Gladstone Investment Corp (GAIN) 2014 Q1 法說會逐字稿

Presentation

Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation's first quarter ended 6-30-2014 Earnings Call and Webcast. (Operator instructions.) As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. David Gladstone. Sir, you may begin.

All right. Thank you, Vincent, for that introduction, and good morning to you all. This is David Gladstone, Chairman, and this is the quarterly earnings conference call for shareholders and analysts of Gladstone Investment, the common stock NASDAQ-traded symbol GAIN, and thank you all for calling in. We're always happy to talk to loyal shareholders and potential shareholders. I'd like to give an update on our Company and our portfolio and our business environment. I wish we could do this much more often so you'd be more informed, but we only do it once a quarter.

By the way, this is an open invitation to visit our offices in McLean, Virginia, just outside Washington, DC. Please stop by and say hello. You'll see some team members here. There's about 60 people now in the Company, and I think they're some of the finest people in the business.

Now, we'll hear from our General Counsel and Secretary, who's also President of our administrator, Michael LiCalsi. He'll make a statement regarding forward-looking statements and give you some other information.

Good morning, everyone. 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. And these forward-looking statements inherently involved certain risks and uncertainties and other factors even though they are based on our current plans, which we believe to be reasonable. And many of these forward-looking statements can be identified by the use of 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 these forward-looking statements, including those factors listed under the caption "Risk Factors" in our 10-K filings and our registration statement as filed with the SEC, all of which can be found on our website at www.gladstoneinvestment.com, or the SEC's website, www.sec.gov. The Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, after the date of this conference call except as required by law. And please also note that past performance or market information is not a guarantee of future results.

Please take this opportunity to visit our website, www.gladstoneinvestment,com, signup for our email notification service. We don't send out junk mail, just timely news on your company. You can also find us on Facebook, keyword The Gladstone Companies, and you can follow us on Twitter at gladstonecomps. The presentation today will be an overview, so we ask that you read our press release issued yesterday and also to review our form 10-Q for the June 2014 quarter-end filed this morning with the SEC. You can access the press release and 10-Q on our website as well, www.gladstoneinvestment.com.

We also invite you all to come to the annual meeting of shareholders, which is scheduled for August 7 at 11 a.m. Eastern Time at the Hilton McLean, Tyson's Corner, and that's located at 7920 Jones Branch Drive in McLean, Virginia. If you're not coming, we ask you to please vote your shares using your proxy card so that we can get all the votes in and ensure a quorum at the meeting. You can vote your shares by mailing in your proxy card, or you can vote by calling 1-800-690-6903. And if you call, you're going to need your proxy card so that you can vote. And another way to vote is with your proxy control number. Go to www.proxyvote.com and vote online. You can also vote by calling your broker, who can help you vote your shares, as well.

And your brokerage firm is not permitted to vote your shares for you on non-routine matters. All matters up for vote at this meeting are non-routine matters, thus, your brokerage firm may not vote your shares for you. You'll need to vote them yourself. As a result, we need you to vote your shares, and the cost to your fund to round up votes by calling and asking shareholders to vote to ensure a quorum is now a major expense for the fund, and that takes away dollars that could be paid in dividends to shareholders. More government regulations for us to comply with make our Company less profitable, and for us and all public companies.

And now, the Fund's President, David Dullum, will give you his report.

Thanks, Michael, and good morning, all. I'll just briefly review what it is we do, as this always helps to keep the long-term goals in mind while we update the near-term results. So, Gladstone Investment provides capital for the buyer of businesses. These are usually companies with annual sales between $20 million to $100 million. We provide what we call the subordinated debt in combination with the equity and senior debt, if available. So, this combination produces a mix of assets for Gladstone Investment which is the basis of our strategy. This means the debt portion of our investments provide income to pay and grow monthly dividends, and then we look to the equity portion to increase in value and provide the capital gains from time to time.

So, you might ask how are we different from other BDCs and perhaps other finance companies. Well, we take large equity positions in the companies that we finance, and this differs from other public BDCs that are predominantly the debt-focused firms. So, for instance, the proportion of equity and debt for the investments in our portfolio is at approximately a 30-70 mix. Most other BDCs you'll find are closer to around 10 to 90, in other words 10% equity, 90% debt.

