis of all loans in our portfolio. On the fair value perspective, the non-accrual fair value represents 3.2% of the fair value basis for all loans.
We continue to have a high concentration of variable rate loans so that we should have higher income when interest rates begin to increase. And while our rates are variable they often have a minimum interest rate, or a floor, so that declining rates are mitigated. Approximately 84.7% of our loans have floors. However, 5.6% of our loans do not have floors and the short-term floating rate at all-time lows were generating less income. The remaining 9.7% of our loans have fixed rates.
Another measure of the quality of our assets is that our average loan rating for the quarter that just ended remained relatively unchanged. Our risk rating system attempts to measure the probability of a default for the portfolio by using a zero-to-ten scale; zero representing a high probability default and ten representing a low probability.
Our risk rating system for our non-syndicated loans, which constitutes over 92% of our loans showed a weighted average rating of 6.5 up from 5.9 during the prior quarter. As for our rated syndicated loans, they had a weighted average rating of B, B2 for this quarter, down flatly from a B+, B2 during the prior quarter.
In addition to the quality of assets, the quality of income continues to be good. As we discussed before, we try to avoid income generated from paid in kind or original-issue discount structures. These generate non-cash income which has to be accrued for book and tax, but it’s not received until much later. As we all know, sometimes not at all. This type of non-cash income is subject to our 90% payout requirements, so we would be paying out cash that we had not yet received.
The senior and second lien debt marketplace for larger middle-market companies continue to improve. At December 31, we had a cost basis of approximately 18.7 million in senior and second lien syndicated loans.
The market 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 the companies at the lower end of the middle market. Currently, most banks are making really asset-based loans, although we are seeing an increase in non-bank lending.
Net of all these conditions, we still feel we have a 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.
And with that, I’ll turn the presentation back to David.
All right, thank you, Chip. That was a great report. Now, let’s turn to the financials and for that we’ll hear from David Watson, our Chief Financial Officer. David Watson, go ahead.
Thank you David, and good morning everyone. Before I go through the financial statements, I’d like to highlights a few key points for this quarter.
First, during the quarter we made five new investments and exited from two investments. Our goal is to continue those increased investment activity.
Second, on November 22, 2010, we admitted our credit facility. In effect, the interest rate, subject to a 1.4% LIBOR floor on advances went from 6.5% to 5.25%, a decrease of over 19%. The undrawn commitment fee is between 0.5% and 1%, depending on how much is outstanding at any given time.
Additionally, we are no longer obligated to pay an annual minimum earnings shortfall fee to the committed lenders, which resulted in the reversal during the current quarter of 0.6 million in estimated shortfall fees previously accrued in prior quarters. We paid a 0.5% amendment fee on the commitment.
Third, at the time of this call, we have 6.6 billion borrowed on our credit facility so the availability on our line gives us the ability and the flexibility to deploy more capital for the right opportunities.
Now for the detail. I’ll start with the balance sheet. As of December 31, we had 275 million in assets consisting of 253 million in investments at fair value, and 22 million in cash and other assets. We borrowed 25.3 million on our line of credit and had 247 million in net assets. Therefore, we are less than one-to-one leveraged. This is a conservative balance sheet for finance company, which are usually leveraged much higher. So we believe that our overall risk profile is low.
Moving over to the income statement, for the December quarter net investment income was approximately 4.6 million versus 4.4 million for the same quarter last year, an increase of 4.7%. The increase was primarily due to lower interest expenses because of lower borrowings outstanding and the reversal of related fees during the current quarter as previously discussed, partially offset by decrease in interest income resulting from the reduction in the size of the company’s investment portfolio subsequent to December 31, 2009.
On a per-share basis, net investment income for the quarter was $0.22 per share as compared to $0.21 for the same quarter last year.
Let’s turn to realized and unrealized changes in our assets. Realized gains and losses come from actual sales or disposals of investments. Unrealized appreciation and depreciation come from our requirements to mark our investments to fair value on our balance sheet. But the change of fair value from one period to the next, being recognized in our income statement. Unrealized appreciation and depreciation is a non-cash event.
For the December 2010 quarter end, there were no realized gains or losses. For the December 2009 quarter end, there was 0.9 million in realized losses related to the sales to syndicated loans.
