Gladstone Investment Corp (GAIN) 2010 Q1 法說會逐字稿

Greetings and welcome to the Gladstone Investment first-quarter 2010 ending June 30th conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman and CEO for Gladstone Investment. Thank you, Mr. Gladstone. You may begin.

Thank you, Jackie and thanks for that nice introduction. And hello and good morning to all of you. This is David Gladstone, the Chairman and this is our quarterly conference call for the shareholders and analysts of Gladstone Investment. Our trading symbol is G-A-I-N, GAIN. We thank you all for calling in. We are really happy to talk to shareholders. I wish we could do it more often and by the way, if you are ever in the Washington, DC area, we are here in McLean, Virginia, a suburb of Washington, so please stop by and say hello. You'll see some of the greatest people in the business doing work here.

And now I need to 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, 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, even though they are based on our current plans and we believe those plans to be reasonable.

There are many factors that may cause our actual results to be materially different from the future results that are expressed or implied by these forward-looking statements, including those factors listed under the caption Risk Factors in our periodic filings that are filed with the Securities and Exchange Commission and can be found on our website at www.GladstoneInvestment.com and also on the SEC website. The Company undertakes no obligation to publicly update or revise these forward-looking statements whether as a result of new information, future events or otherwise.

Just a reminder before we get started to everyone that we are having our annual shareholders meeting on August 5; that's Thursday. And you're all invited, of course. If you have not voted your shares, please do so today. You can go to our website at GladstoneInvestment.com and vote your shares and you can also go to a website. www.proxyvote.com and vote your shares. We need -- you will need the proxy control number when you vote on either one of those websites and you can also use that proxy control number and go call an 800 number. It is 800-690-6903 and vote your shares that way. And if you need some assistance, you can always call your broker and they can help you vote your shares.

First up, we will hear from David Dullum. Dave Dullum is the President of the Company. He will cover a lot of ground, including a view about the future. Dave, take it away, please.

Thank you, David and good morning, all. To review our business objectives briefly, GAIN, as we know, is an investor in business transactions of lower middle market businesses. We partner with management teams, private equity sponsors in these transactions to help them achieve the necessary leverage and the best financing solution. We may also find opportunities to provide capital in support of owners and management teams who wish to achieve partial liquidity through a recapitalization of their business.

Our specific products are what we call mezzanine or subordinated debt instruments with a combination of warrants, preferred stock or common stock. This approach provides the investing discipline to be focused on generating income for dividend distributions on a current basis and future capital gains, which indeed enhances the overall returns to our shareholders.

We currently are in a favorable environment for our type of financing with the availability of asset-based and bank senior term loans still being somewhat of a challenge for private equity sponsors and leveraged transactions. Therefore, these structural circumstances today as we see it tend to expand the need for the junior debt/mezzanine tranche that we actually provide.

So with that brief overview, I will turn to some of our fund activity for the quarter. For this quarter ended June 30, we invested about $1.4 million in some of our existing portfolio companies. We actually made no new investments. We previously had mentioned that one of our buyout portfolio companies was reviewing its strategic options. We are pleased to announce and report that, this quarter, we executed a successful exit from this company, which is A. Stucki.

This transaction is actually the first liquidity event from our buyout portfolio that indeed is consistent with our business plan and the investment objective of generating interest income over the life of the investment and ultimately a capital gain for the equity portion of the investment.

For instance, we invested $4.5 million in the equity in A. Stucki. This was about three years ago and we ended up selling that equity in the transaction for about $22.2 million, roughly five times our equity investment, or for an over roughly 65% annual rate of return. We also were repaid the debt portion of that investment and we had an average return on that of about 11.75%. And that is inclusive of a fee that we received at the end of the transaction. So really this was a terrific investment and certainly a goal that we will strive to repeat with the balance of our portfolio and our yield products going forward.

As a result of these activities, at the end of the June quarter, we had about $179.4 million invested in 13 buyouts of the type that I just mentioned at cost and $5.4 million invested in one syndicated and one non-syndicated loan. These are legacy loans for a total portfolio cost of about $184.8 million with total assets of approximately $291 million.

