Gladstone's CEO Discusses Q4 2011 Results - Earnings Call Transcript

Nov.15.11 | About: Gladstone Capital (GLAD)

Gladstone Capital Corporation (NASDAQ:GLAD)

Q4 2011 Earnings Call

November 15, 2011 8:30 AM ET


David Gladstone – Chairman and CEO

Chip Stelljes – Chief Investment Officer

David Watson – Chief Financial Officer


Troy Ward – Stifel Nicolaus

Jeff Rudner – UBS

J.T. Rogers – Janney Montgomery Scott

Dixon Braden – Morgan Keegan

Mark Hughes – Lafayette Investments


Good morning. And welcome to the Gladstone Capital Corporation’s Fourth Quarter Year Ended September 30, 2011 Conference Call. All participants will be in listen-only mode. (Operator Instructions)

Please note that this event is being recorded. And now I’d like to turn the conference over to David Gladstone. Mr. Gladstone, please go ahead.

David Gladstone

Well, thank you, Keith. And hello out there all of you. Good morning. This is David Gladstone, Chairman and this is the quarterly conference call for shareholders and analysts of Gladstone Capital, trading symbol, GLAD. We thank you all for calling in.

As always, I love these moments and I’m happy to talk to shareholders about the company. I wish we do it more often, but once a quarter is the thing that we do. We hope you’ll take the opportunity to visit our website, where you can find and sign up for e-mail notices. You can receive information about the time -- in the timely fashion about the company.

Please remember that if you’re in the Washington, D.C. area and you have a little extra time, you have an open invitation to come by here in McLean, Virginia stop by and say hello. You’ll see some of the finest people in the business. 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 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, 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 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 and 10-Q filings and in our prospectus as filed with the Securities and Exchange Commission. All those can be found on our website as well as the SEC website. 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.

As we always do, we’ll start off with our President, Chip Stelljes. Chip is also the Chief Investment Officer of all the Gladstone companies and he’ll cover a lot of ground. So, Chip, go ahead.

Chip Stelljes

Good morning. We closed two new investments during the quarter totaling $9.9 million and we invested $7.7 million in existing portfolio of companies in the form of additional investments or draws on revolver facilities. Also during the quarter, we received repayments of approximately $6 million due to normal amortization, pay-downs of revolvers.

So, in total we had a net production increase in our portfolio of approximately $11.6 million for the quarter. And we funded the net increase in production from operating income and draws on our credit facility.

For the fiscal year ended September 30, 2011, we invested $136 million and have repayments of $46 million for a total net production of $90 million compared to a total net contraction of $59 million last year. So, we’re pleased we were able to make any new investments this year.

Since the end of the quarter, we invested $3.6 million in existing portfolio of companies and we received $3.9 million repayments. This is primarily against scheduled principal amortization. Included in these numbers was an investment of $1.5 million to our new portfolio of company in relation to a workout of a non-accrual investment that we’ll talk about in a few minutes.

Also, after the quarter end, we sold $1.4 million term preferred shares. We received $33 million in net proceeds. By completing this term preferred offer, we were able to pay down $33 million on our credit facility. Now, we’re encouraged by this capital raise and look forward to using the capital to make new investments over the next six months.

At the time of this call, we owe $64 million on our line of credit. And since that line is $137 million in capacity, we’ve got liquidity to make new investments. We continue to see attractive investment opportunities. Although there seems to be a good deal of capital coming in to the market for the right deals, we’re actively searching for new investments and believe will close some in the next quarter or two.

At the end of the September quarter, our investment portfolio was valued at approximately $303 million versus the cost basis of $383 million or approximately 79% of cost. At the end of the quarter, we have loans with eight companies on non-accrual, including two new wins added during the current quarter, Newhall Holdings and Access Television. Of the eight in an operating controller, over half of these companies as of September 30.

