Gladstone Investment Corporation
Q3 2012 Earnings Call Transcript

Published: 30 Jan 2013

[Operator:]

Good morning and welcome to the Gladstone Investment Corporation’s third quarter ended December 31, 2012 conference call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded. And I would now like to turn the conference over to David Gladstone. Please go ahead. David Gladstone Alright, thank you Emily for that nice introduction and hello and good morning to everyone out there. This is David Gladstone, the Chairman, and this is the quarterly earnings conference call for shareholders and analysts of Gladstone Investment, the common stock trading symbol GAIN. And of course the preferred stock trading symbol GAINP preferred. We thank all of you for calling in. We are always happy to talk to shareholders about the company. I often wish they were more opportunities but this is that once a quarter opportunity for us to talk to you and you can ask questions. Hope all of you will take this opportunity to visit our website. Its www.gladstoneinvestment.com, you can sign up for email notices so you receive information about us on a timely basis. And please remember that if you are ever in the Washington D.C. area you have an open invitation to come by and visit us here in McLean, Virginia. We are just outside of Washington D.C and please stop by and say hello to the folks here, you will see some of the finest people in the business. And now let’s read the statement about forward-looking statements. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, including statements with regard to the future performance of the company. These forward-looking statements inherently involve certain risks and uncertainties and other factors even though they’re based on our current plans and we believe those plans to be reasonable. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. There are many factors that may cause our actual results to be materially different from any future results that are expressed or implied by the forward-looking statements, including those factors listed under the caption, both “risk factors” include in our 10Ks and 10Qs filings in our registration statement that are filed with the Securities & Exchange Commission and all of those can be found on our website at www.gladstoneinvestment.com and obviously on the SEC website. The company undertakes no obligation to publically update or revise any forward-looking statements whether as a result of new information, future events or otherwise after the date of the conference call. So please also note that past performance or market information is not a guarantee of future results. First we always hear from our President, Dave Dullum. And so he is up, he is the Board member. With Alan, he’ll cover a lot of ground. So Dave Dullum, go at it.

[David Dullum:]

Thank you David and good morning all. Usually I try to give a quick review of what we do, and so here goes. The business of Gladstone Investment is to provide capital for businesses that are being purchased with the management team and other equity investors. These are usually companied with annual sales in the range of $20 million to $100 million, and we describe that as the lower middle market. What we do is provide subordinated debt and equity and occasionally some senior debt [ph]needs transactions, which combination produces a mix of assets which is really the key to our business strategy. In that our debt investments provide the income to grow the dividends while we expect the equity to appreciate and therefore build shareholder value overtime. I should say that somewhat different if you will from other publicly traded business development companies that you’ll notice, some of them are predominantly debt focused. So, it is important to keep in mind that the equity portion of our assets are important to us and to our overall strategy. So, on December 31, 2012 last quarter, based on its costs our investments consisted of a mix of approximately $228 million or 70% in the dead investments which are the ones producing income and about $95 million or 30% in equity securities which are the ones that we expect to produce the capital gains. This ratio of roughly 70

[David Gladstone:]

Alright, David Dullum that was a good report and we’re excited about the future of the company. Now let’s hear from our Chief Financial Officer and Treasurer, David Watson on the [ph]fund’s financial performance for this quarter.

[David Watson:]

Alright, good morning everyone. I’ll start with our recent capital activity, as I am sure some of you are aware, during the third quarter we completed a public offering of approximately 4.4 million shares of our common stock at a public offering price of $7.50 per share, which was below NAV per share. Gross proceeds totaled 33 million and net proceeds after deducting underwriting discounts and operating expenses borne by us were 31.1 million which was used to repay borrowings under our credit facility. These proceeds impart will allow us to grow the portfolio by making new investments, generate additional income through these new investments, and provide us additional equity capital to help ensure continued compliance with regulatory tests and allow us to increase our debt capital while still complying with our applicable debt to equity ratios. Also during the quarter, we extended the maturity date on our credit facility one year with our bankers. As a result, the credit facility is now three years in duration again with a scheduled maturity date in October 2015. If we do not extend it again, all principal and interest will be due in October 2016 or approximately four years out. The remains of one-year extension option to be agreed upon us and our bankers, which may be exercised on or before October 2013. All of the terms of our credit facility have remained the same. So, between the proceeds from our common offering and the extension on our credit facility, we feel we are well capitalized for the remainder of the fiscal year and into the next to continue making good investments for our shareholders. Turning to our balance sheet, at the end of the December quarter we had $346 million in assets, consisting of $273 million in investments at fair value, $56 million in cash and cash equivalents, and $17 million in other assets. Included in the cash and cash equivalents like other quarters is $50 million of U.S. Treasury securities purchased for the use of borrowed funds at quarter end to satisfy our asset diversification requirements. We have $117 million in liabilities consisting of $40 million in term preferred stock, $25 million in borrowing outstanding on our three-year credit facility, $5 million in secured borrowings, and $45 million borrowed via the short-term loan, and $2 million in other liabilities. In all, as of December 31, 2012, we had $229 million in net assets, or $8.65 per share, so we are less than 1

