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Gladstone Capital Corp (NASDAQ:GLAD)
Q1 2020 Earnings Call
Feb 6, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and welcome to the Gladstone Capital Corporation First Quarter Ended December 31, 2019 Earnings Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to turn the conference over to your host, Mr. David Gladstone, you may begin.

David J. Gladstone -- Chairman and Chief Executive Officer

Thank you, Sarah. This is David Gladstone, Chairman and this is the quarterly earning conference call for Gladstone Capital for the quarter ending December 31, 2019. Thank you all for calling in. We are also happy to talk to you and all our shareholders and analysts. We welcome the opportunity to provide an update on the Company and our investment portfolio. And now, we'll hear from our General Counsel, Michael LiCalsi, who will make a statement regarding certain forward-looking statements. Michael?

Michael LiCalsi -- General Counsel and Secretary

Thanks, David and good morning, everyone. 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 listed in our Forms 10-Q, 10-K and other documents that we filed with the SEC. You can find these on the Investor Relations page of our website www.gladstonecapital.com. You can also sign up for our email notification service or also on the SEC's website, www.sec.gov. 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.

Today's call is simply an overview of our results. So we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Again, you can find those on Investor Relations page of our website.

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

Bob Marcotte -- President

Good morning, all. Thank you all for dialing in this morning and let's dive right into the summary of the results for Gladstone Capital for the quarter ended December 31, 2019. Net originations for the quarter totaled $30 million as originations of $42.5 million, including two new proprietary first lien investments outpaced exits and repayments of $12.6 million. Interest income declined $400,000 or 3% to $11.5 million compared to the prior quarter as higher average investment balances did not offset the $900,000 of previously deferred ADC interest collected last quarter. Prepayment fees, exit fees and dividend income also declined to $700,000 on the quarter from $900,000 last quarter with a lighter volume of prepayments. As a result, total investment income for the quarter was down $600,000 to $12.2 million.

Borrowing costs declined on the quarter with the refunding of our 6% preferred stock with the 5.375% GLADL issue and higher bank borrowings, the cost of which declined with lower LIBOR rates. Excluding the ADC interest collected last quarter, our net interest margin improved approximately 45 basis points on the quarter. Net management fees declined by $500,000 to $1.9 million, with origination in higher incentive fee credits, resulting in net investment income of $6.4 million or $0.21 a share. The net assets from operations declined $700,000 or $0.02 per share, which included a $1.4 million write-off of the unamortized issuance cost associated with the call of our preferred stock and a $4.3 million of net portfolio depreciation on the quarter, resulting in the NAV declining $0.14 to $8.08 per share as of December 31.

Regarding the portfolio, the asset mix at the end of the quarter shifted with a predominantly first lien originations and second lien syndicated loan exits, lifting the first lien exposure by 6 points to 52% at cost and dropping the second lien exposure similarly to 39% of the portfolio at cost. The largest contributor to the portfolio appreciation in the quarter was the $1.5 million increase in the equity investment in the Mochi Ice Cream Company, which was exited after the end of the quarter. Defiance, another portfolio company was the largest decliner on the quarter at $2.7 million. In total, the decliners outnumbered the gainers on the period, resulting in net portfolio depreciation of $4.3 million. Approximately 85% of this depreciation was associated with our equity investments and not our core debt portfolio. Much of the depreciation can be attributed to manufacturing sector investments where Q4 disruptions and inventory drawdowns occurred, including sectors such as the heavy truck and auto sectors, for example.

In the quarter, we realized the $4.4 million anticipated loss on our New Trident syndicate investment and subsequent to the end of the quarter, we exited our position in Meridian Rack and Pinion. There were no other non-performing assets as of the end of the quarter. Since the end of the quarter, we have closed two follow-on investments totaling $8.5 million and received prepayment at par plus the $3 million of equity proceeds from Mochi. So our net -- our interest earning assets are down slightly as of today.

Turning to the outlook for the balance of 2020. We've been able to maintain a healthy flow of new deal opportunities and are cautiously optimistic that based on our current pipeline, we should be able to continue to outpace prepayment activity and prudently deploy the nearly $65 million of additional investment capacity, which would bring us to a 1:1 debt-to-equity ratio. That said, our competitive -- the competitive pressures are continuing, particularly for senior unitranche investments, where margins are inching down in spite of the decline in LIBOR. In response, we have taken action to reduce our borrowing costs to improve our net interest margin, which will positively impact our results as we work to grow the portfolio. As you will know from our exits of last quarter, we're also de-emphasizing our syndicated investment activity, which is predominantly second lien in light of the elevated leverage and credit profile of investments available in the current market. We intend to deploy some of this capacity proprietary second lien or last out investments in unitranche deals, where returns, leverage metrics, credit protections are more favorable.