Briefly on the portfolio company update, in general, the portfolio companies are performing well in this current economic environment and we are starting to see some improvement in these companies. We continue to emphasize the portfolio management activity, which, as mentioned before, is one of our strengths and a very important part of our investment management approach of working very hard to limit losses and preserve cash flow from our portfolio of companies.

The portfolio management team continues to provide value-added services and I mentioned this before, but it is worth reiterating. These services are such as, one, strategic business planning. This is where we work with outside resources to assist these companies in continuing to review their competitive positioning and talent resources among other key business metrics. Very important in this environment.

Second, operating management support. This is where we tap experienced operating management talent either on our staff or from a pool of talent we have cultivated over the years. And indeed, have that need in certain cases to exercise these rights and it has been a very positive thing for our portfolio company.

Third, we continue to facilitate interaction between portfolio company management teams. This allows an exchange of ideas such as best practices and purchasing pricing manufacturing disciplines.

So the important point here is that it is an experienced operating resource that works with the portfolio management and the equity sponsors to improve the company's operations and growth potential. Extremely important in these challenging times and adds value to our portfolio.

Turning to the marketplace as we see it today, we are beginning to see some expansion and improvement in the quality of deals and potential transactions. Some of the key factors I believe contributing to this are the economy and financing availability. The economic conditions continue to create uncertainty certainly around earnings and cash flow of lower middle market companies; though we are seeing some stability and greater visibility most importantly in these earnings. And those companies that have been well-managed and have come through this downturn, proving their resiliency are certainly contributing to increasing sell-side supply of these deals and therefore increasing merger and acquisition activity, which, of course, is what we strive for.

Generally, we are seeing an expansion of available credit; though senior debt continues to be primarily asset-based and total leverage ratios, including the junior and mezzanine capital layers, have increased to around 3.5 to about 4.25 times earnings before interest, taxes, depreciation and amortization.

The result of all of this is, first, good companies are attracting attention on the buyout side. Two private equity firms need to continue to provide around 50% of the equity in this capital structure for these transactions. And third, as a result of that, the mezzanine and the equity coinvestment is seeing increasing demand to fill the gap between the senior lenders and the equity investors and it is this financing tranche that we provide and we are also seeing somewhat becoming a bit more competitive. So we have to be very sharp going forward in continuing to grow and build our portfolio.

In that regard, the factors that I have previously mentioned are to our advantage because, one, valuations are -- we still find somewhat reasonable. Overall leverage is attractive and the greater demand for the junior or the mezzanine debt in the equity coinvestment is right in our sweet spot.

So having successfully navigated the many challenges of the past year, we have been able to, over the past quarter, turn our attention to increased marketing and deal-generating activity. As a result, we are experiencing an increase in the flow of both the quality, which is very important and the number of new opportunities for the mezzanine loans and equity coinvestments that we strive to put in our portfolio.

We currently, as a result of this activity, we have one company under a letter of intent and a number of others where we have issued what we call indications of interest. This, therefore, is really the beginning of our review and due diligence process on our new investment activity. And just really to elaborate here briefly. Letter of intent really means where we have spent a fair amount of time with management; we have decided to provide an opportunity to make the investment and it is terms we have agreed to basically with either the sponsor or the management teams. However, that really just kicks off the activity that we need to go through on our due diligence, which is very intense as far as we are concerned.

The indication of interest that I mentioned, these are more preliminary and this is where we are really building our backlog of opportunities and hopefully, if we move forward, those become letter of intents. Now I should just mention, even if we have a letter of intent, it does not necessarily mean that that will indeed become a portfolio investment as a number of things could occur during the due diligence process.

But the main takeaway here is that we are not only in process in due diligence for the few transactions, we also are seeing this activity on our backlog building. However, we will continue to be cautious about the economy and we will be diligent in our pursuit of new investments. However, we have a very good capacity for new investments, resulting from the funding availability of our recently renewed two-year line of credit and the cash receipts, of course, from the A. Stucki transaction previously mentioned. So our increased marketing efforts and our presence actually in the marketplace we believe should be favorable to making a few new investments over the next year.

