Yahoo Finance Gladstone Capital Corp (GLAD) Q3 2019 Earnings Call Transcript
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Gladstone Capital Corp (NASDAQ: GLAD)
Q3 2019 Earnings Call
Aug 6, 2019, 8:30 a.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good day, ladies and gentlemen, and thank you for standing by and welcome to the Gladstone Capital Corporation's Third Quarter Earnings Call. [Operator Instructions] It is now my pleasure to turn the call over to Mr. David Gladstone. Sir, the floor is yours.
David J. Gladstone -- Chief Executive Officer
Thank you and hello everyone. Thank you for calling in. This is David Gladstone, chairman, and this is the quarterly earnings conference call for Gladstone Capital for the quarter ending June 30, 2019. Again, thank you for calling in. We're always happy to talk with our shareholders and analysts and welcome the opportunity to [Indecipherable] updates on the company and its investment portfolio. Now, we're gonna start off Michael LiCalsi. He's our general counsel and make some statements with regard to forward-looking statements.
Michael LiCalsi -- General Counsel and Secretary
Thanks, David, and good morning. Today's report may include forward -looking statements under the Securities Act of 1933 and the 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 and may future results expressed or implied by these forward-looking statements including all risk factors in our Forms 10-Q ,10-K, and other documents that we filed with the SEC. To find these on our website, which is www.gladstonecapital.com, specifically look on the Investor Relations page or on the SEC's website, which is www.sec.gov.
Now, we undertake no obligation to publicly update or revise any of these forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. We also ask you to take the opportunity to visit our website once again, www.gladstonecapital.com, Please sign up for our email notification service. We can also be found on Twitter. The handle there is at @GladstoneComps and on Facebook keyword Gladstone Companies. Today's call is 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. Those can be found on the Investor Relations page of our website. With that, I'll turn the presentation back over to Gladstone Capitals President, Bob Marcotte. Bob?
Bob Marcotte -- President
Good morning. Thank you all for dialing in today to spend a few minutes with us this morning. And now let's get into the headlines for Gladstone Capital for the quarter end of June 30, 2019.
Originations on the quarter were strong at $58 million as we referenced in our prior call, and included two new proprietary investments and three syndicated investments. Exits and repayments were higher than anticipated at $41 million, and included the repayment of our senior debt investment, IA Tech, which is $30 million, was one of our top five, which was prepaid at par plus a prepayment fee. Net originations on the quarter thus were $17.3 million after all other portfolio movements.
Interest income rose slightly to $11.2 million on the quarter from the prior as the decline in average yield on our investment portfolio to 11.8% was offset by a small increase in the average interest-bearing investment portfolio from the prior quarter. Prepayment fees, exit fees, and dividend income rose on the quarter to 1.7 million including the IA Tech prepayment fee of $900,00, which lifted our total investment income to $12.9 million or 2.9% higher than the March quarter. Our borrowing related costs were unchanged on the quarter as average borrowings fell slightly and commitment fees associated with a lower utilization of our credit line rose on the quarter.
Net investment income was up slightly at $6.2 million or $0.21 share as operating expenses were unchanged and net management fees rose compared to the prior quarter as incentive fees increased with the increased investment income and incentive fee credit decline. The net assets from operations rose to $8.9 million on the quarter or 30% -- $0.30 per share as a result of the $2.6 million of net portfolio appreciation on the quarter, and NAV rose to $0.12 per share or 1.5% to $8.23 per share at June 30.
With respect to the overall portfolio, the asset mix is at the end of the quarter shifted slightly with all the portfolio activity resulting in the senior secured assets falling 3% to 46% of our investment portfolio at fair value while the second lien investments rose to 42% of the portfolio.
A major contributor to the portfolio appreciation in the quarter was the continued improvement in ADC's operating results and better visibility into the potential exit opportunities for that investment. Detracting from this momentum was a realized loss in the exit of a non-core defense sector fund investment, FedCap[Phonetic] and unrealized depreciation of our equity interest in [Indecipherable].
During the quarter, there was no change to our two non-earning assets, which represent an aggregate cost of $8.5 million or 2.2% of all debt investments and an aggregate fair value of $2.1 million or 0.6% of the fair value of all debt investments. Since the end of the quarter, we closed an additional $5 million follow on investment and between repayments and exits, total investments have increased by $3.8 million, so our earning assets are up slightly as of today. We also expect to close a new proprietary deal in the very near term.
