Gladstone Capital's (GLAD) CEO David Gladstone on Q3 2016 Results - Earnings Call Transcript

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Gladstone Capital Corporation (NASDAQ:GLAD) Q3 2016 Earnings Conference Call August 4, 2016 8:30 AM ET


David Gladstone - Chairman & CEO

Michael LiCalsi - General Counsel & Secretary

Bob Marcotte - President

Nicole Schaltenbrand - CFO & Treasurer


Andy Stapp - Hilliard Lyons

Christopher Chestnut - National Security


Good day, ladies and gentlemen, and welcome to the Gladstone Capital Corporation's Third Quarter Earnings Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded.

I would now like to introduce your host for today's conference, Mr. David Gladstone. Please go ahead Sir.

David Gladstone

All right thank you Christy. Nice introduction. Hello everyone. This is David Gladstone chairman and this is the third fiscal quarter earnings conference call for shareholders and analysts of the Gladstone capital. Our common stock is traded on symbol GLAD in the preferred stocks trading on the symbol GLA.DO.

Thank you all for calling in, always happy to have these shareholder calls with shareholders and analyst and welcome the opportunity to provide updates on our company and the investment portfolio as always. Imitation is open to visit us here in the in McLean Virginia, we're just outside Washington D.C.

The Gladstone team has grown about sixty people and little under $2 billion in assets under management and now we hear from our general counsel and Secretary Michael LiCalsi who is also president of Gladstone administration which is the administrator of all the Gladstone funds and some other related companies and he'll make some statements regarding forward looking statements. Michael?

Michael LiCalsi

Good morning everyone. This conference call may include forward looking statements within the meaning of the securities act of 1933 and the Securities Exchange Act of 1934 including statements with regard to the company's future performance. These forward looking statements inherently involve certain risks and uncertainties and other factors even though they are based on current plans which we believe to be reasonable and many of these forward looking statements can be identified for such a system we anticipate, believe, expect and similar expressions.

And 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 listed under the caption risk factors. There are Form 10-K filing and a registration statement as we follow with the SEC and all of those can be found on our website or the SECs website

And the company undertakes no obligation to publicly update or advice any forward looking statements whether as a result of new information, future events or otherwise except as required by law and please also note that past performance or market information is not a guarantee of any future results. We also ask that you visit our website and sign up for our e-mail notification service. You could also find us Facebook, keyword The Gladstone companies and follow us on Twitter at Gladstone comps and please read our earnings release issued yesterday.

And also review our Form 10-Q for our third fiscal quarter ended June 30. 2016 also filed yesterday with the SEC. Those can be accessed on our website and the SEC's website as well as An audio presentation of this phone call will be archived on our website.

And please note that we will begin our presentation today by hearing from Gladstone Capital's President, Bob Mark.

Bob Mark

Thank you, Michael. Before diving into the results for the quarter, I'd like to summarize Gladstone capital's core investment strategy as the lending fund within the Gladstone Company. Gladstone Company's family have publicly traded funds. We provide cash flow based loans to privately held US based lower middle market businesses which we define as having $3 million to $15 million in earnings before interest and taxes. Our target asset mix is for loans to represent approximately 90% of our portfolio with Equity Coinvestment representing the balance.

The majority of our investments are senior secured loans to growth oriented or recession resistant businesses which have the revenue visibility and cash flow profile to support and leverage capital structure. Our investments are generally made in concert with private equity sponsors investments or owner operators with significant equity at risk. We target to make loans of $8 million to $30 million but we will opportunistically consider smaller positions in broadly syndicated loans from time to time.

Without introduction let's get into the results for last quarter. As many of you are aware the M&A stats were down last quarter. The broad, however the broad market leverage loan market improved compared to the prior quarter. From our perspective the lower look middle market deal flow was healthy as we evaluated a similar number of deals as we did in the prior quarter. However we did note, we did notice a notable improvement in the quality of the companies which translated into an uptick in originations in near term investment pipeline.