Also, we generally do not buy syndicated loans, or portion of loans where there is no equity participation, and we certainly are different from most banks and finance companies that are generally just lenders. And as far as other private equity funds, which are generally private partnerships, we are different in that, as a publicly traded entity, our structure allows liquidity for shareholders. So, keep in mind that we look to the equity portion of our assets as a contributor to the overall value of our Company even though quarterly valuations of the equity portions of our portfolio can be volatile.

So, for example, we've talked briefly about this in prior calls, but it's important to refresh our memories that, last August, we sold Venue Solutions, Inc., a company that we'd purchased with the management team in the late 2010 timeframe. The equity portion of this investment generated cash proceeds of about $32 million, resulting in a realized capital gain of approximately $25 million and dividend income of about $1.4 million. So, in addition, we received full repayment of our debt investment of $19 million and an additional $1.9 million in success fee income. Therefore, our original $6 million equity investment generated approximately a 5.5 times return, which included the dividends we'd received.

So, the point of this is that that sale of Venue is the fourth exit from our management-supported [borrowed] investments since June of 2010. During this period, these four liquidity events generated approximately $54.5 million in realized gains. And in managing the Company, we're always assessing the merits of achieving liquidity in our equity positions, and we will continue to exit an investment when appropriate.

So, the point, again, of all this is that, with this continued growth in both operating income and these realized gains, our Board was able to declare a dividend of $0.06 per share per month for July-August September, the quarter that we're in, which is a run rate of about $0.72 per share per annum.

Now, how do we go about finding these deals? Well, we're very proactive in our deal generation activity, and we have offices in New York, Los Angeles, Chicago, and here at our headquarters, which is outside of Washington, DC. So, we have a broad and very deep geographic footprint, and we, in fact, invest across the country. So, we primarily call on independent sponsors, middle market investment bankers, and other sources, which helps create somewhat of a proprietary investment opportunity deal flow.

Now, we do not depend on others to negotiate or structure our investments, and generally our investments do include partnering with the management teams and other sponsors in the purchase of a business. So, our strategy, which provides financing package, which includes both the debt and the majority of the equity, as I mentioned, is a competitive advantage, as it gives both the seller and any independent sponsor if they're involved, and certainly the management team, a high degree of comfort that the purchase will happen at least from a financing perspective. So, in addition to outright purchases, we also will occasionally find opportunities to partner with a business owner who will sell a portion of the Company to us and use that capital to grow the business.

Now, what's our sort of focus of investment? Well, we generally invest in companies that have at least about $3 million of consistent EBITDA and a potential to expand this cash flow. Some of the industries that are of interest to us today are light and specialty manufacturing companies, specialty consumer products and services, industrial products and services, and certainly anything in the aerospace and energy sector. So, our goal is to find opportunities that fit our investment parameters with a cash-on-cash equity return of around two times and yields on our debt investments in the mid to high teens.

Now, in today's market, most of the opportunities we see make it very challenging to meet these expectations. So, we tend, frankly, to avoid the much higher valuations even though occasionally we will pursue one of these if there is some unique characteristic to that business or perhaps something around the management team that makes it pretty compelling. For the quarter ended June 30, we had no new deals that we closed, but we do continue to work hard in sourcing, and we have been building a pipeline of new investment activity that indeed meets our investment parameters, as mentioned previously.

So, we're encouraged by our marketing efforts. We are growing our presence in the marketplace. And this provides that foundation to continue our growth trend despite the temporary pause during this first quarter.

So, in summary, our goal for this fund is to maximize distributions to shareholders with solid growth in both the equity and the income portion of our assets. And now, this concludes my part of the presentation, and let's turn it over to our CFO and Treasurer, David Watson, and give you some more detail on the financial performance of this quarter. David?

Thank you, and good morning, everyone. As one would expect, with a quiet quarter on the production front during the three months ended June 30, 2014, numbers and ratios remain pretty even at a good level, and we remain poised to grow still.

There are a few things I want to highlight before getting into the details, and the first one is we were able to extend the maturity date of our $105 million line of credit approximately 14 months through June 2017, or three years out. If it is not renewed or extended by the maturity date, all principal and interest will be due and payable on or before June 2019, or five years out. In addition, there are two one-year extension options to be agreed upon by all parties, which, if exercised, could, in effect, push the facility out seven years. We were also able to reduce the interest rate from LIBOR plus 3.75% to LIBOR plus 3.25%.