[David Gladstone:]

Okay. Thank you, David Watson. I hope each of our listeners will read the press release and obtain a copy of our quarterly report called the 10-Q which has been filed with the SEC and can be accessed on our website at www.gladstoneinvestment.com and also on the SEC website. I think the big news here in this quarter is that we are actively investing in new portfolio companies and I think the rest of the fiscal year which ends on March 31 will be a good time to invest. I think we will end the year on very solid footing and hopefully for March 31, 2014 we will be even better than this year. We have been active in the capital markets and we were able to obtain some long term capital in March with a $40 million term preferred offering and with a $31 million common offering, in addition we have favorable lines of credit through October 2015 with BB&T and KeyBank and room to borrow under that line. So, we are in good shape right now to go forward. We did something this time that I don’t like to do, it’s the first one that I have ever done it before (inaudible) we were running out of money we invested in and the ratio of debt to equity was just too high. So, we sold some stock below net asset value and by taking some dilution of all shareholders and letting new shareholders in at a lower price, we have been able to push the company back on a good position to grow the assets and I think the dividend as well. The offering really didn’t hurt our ability to continue to pay the existing dividend and hopefully it will put us in a position to increase that dividend in sometime in the future. In October, we made limited revisions to our strategies and investment objectives and that went into effect on January 1st. There is not much change really between what we had before and what we put out. The marketplace I think looked back and said no change. There are a few minor changes in there. Our main business strategy is to be consistent between the two funds, allowing for additional situations in which Gladstone Capital and Gladstone Investments can pull in best. Also, all of our existing portfolio investments followed in the scope of the revised investment strategies and objectives that we have put into place that became effective on the first of January. Folks, I think this is a fabulous fund with a great opportunity and I think there is some good upside coming in the future, we just still have concerns about what’s going on in the marketplace. Our economy doesn’t seem to go and I attribute that because small businesses are not growing and the number of small business is starting, in the United States it’s lowest in 20 years, you can’t really have a recovery without small business growing and producing the jobs, they still produce about 75% or 80% of all the new jobs. We also worry about oil prices, one hit over a pipeline in the Middle East or blockade or somehow, and oil prices would go sky high. We also have supply too dependent on countries that don’t wish us well. High gas prices for cars and trucks just hurts every business in the US. So, we need to develop more oil and gas here obviously, we are frightened to death about inflation, the decision by Congress and the President of the United States to expand the money supply, will ultimately cause serious inflation in the dollar, we will have a much lower buying power there. It’s just a bad idea that to think that we can borrow and spend our way to prosperity, it’s been disproven hundreds of times in other countries and I don’t know why we think it is (inaudible). The spending by the federal government as you read and hear about every day in the news is still just out of control. It’s so out of control that we are now borrowing about 43% of dollar we spend and that looks like it’s probably going to be closer to 50% as we move forward. The amount of money being spend on the war in Afghanistan hurts our economy, but obviously that’s being rundown and we are really happy to see that go away. And the terrible news is that part of the government still talks about raising more taxes, we have seen huge tax increase that was put in place just recently and they are talking about additional taxes and they always talk about the rich paying it, but at the end of the day it’s the middle class and even some of the lowest paid workers are paying more taxes than they were before this big tax increase went in place. Trade deficit with China continues to be on my mind, it’s just terrible, China continues to subsidize their industries to the disadvantage of our businesses, and this really means our companies can’t compete with them, so jobs go away from our country, they go out of this country into places like China. We need a government that will stand up to China and stop them from cheating. The continued stagnation of the housing industry and related disaster in the home mortgage default area, it just continues to drag down our economy. There has been small changes in the housing business and they are positive, but those small changes are just a small fraction of what needs to happen in order for recovery to happen in housing. We see the economic problems in the Euro zone and that may hurt some companies, thank goodness, most of the investments we have in small or mid-sized businesses don’t have a lot of fails in Europe and as a result I don’t think we get to hurt by the downturn in slowing and continues to go on there. Unemployment is far too high, the numbers used by the government reporting in the popular press really don’t include all those who are working part time but seeking full time, nor does include those who have stopped looking for work and more realistic numbers probably in the 15% to 18% range. In spite of all these negatives, I think the small business base that we lend to investment is not a disaster. Really the best ones are still have gone through the recession and survived. The lingering recession is still having an impact on the portfolio companies, it’s still not a disaster, and it’s just keeping things at a slow move. Like most companies, some of our portfolio companies have not been increases in revenues and backlogs; however, some others are seeing good increases and have a few others that have seen really great increases. So, it’s a very uneven economy by our standard which is what we have in our portfolio. Our distribution declared by the board for January and February and March is $0.05 per month for those three months, January, February and March 2013. And this is $0.60 a year, the board next meets in April to consider a vote on the dividend for April, May and June. This currently at its current distribution rate with the stock at about $7.42, about 8.1% yield, so that is a fabulous yield since its coverage, so nicely and hopefully there is some capital gains out there. And our monthly distribution is 7.125 for our term preferred stock that’s a $1.78 annually. Currently, the price of the stock is about $25.29. So, please go to our website and sign up for e-mail notification service. We don’t send out a lot of junk mails, just the news on your companies, so go to GlasdstoneInvestment.com, that’s the site and you can follow us on whether you think GladstoneComps.com and also Facebook, under the keyword The Gladstone Companies. In summary we see the next 6 months looking okay, probably going to do a lot better. Economy is not strong but we’re looking for a lot of good investments, I think will hit those and all by the way, as you noticed we redesigned our press release to shorten it substantially, and we were just duplicating a lot that was in the 10-K’s and 10-Q’s, and there is really no reason to do that. Anybody who’s going to invest is going to go over to the 10-Q or 10-K and read it at pretty thoroughly before they invest. So, with that we’ll stop now and see if there is some questions from our analysts or some of our loyal shareholders.

