Gladstone Investment Corp (GAIN) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation second-quarter ended September 30, 2015 earnings call and webcast. At this time all participants are in a listen-only mode. (Operator Instructions). As a reminder, this call is being recorded.

I would now like to turn the call over to David Gladstone, Sir, you may begin.

Thank you, Tricia. We like those nice introductions and hello and good morning to everybody out there. This is David Gladstone, your Chairman, and this is the quarterly earnings conference call for shareholders and for analysts for Gladstone Investment, common stock traded on NASDAQ symbol GAIN. We have some preferred stock out as well GAIN-O, GAIN-P, GAIN-N so you have your choice of preferred stocks with this Company as well.

Thank you all for calling in. We love these moments that we have with loyal shareholders that like to listen to these calls and potential shareholders and we like to give you an update on the Company and its investments and we like to give you a view of the business environment from our point of view. We wish we could do this more often and try to do this sometimes with some press releases but we have never gotten around to that.

Also the invitation is open if you are visiting this area, the McLean is just outside Washington DC so please stop by and say hello. We have about 64 people now. I think we have only got about 60 here.

Now we will hear from our General Counsel, Secretary Michael LiCalsi. Michael is also our President of Gladstone Administration which serves as for all of the Gladstone funds and related companies. He will make a statement regarding forward-looking statements and some other important information.

Good morning, everyone. This conference call may include statements that constitute forward-looking statements within the meaning of the Securities Act of 1933 and Securities Exchange Act of 1934 including statements with regards to the future performance of the Company and these statements inherently involve certain risks and uncertainties and other factors. Even though they are based on our current plans which we believe to be reasonable, many of these forward-looking statements can be identified by the use of words such as anticipate, believes, expects, intends, will, should, may and similar expressions. There are many factors that may cause our actual results to be materially different from results that are expressed or implied by these forward-looking statements including those factors listed under the caption risk factors in our Form 10-Q filing or 10-Q filing and our registration statement as filed with the SEC all of which can be found on our website, www.gladstoneinvestment.com or the SEC's website, at www.SEC.gov. And 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.

Please also note that past performance or market information is not a guarantee of future results.

Please take the opportunity to visit our website, GladstoneInvestment.com and sign up for our email notification service. You can also find us on Facebook. The keyword the Gladstone companies and on twitter at Gladstone comps.

The presentation today will be an overview of results through September 30, 2015 and for more detailed information, please read our press release issued yesterday and review our 10-Q for the quarter ended September 30, 2015, which we filed with the SEC yesterday. You can access the press release and 10-Q on our website, GladstoneInvestment.com.

Now let's turn to Dave Dullum, President of Gladstone Investment, to get an update on the Fund's performance and outlook.

Mike, thanks very much for that and good morning everybody on the call. Usually I try to just give a very brief reminder, recaps what it is we do here at Gladstone Investment and of course as everyone knows, we are a publicly traded fund. We are focused on buying businesses, generally US businesses with annual sales anywhere from roughly $20 million to $100 million.

We structure our deals and these buyouts to usually consist of secured first and second lien debt and in the combination with the direct equity investment because that is where we generate and have our significant ownership position and ultimately capital gains.

So this combination of using debt and equity does produce a mix of assets which is really the basis of our investment strategy for Gladstone Investment whereby the debt portion of the investments provides the income to pay and grow our monthly distributions and at the same time we look to the equity portion of course to increase in value and provide the capital gains over time. We will be able to chat some more about that.

So we might ask our we different from other BDCs or other typical finance type companies like us and basically one very significant difference with us and other BDCs that we take significant equity positions in the companies that we invest in and this differs from other public BDCs generally that are predominantly debt focused and usually those are referred to as credit oriented BDCs. So for instance where the proportion of equity to debt for the investments in our portfolio is approximately 25 to 75 ratio, you will find that most other quote credit oriented BDCs in their portfolio, they will typically be at around 10 to 90% or a 10 to 90 ratio of equity to debt.

As to other sort of private equity funds that are typical buyout funds, usually they are 10-year type private partnerships with a long-term liquidity horizon for their investors. We differ basically in that as a publicly traded entity, our structure allows for the daily liquidity service fee for our shareholders who then are able to participate in this middle-market buyout business through our structure without being necessarily locked up for at least 10 years.