Other highlights include $5.5 million of appreciation on our investments, not having to purchase T-bills in order to comply with RIC size requirements for the second straight quarter, and earning our dividend as net investment income, or NII, of $0.18 per share equaled our distributions for the quarter.

So, regarding our balance sheet position, at the end of the June quarter, we had $338 million in assets consisting of $322 million in investments at fair value with a cost basis of $385 million. At our cost basis, 73% of our portfolio assets consist of debt investments of approximately $280 million and 27%, or $105 million, consisted of equity securities, which we hope will produce capital gains.

As for our liabilities and equities at June 30, 2014, we had $63 million in borrowings outstanding on our renewed three-year $105 million credit facility, $40 million in term preferred stock, $9 million in other liabilities, and $227 million in common stock. Our net asset value per share was $8.57, which is up $0.23 from March 13, 2014.

Moving over to the income statement, for the June quarter-end, total investment income was $9.8 million versus $8.8 million in the prior quarter. Total expenses, including credits, were $5 million versus 4.2 million in the prior quarter, leaving net investment income, which is before appreciation-depreciation gains or losses, of $4.9 million versus $4.6 million for the prior quarter, an increase of 4.6%.

Regarding our revenue, the increase in our investment income was due to an increase of $0.4 million in interest income, which is from holding a larger portfolio on a weighted average basis over the entire quarter, and an increase of $0.6 million over the prior quarter to a total of $1.4 million in other income, which primarily resulted from $1.3 million in dividend income from [Mathey] Investments, Inc. Over the last two quarters, other income has accounted for 14.6% and 9.4% respectively of our total investment income.

Our net expenses increased quarter-over-quarter primarily due to a $0.3 million decrease in fee credits resulting from higher amounts in the prior quarter from new deals and a $0.2 million increase in other expenses, which is primarily a reflection of the prior quarter being below our historical average and small increases in the remaining expense line items resulting from a larger weighted average portfolio quarter-over-quarter. In total, our net investment income, which was $0.18 per common share, remained flat on a rounded basis when compared to the prior quarter.

Our debt investments drive our current income, and we believe they have favorable attributes in the market today and are well positioned for the future. 83% of our loans have variable rates, but they all have a minimum or floor in the rate charged. The remaining 17% are fixed. The weighted average yield on our interest-bearing debt investments remained flat quarter-over-quarter at 12.6%. While we believe 12.6% is a great yield, we also often have success fees as a component of our debt investment, which are excluded from our reported yields. As a reminder, success fees are contractually due upon a sale of a portfolio company although the portfolio company can pay it earlier.

So, for comparison purposes, if we had accrued these success fees as we would pick, our weighted average yield on interest-bearing assets would approximate 15.6% during the June quarter. From a credit priority standpoint, 70% of our loans are senior and priority, with the remaining 30% being senior subordinated in the capital structure of the respective portfolio companies. So, overall, we believe we are well-positioned for the future and with the income we are able to generate, which [is reflective] of the fact that we were able to increase our dividend rate on our common stock by 20% during the prior fiscal year.

Let's turn to realized-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 recognized in our income statement. Again, unrealized appreciation and depreciation is a non-cash event.

So, we did not record any realized gains or losses in the three months ended June 30, 2014. During the prior quarter, we realized a capital loss of $3.4 million in the restructuring of one of our companies. As for our unrealized activity during the quarter, we had net unrealized appreciation of $5.5 million, which was due to increased debt and equity valuations in several of our portfolio companies, primarily due to increases in certain comparable multiples used to estimate the fair value of our investments, and to a lesser extent an increase in the performance in some of our portfolio companies. During the prior quarter, the net unrealized appreciation over our entire portfolio was approximately $0.2 million.

So, given our long-term view related to our investments, we have been pleased with the realized values for which we have exited our investments over the years and are generally less concerned about the inherent quarter-to-quarter fluctuations in our valuations. So, for the June quarter-end, our entire remaining portfolio was fair valued at 83.5% of cost, which is up from 82% of costs last quarter.

So, let's turn to our net increase in net assets from operations. This term is a combination of net investment income, unrealized net appreciation or depreciation in our realized gains and losses.

So, for the June 2014 quarter-end, this number was an increase of $10.8 million, or $0.41 per share versus an increase of $0.9 million, or $0.04 per share in the March quarter. The quarter-over-quarter change is primarily due to the aforementioned unrealized amounts over the two quarters.