For the quarter ended June 30, we closed 2 new investments totaling $32 million. Principal repayments total $20.4 million during the quarter including one proprietary and two syndicated loan exits. Including follow on investments our net originations for the quarter totaled total $14.1 million. Going into the current quarter we anticipate new originations to remain strong based on the current deal pipeline which included four deals in due diligence and documentation.

Net of several pending repayments expected in the quarter new deals are expected to result in net asset growth similar to what we've experienced last quarter, while maintaining our investment discipline and portfolio yields. Consistent with these comments after the end of this quarter we closed on a new proprietary secured second lien investment in the amount of $10 million dollars which was included in our earnings press release of yesterday.

If you roll forward the total amount of investments on the quarter and the recent investment announced yesterday, we've invested $42 million dollars and companies with less than three terms of leverage at an average rate of approximately 12%, 70% of which was senior secured loans. The weighted average yield on our loan portfolio was down slightly on the quarter compared to last several at 10.9%. What we did, we have been successful in maintaining our new origination yields, the small declines caused by prepayments as well as the impact of a non-accrual asset.

It should be noted that while we have successfully maintained this yield while reducing our portfolio risks as lien, first lien secured investments have grown 61% of the fair value portfolio as of June 30, 2016. Second lien investments represent the balance of our loans and in total secure debts represent 93% of the portfolio at fair value the end of the quarter. For the quarter ended June 30, the net realized and unrealized appreciation the portfolio totaled $600,000 which is a significant improvement from the last several quarters and we feel is more indicative of the underlying health and diversify, diversity of the senior secured portfolio.

While there have been a number, while there were a number of individual investment valuation movements, we experience offsetting appreciation and depreciation with our energy portfolio and a couple of other proprietary investments in the process of undergoing management transitions. It's not uncommon for us to face some management retooling over the duration of our lower middle market investments and we hope to be able to report depreciation, recovery from some of our recent portfolio actions.

Syndicated investment valuations represented in that positive swing in the quarter as we got paid out at par in two positions. However several other second lien documents in the syndicated portfolio experienced large valuation swings relative to their underlying leverage profile due to limited trading interest in these low rated credits. During the quarter, one of our smaller syndicate investments was added as a second non-accrual loan, as company filed bankruptcy in anticipation of the near term sale of the company.

Non-accrual investments at the end of the quarter totaled $6.5 million for 2.3% of our portfolio at fair value. We currently have 43 companies in the portfolio which is down 1 from the prior quarter and our portfolio remains highly diversified by industry classification with 20 different industries and headquarters in 20 different states. With respect to the portfolio yields an income for the June quarter total interest income was down by 4.8% compared to the prior quarter based on a small decrease in the average entering, average interest earning assets and the weighted average yield.

Other income consisting mostly of success fees received increased $800,000 over the prior quarter to $1.6 million and lifted total investment income a quarter by 4.1% to $9.8 million. Fees and expenses were largely unchanged for the prior quarter and except and excluding a small incentive the waiver by the advisor, we're happy to report the GLAD generated a return on equity of 11.5% for the quarter. With respect to the investment outlook and backlog, based on the deal flow of the past quarter and our current pipeline of deal opportunities we're, we believe we're well positioned to continue to achieve measured asset growth to drive our net investment income and support stockholder distributions.

In addition to our growing earning assets the team is committed to proactive management of our portfolio with a goal to maintain our net asset value and demonstrate a consistent return on equity commensurate with our predominantly senior secured investment portfolio. While we are optimistic regarding our investment outlook and current backlog of opportunities, we're also mindful of the volatile trading swings of our common shares over the past quarter. Accordingly early in the June quarter we used a portion of the $7.5 million re-purchase plan and were able to purchase just over 41,000 shares at an average cost of $6.95 per share for total cost of $288,000.

And now I'd like turn it over to Nicole Schaltenbrand, our Chief Financial Officer who will provide an update on the fund's third fiscal quarter financial results.

