Good day, ladies and gentlemen, and welcome to the Gladstone Capital Corporation's first quarter ended December 31st, 2018 earnings conference call. 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. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. David Gladstone. Sir, you may begin.
All right. Thank you, Lauren. Nice introduction. Good morning, everybody. This is David Gladstone, chairman, and this is the quarterly earnings conference call for shareholders and analysts of Gladstone Capital for the quarter ending December 31st, 2018. Thank you all for calling in. We're always happy to talk with our shareholders and analysts and welcome the opportunity to provide updates for the company and our investments that we're in. Now we'll hear from our general counsel, Michael LiCalsi, who'll make a statement regarding forward-looking statements. Michael?
Thanks, David. Good morning. Today's report may include forward-looking statements on 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. 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 on our forms 10-Q, 10-K, and other documents that we file with the SEC. Those can all be found on the investor relations page of our website, www.gladstonecapital.com, and on the SEC's website at www.sec.gov. We undertake no obligation to publicly update or revise any of these forward-looking statements as a result of new information, future events, or otherwise, except as required by law.
We also ask that you take the opportunity to visit our website, once again, gladstonecapital.com, sign up for our email notification service. It can also be found on Twitter, and that's @GladstoneComps, and on Facebook, keyword there is The Gladstone Companies. Today's call is simply an overview of our results. We ask that you review our press release and form 10-Q, both issued yesterday, for more detailed information. Again, those can be found on the investor relations page of our website. With that, I'll turn the presentation back over to Gladstone Capital's president, Bob Marcotte. Bob?
Thank you, Michael. Good morning, and thank you all for dialing in today. Let's get into the results for last quarter and our portfolio performance and capital position. I'll conclude with some comments regarding the outlook for the balance of fiscal 2019. The highlights for the quarter ended December 31st include, per our prior quarter guidance, our originations on the quarter were very strong, totaling $59.2 million, included three new proprietary senior secured investments. Exits and repayments totaled $8.9 million, net originations for the quarter were $50.4 million, excluding any appreciation or depreciation on the quarter. Interest income rose 7.7% to $11.7 million, lifted by the net originations, the majority of which closed in the latter half of the quarter.
Total interest income was $11.9 million, which was up $700,000 or 5.8% as prepayment and success fees fell with the level of exits on the quarter. For the quarter, the overall portfolio yield on our interest-bearing portfolio increased to 12.3%. Borrowing costs rose by $500,000 on the quarter, with higher outstanding supporting the asset growth, the increase in LIBOR rates, and the decision to fix a portion of our borrowings with the 6.125% senior secured notes issued during the quarter.
Net investment income was up slightly to $6 million or $0.21 a share as net management fees were largely unchanged compared to the prior quarter as those advisor fee credits associated with new originations rose since we credit any closing fees paid to the manager against the base management fee. The advisor incentive fee credits also declined. The net assets from operations declined by $3.7 million or $0.13 a share as a result of $9.7 million of net portfolio depreciation on the quarter. Net asset value dropped $0.34 a share or 4.1% to $7.98 per share at December 31st.
With respect to the portfolio, the asset mix at the end of the quarter shifted slightly with the magnitude of the senior secured originations, which rose to 54% of the investment portfolio fair value at the end of the quarter. The second lien investments dropped to 34.7%. During the quarter, we completed the restructure of our second lien loan position in FDF Energy in connection with the company's exiting bankruptcy. As a result, we realized a substantial loss on our exposure and also made a $5 million preferred equity investment in the business as it exited the significant equity interest in the business going forward. This dropped our oil and gas industry exposure to 11.4% of the portfolio at fair value at the end of the quarter, and we expect this to drop further in the near term.
The balance of the underlying portfolio performed well in the quarter, as reflected in the appreciation of $4.8 million across a number of equity co-investments. When you consider the unrealized depreciation reported also includes approximately $5 million, which we attribute to the year-end selloff in the broadly syndicated market, which has already begun to recover. Our non-accrual investments decreased this quarter with the restructure of FDF, and as of December 31st, we had no non-performing assets. Since the end of the quarter, we've received a prepayment of our second lien investment in Merlin International, generating proceeds of $20.9 million, which include $900,000 of exit and prepayment fee income. As referenced previously, several of our investments are under contract to be sold or are being marketed for sale, and we expect prepayments in the range of $20 million-$30 million over the balance of this quarter.