So our outlook, our goal for this fund is to maximize our monthly distributions to shareholders while achieving solid growth in the portfolio of proprietary investments in the lower middle market buyout area. So David, this concludes my part of the transaction or the presentation. I will turn it back over to you.

Thank you, Dave. We appreciate that. That was very exciting about the future of the fund. Now let's hear from our CFO, David Watson, on the fund's financial performance for this quarter just ended.

Thank you, David and good morning, everyone. Before I go through the financial statements, I would like to highlight several key points for this quarter-end. First, the A. Stucki sale was a great exit and an equity investment success, which highlights our investment strategy of achieving returns through current income from debt investments and capital gains from equity coinvestments.

Second, we believe our portfolio is performing well. This is reflected in the net increase, excluding reversals due to the realized exit and the valuations during the quarter of $1.6 million, which follows a net increase from the prior quarter of $17.8 million. It is also reflected in that all of our companies are current with interest and principal payments.

Third, at the time of this call, we have nothing borrowed on our line of credit. We have about $37 million invested in short-term securities and we have $8.6 million in cash. So we have the ability and the flexibility to deploy more capital for the right opportunities.

Fourth, as we have done for the last four quarters, we purchased $85 million in short-term US Treasury securities through a use of borrowed funds at quarter-end to satisfy our asset diversification requirements. The amount is expected to be far less in September and hopefully will not be needed by the end of the year.

Lastly, net investment income increased 72.1% over the prior-year quarter and is on target to cover 100% of our dividends to stockholders.

So now for the details and I will start with the balance sheet. At the end of the June quarter, we had $291 million in assets, consisting of $148 million in investments at fair value and $143 million in cash and other assets. Included in the cash and cash equivalents is $85 million of US Treasury securities, which I previously mentioned. Therefore, at the June quarter-end, we had $16.5 million borrowed on our line of credit, $75 million borrowed via the short-term loan and had $196 million in net assets. So we were less than one to one leveraged on our senior secured borrowings.

We had a net asset value of $8.86 per share. Currently, we have $148 million in investments at fair value, cash and short-term securities of $45.6 million and no outstanding borrowings. We believe this to be an extremely safe balance sheet for a company like ours and we believe our overall risk profile is low.

So moving over to the income statement, for the June quarter-end, total investment income was $7.2 million versus $5.2 million in the prior-year quarter while total expenses, including credits, were $3 million versus $2.7 million in the prior-year quarter leaving net investment income, which is before appreciation, depreciation, gains or losses, of $4.2 million versus $2.5 million for the quarter last year, an increase of 72.1%, primarily due to the additional success fees and dividend income resulting from the A. Stucki exit during the current quarter.

Let's turn to realized and unrealized changes in our assets. Realized gains and losses come from actual sales or disposals of investments. Unrealized appreciation and depreciation come from our requirement to mark our investments to fair value on our balance sheet with the change in fair value from one period to the next getting recognized in our income statement. Unrealized appreciation and depreciation is a non-cash event. So for the June 2010 quarter-end, there was a net realized gain of $17 million related to the before-mentioned A. Stucki sale. For the June 2009 quarter-end, we had $34.6 million in realized losses related to the sale of senior syndicated loans in connection with the termination of our prior credit facility with Deutsche Bank AG.

For the June 2010 quarter-end, we had net unrealized depreciation of $15.8 million over our entire portfolio, which included the reversal of $17.4 million in unrealized appreciation related to A. Stucki. So excluding reversals, we had $1.6 million in unrealized appreciation for the current quarter. The remaining net appreciation was primarily due to increased multiples and performance at our portfolio companies.

Our entire portfolio was fair valued at 80.2% of costs as of June 30, 2010. The cumulative unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders, but does indicate that the value is lower and there may be future realized losses that could ultimately reduce our distributions.

So now let's turn to net increase or decrease in net assets from operations. This term is a combination of net investment income, unrealized net appreciation or depreciation and realized gains and losses. So please note that we are talking about weighted average fully diluted common shares when we use per share numbers.

For the June 2010 quarter-end, this number was an increase of $5.4 million, or $0.24 per share, versus a decrease of $9.2 million, or $0.42 per share in the prior year's June quarter. The year-over-year change is primarily due to the large losses recorded in the quarter ended June 30, 2009. But while we believe our overall investment portfolio is stable, as demonstrated by two consecutive quarters of gains, and continues to meet expectations, with continued investor uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of the portfolio.