From an unrealized standpoint for the December 2010 quarter end, we had net unrealized depreciation of 2.9 million over our entire portfolio. The decrease was primarily due to depreciation and a debt of certain of the company’s portfolio investments, most significantly Sunshine Media Holdings.
Our entire portfolio was fair valued at 85.1% of cost as of December 31, 2010. The accumulative unrealized depreciation of our investment does not have an impact on our current ability to pay distributions to stockholders. It does indicate that the value is lower and there may be future realized losses that could ultimately reduce our distributions.
During the quarter, we had another component of unrealized depreciations, which related to the fair value of our credit facility. For the quarter ended December 31, we recorded an unrealized depreciation of 0.4 million primarily based on estimates of value provided by independent third-party.
On our balance sheet, as of December 31, we had to pay cumulative net unrealized appreciation on the line of credit of 0.7 million, down from 1.1 million at September 30, 2010.
Our bottom line is the net increase to net assets to operations. This term is a combination of net investment income, unrealized net appreciation or depreciation and realized gains and losses. For the December 2010 quarter end, this number was an increase of 2.1 million or $0.10 per share versus an increase of 6.3 million or $0.30 per share in the prior year’s December quarter. The year-over-year change is primarily due to the 2.9 million in unrealized depreciation in our investments in the current quarter when compared to the 2.6 million in unrealized appreciation recorded in the prior year quarter.
While we believe our overall investment portfolio is stable and continues to meet expectations, we continue investor uncertainty in the current economy and credit markets. Investors should expect continue volatility in the aggregate value of the portfolio.
And now, I’ll turn the program back over to David.
All right, thank you David Watson. That was a very good presentation. I do hope all of the listeners out there will read our press releases and also obtain copies of the quarterly reports called the 10-Q. And we just filed that yesterday with the SEC. If you can access all of that, plus press releases and the 10-Q is on our website at www.gladstonecapital.com and also on the SEC website.
I think the big news for this quarter is that we continue to make progress with our portfolio companies. They are getting stronger as the economy gets better. We also added a few new investments to the portfolio of our loans and some of these were syndicated loans.
You’ll note that from the presentation that one of these last syndicated loans that was purchased before the recession paid – it paid off in full and that was Puerto Rico Cable, and it was valued at about 80% of par in September 2009, and then 90% of par in September 2010, and now it’s paid off in full at par.
I think this exit demonstrates the ability to pick good investments. And we all still believe that if Deutsche Bank renewed our line of credit we’d have been paid back with interest and just from our syndicated loans. And like the example above, rather than having to sell them at a loss in the spring of 2009 and payoff Deutsche Bank line.
It was also reported that the U.S. Federal Reserve purchased $280 billion of poor loans at par from the Deutsche Bank to keep them a float during the recession. So while U.S. tax payers were bailing out Deutsche Bank, that bank still felt the need to liquidate our line of credit, and cause us to have a big loss in the sale of our syndicated loans. It’s really too bad, the Fed wouldn’t buy some of our loans and bail us out the way they bailed out the bank in Germany, the Deutsche Bank. But we’ve recovered from all of that. That’s the end of a very bad chapter for us and we’re finished with that and looking for a positive now. And the positive, I think for this quarter, is that our backlog of opportunities to lend money is increasing, seems to be increasing every month and I think it will continue through this year.
We do have plenty of room to borrow in our line of credit. We only owe $6.6 million, have a 127 million, so we should put 50, $75 million on the books before we need to raise equity or debt, or some kind of long-term credit. So there’s really plenty of room to grow and we’re depending on Chip Stelljes and his team to put those deals on the books.
Our biggest challenge today is long-term debt. The long-term debt marketplace for our company is not good. We’re a small business compared to many of the big borrowers. We have a line of credit with supportive lenders. They’re great lenders on our line of credit and it’s working fine, and we believe it will be sufficient in the near-term. But we’re going to have to find long-term solutions for our company. In order to make a lot of long-term loans and investments, we’re going to need to raise long-term debt or long-term capital such as the issuance of preferred stock.
Our new investments that are long-term are going to need to be matched up with long-term liabilities. We just can't rely on the short-term lines of credit for our company. So we’re talking with some very interesting insurance companies and we’re not there yet with them. Even though this problem hasn’t been solved, that is the long-term debt problem hasn’t been solved, we’ll continue to look for solutions. And I feel very confident that we’re going to find the long-term debt solution in the near term.