Now let's talk about exit strategies because realizing capital gains through our portfolio company exit is definitely a component of the value proposition of an investment in our fund. I do want our shareholders to know that this is an important part of our business planning and we will be selling or exiting companies from time to time. These activities generally are based on market conditions obviously and to some extent an assessment that we make of the risk return in for instance continuing to hold an investment even performing well versus perhaps exiting that investment. So we are trying to assess the benefit if you will love taking a gain versus potentially keeping and holding that investment. Of course some of that is a function again of the market.

Now in this regard, we are actually expecting to close on the sale of one of our portfolio companies within the next few days, not able to say much more about that but I will say that it will produce a sizable capital gain on equity and we will also receive back the repayment of all of our debt so we will have total cash proceeds of a pretty significant amount.

Now during the quarter ended September, we also exited the remaining investment we had in Cavert II Holding. This is where we had our remaining preferred equity investment. It was redeemed at par, roughly $3.4 million and we also received dividend income on that preferred accrued of approximately $1.5 million.

Additionally, we sold the assets of NDLI which was one of our investments, we sold it to a company called Diligent Delivery Systems. The total proceeds on that one was roughly just under $15 million which consisted of about $2 million in cash and a secured second lien note of about $13 million with warrants to purchase common stock. So by selling these assets of NDLI to a somewhat similar business well-managed business, we have continued with an investment however we have been able to exit that investment today.

So therefore, since June of 2010, which are including these actual exits and of course not the aforementioned expected sale, we will have exited six of our management supported buyout investments generated roughly $52 million in net realized capital gains and a roughly $14.6 million in other income associated with those transactions.

We also I should tell you are currently in the process of a few other possible sales which could occur over the next several months and obviously we will have to chat more about that as we move further into our calendar year of 2016. I just always like to caution that the buyout market is obviously still somewhat I would say seller friendly so we have to keep in mind that whenever we do sell a portfolio company for the right reasons and good reasons, it will and potentially could reduce our income producing asset base and then we are going to have to be obviously working very hard and will be challenged to incrementally replace that investment we generate current income as well.

So let's turn to deal generation because that impacts how we do that. We have a very high priority of our deal generation activities and that has resulted obviously in our continuing growth in new buyouts and income producing assets. We do this with a very broad and deep geographic footprint which we have offices in New York City, Los Angeles, Chicago and of course, here in McLean which as David Gladstone mentioned just outside Washington DC.

Now to generate these new investment opportunities we have to primarily call on what we refer to as independent sponsors, other middle-market investment bankers, folks that will find deals that we will be interested in acquiring and other sources that might create and help create proprietary investment opportunities.

We do not depend on others to negotiate or structure our investments.

Generally though our investments of course do include partnering with the management teams of those companies and to the extent that there are other sponsors such as independent sponsors who may be working with us to purchase the business. Again, our strategy which is providing a package, a financing package, which includes both the secured debt and the majority equity investment is a very competitive advantage as it gives the seller and the sponsor independent sponsor say if one is involved. And the management team that we will be working with a very high degree of comfort that as least from a financing perspective, that purchase will occur.

In addition from time to time we might do an outright purchase where we occasionally will find an opportunity to partner with say a business owner who is not actually selling the whole business but maybe a portion of the business and then use our capital to continue growing the business.

Where do we focus? Well, we generally invest in companies as I said before with revenues $20 million to $100 million but also more as importantly with consistent operating cash flow and generally at least around $3 million annually, and ability of coarse to expand and grow that cash flow.

Areas of interest that we look at and historically have done are light, specialty manufacturing, specialty consumer products and services, industrial products and services and the aerospace and energy area.

Now I should note that historically in energy we historically have had minimum exposure here and we do look at that owl an opportunistic basis. Currently we do not really have any major exposure to the energy sector.

Our secured debt investments which are primarily first lien loans typically carry a cash yield that are in the mid-to high teens and that balances the equity portion of our investments which is a blended current cash yield which supports our shareholder distribution expectations. We generally also have a success fee on these loans which are paid in cash on a change of control or in some cases in advance at the portfolio companies option.

As to the equity portion when we model out a potential opportunity, we always target and equity portion that will have a return somewhere in the two to three times cash on cash return. We believe with what we have been doing that there is a positive origination trend as we have continued through our third-quarter fiscal 2016. We are currently in various stages of diligence on a few new investments and we would hope and expect to close somewhere in the upcoming quarter.

So we continue expanding our marketing efforts and we are definitely continuing to grow our presence in the marketplace.

So just take a quick look at our activity over this past quarter and how we have done. We invested $20.9 million in a new deal, we received as I mentioned earlier $13 million new debt investments which included warrants to purchase common stock and as a result of the aforementioned sale of that portfolio company, we also invested an incremental $1.8 million into the existing portfolio companies.