Regarding our loan ratings, the risk rating system we use set our proprietary loans, which represent over 96% of our portfolio at a weighted average of 6.0 for this quarter, which is slightly up from the prior quarter. Our risk rating system gives investors a probability of default rating for the portfolio with a scale of 0 to 10 with 0 representing a high probability of default. We see the risk of our portfolio staying relatively the same as prior quarters.

Historically, we had concentrations of variable rate loans in the syndicated markets. We have sold or exited all but one syndicated loan. Some of our buyout loans have variable rates, but we almost always have a minimum or floor in the rate charge so if interest rates decline, it will minimize the impact on our ability to make distributions. We have $139 million at cost in fixed rate loans or rates with a fixed floor all in our buyout deals. In other words, 97% of our debt investments at cost have a floor or are fixed and they are also at relatively high rates.

In addition, we purchased an interest rate cap on $45 million of the debt on our new credit facility in order to have some protection on our cost of funding if interest rates rise over the next two years. As of June 30, 2010, we do not have any loans with paid-in-kind income or original issue discount income. PIK income would result in recording non-cash income from which we would have to distribute out to our stockholders under tax rules. In essence, we would have to borrow money to make a distribution to our stockholders because we do not receive any cash from our PIK income. We avoid being in an unsustainable situation that could result from PIK income.

Currently, all of our portfolio companies are paying. However, our investment in ASH remains on non-accrual as of this quarter-end and we applied interest payments received from ASH against our cost basis in that investment. With that, we look forward to maintaining momentum in fiscal year 2011 and now, I will turn the call back over to David.

All right, thank you very much, David. That was a good summary of our financials. I hope each of the listeners will read our press releases and also 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's website.

The big news this quarter, of course, is that we recovered from the recession and that we are on our way back up. It is nice to have such a positive outlook on everything now. So we just have to get busy and redeploy the money that we have, the about $45 million in cash. We have a nice line of credit with BB&T and KeyBanc for $50 million, so perhaps $25 million or $30 million of that could be invested. So we are looking at around $75 million to get redeployed out into the marketplace before we need to do anything like borrow additional money or raise any capital.

Of course, the sale of A. Stucki was wonderful to see and I hope the listeners out there will see that this if proof of a concept of the method of operation of this fund. We have more companies just like that one in the portfolio and we are not looking to sell any of them today. Of course, we need to invest all of the capital that we have and to borrow lots from our line of credit before we talk about doing any kind of sales.

And we need to layer in also some long-term debt in this fund in order to make it match up with the long-term investments that we have and we need to increase our assets over what we have today at a very good clip over the next year. But please know that some of the portfolio companies are doing very well in our portfolio today and every month, we see more progress.

As we redeploy this cash that we have, you should see more in the way of income in the fund and you should see some long-term profits in the future. While we can't make any promises or guarantees about the future, we think this fund is in a fabulous position and a great opportunity in the future.

We, of course, continue to worry about some of the things that are going on in the world and in our economy today. We, of course, continue to worry about the oil because we believe it is going to go up as the economy gets stronger. The United States, of course, is still too dependent on foreign oil. We need to increase our use of domestic energy sources such as coal, natural gas and nuclear. We don't seem to be doing a very good job at doing that today, but hopefully it will progress over the next 10 years.

The trade deficit with China and other countries is a tremendous drain on our economy. China subsidizes their businesses and then they sell the products back to us. China has destroyed thousands of businesses in the United States and caused the loss of many thousands of jobs. It is so difficult to watch those jobs disappear to China and to other countries, but it seems to be happening still every day.

My own personal view and I think I said this last time, China is having big problems. Their economy should suffer I think over the next 18 months and the reason it will is it is based on a huge building boom that is going on over there. They continue to build office buildings and other buildings that really have no occupants. And as a result, the banks keep lending money to the developers to continue to build those buildings. So they are propping up their economy rather than letting it fall as we have in the housing area.