Nicole Schaltenbrand

Thank you Bob and good morning. Let's start by reviewing the income statement for the June quarter total interest income was $8.3 million which is down by 4.8% or $400,000 compared to the prior quarter. This is driven primarily by the decrease in average interest earning as assets as the majority of our new originations closed later in the corner as well as a slight decrease in our weighted average yield. Other income consisting mostly of dividends and success fees received, increase quarter over quarter. From $800,000 to $1.6 million and listed total investment income to $9,8 million.

Interest related fees and expenses in the quarter were unchanged and as a result total net interest income on the quarter declined by $400,000 to $6.3 million. Non-financing costs excluding management fees decreased by $100,000 compared to the prior quarter to $900,000 due to a decrease in shareholder related costs and professional expenses incurred. Growth management fees for the quarter were unchanged at $2.2 million. However the net management fee increased as the advisor fee credits decline to $200,000 in the current quarter.

For the quarter ended June 30, 2016 net investment income was $4.9 million for $0.21 per share and covered 100% of shareholder distribution. As we have demonstrated over the last several years and in the most recent couple of quarters, our advisors remains committed to crediting its fees for the annual net investment income cover of our shareholder distribution. Moving over to Gladstone Capital balance sheet. As of June 30, 2016, we had approximately $326 million in total assets. Consisting of $308 million in investments at fair value and $18 million in cash and other assets.

Liabilities totaled approximately $140 million and consisted primarily of $73.3 million and borrowings on our line of credit and $61 million in our series 2021 term preferred stock. Our net asset value increased slightly by $0.03 per share quarter-over-quarter with the decrease in the cumulative net unrealized depreciation in the quarter from the share to $7.95 as of June 30,2016 compared to $7.92 per share as of March 31.

Inclusive of all of the liquidity events of the past quarter we are well positioned going into the balance of our fiscal year 2016 to grow our investment portfolio and net investment income with about $24.5 million in aggregate cash and availability on our $170 million credit facility to fund additional new investments.

Now, David will conclude the presentation.

David Gladstone

Thanks, Nicole. You and Bob and Michael all did great presentations to inform the shareholders and I think the stockholders should feel pretty good about the progress of the company. In summary Gladstone Capital delivered on a number of key metrics for the quarter. We made two new loans totaling $32 million dollars and there was a transaction after the quarter end as well. We used our stock buyback program to respond to the stock price and dropping to really unwarranted low prices.

It always keeps things in line and we pay dividends on our common and preferred stocks. That's a key indicator of our strength in our net asset value per share is pretty much the same up or down a little bit every quarter. I do believe this company continues to be well positioned to grow, grow the earnings and support our dividends. Our goal is always to protect the dividend distributions and then increase it when we see the strength in the earnings and the outlook is favorable.

Right now we're looking at the future and are all mindful of the recent economic trends which might show that the economy is slowing down and some of the middle market businesses that we lend to still have great strength in here some of the things though that we worry about. The credit markets are still unsettled. There's weak cash flows going into the syndicate loan marketplace which we've used in prior years but not much recently.

I think this will turn around because the buy-out funds have plenty of capital and they should be out buying businesses and giving us an opportunity to help them and the buyouts. Lower oil and gas prices, they're always positive an impact on the rate of inflation, keeping inflation down and also it impacts the income of many oil and gas producing states and companies in those states and certainly the future prices have already negatively impacted the capital investment activity in that business.

We do have three energy related companies all of those are downstream. We're not out poking holes in the ground looking for oil. So we're not expecting to have any repercussions to our loans due to low oil prices. Reason impact of Britain leaving the E.U., that vote really had an impact on bond yields and made a lot of things unsettling and we still are uncertain about the Federal Reserve and their move on interest rates.