In conclusion, we continue to believe the depth and opportunities in lower-middle market are attractive and we are well positioned to take advantage of our strong capital position to grow our net interest margin to enable us to improve our returns to our shareholders.

And now I would like to turn the call over to Nicole Schaltenbrand, the CFO for Gladstone Capital, to provide some details on the Fund's financial performance for the quarter. Nicole?

Nicole Schaltenbrand -- Chief Financial Officer and Treasurer

Thanks, Bob. Good morning, everyone. During the December quarter, total interest income declined $400,000 or 3% to $11.5 million, primarily due to the absence of the $900,000 of past due interest collected in the prior quarter. The growth in the investment portfolio offset much of the prior quarters past due collection, as a weighted average principal balance of our interest-bearing investment portfolio rose $25.6 million or 6.8% to $401.4 million for the three months ended December 31, compared to $375.8 million for the three months ended September 30.

The higher investment balance also helped mitigate the approximate 40-basis point decline in LIBOR rates, as 84% of the portfolio is tied to floating rates. Other income decreased by $200,000 compared to the last quarter, driven by lower prepayments and a decrease in success fees received resulting in total investment income for the quarter, declining $600,000 or 4.4% to $12.2 million.

Total expenses decreased by 9.6% quarter-over-quarter, primarily due to an $800,000 decrease in dividend expense on mandatorily redeemable preferred stock and a $400,000 increase in the incentive fee credit granted by the Adviser, partially offset by a $500,000 increase in interest expense on long-term debt, with the new issuance during the quarter.

Net investment income for the quarter ended December 31 was $6.4 million, a slight increase of 0.8% as compared to the prior quarter or $0.21 per share, covering 100% of our shareholder distribution. The net increase in net assets resulting from operations was $700,000 or $0.02 per share for the quarter ended December 31, compared to $5.4 million or $0.18 per share for the quarter ended September 30. The current quarter decrease was driven by $4.3 million of net portfolio depreciation and a $1.4 million loss on the extinguishment of debt recognized in connection with the voluntary redemption of our Series 2024 term preferred stock in October.

Moving over to the balance sheet. As of December 31, total assets were $439 million, consisting of $429 million in investments at fair value and $10 million in cash and other assets. Liabilities rose by $11 million to $188 million and consisted of $91 million in borrowings on our credit facility, $55.8 million of 6.125% senior notes due 2023 and $37.5 million of 5.375% senior notes due 2024.

Net assets rose by $1.5 million from the prior quarter end with the $4.3 million of net realized and unrealized portfolio depreciation and common stock issued under our ATM program, which generated net proceeds of $7.2 million. For the quarter, we issued 705,000 common shares at an average price of $10.37 per share or 126% of NAV. The accretive ATM issuance offset a portion of the portfolio depreciation and NAV dropped from $8.22 per share at September 30 to $8.08 per share as of December 31, 2019.

Our leverage as of December 31 increased slightly from the prior quarter end at 75% of net assets from 71% due to the increase in assets for the period. As of the end of the quarter, we had an excess of $75 million of current investment capacity and availability under our line of credit. With respect to distribution, Gladstone Capital has remained committed to paying its shareholders a cash dividend and in January, our Board of Directors declared a monthly distribution to our common stockholders of $0.07 per common share per month for January, February and March, which is an annual rate of $0.84 per share. The Board will meet in April 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 $10.36 yesterday, the distribution run rate is now producing a yield of about 8.1%, which continues to be attractive relative to most yield-oriented alternatives.

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

David J. Gladstone -- Chairman and Chief Executive Officer

Okay. Thank you, Nicole and Bob and Michael, you all did a great job in informing our stockholders and analysts that follow the Company. In summary, Gladstone Capital, another good quarter, originating $42 million in investments last quarter ending December 31, 2019. Team grew the investment portfolio by $26 million to come in now at $429 million, which is a new high. They redeemed the last outstanding series of the Company's preferred stock to achieve and added financial flexibility and reduced the Company's financing cost to enhance the Company's core interest earnings, which we use to pay the dividend. We've maintained a strong balance sheet with significant money and borrowing capacity to grow the investments in attractive lower middle-market businesses.

In summary, the Company is continuing to demonstrate strength and finding opportunities of mid-sized private businesses. Any of these loans that we make to those businesses are in support of a mid-sized private equity fund that are looking for experienced partners to support the acquisition and growth of the business that they're investing in. This gives us an opportunity to make attractive interest-paying loans to support our ongoing commitment to pay cash distributions to shareholders.