And now we worry about inflation, but this comes not so much by increase in pricing as it is from printing so many T-bills. We worry that the dollar will have a big depreciation over the next 18 months because the federal government is borrowing so much by printing so much of these debt instruments and selling them into the marketplace.

Also, the amount of monies being spent in the two wars that we are in in Iraq and Afghanistan continues to hurt our economy. Again, I want to say that we are 100% behind our soldiers. They are wonderful. Those are the troops who stand for us each and every day and risk their lives. They are the true heroes that we have in this world today. However, we have to remember that the war is draining our economy and we hope it ends soon and all the troops come home.

The worst thing that is going on today is the excessive spending of the federal government. The government spends trillions of dollars on wasteful projects and these so-called stimulus are just filled with projects that have little impact on job creation. And as a result, you are not seeing much in the way of the reduction of the unemployment rate.

State and local governments are starting to lay off folks now. They are shocked from their tax income that has gone down. They are not spending like they did before the recession and they are probably -- well, the numbers are about 40 states that are having severe budget problems today.

All of the money being spent, very little of it is in the area of small businesses and this is a tremendous mistake on the part of our administration. Small businesses create 80% of all the new jobs and the new spending has missed an opportunity to stimulate small business. Congress says they are going to do a lot to help small business, but they almost never do. We really need to have some kind of term limits on the Congress that is in now in order to move them along so that a new Congress can come in and look at this problem that we have. And the stimulus bill that they've passed to date has created some long-term employment, but it has only created by propping up some of the worn-out businesses that are out there rather than creating new jobs.

In many other ways, even though those are very negatives that are coming forward, in many other ways, the US economy continues to chug along. As long as a business that you are looking at or investing in is not related to housing or autos or financial institutions such as our Company, the business has avoided much of the traumas that are in those industries and the economy.

But all the industries have suffered due to some bad acts of a few and compared to the operations before the recession, most backlogs are still down and so are sales, but I am happy to report that they are now turning around. We are seeing those backlogs build and we are seeing sales build. It will take us a good deal of time to get through the difficulties caused by the recession, but it is happening now. We are starting to see some pretty good traction out in the marketplace. We are very lucky to have so many of our portfolio companies that are still doing okay and it is really a testament to the tenacity of those managers and teams that are managing those companies.

The employment rate, the unemployment rate is really much worse than we had forecast. While the government is reporting that the percentage of people out of work is going down, the government is really not counting so many that have given up and not even looking for jobs anymore and they certainly aren't counting the part-time workers or even some of the full-time workers that would like to be in different jobs or full-time jobs. The figure for unemployment in our best guest is somewhere around 15%, which is exceedingly high today and certainly the younger members of the employment workforce are looking at 20% and 25% unemployment.

There are many things that are out there that are hurting us from the recession. And I know there are many people who say the recession is over, but many aspects of the recession continue today and are likely to continue for certainly the next six months and maybe even the next year. I believe that we are on the way back up and that things will likely be better even though the recovery is going to be slow. There is many companies that are showing good results in our portfolio and certainly the ones that we look at, so we are seeing things that bode well for a very fine future. And you may see some of the folks here in the Company buying some stock in this Company, so keep your eye out for that.

Turning now to distributions, the distributions declared by the Board of Directors in July was $0.04 a month for July, August and September. This is a run rate of $0.48 a year. The Board next meets in October to consider a vote on the dividend again. Now we have to get busy, of course, here in the Company and generate the income so that we can, somewhere down the road, increase our monthly distributions.

At the distribution rate that the stock is at today and with the price as it was yesterday at $6.47, the yield is extremely high. We certainly have no plans to reduce the distribution and this means that buyers of the stock today I think are getting a fabulous return, especially as we put the money to work and hopefully increase the dividend over time.

Please go to the website, sign up for our e-mail notification service. We don't send out junk mail, just news about your Company. Please go to www.GladstoneInvestment.com and sign up so that you get the news as it breaks from the Company.