All of our portfolio companies are current in payment except for one, which continues to remain on non-accrual, which represents 0% of the fair value and 4.5% of the cost basis of our total debt investments as of June 30, 2014. And now, I'll turn the program back over to Mr. Gladstone.

All right, thank you, David, and Michael and Dave. All three of you gave good reports.

This first quarter was mixed for us. We were able to report some accomplishments, such as the earnings of our dividends. We -- always proud to do that, renewal of our line of credit, which reduced the interest rate and pushed out the terms substantially and put us in a better position if there is a recession, and recorded appreciation on our investment portfolio. However, as mentioned, we're disappointed in not making any new investments during the quarter, but I believe that should change as we move forward. We had our Monday morning meeting the other day, and quite a number of deals in that list.

Switching back over, although the recent economic indicators have been more positive, the economic recovery still continues to be sluggish. We continue to monitor the economic outlook, which affects all of our investments and the investment climate which we operate. We feel we have some still tremendous concerns out there, a lot of uncertainty around the Federal Reserve's monetary policies and the impact on future interest rates, the fiscal crisis that the federal government is still not on top of, they're about $17 trillion in deficit and will continue to climb as the government continues to spend, and we all know that that spending rate is unsustainable.

Many of the private companies, like those we invest in, feel there's much too much regulation coming out of Washington. Some of the areas like healthcare, financial services, the energy area, emissions, the environment, taxes, these seem to be hindering the performance and expansion of job growth of many of the small businesses in our country. This Company, though, is in a strong position to move forward with strength in the balance sheet in the form of large equity interest and a list of good companies. We have excess earnings that we roll forward. I think [we] can use that to pay some dividends in the future if we need it. We have equity interest in a number of companies that could be sold in the future, and hopefully will be sold in the future to bring in some capital gains. So, we're in a very strong position today.

Despite all the past, current economic issues, our fund has continued to make consistent monthly dividends. We have a history of earning our monthly distributions to our shareholders. In July 2014, our Board of Directors did declare a monthly distribution [on] our common stockholders at $0.06 per common share for each of the months of July, August and September. That's a $0.72 per annum rate. The Board will meet again in October to consider the vote on the monthly distributions for the next three months, and we'll see what that is.

Through the date of this call, we've made about 110 sequential monthly cash distributions to our common shareholders and some bonus dividends and extra dividends. At the current distribution rate on the common stock, with the common stock trading at about $7.43 yesterday, the yield distribution's about 9.7%, which is far too high. We hope that comes down and the stock price goes up.

Considering the average yields during the last three calendar years of approximately 8%, we're trading way above that, and I think it should drift down over time. Our monthly distribution of 7.125% for our preferred stock, which translates into about 14.84%, or $1.78 annually, the preferred stock had a closing market price yesterday of $26.60 on NASDAQ. The trading symbol there is GAIN, and P for preferred. That's about a 6.7% yield, which is quite nice as a monthly dividend paying preferred stock.

I think our management team has a successful track record of investing in middle market businesses and has worked together through multiple economic downturns. We certainly believe that Gladstone Investment is an attractive investment for investors seeking continuous monthly distributions with a potential of some special dividends from our capital gains. We continue to be disciplined in our investment approach while focused on making conservative investments in American businesses.

And before we have some questions, please come to our stockholder's meeting on August 7 at 11 a.m. We're at the McLean Hilton here in McLean, Virginia. And if you can't come, please vote your stock. You can go to proxyvote.com, www.proxyvote.com, and vote, and you can call your broker, and the broker can help you vote. And if you want to, just call the 800 number. It's 800-690-6903 to vote your shares, but we need you to get the votes in so we can conduct our meeting.

Now, if Vincent will come on, we'll have some questions from our analysts and many of the loyal shareholders out there. Vincent?

Yes, sir. (Operator instructions.) Mickey Schleien, Ladenburg.

My first question relates to the overall market, probably directed at Dave Dullum. Dave, given what?s going on in the equity markets and valuations in general, it would seem like a good time to sell. Do you have expectations to sell any of your positions this fiscal year?

Mickey, as I mentioned on my part of it, we always assess obviously and look at our portfolio. I think because we have may have chatted with you before, we?re not, frankly, aggressive sellers in part because the structure of our deals give us an opportunity to continue generating good income, and we also typically are investing with management teams and sponsors. We always say, look, you guys are the ones that going to dictate to us generally when the right time of sell is.