And we’re working hard to fix the problems and improve profitability. But the investments classified as non-accruing have a cost basis of $41.1 million or about 10.8% of the cost basis of all investments in our portfolio at fiscal year-end. From a fair value perspective, the non-accrual’s fair value represents $5.3 million or about 1.7% of the fair value basis for all investments in the portfolio at fiscal year-end.

We sold the assets of one of our non-accruing loans, KMBQ, to Ohana Media. After fiscal year-end, Ohana will replace KMBQ on our schedule on investments. And Ohana is now a performing loan, reducing the number of investments on non-accrual to seven.

We continue to have a high concentration of variable rate loans so that we should have higher income when rates begin to increase and while our rates are variable, they usually have a minimum rate or a floor, so that declining rates are mitigated. Approximately 86% of our loans have floors.

However, even with a high percentage of floating-rate loans having floors with short-term rates, floating rates remaining at all-time lows, we’re still generating less income than in the past. 6.3% of our loans do not have floors or ceilings. And the remaining 7.7% of our loans have relatively high fixed rates.

Another measure of the quality of our assets is that our average loan rating for the quarter that just ended remained relatively unchanged. Our risk rating system attempts to measure the probability default for the portfolio by using a 0 to 10 scale. Zero represents a high probability of default and 10 represents a low probability.

Of significance, our risk rating system for our non-syndicated loans, which constitutes 70% of our investments deferred value showed weighted average rating of 5.9 as of fiscal year-end, which remained unchanged from our prior fiscal year-end.

As for our weighted syndicated loans, which make up 23.7% of our portfolio at fair value, they had a weighted average rating of B/B2 for the year-end, down slightly from a B+/B2 at our prior fiscal year-end. Our unweighted syndicated loans represented 6.3% of our portfolio at fair value and had a weighted average rating of five down from sever at our prior fiscal year-end.

Quality of our income continues to be good. As we’ve discussed before, we try to limit income generated from paid-in-time or original issue discount structures. These generate non-cash income which has to be accrued for book and tax but is generally not received until much later. This type of non-cash income is subject to our 90% pay-out requirements, so we would be paying out cash that we’ve not yet received.

The senior and second lien debt marketplace for larger middle-market companies continues to improve, albeit, inconsistently. Our new investments this year came primarily from these larger middle market companies, which were reflected in our cost basis of senior and second lien syndicated loans of $19 million at September 30 2011, up from $18 million at the end of last fiscal year, so we believe there are many attractive investments in this space coupled with decent liquidity.

Market for loans to companies at the lower end of the middle market in which we typically invest most of our capital has seen more competition but not from banks. Most banks continue the policy of tightened credit standards, especially for companies at the lower end of the middle market. Many banks are making purely asset based loans although we’re seeing an increase in non-bank lending sources.

Competition comes from other public funds like ours and from many small private funds as well. But net of all these conditions, we still feel we have the market opportunity. Our loan request pipeline is still full and should be able to show some good investments over the next several quarters.

And with that, I’ll turn the presentation back to Dave.

David Gladstone

All right. Thanks, Chip for the good report. And now, let’s turn to financials and for that we’ll hear from David Watson, our Chief Financial Officer. David?

David Watson

Great. Good morning, everyone. I’ll go over the financial starting with the balance sheet. As of September 30, we had approximately $318 million in total assets consisting of $303 million in investments at fair value and $50 million in cash and other assets.

Our borrowings outstanding totaled $99.4 million on our line of credit and we had approximately $214 million in net assets as of the 2011 fiscal year-end. Therefore, we are less than 1/1 leverage.

This is a conservative balance sheet for a finance company, which are usually levered much higher and we believe that our overall risk profile is low. At the time of this call, we only have $64 million borrowed on our $137 million line of credit. So, we have the ability to deploy more capital for the right opportunities.

Moving over to the income statement. For the September quarter, net investment income was approximately $4.8 million versus $4.4 million for the same quarter last year, an increase of 8.7%. The increase was primarily due to an increase in interest income resulting from 20 net new investments since September 30, 2010.