For our portfolio companies, we worry too that their not able to get long-term senior loans that they need. There’s a fair number of regional banks around that make new loans based primarily on assets of the business, and these asset-based lenders are certainly more plentiful today than they have been in the last two years. I think they’ll take care of all the short-term needs of our portfolio companies, but we do need long-term loans as well, senior debt. And I think the banks are going to come around this year, they’re just not there yet.
We do still have the same worry that I mention on almost every phone call, that is oil prices going up. The prices have been going up over the last 90 days, and we are worried about inflation. The politicians in Washington continue to expand the money supply, and that will probably cause a lot of inflation as time goes on.
Government is projected to issue trillions of dollars more in T-bills. The government tends to right now, sopping up all the available lines of credit in order to finance its growth in the money supply.
Spending by the Federal Government is continued off the charts. The so-called stimulus packages, they’re just filled with spending goodies for many other supporters of the legislators. We’re hoping that they’ll do away some of this kind of stuff with the new legislation, new legislators that we have on board.
The amount of money being spent on the war in Iraq and Afghanistan continues to hurt our economy. All of us here at the company certainly support our troops; they’re the true hero’s. They lay down their lives and risk them every day for us. We’re hopeful of their safe return.
All of this spending will mean more taxes, and I just don’t know how people can handle more taxes given the situation that we’re in today. It will certainly cause much more dislocation in the economy, and the government will have to sell much more debt to cause inflation. It’s just going to continue as far as we can see.
The trade deficit with China and certain other nations is just terrible today. China continues to subsidize their industries to the disadvantage of our businesses. They have huge subsidies for oil and gas in their country. This means our companies can’t compete with them for jobs, for products, and so the jobs leave the United States and go to Asia. And now, I’ve been reading for the last two months, China’s even stopped buying our government paper.
The downturn in the housing industry and the related disaster in home mortgage defaults continues to hurt the economy. I don’t think anyone knows when – how many home mortgages will ultimately fail, but some of the estimates put it in the trillions of dollars. And that was the main cause of the recession, and I think it’s continuing to hold us back.
In spite of all the negatives that we run into, the industrial base and many of the small businesses out there today are certainly not in a disaster mode anymore. The lingering recession is having an impact on our portfolio company but it’s not the disaster that all of us expected. Like most companies, some of our portfolio companies have not seen an increase in revenue or backlog. However, some of them are seeing tremendous good increases and I think there’s a lot of good news in the economy today.
We certainly believe that the downturn that began in late 2008 will continue into 2011. However, I think the economy has stabilized and if that’s true, I think we can take advantage of it and this will be a great time for us over the next couple of years. We are not considering issuing any common stock at this time because the stock price is still much too low. We’ve got plenty of room on our line of credit, probably $120 million worth of borrowing capacity on the line.
Just to turn now, our distributions are still $0.07 per share per month. We paid that in January, and we’re going to pay it again in February/March. So that is in a good position. And at that distribution rate, the dividend with the stock price at about $10.99 as it closed in yesterday, the yield on this distribution is now very high, it’s at 7.6%. And with the NAV now at $11.74, we’re trading at about 94% on NAV. I just think this is an incredible buy given that the company is very under leveraged in terms of the amount of money that we have borrowed from the bank.
Please go to our website, www.gladstonecapital.com and sign up for our email notification service. We don’t send out any junk mail, just news on your company. So sign up if you would please.
And in summary, as far as I can see, the economic conditions that we’re looking at today, have changed to the positive. We think the economy has reached bottom. We’ll start to gain strength over time. I think the next two quarters would be very telling as to how fast it’s going to change. And we’re certainly stewards of your money, and we continue the course that we’re on today, which is to be very conservative in investment approach until we can get a better fix on which way the winds are blowing in terms of the economy.
We invite you all to come to our shareholders meeting. It’s on February 17, at 11:00 a.m. at the Hilton Hotel, in McLean, Virginia, 7920 Jones Branch Drive. If you’re not coming, please vote your shares using your proxy so that we can get the votes in. You can vote by proxy, just mailing in the proxy card. You can also vote by calling an 800 number, it’s 800-690-6903. But you’ll need your proxy card in front of you at the time because they’re going to ask you for your proxy control number.