With respect to the near term outlook within our lower middle market focused principally sub $10 million EBITDA business, we have seen a healthy level of deal flow in the past several months. That said, competitive pressures have also increased, particularly for senior investments causing lending margins to inch down. Between our current investment backlog and follow on fundings to our existing portfolio companies, we expect to be able to outpace some of the anticipated liquidity events on the horizon and continue to increase our average investments and core net interest income.
Interest rates are not obviously expected to provide much near-term lift to our interest income; however, we do expect fee and other income to remain elevated as our portfolio continues to mature and expected exits are realized. The flip side of the declining interest rate outlook is that we are optimistic that we are able to refund our existing 6% GLADN preferred early next quarter at a lower effective cost through some combination of capital market issuance or bank facility borrowings. This refunding is a prerequisite to clearing the last hurdle to be able to lift the 200% minimum asset coverage limitation. However, given our 242% coverage as of June 30, we're probably several quarters of solid originations away from being in a position to utilize any of this additional leverage capacity.
And now, I'd like to turn the call over to Nicole Schaltenbrand, the CFO for Gladstone Capital, to provide some of the details on the fund's financial results for the quarter. Nicole?
Nicole Schaltenbrand -- Interim Chief Financial Officer
Thanks, Bob. Good morning everyone. During the June quarter, total interest income rose 1% to $11.2 million as higher average investments more than offset the 20 basis point decline in the average yield on the investment portfolio. Other income rose by $300,000 to $1.7 million with the IA Tech prepayment fee as well as other active fees and dividends received. Total investment income rose $400,000 or 2.9% to $12.9 million on the quarter.
Total expenses for the quarter increased by $200,000 driven mainly by a $600,000 increase in net incentive fees, partially offset by a $400,000 decrease in net-based management fees. The increase in net incentive fees is driven by both an increase in net investment income and a $400,000 decrease in advisor fee credits quarter-over-quarter. The $400,000 decrease in net-based management fees is driven by the credits received associated with origination fees on our new investments during the quarter.
Financing expenses were unchanged at 3.2 million and other expenses were also unchanged at $800,000 or 79 basis points on average assets on the quarter. For the quarter ended June 30th, net investment income was %6.2 million or %0.021 per share and covered 100% of our shareholder distribution.
Moving over to the balance sheet. As of June 30th, total assets were $415 million consisting of $408 million in investments at fair value and $7 million in cash and other assets. Liabilities rose by $8 million to $169 million and consisted of $59 million and borrowings on our credit facility, $55.6 million of out [Indecipherable] 2023 senior notes, and $52 million of series 2024 term preferred stock.
Net assets rose by $11.3 million since the prior quarter end with $2.6 million of net realized and unrealized portfolio appreciation and common stock issued under ATM program, which generated net proceeds of $8.6 million. For the quarter, we issued 939,000 common shares at an average price of $9.34 per share or 113.5% of NAV. The accretive ATM issuance accounted for approximately one-third of the $0.12 increase in NAV, which rose to $8.23 as of June 30, 2019 compared to $8.11 as of March 31, 2019. Our leverage as of June 30th was unchanged from the prior quarter end at 69% of net assets despite 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 in approximately $117 million of available under our line of credit.
With respect to distribution, Gladstone Capital has remained committed to paying its shareholders a cash dividend and in July, our board of directors declared a monthly distribution to our common stockholders of $0.7 per common share per month for July, August, and September, which is an annual rate of $0.84 per share. The board will meet in October to determine the monthly distribution to common stockholders for the following quarter. At the current distribution rate for our common stock and with the common stock price of about $9.21 yesterday, the distribution run rate is now producing a yield of about 9.1%, which continues to be attractive relative to most yield oriented alternative.
And now, David will continue the presentation.
David J. Gladstone -- Chief Executive Officer
Okay. Thank you, Nicole. Good report and a good report from Bob and Michael as well.
I think our shareholders and the analysts are well informed of what we're doing. This is another good quarter for Gladstone Capital originated more than $60 million in due investements to more than offset the spike in payments and continued growth over the assets generating a record $12.9 million of investment income aided by some significant fees, but nonetheless made good money, maintaining a strong balance sheet with significant dry powder to grow the investment portfolio in this area that we specialize in and that's the lower middle market businesses. And the company, we believe, has enough liquidity to weather any kind of recession should there be one.
In summary, the company sees strength in the private businesses that are mid-size with a good management team. Many of these are owned by mid-sized buyout funds that are looking for experienced partners that can lend money to the businesses they invested their equity in. This gives us a chance to make attractive interest paying loans, which support our ongoing commitment to pay cash distributions to stockholders. Have a great team here and they're doing a good job. And now, I'm going to ask the operator to come in and get some questions from those out there that would like to ask us some more particulars.