Just one more on loan out there and we like all the businesses, we hate uncertainty and I always ask myself how am I supposed to plan if you have a few people in Washington D.C. that can make rates go up and down there, whenever they want to do so. It's really hard sometimes to figure out what costs going to be in the future. Federal and state regulations impacting many of the private companies that we lend to. I know all of them and as well as we here and in our office say, businesses are just feeling the crushing burden of paperwork on reporting to the government.

It's become overwhelming. Distributions, despite the economic trends we believe Gladstone Capital will continue to make good loans. And it will be growing as well as if there's a recession coming. I think our businesses are pretty much recession resistant, so we feel comfortable about that. We are selective in everything we do just to be safe and as you may know middle market businesses continue to be an important part of the U.S. economy. They are the primary creators of economic growth and certainly creating jobs and if you like lending to these businesses, we've developed a great credit rating system that's a good predictor of the future operations of these borrowers and it's held us well in the past and I think it will in the future as well.

Gladstone Capital is and will remain committed to paying shareholders cash dividends. As a large shareholder myself I like dividends and in July our Board of Directors declared the monthly distribution on our common shareholders and $0.07 per common share per month for the July, August and September. They also declared the dividends for the preferred stocks. They'll look at the dividends again in early October and I think what claims that are in there for the dividend as well.

Through the day to this call the company's made 162 sequential monthly and core or quarterly cash distributions on a common stock. Now that's almost $273 million dollars and the company has never missed a distributional. That's about $11.70 per share on the shares outstanding at June 30, 2016. Current distribution rate on our common stock, with a common stock price at about $8.07 yesterday. The distribution run rate is now producing a yield of 10.4%.

It's pretty much in line with the DDC's in the market place today. That percentage rate is above historical norms and we are but most yield oriented alternatives. It is incredibly good vibe I think right now if you want something with a great yield the monthly distribution of 6.75% on our preferred stock, gives $1.69 per share annually. Now that's preferred stock at a closing market price yesterday of 2546 on NASDAQ and it assembled GLADO. That's another terrific deal by about 6.6%, very safe stock to hold as an income producer.

In summary this company Gladstone Capital is in good shape. I got a phone call I thought that was because we were off the air. But we're not so and to the end to have continued to strengthen the company's [ph] money from our, from those companies that are borrowed money from us and we have strong team. Thank you all very much. If you come on now and we'll talk about some questions.

Question-and-Answer Session


[Operator Instructions] Our first question is from the line Andy Stapp of Hilliard Lyons. Your line is open.

Andy Stapp

Good morning.

Michael LiCalsi

Good morning Andy.

Andy Stapp

So could you talk about the price environment for new investments compared to quarter in a year ago.

Michael LiCalsi

Bob why don't you take that, on the line every day.

Bob Marcotte

Right now. I think there's definitely been some compression at the upper end of the marketplace. In the lower middle market and we're really not seeing that, as I mentioned earlier we're still closing deals, South of three terms of leverage and continuing to generate a mix of senior asset roughly two-thirds of our investment and secondly assets that one-third, generating aplenty yield which is very similar to where our current weighted average yield is.

Obviously moving up to the lot higher credit in the syndicated loan market, leverage in the approach six, and the rates are probably just south of double digits. That's certainly not where we're going to be investing the majority of our funds.

Michael LiCalsi

Okay, let's get the next question.


Our next question from the line of Christopher Chestnut of National Security. Your line is open.

Christopher Chestnut

Good morning, thanks for taking my questions, just on the investment flow I notice you had some transfers out of the senior debt and some common into senior some debt, and also on secured debt. Can you just have some color on why they were those transferred.

Bob Marcotte

There were really two transactions that draw that, I think is we describe a couple of quarters ago we did a unit tranche for a sponsor called United flexible, which was a an investment as a unit tranche they put on a couple of add-on investments, and given our comfort level in the add-on investments we actually transferred from a unit tranche to a second lien investment as the companies grew and it made acquisitions and EBITDA in that particular business has grown substantially.