[Operator:]

Thank you, we will now begin the question and answer session. (Operator Instructions) And our first question will come from Daniel Furtado of Jeffries, please go ahead.

[Daniel Furtado:]

Good morning David. Thank you for the opportunity to ask a couple of questions. The first is just a competitive environment, I think I’ve got a good read here, but I mean, would you classify this as relatively stable or stable cents on the last earnings period?

[David Gladstone:]

I think it’s pretty much stable. David Dullum might be able to answer that, you are in the field everyday and I have been out for about a month.

[David Dullum:]

I think it is. I think we’re at, usual supply of good opportunities that we’re looking at and if you broker through them, yes, I would say there’s any significant increase in the supply of good options are decrease, are pretty stable.

[Daniel Furtado:]

Excellent, thank you David. The other question I had is just thinking about the co-investment opportunity with the other Gladstone family of companies, how are you guiding people to think about that. If we think about 100 deals that come through the pipeline, what percentage of those deals would [ph] primarily be attractive for a co-investment from GAIN. I know it’s relatively early still since [ph]CCE is allowed you to do this, but how should we think about that moving forward?

[David Dullum:]

I think there a number of ways to think about it. First of all, there are some deals that we do now that fit within investment very nicely and would partially in capital as well. We pretty much know that they are going to need more money in the future so, those become candidates for us to do in both companies so that we much more money to use and that, we had to sell a couple of our companies in investment. In the past because, we’d really run out of the ability to lend in more money and invest more money and we ended up going out, and selling them. We’ve got great capital gains out of them, so that sorted the first category of good solid investments and we really think about what we’re trying to do. We’re trying to make sure that we do the second part of that which is, there are some larger transactions out there that we can’t handle today. So, now with both companies investing, we should be able to do larger transactions. So, rather than stopping at a certain size, we’ll now be able to stop at the size of the two companies combined rather than just one of the two companies. But I think you get this in to A, a new category, roll ups and increased investments in different companies that we’re in and the second part of it gets us into larger businesses on Day 1 that both companies can handle in. And that’s the way we’re looking at it. Again, you have to remember that Gladstone Capital is more of a lender, Gladstone Investments more of a buyout company. And so we have to make sure that it fits both of those categories reasonably well. Nothing ever fits any other categories perfectly, but its fits both of them reasonably well before we would put it into even one of the companies and certainly both.