The current backlog of new proprietary investments slated to close in the near term is modest, which is very typical of the first quarter of the year. We expect new originations to lag prepayments in the near term, the impact of which will reduce our leverage and should generate additional prepayment income. Now I'd like to turn the call over to Nicole Schaltenbrand, the Chief Financial Officer for Gladstone Capital, to provide some of the details on the fund's financial performance for the quarter. Nicole?
Thanks, Bob. Good morning, everyone. During the December quarter, total interest income increased by $800,000 or 7.7% over the prior quarter, driven mainly by the $15.5 million increase in the weighted average balance of our interest-bearing portfolio, as well as the 40 basis point increase in the average yield on the investment portfolio. Other income declined in the absence of any significant repayments to $200,000 from $400,000 last quarter. Total investment income rose $700,000 or 5.8% to $11.9 million on the quarter. Total expenses for the quarter increased by $600,000, driven mainly by the $500,000 increase in financing expenses associated with $11.7 million in higher average borrowings, the 22 basis point increase in average LIBOR, and the higher fixed rate associated with the 6.8% senior notes issued during the quarter.
Net management and incentive fees declined by $100,000 for the period, as base management fee credits increased with higher originations, which more than offset the higher management fees and reduced the incentive fee credit. Other expenses were up slightly with annual legal and filing costs at approximately 89 basis points on average assets on the quarter. For the quarter, net investment income was $6 million or $0.21 per share and covered 100% of our shareholder distribution. Moving over to the balance sheet. As of December 31st, total assets were $438 million, consisting of $431 million in investments at fair value and $7 million in cash and other assets. Liabilities rose by $49 million to $211 million and consisted of $102 million in borrowings on our credit facility, $57.5 million of our newly issued long-term notes, and $52 million of Series 2024 Term Preferred Stock.
Net assets declined by $9.7 million since the prior quarter end with the net realized and unrealized portfolio depreciation. NAV per share declined by $0.34- $7.98 as of December 31st compared to $8.32 as of September 30th. Looking forward, we continue to be well positioned to benefit from any upward movement in interest rates, as 91% of the portfolio is tied to floating rate investments. The weighted average LIBOR floor on these assets is 1.3%, and with floating rate assets of $369 million at principal and only $102 million of floating rate debt, a 100 basis point rise in LIBOR should generate an approximate 7% increase in net interest income. Inclusive of the net originations and change in our net asset value over the past quarter, our balance sheet leverage increased significantly.
Pro forma for the subsequent prepayment, our leverage has dropped to 84% and is expected to moderate further with the prepayments discussed earlier by Bob. We ended the quarter with approximately $67 million of availability under our line of credit, and our current unused commitment is approximately $80 million. Now I will turn the call back to David to conclude the presentation.
All right, Nicole and Bob and Michael, you all did a good job of informing our stockholders and analysts that follow the company. In summary, Gladstone Capital had a very good quarter and is continuing to build on the lower middle market business focus that they have. It's well positioned to grow over the fiscal year that ends in September 2019. The fund closed $59 million in originations, including the three new proprietary investments. The company completed $57.5 million of 6,25% senior notes, which have further diversified their funding sources and locked in the financial cost in case there's a potential for LIBOR to go up. Net investment income was $6 million, which fully covered our dividends on the quarter of $0.21.
As you all know, Gladstone Capital remains committed to paying its shareholders a cash dividend. In January, our board of directors declared our monthly distribution to our common shareholders of $0.07 per common share for the months ending January, February, March, which is an annual rate of $0.84. The board will meet again in April to determine the monthly distribution of common stockholders for the quarter ending March 31st. Through the date of this call, we've made 192 sequential monthly and quarterly cash distributions to our common stockholders. That's almost $329 million. We've never missed a distribution, and that's about $11.53 per share of the shares outstanding at December 31st, 2018.
The current distribution rate of our common stock, with the common stock priced at $8.86 yesterday at the close. Distribution run rate now is 9.6% and continues to be very attractive relative to most yield-oriented alternatives. Our monthly distribution is 6% of our preferred stocks, which translates into $1.50 annually, and that's paid on a quarterly basis as well. The term preferred stock trades under the ticker symbol GLADN and closed yesterday at $25.13, which is a little bit under 6% because it trades above the $25 that we originally sold the stock at. In summary, the company seems to be improving positions in private businesses that are mid-size with good management. Many of these are owned by mid-size buyout funds that are looking for experienced partners that can lend money to the businesses they invested in.