So we've chosen to migrate our work position to a second lien investment which obviously we're getting a far more improved yield on it. Secondly the only on security asset that you're referring to is the outgrowth of a restructuring that was associated with one of the syndicated loan assets. I believe the entirety of the Plato [Ph] which is an educational related asset restructured about two quarters ago I believe. In participating in that restructuring our second lien investment was migrated to an unsecured investment in the recapitalization of that company that was not in the origination.

Christopher Chestnut

OK, alright that's very color. Just shifting gears kind of looking at capital and as walls drive power so you're up 72% debt equity but in the past you guys have gone up well past 83 times and all the way up to the top -- how should we think about this given you guys are trading at a pretty fair NAV, Would you be looking opportunists believe raise capital now to pay down debt balances or would you rather let that about o.8 times, 0.85 times.

Nicole Schaltenbrand

That's fairly involved question, Chris. I guess what I would say is a couple of things; One is we start to look at the outlook of where the investment flows are if we have strong investment flows and are expecting a reasonably decent net asset growth, we obviously have to sort that into our capital stack in our longer term opportunities, as I mentioned we do anticipate a fair number of prepayments over the course of the next quarter to two, so that will certainly fund a portion of it but we do expect a net asset growth above those prepayments. we do have capacity under our current lines and so certainly we have that dry powder added speak -- as you speak to the underlying equity capital, I think there's a couple of considerations; one we feel pretty good about where the portfolio is today. So if we feel that there are certainly some reductions in some of the depreciation our capital base is going to be strengthening, we've got more ups than downs, Certainly that will affect it. And there are some things in the works that we hope to announce in the near term that would be positive in that respect.

That being said. Given what we believe to be the long term opportunity in the consistency -- consistency in performance and yield we would certainly be prepared to opportunistic look at equity capital raises, As the market continues to recognize, but certainly feel given where we're performing, given the person of senior secured assets and given our current yield that there is certainly a upside in our current shares and be mindful of when and how we go raise capital. We do have some capacity and frankly its part of a process we're continuing to evaluate I don't know if you have any add on that David.

David Gladstone

One of the things that we do have is a co investment with our other -- our sister company Gladstone investment and they are preparing one of the companies to be sold, it could be sold in the next 90 days and if it is it would trigger pretty substantial capital gains based on the indications of interest we're seeing but I don't want to start down that trail about. I want to say last year I started talking way early when one of them was coming off and it took us nine months to get it to the altar and get it sold, so just keep that in mind as that would produce a pretty substantial amount of opportunity for the company reinvest it and that's like free equity.

Christopher Chestnut

Okay, that's great color thank you, and then just one last one for me would be the lower middle market it seems that you know M&A has been down substantially from the first calendar quarter into the second just what do you think quarter of the date in L&M [Ph] the sponsor opportunities and do you see this you know picking up.

Bob Marcotte

You know as I laid out in my comments. We looked at about 120 deals each of the last two quarters. Obviously we did not do much with the first quarter, the second quarter. Some of them carried over and certainly the flow of what we're seeing is affecting our current outlook and pipeline so I would say the level of activity is consistent. I think the quality of deals have improved and in part of think they've improved because companies, good operators have got solid numbers have completed their audits for 2015, and they outlook for interest rates and the attraction of the domestic market as opposed to international markets is providing a very favorable opportunity for some of these companies that haven't been published or hadn't come out to be sold to come out, and you're obviously seeing a buoyant market in enterprise valuations at the upper end of the market where it's a little bit more noticeable, your enterprise value multiples are approaching 11 or north of 11.

So I think what you're seeing is a market that's attractive for new companies to come and I think we saw that in the second quarter. Whereas in the first quarter I think there was a fair bit of companies that were desperate for refinancing and anticipation of what we thought to be a potential increase by the fair over the course of the next couple of quarters and rates. So the profile in character is changed more than the actual flow of opportunities.

Christopher Chestnut

Thanks for that color.