And just a reminder again to everyone that we do have our annual shareholders meeting on August 5; that is this Thursday. And you're all invited and certainly please go vote your shares if you haven't voted them already. Please go today and vote them. We are always in a bind trying to get all of the votes in. You can vote by going to www.GladstoneInvestment.com. There is a site there that you can click on and vote. And you can also go to www.proxyvote.com and vote your shares. You need your proxy control number off your proxy card in order to do that and if you want to, you can call the 800 number. It is 800-690-6903 and vote your shares and certainly your broker can help you vote your shares if you need assistance.

So in summary, as far as we can see, the rest of the calendar year 2010 looks much better than 2009. But again, we can only see a couple of quarters out and we want to be careful; we are stewards of your money. We think the worst is behind us now. We have a good base to build from. You have seen some activity in our portfolio that demonstrates the concept works even in a horrible recession like we have just went through. We are out looking for new investments now and hope to have some very good news for you as we go forward in the future. And now let's have some questions from our analysts and our many shareholders. So Jackie, would you come back on and announce how they can do that?

(Operator Instructions). Vernon Plack, BB&T Capital Markets.

Good morning and thanks very much. This question is for David Watson. David, I noticed on the balance sheet there was an item due from a custodian for $17.4 million. Could you explain that to me, please?

Certainly, Vernon. The due from custodian is due to the timing of our waterfall with the sale of A. Stucki, which was part of the collateral of our facility. We weren't able to -- that wasn't released from the custodian until I guess the 11th or the 9th of the following months. So it was released on July 9.

Okay. (multiple speakers). And this question is either for -- either of the Davids. It really relates to the pace of investing and knowing that this is a lumpy business. Just curious in terms of your best guess today, how long do you think it will take for you to put $75 million to work?

Obviously, great question. As I mentioned, we are building the backlog. As you know, the business, you are right, it is lumpy. Certainly, one would hope over the next, I would say, 12 to 18 months, you would have the ability to put that to work. The transactions we are seeing tend to range on average in sort of anywhere from $10 million to maybe $15 million to $18 million per transaction. So can't be real specific on it, but I think we will see a few deals certainly in the next couple of quarters. And we are working very hard to put that to work.

Fair enough. Thanks very much.

(Operator Instructions). J.T. Rogers, Janney Montgomery Scott.

Good morning. I just had a quick question on a comment you all made that you expected that, by year-end, there was a potential that you would not need to draw down on the short-term loan to meet the [reg] diversification requirements. Was that the end of the fiscal year or the calendar year? And if so, --

We were actually thinking more along the lines end of the calendar year. We had -- with the sale of A. Stucki, it was $50 million of investment that was considered -- by the code, it wasn't qualified. With the monetization of that, it effectively transformed that $50 million into a qualified asset because it is now in the form of cash. So that greatly improved our standing with the 50% threshold and we actually expect, going forward, that we will not have to borrow nearly as much money in the next quarter and potentially by the end of the year not have to borrow anything.

Okay, great. Just sort of backing out of it, assuming all of the affiliate investments meet that requirement, it seems that -- long story short, it seems that you could reach to not need to draw down on that short-term loan that we are talking about potentially putting $75 million to work by the end of this year.

J.T., this is David Gladstone. It is hard to know every time you look at the track record of putting money to work when it is going to go to work and then what (inaudible). There may be somewhere along the way that we choose a deal that might be nonqualifying for the code. So it is going to depend on all the deals. Now we are not out looking for nonqualifying deals obviously today, but they sometimes come along.

It is conceivable that in September we may not need to borrow more than a very small amount in order to make the test, if at all. But it is just up in the air as to how we put the money to work and when it goes to work. It is conceivable if we found three or four good deals -- I mean you really only need five deals at $15 million to put $75 million to work. So for us, five deals could conceivably happen over the next six months at a reasonable pace.

Okay, great. Sounds like things are going well. Thanks a lot.

[Leroy Carter], private investor.

Good morning, David, David.

David, David and Dave.

It's hard remembering your first names.

The problem is how you sort it out when you say David down here.

What kind of leverage will it take to get the dividend back to where it was when you started at $0.08?