[Daniel Furtado:]

Excellent, thank you for the insight.

[David Gladstone:]

Okay, somebody just nudged me and said that I said I was out for 30 days. I was not out sick or any of those kind of problems. I was doing a road show for Gladstone Land which we closed last night. Next question.

[Operator:]

The next question comes from [ph]Nigish Lan of Weidenberg.

[[ph]Nigish Lan:]

Good morning gentlemen and thank you for your time today. Just a couple of quick questions, I wanted to get a sense of how the uncertainty regarding tax rates at the end of last year, either helped or hindered deal flow in the fourth calendar quarter. And also what the state is of your spillover on distributed taxable income.

[David Dullum:]

This is Dave Dullum. I’ll take a stab at the first part and then let David Watson address the second. Deal as you probably know, there are certainly people talking hard about easily have to get a deal done by the end of the year. You know, we looked at a few of those deals and some of those that we’re still anxious to get it done, did not get done for variety of reasons and those still are deals this year. So, you know all has been equal I’d say to be honest. I don’t think we felt like there was a significant impact on the potential of tax increase. And once people started realizing where things were headed, I think everyone just sort of settled in and just, you know the deal makes sense or doesn’t make sense. So, that would be how I’m seeing it anyway.

[[ph]Nigish Lan:]

David Watson, on the spillover dividend?

[David Watson:]

Yes, last couple of years we’ve had a spillover dividend and the balance going into fiscal year March 31, 2013 was approximately $700,000.

[[ph]Nigish Lan:]

And has that changed dramatically during the current fiscal year?

[David Watson:]

During the current fiscal year are from a net investment income standpoint, we have covered our distributions, obviously net investment income isn’t always identical to our tax ordinary income, so those adjustments tend to occur at the end of the year. But my expectation is that we will have covered all of our distributions from both the tax, and from the net investment income standpoint, going into the fiscal year, but again we can’t project that at this point in time.

[[ph]Nigish Lan:]

Fair enough and just last one, wanted to confirm what I think I heard, but I wasn’t quite clear, did you say that post third quarter originations were $1.1 million and repayments were $400,000?

[David Watson:]

Yes. Approximately correct.

[[ph]Nigish Lan:]

Okay, so that is year-to-date in the – while actually it is a quarter-to-date in the fourth fiscal quarter.

[David Watson:]

That is correct.

[[ph]Nigish Lan:]

Okay, thank you for your time.

[Operator:]

The next question comes from Ross Demmerle, Hilliard Lyons, please go ahead.

[Ross Demmerle:]

Good morning. As we look at the total interest income that was recorded for the current quarter, trying to get a sense of that is a clean number and what I mean by that is if you’ve got one company going on non-accrual and one coming off and I am wondering if there was a large amount may have been caught up and then or amount that was reversed out because that one company went on non-accrual.

[David Watson:]

Hey Ross, this is David Watson. The number is a clean number, it doesn’t reflect any interest income recorded from our two non-accruals Tread and ASH. It does reflect interest income from the investment CTE that went on accrual. Obviously, it will adjust going into the following quarter based up of the timing of payoffs of certain investments throughout the third quarter or the timing of when new investments were made during the third quarter, but it is a clean number.

[Ross Demmerle:]

Okay, thanks.

[Operator:]

(Operator Instructions) And the next question will come from J.T. Rogers, Virginia Capital Markets, please go ahead.

[J.T. Rogers:]

Good morning everybody. I have my first question on Tread, sort of what is going on there and what your next steps are to moving that to back to accrual status or maybe exiting the investment.

[David Dullum:]

It is up in the air right now, we are in study and it is a little early to try to project which way those are going, got a lot of things to consider before we make a judgment on that. So, let me just leave that one open, I am sorry to leave you hanging.

[J.T. Rogers:]

Sure, I understand it, it is relatively recent. Is there anything in particular that changed over the last quarter obviously that it was marked down to zero from fairly close to (inaudible) in the prior quarter? Maybe not what you always plan is, but what happened with that investment?

[David Dullum:]

Yeah, the underlying discovery of what is going there is still going on. We think there were some things that shouldn’t have gone on obviously and we are investigating those in detail, but really not something we can put out into the public right now. We just want to make sure we get it all right first.

[J.T. Rogers:]

Okay. Very understandable. Begins on the positive side for the dividend from Acme Cryogenics, were there any other dividends during the quarter that were maybe driven by tax considerations and discontinue the current levels of other income, barring success fees as stable going forward or maybe dropping off in the future?

