Gladstone Investment (NASDAQ:GAIN)
Q1 2015 Earnings Conference Call
July 29, 2014 08:30 AM ET
David Gladstone - Chairman and CEO
Michael LiCalsi - Internal Counsel and Secretary
David Dullum - President
David Watson - CFO and Treasurer
Mickey Schleien - Ladenburg
Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation's First Quarter Ended 6/30, 2014 Earnings Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.
I would now like to introduce to your host for today's conference, Mr. David Gladstone. Sir, you may begin.
All right. Thank you, Benson 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 of Washington D.C. 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 are some of the finest people in the business.
Now, we’ll hear from our General Counsel and Secretary who is also President of our Administrator. Michael LiCalsi, he will 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 and the Securities Exchange Act of 1934, including statements with regard to the future performance of the company. These forward-looking statements inherently involve certain risks and uncertainties and other factors even though they 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; 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, sign-up for our email notification service. We don't send out junk mail, just timely news on our company. You can also find us on Facebook, keyword The Gladstone Companies and you can follow us on Twitter at Gladstone Comps.
The presentation will be an overview so we ask that you read our press release issued yesterday and also to review our form 10Q for the June 2014 quarter end filed this morning with the SEC. You can access the press release in 10Q on our website as well, www.gladstoneinvestment.com. We also invite you all to come to the Annual Meeting of shareholders which is schedule for August 7 at 11 AM Eastern Time at the Hilton McLean Tysons 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 a proxy card so we can get all the votes in and ensure form at the meeting. You can vote your shares by mailing in your proxy card or you can vote by calling 1800-690-6903 and if we call during you needs your proxy cards so that you can vote. And in other way to vote is with your vote control number, go to www.proxyvote.com and vote online. You can also vote by calling your broker who can help you vote your share as well. And your brokerage firm is not permitted to vote your shares for you on non-routine matters or matters up for vote at this meeting are non-routine matters, thus your brokerage firm may not vote your shares for you need to vote them yourself. As a result we need you to vote your shares and the cost to your fund to rend up votes by calling and asking shareholders to vote to ensure firms is now major expense for the fund and that takes away dollars that could be paid in dividends to shareholders, more regulation first to comply with make our company less profitable and for us and all public companies.
And now the firm’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 bio businesses, these are usually companies with annual sales between $20 to $100. We provide what we call is subordinated debt in combination with the equity and senior debt if they are available.
So, this combination produces a mix of assets for Gladstone Investment which is the basis of our strategy. This means that 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 an approximately a 30-70 mix. Most other BDCs you will 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 are certainly 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 portion of our portfolio can be volatile. So, for example we have talked briefly about this in prior calls but it’s important to refresh our memories that last august we sold Venyu Solutions Inc., the company that we 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 5.5 times return which included the dividends that we received. So, the point of this is that that sale of Venyu is the fourth exit from our management supported buyout 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 are always assessing the merits of achieving liquidity in our equity positions and we will continue to exit and invest when appropriate.
So, the point again of all this is that with its 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 are 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 are 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 to 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 new independent sponsor if they are 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 the 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, while 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 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 are 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 firm 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 for this quarter. David?
Thank you and good morning everyone. As one would expect with a quite quarter on a production front during the three months ended June 30, 2014, numbers and ratios remain pretty even at a good level and will remain for it to grow still. There are few things that I want to highlight before getting in to the details. And the first one is, we were able to extend the maturity date of our $105 million line of credit to approximately 14 months to June 2017 or three years out. If it is not renewed our extended by the maturity date, all transform 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 is exercise, could in effect push this facility out seven years. We were also able to reduce the interest rate from LIBOR plus 375 to LIBOR plus 325.
Other highlights include 5.5 million of appreciation on our investments, not having to purchase [indiscernible] in order to comply with rig 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 consist of equity securities which we hope will produce capital gain. 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 31, 2014.
Moving over to the income statement, for the June quarter in 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 leading 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 our 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 and income from Matthew 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 the 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 outline 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 charge the remaining 17% are fixed. The weighted average yield on our interest bearing debt investments remain 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 investments which are excluded from our reported yields. As a reminder, success fees are contractually due upon the salable portfolio company although the portfolio company can pay it earlier. So for comparison purposes if we had a crew of the 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 subordinate and 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 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 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 30, 2014. During the prior quarter we realized the 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 an increased debt and equity valuations and 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 portfolio companies.
Turning to prior quarter, the net unrealized appreciation of our entire portfolio was approximately 0.2 million. So given our long term view related to our investment we have been pleased with realized values for which we have exited our investment 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 cost last quarter.
So let’s turn to our net increase and 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 amount 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 a 0% of a fair value and 4.5% of the cost bases 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, Michael and Dave all three of you gave good reports. This first quarter was a mix for us, we’re able to report some accomplishments such as the earnings of our dividends, we're always proud to do that. The 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 are disappointed in not making any new investments due in 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 investment climate which we operate. We feel we have some still tremendous concerns out there as lot of uncertainty around the Federal Reserves, monetary policies and the impact on future interest rates.
Fiscal crises that the Federal Government is still not on top out there about $17 trillion and 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 is 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 now 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 in 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 a 110 sequential monthly cash distributions to a 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 is about 9.7% which is far too high and 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 overtime. Our monthly distribution of 7.125% for our preferred stock which translates into about 14.84% or $1.78 annual, 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 the potential of some special dividends from our capital gains. We continue to be disciplined in our investment approach and while focused on making conservative investments in American businesses.
And before we have some questions please come to our stockholders meeting on August 7th at 11 AM, we’re at the McLean Hilton here in McLean, Virginia and if you can’t come, please vote your stock where 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 Vincent will come on we’ll have some questions from our analysts and many of the loyal shareholders out there. Vincent?
Our first question comes from Mickey Schleien of Ladenburg. Your line is open.
Mickey Schleien - Ladenburg
My first question relates to the overall market probably direct at the David 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 structural 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 we’ll 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 evaluation 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.
Mickey Schleien - Ladenburg
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 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.
The other thing we just again touched on and David Watson mentioned it that we keep making the point our exit fees that we have a structure 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 some of their tax planning purposes and its cash income to us. And so that’s another income stream if you will that we managed in our portfolio companies.
Mickey Schleien - Ladenburg
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 evaluation 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 and I think it is conservative but who knows you give evaluation to you and me and David Watson and David Dullum and I think we 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 evaluations 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’d not made any major changes to our valuation techniques at this point in time.
Yes, Mickey you might have seen that in the 10-Q that it’s showed up this morning on the SEC website that we have filed last night. We did revamp our disclosures around our valuation policy and this is really an effort just to enhance the language we use and 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 evaluation officer in September of last year and we are very happy to have her here as an added resource of 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, a major changes in the future as really it’s any type of policy change but the disclosures obviously have changed and enhanced.
Mickey Schleien - Ladenburg
My last question is just if you could give us any update on Noble 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 have got some of the things corrected. The old Noble is dealing with under the bankruptcy law of court protection doing what it needs to do there with some of those lawsuits. And I don’t know if 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 with Gladstone Investment and Gladstone Business Investment and even Gladstone Capital were named as defendant, that lawsuit has been dismissed a few weeks back, so there is no longer a pending lawsuit.
Mickey Schleien - Ladenburg
And that's good news, so there is no lawsuits related to Noble where GAIN is the defendant any longer.
That is absolutely correct.
At this time, I am showing no other questions in queue sir.
All right, we will wait one second if somebody wants to ask a question and otherwise we are going to be gone for another quarter, so ask your questions.
All right. Well, thank you very much all of you for calling in and we will see you next quarter. That’s the end of this conference call.
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