Yes, as you know, because of the Deutsche Bank fiasco, we lost about $35 million. So we made up a good chunk of that with this deal and as we put the money to work, I think you're going to see the dividend rise. Now getting it back to where it was, which is $0.08 versus $0.04, is going to be a little bit of a stretch. And it depends on a number of things. Here is one of the dependents. We need to raise long-term debt somewhere along the way to match up with our long-term investments. And we don't want to go out and do what we did before trying to hope that we can put together a big portfolio and then securitize it. That is what got us in trouble because the bank didn't stand behind what they told us before.

So as a result, we don't want a big line of credit that is a revolving line of credit because that is the way you get in trouble in case one of the banks is in trouble, they can't extend the loan. So somewhere along the way, you're going to have to see us get a long-term debt position. And the only way we are going to go out and get a long-term debt position is if we have gone into our line of credit for $25 million, or $30 million or $40 million and then we raise long-term debt to pay off that short-term debt. That is the goal.

We are talking to some insurance companies now and beginning to work with them. They are becoming more active. As you probably know, many of the insurance companies had waded into the financial sector before the recession. They got burned very badly. So as a result, even though they are putting out hundreds of millions of dollars, they are not putting it out into the financial world. They are just now beginning to look at the financial world and we have talked to several insurance companies -- in fact, they have been here and talked to us -- that are interested in getting back into the marketplace and lending to BDCs and other finance companies. I expect that to happen over the next six months as someone will start to get long-term debt in the BDC marketplace because I think the insurance companies see that no one has ever gotten hurt lending to a business development company.

And so that is our goal right now is just to go out and put good deals on the books that will withstand any kind of recession that is coming up should we have a double dip or should anything happen. I really don't expect a double-dip now, but we just want to put solid deals on the books.

A second question, the Company is about five years old, which means the 13 loans you have got on there, based on a five to seven-year maturity, probably are down to about $3 million, $3.5 million. What happens if they get paid off or what will happen with that?

Well, we get paid off -- we get paid down. One of our companies that is doing extremely well paid a big chunk of money in the other day. So we are getting paid down and we are redeploying that money. You will see it go back out. Those companies that pay off all their debt, what we normally do -- let's say one of our good companies has paid down most of its debt, we would suggest to them and work with them on doing a dividend recapitalization. That is they would go to a bank or they might even come to some other lending institution and borrow money, pay out a dividend to us and to the management team that is running the Company and then they would be amortizing that debt off over some period of time.

We did that with A. Stucki. We actually took about $900 -- was it $900, 000? Almost $1 million in a dividend recap before we talked about even selling the company. So as these companies mature, they become available to pay out a nice chunk of dividends.

Last is when I see IBM borrowing money at 3.5%, it would be nice if, at this moment in time, we could line up $100 million in reasonable interest debt. Is that possible?

I think we won't get the same rate that IBM gets. We certainly don't have the rating that they do. But if we can get money at 5.5%, 6% and lend it out at 12%, that would be a very good spread for us.

Yes, super. Anyhow, we are looking forward to more good news, okay?

It will happen. Thank you very much, Lee. Next question please.

David West, Davenport & Co.

Good morning. Certainly encouraging to hear some of the commentary about the new pipeline activity. I was just curious on your comments. You have always taken a very conservative stance toward PIK income. What type of competitive disadvantage does that put you at right now when you are trying to originate new loans?

I think I'll answer it and then Dave Dullum will answer. I think when you look at PIK income, it cuts two ways for companies and we do success fees from time to time, which are the same thing as PIK except we don't accrue them.

What I think you should look at some time is some of the business development companies and other finance companies will say that their portfolio is averaging, let's use a round number, 12%. What they don't tell you is 2% of that is PIK income and it is not cash and they may not collect it somewhere down the road. We, on the other hand, are saying that our current yield on our portfolio is -- what is it today?

10.3%.

10.3%. That is actually cash. That is cash coming in the front door. That is not accrual. So as a result, you have to weigh that difference. What you don't hear is what is going on in our portfolio in terms of success fees that may be building up or other kind of income that may be coming in such as these dividend recaps that we look at and don't report until we get them in.

So from our perspective, I think it is not a disadvantage except that, of course, when there is a success fee, the small business concern cannot deduct that interest that it is building up the way it does -- in a success the way it does with PIK income. So there is a little bit of disadvantage there. Dave Dullum, why don't you speak to that? You are out on the street every day.