This gives us a chance to make attractive interest-paying loans, which support our ongoing commitment to pay cash distributions to stockholders. We have a really strong team in place. Now we'll get the operator back on and have callers ask us some questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that's star then one to ask a question. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Again, that's star then one to ask a question. Our first question comes from Christopher Testa with National Securities. Your line is open.
Hi, good morning, David. Excuse me. Good morning, David and Bob. Thanks for taking my question today.
You're welcome.
Just wanted to start off on the markdowns on the oil and gas portfolio were relatively modest, given the drop in oil prices. I do know that these are removed from E&P. They're not necessarily drilling into the ground except for Francis, which is restructured. Isn't there still a tie-in that if oil prices decline, the activity of these businesses might slow accordingly?
Bob?
Christopher, the adjustments in the valuations were all associated with FDF. The other couple of exposures are mostly chemical distribution businesses.
They are actually benefiting from the increased production and the volume of oil coming out of the Permian. The volume of oil coming out of the Permian requires both chemicals to maintain the production, and more recently, the completion of pipelines to move that oil to the Gulf Coast and unlock the additional production is increasing the demand for chemicals. The production is what drives the value of the other businesses that are the bulk of our exposure, and that is continuing to increase on both scores I've outlined. Those companies are growing rapidly and de-leveraging. There is no expected depreciation other than the year-end relative value marks that I referred to in my comments.
Got it. Okay. That's appreciated, Bob. Excuse me. Kudos on actually marking down your book, given the broadly syndicated market, because let's just say there's some of your larger peers who declined to do that this quarter. Kudos on keeping it honest there. Just remind me, is your credit facility compatible with the reduced asset coverage that you guys have available?
It is not. As I've stated in previous quarters, we've been given every indication because it's structured as an asset-based advance rate. The quality of our assets and the cushions associated with the facility have given our banks high level of comfort that moving to a higher overall leverage is not something that they are concerned about. We just haven't had the opportunity or a reason to want to open up the facility. We've let a number of the other banks go and make the modifications that are associated with it, and we would expect to do that in the next quarter or two. It's not something that we expect an issue with. As further affirmation, the agent bank on the facility is the same agent bank for GAIN, and they have appropriately modified their facility.
The proxy and the track record has already been established with our sister BDC.
Okay, great. That's helpful. Obviously, you guys completed a good fixed rate issuance at a very good coupon, and now spreads have come back in. Does this at all change maybe your planning for a new fixed rate debt issuance, either at the end of FY 2019 or maybe early 2020?
As we've stated previously, the determiner on our leverage, taking advantage of the asset coverage relief is taking out the existing preferred issue, which includes the covenants to the old leverage advance rate. Taking that out, we would expect that doing that with bank facilities is probably not the most prudent approach, and that more likely we would consider either an upsize or some other form of issuance to replace that preferred stock when the no call period expires in September of 2019.
Got it. That's helpful. Thank you. The last one for me, you guys had mentioned, I think it was Merlin, this company, repaid with $29 million. You said something about $20 million-$30 million repayments. Is it the Merlin repayment is $29 million plus an additional $20 million-$30 million of repayments total? We're looking ballpark, $50 million-$60 million of total repayments for the 331 quarter?
Merlin was $20.9 million. $20 million was the investment.
Oh, $20.9 million.
$900,000 were fees and exit fees. The $20 million-$30 million is incremental to that. There is two separate situations that we would expect to close. We've been anticipating a fairly bulky prepayment window. They seem to be coming, or expect to come this quarter. Hence, as I noted in my comments, we ran a little high on our leverage at the end of December in anticipation of an influx of those prepayments. Yes. Overall, we're talking about $40 million-$50 million of prepayments on the quarter.
Got it. Okay. Those are all my questions. Thank you for taking my questions today.
Thank you, Christopher.
Next question.
Our next question comes from Mickey Schleien with Ladenburg Thalmann. Your line is open.