Another way to vote is to go to a website called www.proxyvote.com and there you can vote online by using your proxy control number again. Also, if you need to vote, you can call your broker and your broker can help you make that vote as well.
I know you all know this, but I want to mention it again. Recent regulation change made the voting of shares a very difficult matter. The government now requires that shareholders of the stock actually vote the shares, and your broker can no longer vote the shares for you. So you have to do the duty of voting your shares. As a result to your fund, to round up the votes by calling all of you is very costly today, and it takes a lot of time and attention. So please vote your shares so that we can move this along. It just takes away dollars that we could pay out dividends to shareholders to go through this.
Before I forget, some of the folks have been asking if I’m buying shares in this company, and the answer of course is yes. But I buy them through the Dividend Reinvestment Plan, or is it known as the DRIP. And that doesn’t show up in the quarterly filings. So we’re now filing at the end of each year and update to my holdings each year. For example, we filed a Form 4 last week showing that I had purchased during the year 23,326 shares of Gladstone Capital during 2010, using the DRIP plan again, and that had a value of about 250,000. So yes, I keep buying the stock, just buying it through a way that doesn’t show up in the data that’s out there today.
So okay, let’s stop here and open it up. If Mike, you’ll come on and we’ll have some questions from analyst and shareholders.
Yes sir. Okay, we will now begin the question-and-answer session. (Operator instructions).
The first question we have comes from Troy Ward, of Stifel Nicolaus, please go ahead.
Troy Ward-Stifel Nicolaus & Co.
Great, and thank you. Good morning, David.
Good morning, Troy.
Troy Ward-Stifel Nicolaus & Co.
I’m going to ask a couple of questions, and if the operator could put me on mute afterward, because I’ve got a lot of background noise at my location.
Just real quick, two topics, David. On Sunshine Media, and then on syndicated loans, could you just give us an update on the Sunshine Media, you’d made the comment that you bought the equity in January of ’11, and just talk about the valuation as of December 31st. I’m assuming all of that was kind of already baked in to that valuation. Obviously, the pieces are going to change. Also, it looks like you have two pieces of senior term debt, one of them is a last-out senior, is it only behind the other piece that you hold? I guess, how much other senior debt is in front of that last out other than what I see on your balance sheet?
And then secondarily, on the syndicated loans, if you could just talk about the opportunities you’re seeing, I mean, it seems a little counter intuitive based on where the high-yield market’s gone, and kind of the running of the assets that you’re finding your best opportunities in syndicated loans, versus smaller one off kind of deal. So if you could address those, I would be grateful. Thank you.
All right, Troy, thank you for the question. Chip, do you want to answer that question on Sunshine?
Sure. Sunshine Media, you had a couple of questions in there. First of all, the situation itself was one where we got a strong management team. It was a company that was already in a business model transformation. As you may recall, this company had some advertising exposure, revenue exposure, and had some real estate advertising exposure. So this business model was changing. Anyway, we’ve got a very strong management team there, and quite frankly, we just felt that the company would do better in our hands.
So we bought out the existing shareholders, and now really are in partnership with management to continue that transformation. So the valuation that you mentioned is reflected of the fact that the company has had some difficulties, has got two pieces of the business; one of which is very strong, the other which is the transformative part that I discussed, and the one that has more issues to it.
We’ve got good confidence in what we’re doing there. We just felt that the company would succeed better if we had control of the business, so we need to do that in January, and the valuation is reflected.
To your other question about the debt, we are the sole debt holder of that company at this point, so there is – all of the securities that you see that are senior to the [inaudible] tranche, are on our balance sheet, and they are ours.
Let me just pick it up from there.
On the senior syndicated loans side, you’re certainly right, the marketplace has changed. I think the senior debt side, syndicated loan debt side, now has changed and it’s more like 2006. We have not been buying much, recently, obviously because prices have come in so tight to the marketplace today. But the few that we picked up, we thought were good investments, but I’m not sure how much more you’re going to see us do in that area, mainly because the marketplace has changed so much.