David, I add just to that briefly. One other advantage frankly is our success fee, as David mentioned, from the Company's perspective, meaning the portfolio company, is a simple interest, so it is not compounding, which PIK also. So if you were to compare say, just pick a number, a 3% PIK versus a 3% success fee the way we do it, it's actually less expensive for the portfolio company. So over time, that is actually an advantage.

I would say another advantage, we are frankly finding our competitive edge we are finding because, as we pointed out, one of our goals is to make equity coinvestments alongside the junior debt pieces that we do. We are finding that where we are going out and able to write that equity check, that that has some advantage in the marketplace relative to say someone who is doing warrants because it doesn't have quite the same benefit to the underlying portfolio company.

So I would say today we are pretty well-positioned competitively. The key thing frankly is overall yield right now, and it is competitive out there, we are finding some fairly aggressive lenders, but I think we are clearly holding our own. And for those companies that we want to invest in, the ones where we actually bring value to the underlying portfolio company again through our equity coinvestment, working with the smaller sponsors, we are very competitive there.

Other questions, Dave?

That's it. Thank you.

J.T. Rogers, Janney Montgomery Scott.

Hi, David. Yes, I just had a couple of follow-up questions. Could you all talk about the rates that you are seeing out there? What are the equity coinvestment levels that you all are potentially targeting making and then what kind of warrants you may see with new investment?

The way we think about it, we would like to maintain a ratio, let's say for every dollar we invested, if roughly anywhere from 15% to 20% of that was in the equity component, which clearly could be preferred stock and it might have a preferred dividend, but we don't take that into current income or common stock say. So if we keep that rough blend and roughly we are finding we can get anywhere from say 12% to, in some cases, 13.5%, 14% on the debt portion, we are sort of targeting a combined effective yield somewhere in the range of around 12%. And we find we can be competitive there indeed because of the equity coinvest feature. And then in a lot of cases, we may not have a warrant, especially if we are doing the equity coinvesting. We also have the, as previously mentioned, the success fee.

So typically for us today, and we are finding it is pretty much the market, we are able to be in the high teens, 18%, 19% on the type deals that we choose to do in those companies that are in the say $4 million plus EBITDA range, $4 million to say $15 million, which is where we target our effort.

Great. Thank you. That helped. And then I think you said also that you are targeting recession-resistant companies. Can you talk about what industries you are targeting specifically and how that matches up with the private equity sponsors you are looking for?

We are pretty widespread in what we like. It is easier to describe what we don't like. Over the years, as you know, we have stayed away from the housing industry altogether, never been involved in mortgage companies or mortgage servicing companies. We have stayed away from the auto business. We still believe that the auto business is grossly over capacity in terms of the amount of capacity that is in the business and more people are going to have to fail than have failed today. And so we have stayed away from the auto side.

Now we like the auto aftermarket if you are selling to retail. That is a different marketplace altogether because that is existing cars not new cars. And then finally, also, we have always stayed away from the finance area, banking, any of the lending institutions, as well as the leasing companies. We have stayed away from that. It is just a difficult area for a lot of folks over the years.

And then finally, we don't do earlier stage transactions in any industry and we are certainly not technology gurus, so we have avoided the technology area. So pretty much everything else, we like healthcare, we like any of the manufacturing sectors as long as they are not related to the industries we just talked about. Manufacturing is a good area. We like almost all of the service areas. Servicing companies are good and I think that gives you a general overview.

I think if you look in what we have done in the past, if you went into the Q and looked at the industries that we are in, you would see a pretty wide list of things from trending in publishing to telecommunications, machinery and equipment manufacturers. It is a wide list. We have a lot of experience inside the firm here in doing transactions in multiple industries.

Okay, great. And then I guess lastly, any other more candidates in your portfolio -- any other candidates for a dividend recap in the portfolio now?

Absolutely yes, but we are not ready to announce anything.

Okay, thank you.

Other questions?

(Operator Instructions). Thank you, Mr. Gladstone. There are no further questions.

All right. Thank you all for tuning in. We appreciate all the support that you have given us and we will do some good work for you this quarter. That's the end of this conference call.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.