Questions and Answers:
Operator
Thank you, Mr. Gladstone. [Operator Instructions] Our first question in queue will come from the line of Henry Coffey with Wedbush. Please go ahead. Your line is now open.
David J. Gladstone -- Chief Executive Officer
Henry, are you there?
Operator
Mr. Coffey, your line is open. Please check your mute.
Henry Coffey, Jr -- Wedbush -- Managing Director
Can you hear me now?
David J. Gladstone -- Chief Executive Officer
Yes.
Henry Coffey, Jr -- Wedbush -- Managing Director
Sorry about that. So with with rates as low as they are, you know, how -- how are you managing around that challenge and how -- how is market pricing being affected? And if prices -- if yields on investments were low, are they all [Indecipherable] in terms of cutting your funding costs to offset that and keep spreads where they need to be?
Bob Marcotte -- President
Henry, as you know, obviously a significant part of our capital stack, about a third of our debt is floating rate bank debt, so that's obviously, you know, going down with it. The second piece as I mentioned in my comments, we're going to -- we're going to call out our preferred early next quarter and that's at a 6% yield on it. More than likely, there will be some mix of floating rate funding that will come into that, and that's going to be, you know, significantly less expensive than the current dividend on that preferred. So those are certainly two parts of it.
You know, the more challenging part in the marketplace today is there's clearly been some spread compression in the lower middle market as it continued to be an active buyout area, probably even more active than the larger middle market buyouts. So we've seen some incursion of other funds coming in, creating some pressure on margins. So we obviously are are ramping up what we see in deal flow and very mindful of the competitive conditions that we're focusing.
So, at this point, I would say hit rates are a little bit lower, but we're still in a situation where we're lowering our cost and managing to our current yield. And obviously, we would -- we would love, you know, a little bit of rate increase to be able to offset some of the compression, but I think at this point, we're still we're still seeing positive investment opportunities that are accretive to our current book.
So it's -- it's tight, but I think we're we're still managing flow. And I think that's one of the reasons why you don't see our assets growing more dramatically. The incremental asset growth is coming from places where competitive pricing is probably less attractive.
Henry Coffey, Jr -- Wedbush -- Managing Director
So, there's obviously a little difference
sectors of the economy and there are different sectors of the economy that are affected by what the administration is up to. And for example, you know, soybean, agriculture, or something like that. But when you look at your portfolio companies, you know, what sort of economic read do you get? I mean, obviously if you'll be looking at the stock market, you'd would be very negative.But what are your portfolio companies telling you about how business conditions are and how the economy is going?
Bob Marcotte -- President
Well, we've always had a healthy mix of manufacturing smaller manufacturing businesses and, you know, there's certainly been in the past five, seven years a significant outsourcing. But domestic manufacturing, which is what BDC is really focus on, actually are growing quite well. You know, as people realign their supply chains, domestic manufacturing, plant expansion, you know, migration to domestic production where automation, labor costs, delivery times, inventory requirements are all more favorable. So we're getting to a point where, you know, whether it's aerospace or maybe some auto-related businesses, those have become a much more significant uptick in opportunity. Obviously, you know, each of those have their own challenges, but domestic manufacturing certainly is stronger.
I think in some of the other areas we're seeing, you know, services, businesses continue to be strong. You know, we see activity in software-related businesses or, you know, things in other service categories are certainly positive and probably more positive than you would think given basic wage increases and some of the pricing pressures, their costs, but they're still very positive on the -- on their outlook. So I would say it's decidedly a domestic swing for businesses that is creating some of the updraft for us.
Henry Coffey, Jr -- Wedbush -- Managing Director
Great. Thank you very much
David J. Gladstone -- Chief Executive Officer
Okay. Next question.
Operator
Thank you, sir. Our next question comes from the line of Mickey Schlenin with Ladenburg. Please go ahead. Your line is now open.
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
Yes, good morning, everyone. Bob, could you give us a bit more background about the trends at Alloy Die that supported its valuation increase and also how correlated is its business to a potential slowdown of the economy?
Bob Marcotte -- President
ADC die casting business is symbolic of what I mentioned in Henry's question. It's a West Coast-based manufacturer that serves aerospace lighting and some auto-related businesses. The business when it was acquired, some deferred capital expenditures, and over the course of time between those expenditures and some significant management changes, as you may know, that's a -- one of the few co-investments we have these days and is controlled by GAIN. So we have significant insight to what's going there.