Specifically in July, we purchased GI Plastek Inc. with a $20.9 million investment in a combination of secured first lien and equity. GI Plastek, which is headquartered in Wolfeboro, New Hampshire, leading manufacturer of medium to large customized plastic injection molding products for various end markets and generally nonautomotive.

As I mentioned the assets of NDLI Inc. were acquired by Diligent Delivery Systems and as previously mentioned, received consideration of roughly $15 million. This transaction did result in a current net realized loss of about $2.7 million but we do retain of course as I mentioned an income-producing asset as well as warrants which would allow us to acquire common equity in Diligent in the future and could indeed turn into a positive.

In September, we did as I mentioned as well, sold the remaining preferred stock in Cavert II Holdings which was redeemed actually at par and generated dividend income of $1.5 million.

So with all love that, the outlook I would say and our goal is to continue to strategically add accretive investments, position our existing portfolio for potential exits and therefore maximizing distributions to shareholders with the solid growth in both equity and income portion of our assets.

So with all of that I'm going to conclude my part of the presentation and turn it over to Melissa Morrison who is our acting Principal Financial Officer and she will go into a bit more detail on that performance. Melissa?

Sure. Thanks, Dave, and good morning, everyone. As discussed, the Fund had a strong quarter. Through the quarter's originations together with highly successful originations last year, we achieved over $13.7 million in total investment income in the September quarter or 8.1% quarter-over-quarter growth.

For the balance sheet at the end of September, we had over $508 million in assets consisting of $490.6 million in investments at fair value, $5.7 million in cash and cash equivalents and nearly $12 million in other assets.

Our portfolio's allocation at cost is currently $387 million of debt securities and $143 million of equity securities or a 73% to 27% debt to equity allocation.

Our liabilities and equity at September 30 consisted of $103.5 million in borrowings outstanding on our credit facility, $121.7 million in term preferred stock, $9.1 million in other liabilities and over $274 million in equity.

Our net asset value was $9.05 per share as of September 30, down $0.19 from June 30 which primarily resulted from net unrealized depreciation of $3.4 million this quarter which we will discuss in more detail later on the call.

Consistent with the previous two quarters, we continue to use an external third-party valuation specialist to provide additional data points regarding market comparables and other information related to certain of our more significant equity investments. We will continue this practice and we will plan to generally update this externally provided data on an annual basis for all of our significant equity investments.

Moving over to the income statement for the September quarter end, investment income was $13.7 million versus $12.7 million in the prior quarter. Expenses net of credit were $7.7 million versus $7.5 million in the prior quarter leaving net investment income of $6 million versus $5.2 million or an increase of over 16% of our NII. The increase in net investment income quarter over quarter was primarily due to higher income driven by holding a larger portfolio and a receipt of dividend income which caused other income to increase by nearly $0.5 million as compared to the prior quarter.

This increase was partially offset by the additional costs incurred in originating and carrying the portfolio including dividends on our term preferred stock.

As mentioned on previous calls historically other income has been as high as 16% of our total investment income as compared to 13% during the September quarter.

We expect other income which is primarily composed of success fees and dividend income to remain meaningful but variable from quarter to quarter.

Our net (technical difficulty) in the current quarter primarily due to dividend expense on our Series C term preferred stock that we issued in May of this year. Overall, our NII increased to $0.20 per share for the September quarter from $0.17 per common share for the June quarter. Again, an increase of over 16%. Our net investment income more than covered our quarterly distributions to shareholders of 0.1875 per common share.

Now let's turn to realized (technical difficulty) in our assets. Realized gains and losses result from actual sales or disposals of investments. Unrealized appreciation and depreciation is a non-cash event and is driven by the 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.

During the September quarter, we recorded $2.7 million in realized losses related to the restructuring and sale of one of our portfolio companies and excluding certain fees related to certain investments and excluding any reversals of net unrealized depreciation, our portfolio had a net appreciation of $2.1 million during the three months ended September 30, 2015.

For the September quarter end our entire portfolio was fair valued at 92.6% of cost, slightly down from 93% of cost last quarter. All of our portfolio companies are current in payment except one which continues to remain on nonaccrual representing approximately 1% of the fair value and less than 3% of the cost basis of our total debt investments as of September 30.