So, sure, we could look at it, and will continue to look at it, with multiples where they are. Of course, the side of that coin is, if we have a good company doing well, good management team, you sell it, we might take a gain, no question, and then obviously we?ve taken an asset out of the portfolio.

So, we really are careful sellers and, again, always looking, if it makes sense both for -- both the valuation as it was certainly with a few that we sold in the past, and also if the management team believes it?s the right time to do it.

And Mickey, just to tag on to that, sometimes it?s better for us to do a dividend recap, that is, if they pay down the debt, we can lend them money, we can pay everybody a dividend, or the bank can come and lend them money and do a dividend recap. A lot of that?s going on in the marketplace, as you know. So, just another way to continue to generate income for our Company as well as for the management team that may want to stay for another 10 years.

Yes, We?ve seen some significant dividend recap activity in the last quarter or so. So, is that something you -- we might see at Gladstone in this fiscal year?

Well, we certainly are looking at a number of situations. It just depends on how much you want to lever a company. And so, leverage is cutting both ways. It's nice to have it, but it also needs to be repaid one day. So, that?s our dilemma every time we look at doing that in any one of our companies.

Well, the other thing that we -- just to be -- again, touch on, and David Watson mentioned it and we keep making the point, our exit fees that we have structured in our deals, again being different as we all know from the traditional pick, we have the ability with some of our companies, and from time to time they may choose to pay down part of the exit fee. It helps from their tax planning purposes, and its cash income to us. And so, that?s another income stream, if you will, that we manage in our portfolio companies.

Okay, I wasn?t aware of it. That?s interesting. In the past you?ve mentioned that you generally consider your valuations to be somewhat conservative. Could you give us any update on changes you?ve made to your valuation methodology, or thinking about?

I?ll take that first, Mickey. We have one way of doing it. As you may imagine, the SEC has its own approach to this, and we have to give out one single number. So, whether that?s more conservative or less conservative than others, I think it is conservative, but who knows? You give a valuation to you and me and David Watson and David Dullum, and I think we'd have four different valuations on something.

We go through a very lengthy process that?s very expensive. And as you know, PriceWaterhouse does its own evaluations. They?re telling us that probably 20% to 25% of our audit bill every year is due to their need to go through the valuations, as well. So, it?s a lengthy process, but I would guess that overall we have a pretty good handle on the total portfolio. There might be one here or there that?s different, but we?ve not made any major changes to our valuation techniques at this point in time.

Yes, Mickey, you might have seen that we -- in the 10-Q, that it showed up this morning on the SEC website that we have filed last night. We did revamp our disclosures around our valuation policies, and this is really an effort just to enhance the language we use and to make it a little more understandable and reader friendly. So, I encourage you to take a look at those.

As David mentioned, the underlying processes and policies have not changed and are generally in line with prevailing industry practice. Also like to note, we did hire an experienced valuation officer in September of last year, and we're very happy to have her here as an added resource on valuations and just really allows for us to put a lot more robust, from what we have historically done, effort into those.

So, we don?t really expect any changes of -- major changes in the future as related to any type of policy change, but the disclosures obviously have changed and been enhanced.

My last question is just if you could give us any update on Noble, and the lawsuits and how business is progressing there?

So, the Company is now in our portfolio called NDLI, and that business is progressing actually quite well. In fact the business from prior to the bankruptcy and the 363 asset sale, which has been already indicated, that business fundamentally is the same and growing and actually improving.

So, from an NDLI investment, going forward, we believe we've got some of the things corrected. The old Noble is dealing within -- under the bankruptcy law court protection, doing what it needs to do there with some of those lawsuits. And I don?t know, unless Mike LiCalsi, you have anything you would add to that?

Yes, you might have noticed that, in our previous 10-K, there was some disclosure regarding another lawsuit where Gladstone Investment and Gladstone Business Investment, and even Gladstone Capital were named as defendants. That lawsuit has been dismissed a few weeks back, so that is no longer a pending lawsuit.

Well, that's good news. So, there's no lawsuits related to Noble where GAIN is the defendant any longer.

That is absolutely correct.

Okay. Thanks for your time this morning.

Okay, next question, please.

At this time, I'm showing no other questions in queue, sir.

All right, we'll wait one second if somebody wants to ask a question. And otherwise, we're going to be gone for another quarter, so ask your questions.

(Operator Instructions.)

All right. Well, thank you very much, all of you, for calling in, and we'll see you next quarter. That?s the end of this conference call.