Between capital and a swap out of management and a refocus on domestic customers and what we've seen as huge inflow of orders from large scale multi-national corporates that are lifting that business, the result has been significant sales increase, significant margin expansion, and at this point, the cash flow run rate in that business is up very dramatically over the last three years. So in today's market environment, they are building cash significantly and we feel is a business that has clearly turned the corner and is currently well above where the original investment was, and that's reflected in our equity adjustment on the quarter. So I would say that's endemic of what I think is a very strong story in a domestic manufacturing business that is certainly well supported by the underlying fundamentals.
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
So, I guess, I'll congratulate you and Dave Dullum on turning that around. I guess the downside, Bob, is that it sounds like that's a business that could potentially be a nice tuck-in acquisition for somebody, and this will go off your books, or potentially, I guess, if the cash flow profile is as nice as you're indicating it, you could -- you could be refinanced, is that reasonable?
Bob Marcotte -- President
We're -- I guess, we're exploring options in those regards, and between the accumulated liability and the ultimate upper limit value of that business, that's a fair assumption that we're -- that Dave and his team are pursuing.
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
Okay. Just a couple questions on the risk profile of the portfolio. Could you tell us how your average borrower revenue and EBITDA compares for your first lien versus your second lien investments?
Bob Marcotte -- President
We don't really break that information down obviously, each individual business can be very different, as you can imagine. When you're financing a manufacturer versus a software business versus a healthcare business, you come up with very, very different profiles. So we don't try to lump that. I can certainly follow up with you directly and talk a little bit about, you know, specifically overall. But the blend across the portfolio on all of the underlying investments, which we obviously report and have very exacting metrics that are required bar secured lenders, is approximately 3.7 , 3.8 times leverage across the entire portfolio. So when you think about market comps, that's probably closer to senior relative to where the middle market might be. This would be probably significantly north of that.
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
That's helpful. Perhaps I could just follow up and ask just conceptually. When you look at second liens, do you tend to prefer you know sponsor deals with lower LTV fees or is there a different approach in order for you to get interested in a second lien?
Bob Marcotte -- President
You know, that's a -- that's a interesting question and probably moves a lot with the market conditions. I would say, when the leverage starts to increase, second liens certainly become more challenging. You will note that we've closed a number of syndications in the last quarter because we felt the second lien marketplace, the lower leverage levels and the significant equity sponsorship and equity support warranted that.
So that's a clear example where, you know, sponsor and equity were a differentiating factor for us as it relates to, you know, the, you know, only restricting our second lien investments to to sponsor deals. That's not always the case in the proprietary transactions. In the proprietary marketplace, many of the sponsors are looking for second lien to use leverage and spike their their return on equity. We don't necessarily look at that situation where were uncomfortable taking on that level of investment. You also should know that when we classify it as the second lien and this is a bit of a detail, but there are times where we might originate a unitranche loan and we would sell off a strip of the first lien piece inside that loan. So if we provided, you know, four turns of leverage in a buyout, we might sell off the first, you know, two turns of leverage to a bank at a much lower rate. We would then classify that as a second lien loan as you would expect, but it's really inside a first lien leverage facility.
So from a collateral and control perspective and from an overall leverage perspective, we are going to be lower than what a traditional second lien would look like. So we continue to work the second lien angle. It's certainly an important part of our portfolio, but for the most part, I think there is in the syndicated fashion, either a large equity or in a proprietary deal significant control that we continue to exert over those assets.
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
I understand that that's helpful color, particularly labeling a second lien, a second lien as opposed to many of your peers, which don't. I appreciate your time this morning. Thank you.
Bob Marcotte -- President
Thank you, Mickey.
David J. Gladstone -- Chief Executive Officer
Okay. Do we have any other questions?
Operator
I'm showing no additional questions in the queue. I'll turn the program over to David for any additional closing remarks.
David J. Gladstone -- Chief Executive Officer
All right. Thank you all for listening to the presentation. Our company is in great shape today and we look to see you in about three months. That's the end of this call.
Operator
[Operator Closing Remarks]
Duration: 27 minutes
Call participants:
David J. Gladstone -- Chief Executive Officer
Michael LiCalsi -- General Counsel and Secretary
Bob Marcotte -- President
Nicole Schaltenbrand -- Interim Chief Financial Officer
Henry Coffey, Jr -- Wedbush -- Managing Director
Mickey Schleien -- Ladenburg Thalmann -- Managing Director
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