Yes. Good morning, everyone. Bob, I just wanted to refresh my memory on the legacy investments. I know Francis Drilling was one of those. What percentage of the portfolio on a fair value basis still is legacy, meaning something that predates your arrival at Gladstone?
The two that come most immediately to mind would be Defiance, which is still on the balance sheet, and I believe roughly $8 million. True North, which was the old Sunshine, which was restructured in the 930 quarter, which is down to about, I think it's less than $2 million. I think you're talking about roughly $10 million against a portfolio of $430. I'm not sure that rounds to a meaningful number.
Okay, I understand. That's helpful. Going back to the increase in the weighted average yield. It climbed more than LIBOR at the same time that your first lien allocation also went up. Can you just give us a little granularity on how that occurred?
Good question. The increment is largely associated with one of the deals that we closed on the quarter, which had a fairly high overall yield. I think if you track through the schedule investments, we put on a senior investment that was in the mid-teens. That was enough on the quarter to move the numbers, or to create the increment. I'm sure there was some other shifting, but that was the bulk of it.
Mid-teens is a really strong coupon. Can you give us some insight as to what features of that investment attracted you to it?
I think as I have mentioned in the past, we've been entertaining investments in some instances with independent sponsors. This happened to be an independent sponsor transaction, which obviously there's a little bit different negotiating and leverage dynamics in that kind of a situation. This investment happens to be in the defense-related business that's here in the D.C. area. We were able to, given our experience in the sector, given the proximity, given the strength of the management team, and given the rollover investment of that management team, we felt very comfortable with that underlying investment. As you may know, the defense complex here in D.C. is a fairly hot market, and the visibility on growth and revenue in that business was pretty strong. The combination of factors were pretty compelling to us.
We were able to do a senior secured investment at a high yield. We did put some equity in that company, given the attractiveness of it. And the good news is that company also won a nice piece of business very shortly after our close, so it's continuing to deleverage. It was a confluence of factors that enabled us to execute on that, and it is well below our average leverage level in the portfolio. It's a combination of factors that I think made it a compelling investment.
Okay. Thank you for that. That's really helpful. Speaking of D.C., was there any material impact on your borrowers from the shutdown recently?
The only one that I've heard of, it was somewhat recent, one of the investments that we closed on the quarter was in the marketing and media business. They provide systems and support for digital marketing programs. As it turns out, they had a contract with one of the large government museums and art infrastructure here in D.C. While the shutdown was in place, that contract was suspended. It has now been restarted and it has been catching up. Really, that's the only one that I'm aware of that we've seen any impact associated with the shutdown.
Okay. That's helpful. Bob, can you give us an update on Edge Adhesives? I saw that you marked it down fairly meaningfully. Just curious about the outlook for that company.
Edge is in a very interesting and fairly active space. The adhesives and chemical infrastructures continues to be relatively strong. There were management changes that were affected earlier last year. They are currently working on a significant number and backlog of new product lines and launches. We just happen to be in a period of time where they're comping down, the result is, as you expect, when EBITDA goes down and you own a decent block of the underlying equity, there's a magnified effect on the underlying company. We're fairly close to that one since that is in fact controlled by GAIN. I think we have pretty good visibility on what's going on there. I would expect between the pipeline and some other strategic activity, that there are plans to move that asset in a more positive direction in the coming quarters.
That's all I can say at this time.
Okay. Excluding Edge, you had other investments depreciate about $5.6 million. Did I hear you correctly in your prepared remarks that you said $5 million was mark-to-market volatility? In other words, the bulk of the other movements apart from Edge were mark-to-market?
Yes. That is correct, Mickey. The only one that was kind of in a gray area, the $5 million was the mark-to-market. There is $600,000 of depreciation that's associated with the prepayment on Merlin. Merlin was at a fairly attractive rate and low leverage level. Given the fact that we received shortly after quarter end par on that investment, it was marked down to par. The $600,000 difference in that case is associated with that exit more than it is depreciation. Yes, the vast majority of the markdowns are associated with mark-to-market.
You said that as of today, the bulk of that has been recuperated?