Our debt portfolio is well-positioned for any interest rate increases with 81.5% of our loans having variable rates with a minimum or floor and the remaining 18.5% having fixed rates. The weighted average yield on interest-bearing debt investments remained consistent quarter over quarter at 12.7% versus 12.6% in the previous quarter. This strong yield excludes success fees on our debt investment. It also does not include any paid in kind or PIK income as we do not currently have any debt securities with a PIK feature.

Success fees are yield enhancements that are contractually due generally upon a change of control although there are times when the portfolio company can elect to pay it earlier. We generally only recognize success fees in our income statement when they are received in cash.

For comparison purposes if we had accrued these success fees as we would if it was paid in kind interest like other BDCs do, our weighted average yield on interest-bearing assets would approximate 16.1% during the September quarter. As of September 30, the success fees accruing off balance sheet totaled $29.6 million or approximately $0.98 per common share. There is no guarantee that we will be able to collect all of these success fees or have any control over their timing.

From a credit priority standpoint, 100% of our loans are secured with 72.7% having a first lien priority and the remaining 27.3% having a second lien priority in the capital structure of the respective portfolio company.

Overall Gladstone Investment had another good origination quarter which helped the Company generate strong financial results. We have maintained an increased distribution rate while still remaining committed to covering our distributions by net investment income as we have done consistently over our last several fiscal years.

Now I will turn the call back over to David Gladstone.

Thank you, Melissa, and that was a good report, same good report from Michael and Dave. And during the past quarter we were able to report some great accomplishments such as good origination, increase in our net investment income and of course the successful exiting one portfolio company at a good return.

Several more of our portfolio companies are moving closer to be sold. The one I have been mentioning on the call for the last six months has finally signed a definitive deal document and we are waiting for the final funding to close. I am hopeful that is in the very near future. I'm afraid to give any projections on that anymore.

If it does close, it should generate a significant capital gain for our funds. And one of our companies is even talking about doing a public offering. We only own a small part of that but it would be significant so lots of activity in this Company and future outlook of this fund is very good. We expect to explore an increase in dividend sometime in the near future.

I know it doesn't help much when the fund pays an extra dividend but sometimes we have to use that technique to eliminate taxes and comply with government regulations.

So just to recap, the September quarter closed a new investment, $21 million, exited one investment, results over $1.5 million in dividend income and sold a company that had gone through a lot of past problems to sort of get that one out of the way and free up people to work on new deals.

We believe we can (inaudible) this success going into the next few quarters and after that we should have some running room to move even faster. As you probably can tell, I am bullish on this fund, looking very good for the upside.

We feel it is a great time to buy and invest in small companies like the ones we invest in. While we continue to monitor the economic recovery, we have seen some positive trends in the recent economic indicators. The economic recovery has been of course the slowest and the worst one in the last 30 years. I don't think anybody would disagree with that.

We still have the same concerns that I mention every time. We like all the other people sitting around are watching the direction of the Federal Reserve, the monetary policies to see what they will do and while we have variable rates, most of our loans increasing rates are not good for the economy. However, I doubt the Fed will really have now staked out the December month for the increase and I don't think they are going to increase it more than one quarter of 1%. So that is not going to do much in terms of impact to the economy.

The volatility of oil and gas industry pricing has been just crazy. Low oil prices are a terrific benefit to the economy and we should get a lift out of that. I just don't know how long that will last and our oil and gas concentration in this company tends to be minimal. And natural gas and oil prices continue to stay down, then the entire industry is going to have a big adjustment to make and that will be some big changes in that industry.

The (technical difficulty) Federal Government is still top of my mind. I'm sure it is of many of you out there as well. The Federal deficit is now over $19 trillion and continues to climb as the government spending continues with just no end in sight. They can't seem to stop it. Sort of like cocaine addicts, they just keep spending.

The Federal debt has doubled in the last 10 years. That seems unbelievable but that is the truth and this is not sustainable. We can't keep doubling every eight to 10 years and it is going to be crippling for the US economy and all the Americans. So please vote for fiscally responsible people that are running for President side and perhaps this next election we can begin to turn the Company back to a more sane approach to spending.

Many of the private companies we are in like those that like ourselves and like those that we are investing in feel there is still much too much regulation around healthcare, financial services, energy and of course emissions and it is just hindering the portion of job growth. It is crippling so many small businesses. We are now at the same number of small businesses and it has reduced so much that we are back to the age of Jimmy Carter if you can believe that in terms of number of small businesses.

In light of all of these concerns, our Company, Gladstone Investment, has strengthened its balance sheet in the form of significant new equity and used that new equity to buy into a list of good (audio ends in progress)