There’s huge demand that has gone in to that marketplace. These are the senior loan debt funds that are filling up as shareholders bail out of government securities, and go in to these variable-rate loan funds that have been set up by many of the brokerage houses. And right now the amount of money pouring in to those funds is far out stripping any kind of loans that are coming to marketplace. And as a result, you’re seeing all of the, well, I won’t say all of the crazy things, but you’re seeing a lot of the same things that you saw in 2006.
So, Troy, I wouldn’t put emphasis in your projections on us doing a lot of senior syndicated loans, but we’ll keep trying and see if we can find some good ones.
I would also say, Troy, we’re not focused just on syndicated loans. I will say, for the record, while we didn’t book a lot of proprietary direct loans during the quarter, we had two that were signed up and in the due diligence phase fell apart during the quarter. So we’ll continue to focus on proprietary investments as well.
Okay, next question, please.
Yes, sir! The next question comes from Mark Hughes of Lafayette Investments.
Mark Hughes-Lafayette Investments
Good morning, David.
Mark Hues-Lafayette Investments
Just a quick question here; I’ve heard you say several times in the last year that the period when the economy is coming out of a recession should be kind of your sweet spot for making new loans. And here we are, seems to be coming out of the recession, and we don’t seem to be making many new loans, you just mentioned two that fell apart that you thought you were going to make, but they didn’t get done. Meanwhile, your better old loans are paying off, it looks like, at a fairly decent clip. But there hasn’t been any growth in the portfolio, in fact, the opposite is happening. And I’m trying to figure out why we’re not putting more loans on the books. And nobody wants you to make loans just to make loans, but it seems like there’s a lot going on out there, but Gladstone’s not participating, and deals aren’t’ getting done. I’m very frustrated and trying to figure out why this is happening. And maybe you’re just a quarter or two away from showing some real growth, but can you tell me something about why things aren’t getting done, and maybe why you think that’ll change over the next year?
Well, I can tell you that we are perhaps much more conservative, and always have been than some of the other players in the marketplace. We also won’t extend credit to people that we feel uncomfortable with, and that’s not a reflection on perhaps them personally, but just on the business, or where they are in the economic cycle.
Up until this fall, and I would say maybe this summer, but certainly this fall, I and I think many of the people here were not very convinced that the economy was as strong as others believed it to be. And I’m really not sure we’re all that strong today. So we are perhaps more cautious and going slower than others. I think we’ll see some good deals done this year. But again, that’s a projection I can’t back up with anything other than we’ve got a very nice pipeline, and we’ll work on deals, and we’re going to continue to be very conservative because who knows what the next six months will bring, or the next year will bring. And I just can’t, Mark, I can’t really put my finger on it other than to say this is a time in which the winds are blowing in both directions; one day you get a nice strong breeze from the back, and your sails fill up, and you feel like you’re going to go forward, and then the winds reverse and you get a lot of negative news and you feel uncomfortable with it.
But we are working hard to put this company forward, and I can only say that that’s where we are today. I can’t really give you a projection beyond that.
Mark Hughes-Lafayette Investments
Couldn’t you argue that you make your best deals when there is uncertainty in the world because when times are good, there’s too much easy money out there, and there’s other places for people to go to for their money than Gladstone?
I would think some uncertainty, we seem to be past the point of systemic failure, which we might have faced in 2008 and 2009, I would think a little bit of uncertainty isn’t bad for you all for making good loans.
Well, if it were just a little bit of uncertainty I’d be on your side. I’m not as convinced as perhaps you are that that much uncertainty has been taken out of the economy. We still see very dramatic things going on with the government printing $1.5 trillion worth of paper, which has an impact on every single company that we look at. We’re watching oil prices spike one day, and come down the next.
I went through a lot of things that are on our mind here, and when you bake all of those into projections for any small business, it makes the uncertainty range go much higher than perhaps you are listing in on your scale. We’re just being conservative and I can’t do any better than that Mark, on answering why we are where we are.
Mark Hughes-Lafayette Investments
Okay, good luck.
Next question, please.
(Operator instructions). Mr. Gladstone, gentlemen, it appears that we have no further questions at this point.
All right, thank you very much Mike, and thank you all for calling in again. We’ll do our best to make you some profits this year, and we’ll just see where it goes. And that’s the end of this conference. Thank you, all.
We thank you, sir, for your time.
We thank you all for attending today’s conference call. The conference is now concluded. At this time we may disconnect your lines. Thank you.
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