Michael LiCalsi

And Chris as you know on this marketplace that we're in is very similar to the syndicated loan marketplace which is down about 32% versus last year's transactions but it picked up substantially in the Quarter -- past quarter and I think this quarter is going to be a good one but I don't think we'll get back to what it was last year that first quarter just about stymied everybody in terms of putting new deals on the books.

Bob Marcotte

The other thing that's affecting, Chris a little bit is the proportion of deals in the M&A environment that's going to strategies continued in a hurry so I think the debt that I saw was up to 64% of the M&A activity was being driven by strategic buyers, so obviously those are M&A transactions that we're not going to participate in. So you definitely have a lot of things moving, but frankly a lot of that the not affect the lower middle market. You don't have a ton of strategies coming down buying companies with $3 million to $10 million dollars in EBITDA.

Christopher Chestnut

All right thank you guys, that's all for me, thank you guys for the great detail for those question.

Michael LiCalsi

Thank you for calling in. Next question?


Thank you. Our next question is from Bob Brown, private investor. Your line is open.

Unidentified Analyst

Two questions one is just investor relation kind of question, what you see added to announcing investments. As I know like in prior years you've gone for announcing investments pretty much as they have been and in the last two quarters it's like just gone away from that and then last Friday announce the most recent investment, and just wondering how should we think about in terms of what you're going to be looking at going forward in terms of how and when you announce during the quarter.

Bob Marcotte

We will continue and announce investments as close to when they occur as possible, as you may recall we did not close in the new investments in the first quarter, so there was a bit of a hiatus there. The investments closed last quarter were late in the quarter and because they are private companies we take some time to negotiate what the terms of those releases were, and so they were a little slow as a result of that. So the policy is not changed, it's just the timing of the transactions to make it appear as if it was a little bit a little -- bit more of a hiatus between the last time that might have happened. And as you saw we did announce yesterday a deal that closed earlier this week as part of our Q press release a transaction just closed. So you will continue to see investments as they occur.

Unidentified Analyst

Okay, thanks for the second question is more just in terms of how we think about in asset value in terms of going forward if you like the high yield debt market at least the publicly has seemed to have rallied over the last -- especially since debt equity that issue etc. I know if I should have expected or thought to expect a lot more increase net asset value as a result or in terms of our securities or is that something that as companies report more their own year and financial in terms of just more at that point in time and I do know how to think about going forward.

Bob Marcotte

Well, there's two factors in that one. The proportion of investment that we haven't syndicate loans come down dramatically, we're now under 10% so no matter what happens it's not going to be a big mover. Secondly the majority of our syndicated loan investments are probably at the second lien but probably lower rated securities. I think the majority of the recovery that you're citing has been with the securities down to probably mid-single Bs as we have a number of securities there maybe a little bit lower than that and rating, but we're comfortable given the under writings and the industries that they're participating in. my comment in my remarks is those investments that might be in the CCC range tend to be the least liquid in the marketplace. They are not as broadly marketed, and I think if you were look at the general CCC index that the course of the high yield market that has not yet recovered. I would expect it to recover, I mean at the end of the day it is probably the single highest yield opportunity in the range both domestic and international of yield opportunities, but it does point it's been relatively soft. Between BDC and CLOs there's not a tremendous amount of investment capacity right now. And so it has been a weaker part of the market and the result is they have not necessarily performed as strongly.

We I would expect those ultimately to improve but as you can see from the marks in our Que number of those positions were down this quarter, despite the market environment because of some liquidity and particular credit issues. Hope that helps you.

Bob Brown

Yes, thanks.


Thank you. [Operator Instructions] Now showing any further questions, I like to turn the call back over to Mr. David Glass for any further remarks.

David Gladstone

All right, thank you all for calling in and we appreciate the time with you at the end of this call.


So ladies and gentlemen thank you for participating in today's conference. Just ask to today's program. You may all disconnect, everyone have a great day.

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