[David Dullum:]

Yes, the only dividend during the third quarter was from Acme that you just referenced and our other income is difficult to project. If you look back in history, we had $10.3 million in other income in 2011, we had $1.7 million in 2012 and year-to-date we have about $1.6 million in 2013. So, we do generate other income on a very regular basis, but it is also very lumpy and difficult to project.

[J.T. Rogers:]

That is understandable and then I have just looking at B-Dry and Noble Logistics you guys said it would depreciate during the quarter, anything there was that performance related or multiple related?

[David Dullum:]

It is really a combination of both, but somewhat performance related B-Dry as you know is a business that somewhat function of the weather, has been a little unfortunately drier than we would like it to be, but it is basically nothing dramatic with either one of those we continue to work hard on those businesses. So, nothing really to report that would surprise anybody.

[J.T. Rogers:]

Alright great, well I guess this is the last question this time. This Frontier Packaging is generally was more interested in and so what you guys saw on that -- in that company and what the investment thesis there?

[David Dullum:]

Sure, it is a really interest business, it is based in Seattle and they mainly as I mentioned earlier provide what I consider provisioning and logistics expertise to fisheries mainly in Alaska, they are moving into other parts of the world and they’ve been around for quite a while 20 odd years, been doing it very successfully, a very strong management team. We actually bought the business with the management team and they’ve become significant shareholders themselves and so what we looked at there is that when you have a fishery that is in a very odd spot saying Alaska very hard to get to what these guys are able to do is working with the packaging companies, help, develop, create, to some extent the packaging, not that unique necessarily, but there is some specialty to it, getting it all together, getting it properly delivered at the right time because there is time sensitivity when we have a fishery that you know the fishing, there they have their product you need to get it to market. So, it is really – think of it as a logistics and provisioning type business where the expertise of knowing how to do that very effectively and actually with a pretty nice margin and very good management team, which is always the key right.

[J.T. Rogers:]

Great. That is great, thanks a lot for taking my questions.

[Operator:]

And the next question comes from David West of Davenport & Company. Please go ahead.

[David West:]

Good morning. One follow up on Tread, have you made any management changes at Tread?

[David Dullum:]

Yes, we have.

[David West:]

Okay, alright. And just turning to half year note, a little more color if you could CCE is one you handle non-accrual for a good while and great to see if they go back on accrual status. Could you maybe just provide a little color as to what has been going on there?

[David Dullum:]

Yeah, I say (inaudible) Dave Dullum the period of time when we saw the downturn of course was in that ’09 timeframe where there was significant pressure on golf courses in general in the industry and as a result of that they, like everybody else, had to deal with that. We did the right things with the company. We did not change management, did not have to. We have a very strong team, we have a very strong board of directors with some real knowledge and experience in the industry and we have just did all the right things, buckled down where you would get do the non-accrual because it’s the right thing to do for the company and now we are again back to the right trend and business is doing well. They are continuing to grow market share again, and of course, we are seeing the golf industry excited to pick back up. So, it’s really a combination of all of those things and working with the management team just to do the right things. So, we are happy about that one.

[David West:]

Did the accrual, putting it back on accrual status, was that for all three months of the quarter, or did it happen mid-quarter?

[David Watson:]

No, all three months.

[David West:]

All three months, okay, great. Then lastly, David, if you could maybe talk a little bit about Chip’s recent announcement and maybe talk a little bit about his new role for the Gladstone family of companies?

[David Gladstone:]

Sure. Chip was not as involved obviously in this company as he was in Gladstone Capital. He was on the investment committee and did a lot of other things, but Chip is looking at doing another transaction in the Gladstone family and we will see if that gets off the ground. But, in order to do that he needed to move out of that space he was in and into a new space. I am sure he is happy to do that, that’s what he wanted to do. So, no real conflicts or problems, it’s just that fellows reached a certain age and they want to do something different than they have done before and that was Chip’s preference and we have come up with a – I think a great concept for him, which we are not ready to announce yet, but you will hear about it, we will obviously make an announcement when the time is right.

[David West:]

Thanks so much.

[David Gladstone:]

Okay, other questions?

[Operator:]

There are no further questions at this time. So that concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gladstone for any closing remarks.

[David Gladstone:]

Alright. Thank you all again for coming to the meeting and talking to us and giving us good feedback in terms of some of the questions you have asked and we will conclude this meeting now. Thanks again.

[Operator:]

Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.