We have a strong team in place today and this will capitalize on this good market that's out there now. And with the economy so strong -- well, quite frankly, it's the strongest economy I've seen in my lifetime. We have a strong showing when compared to other BDCs, a list I looked at from a large brokerage house showing BDCs. This BDC was Number 4 on their list of 37 and they measured it by the last 12 months total return, which this Company had [Phonetic] 47% according to that list.

I think I'll stop now and we will move over to the operator. Sarah, if you'll come on and tell our callers how they can ask questions about the Company?

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] Your first question comes from the line of Mickey Schleien from Ladenburg. You may ask your question.

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

Yes, Good morning everyone. Just start off with a housekeeping question, were there any adjustments to investment income for the New Trident exit or the upcoming Marine exit?

David J. Gladstone -- Chairman and Chief Executive Officer

Mickey, no, both of those investments are written down to zero. So, there were no adjustments associated with those.

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

Okay. And Bob, could you expand on the deterioration and the valuation of Defiance's common shares in terms of what triggered that?

Bob Marcotte -- President

Sure. I think, as I said, that is a heavy manufacturing business that serves the truck industry as well as some auto-related industries. You may note that, last quarter in the December 31 quarter, there was -- they strike at GM, which had some impact. You also had a number of manufacturers managing their year-end inventory in the face of uncertain growth outlook for 2020. And, so there was a temporary adjustment in the production flows to manage those end inventories and as a result, there was a dip in sales. We are now obviously post that period. Normal inventory flow has commenced, and in fact, that business has a significant book of new orders that expects to ramp over the balance of the year. So, we view that adjustment as largely a temporary phenomenon and feel very strong about where the business is headed at this stage, but it's a quarter-end activity and we adjusted our equity accordingly.

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

I understand. That's very helpful. Bob. In your prepared remarks, I think you said something about target leverage of 1:1, did I hear that correctly?

Bob Marcotte -- President

Yes, I think we've been guiding folks that we were headed in that direction. The question is how quickly we might get there in light of some of the prepayment activity, which we experienced a fairly heavy flow in the second and third quarters of last year. So we're working in that channel of direction, whether we can actually get there at the end of this fiscal year will depend large part on certainly market activities and the level of those prepayments.

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

I understand. And my final question Bob, and may be difficult to answer, but looking at the portfolio structure, there is certainly some exposure to things like consumer durables, and, as you mentioned, transportation and cargo aerospace. My question is, have you started to see or have your -- management teams of your borrowers started to convey to you any information about the impact of the coronavirus on their business? I ask because even this morning I'm starting to read stories in the papers about folks having problems getting supplies from China.

Bob Marcotte -- President

Given the size of the investments that we typically make and the focus on domestic businesses, it tends to be domestic manufacturing. That said, there are several companies in our portfolio that do a heavier flow of imports. The most noted of which, I would say, the business has 70 suppliers from China. So it's very diversified geographically. Secondly, it was somewhat fortuitous that most of these businesses with these long lead supply chains need to be carrying meaningful inventories, given the time in transit. So they do carry inventories that are more than adequate. And the Third is, this event occurring just before Chinese New Year, it's fairly common for businesses to go a little longer on inventory in light of shutdowns that occurred during that time of year in China.

So, the one business that I'm referencing is in pretty good shape, when you factor those three considerations in place. Now, obviously there is a span and scope of shutdowns and disruptions that we can't necessarily fully anticipate, but unless this continues for some period, this particular business does carry an extended inventory and should be able to manage it at least for the time being.

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

I understand. That's helpful. Those are all my questions this morning. I appreciate your time.

Bob Marcotte -- President

Thanks for calling in Mickey.

David J. Gladstone -- Chairman and Chief Executive Officer

Any other questions, please?

Operator

[Operator Instructions] I'm showing no further question at this time. I would like to turn the conference back to Mr. David Gladstone.

David J. Gladstone -- Chairman and Chief Executive Officer

Okay. Thank you very much for all of you tuning in and listening to this and I know a number of you will listen at the call at a later time. So, thank you very much and that's the end of this call and we'll see you again next quarter. That's the end.

Operator

[Operator Closing Remarks]

Duration: 22 minutes

Call participants:

David J. Gladstone -- Chairman and Chief Executive Officer

Michael LiCalsi -- General Counsel and Secretary

Bob Marcotte -- President

Nicole Schaltenbrand -- Chief Financial Officer and Treasurer

Mickey Schleien -- Ladenburg Thalmann Financial Services Inc. -- Analyst

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