There's a couple of ways to look at that. I'm obviously not a soothsayer, and I can't speak to the broad marketplace, but reading some of the trade, the LSTA index for high-yield loans dropped 2.5% in the month of December. As of the end of January, it had recovered 2.2%. It has recovered roughly 80% of the December decline. Whether that holds up to the March 31st is question one, and two, we'll obviously have to have that discussion with our outside pricing service when we do get to that date. All indications are that market has largely been re-inflated. You may note that everything leveraged was largely dumped in the last two weeks of December, and it has come back much like the BDC stocks have come back.
I do agree with that statement. That index that you referenced, the yield on that index widened about 150 basis points in the fourth quarter. Does that metric factor directly into your valuation? In other words, is there a correlation between your valuation of your debt investments and that index, or do you use some other methodology?
There is a little bit of a black box in that, when you read our disclosures in our K, we use what used to be the old S&P pricing service. S&P uses the 3,000 or whatever, 6,000 loans in their pricing service. The movement in those underlying loans are used to then index ours. They use the broader movement, they tie it to sectors, and then they adjust for underlying credit changes. While it's not tied to that index, it is effectively driven by some of the same principles, given the breadth of the S&P pricing model. We've never tried to reconcile it, I think that's a reasonable assumption.
I understand. My last question, sort of a housekeeping question. New Trident was marked at zero, but it's still on accrual. I just want to confirm that I'm correct in that assessment.
You are correct. That investment is certainly challenged. It is controlled by a large buyout complex with an investment that is on the same tier as where we currently are invested. We have an alignment of interest. Whether that continues in the coming quarters is an open question.
All right. Thank you for your time this morning. That is it for me.
Thank you, Mickey.
Any other questions?
Thank you. As a reminder, ladies and gentlemen, that's star then one to ask a question. Our next question comes from Bill Brown, a private investor. Your line is open.
Thank you. First of all, Bob, thank you for your continued stock purchases. As a long-time investor, it certainly gives me great comfort to know you're right in there with us. I just want to know your thoughts. I know that on the comment and the statement about enhanced returns, looking at all the additional, hopefully, fee income that you're expecting. What are your thoughts on likelihood of this being the year we finally get to increase the dividend?
Also, just philosophically, I'm just wondering, if fee income is what generates the additional income that might be sufficient to increase the dividend, and fee income is obviously a little more lumpy in terms of how it comes in, is there a feeling on the dividend to only increase it when you can increase it on a run rate, or is there feelings of if in a particular year you would do a special dividend if it was because of the fee income?
There's a lot in there. Let me give you my view, and I'll let David weigh in. I think in the near term, the prepayments will drive fee income, as you've correctly ascertained. I think we will probably be more oriented towards considering the dividend relative to core earnings and interest income. We've always kind of stated that driving the core interest income is an important factor. We've been monitoring that fairly closely. I would think there are two things that come into mind that are going to drive the dividend considerations. As we get these prepayments, as we reinvest those funds, the fees will cover that reinvestment period and get that money redeployed. As we get towards the tail end of the year, I think we're going to have two things working in our favor.
One is we do expect leverage relief, so we have the ability to move up our leverage, and that is going to be accretive to the dividend. The second thing that we've also taken into consideration is, I think we feel pressure to recognize the increase in overall yields in the marketplace at some point needs to be passed through and reward the loyal shareholders for their continued investment in the company. As rates rise, I think there is a desire on our part to begin to move that distribution consistent with rates and as we begin to lift leverage towards the tail end of the year. Obviously, we've absorbed a fairly significant hit to our net interest income associated with FDF in the last two quarters. That was a fairly material hit. We've absorbed it.
Now we're in a better position in the coming quarters to begin to consider that dividend adjustment you've been waiting for. David, do you have anything to add to that?
Yeah. Bill, we don't like special dividends. They don't seem to add up much in the marketplace. Our goal is to get ahead of the growth and income so that we can look at the dividend coverage ratio and say to ourselves, "We're in good shape. We can raise it." In some of the companies that we manage here, we've taken on the idea that we can raise the dividend a little bit every quarter, and that may be what we end up doing here. At this point, I'll leave it to Bob to make the final judgment on increasing the dividend, but that is the goal.
Great.
Other questions, Bill?
No. Thank you very much.
Okay. Next question from anybody?
I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Gladstone for any closing remarks.
All right. Well, we appreciate the questions that we got. They were good, and they helped us transmit to our shareholders what's going on here. That's the end of this, and we'll see you next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.