On a per common share basis, net investment income for the current quarter was $0.23 per share compared to $0.21 per share for the fourth quarter ended September 30, 2010. For the fiscal year ended September 30, 2011, net investment income was $18.4 million or $0.88 per share as compared to $17.8 million or $0.84 per share for the prior year, an increase in net investment income of 3.7%.

Net investment income increased primarily due to decreased interest expenses resulting from decreased borrowing costs under our credit facility. The effective interest rate was 6% for the fiscal year ended September 30, 2011, as compared to 7% for the prior year which is due in part to the November 2010 amendment to our credit facility which eliminated the minimum earnings shortfall fee.

In addition, professional fee decreased by $1 million due to increased legal fees during 2010 from restructures with certain portfolio investments. These decreases in operating expenses were partially offset by the increase in incentive fee during the 2011 fiscal year, which is due to the increase of pre-incentive fee net investment income. 100% of distributions paid from fiscal year ended September 30, 2011 are covered by taxable income. I think this highlights our commitment to prudent growth.

So, overall while interest income, our portfolio of investments remained consistent year-over-year at $32.6 million and generally trended down throughout fiscal year 2010 compared to generally trending up throughout fiscal year 2011 with our largest quarter coming in the fourth quarter of 2011. These trends primarily resulted from our increased investment activity during 2011.

In 2010, repayments outpaced origination activity resulted in an overall reduction in the size of the portfolio. In 2011, we had an overall net increase in the size of the investment portfolio from the investment activity. We believe this trend is a good indicator for fiscal year ending September 2012.

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.

Regarding our realized activity for the September 2011 quarter end, there was a net realized loss of $1.3 million, which primarily resulted from a restructuring of one of the portfolio companies, SCI Cable. There was no realized activity during the prior year fourth quarter. For the year ended September 30, 2011 where we recorded a net realized loss on investments of $1.3 million which resulted from the aforementioned restructure of SCI Cable.

For the year ended September 30, 2010 where we recorded a net realized loss on investments of $2.9 million, which consisted of $4.3 million of losses from the sale of several syndicated loans, Gold Toe -- excuse me -- Gold Toe, Kinetek, Wesco and the write-off of Western Directories and the payoff of CCS. And this was partially offset by $1.4 million gain from the ACE Expediters payoff.

From an unrealized standpoint, for the September 2011 quarter end, we had net unrealized depreciation of $4 million over our entire portfolio. The decrease was primarily due to depreciation on certain of the company’s proprietary investments. Most significantly, Sunshine Media can buy it back, primarily due to decreased portfolio company performance and comparable multiples.

And this is offset by appreciation in Defiance Integrated Technologies investments due to increased portfolio company performance and related comparable multiples. For the year-end at September 30, 2011 we had net unrealized depreciation of $38.8 million. The largest driver of our net unrealized depreciation for the year was the depreciation in each of Sunshine Media Holdings, $21.2 million and Newhall Holdings, $9.3 million.

And again, these are primarily due to portfolio company performance and a decrease in certain comparable multiples. These depreciation were partially offset by an appreciation in Defiance, $6 million for the year, which resulted from an improvement in portfolio company performance and in certain comparable multiples.

Net unrealized appreciation of $2.6 million was recorded in the prior fiscal year. And that is primarily due to the reversal of previously recorded unrealized depreciation on exited investments. Our entire portfolio was fair valued at 79% of cost as of September 30, 2011.

The cumulative unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders, but thus indicate that the value is lower and there may be future realized losses that could ultimately reduce our distribution.

So, our bottom line is the net decrease increased in net assets resulting from operations. This term is a combination of net investment income, unrealized net appreciation or depreciation and realized gains and losses. For the September 2011 quarter-end, this number was a decrease of $0.5 million or $0.03 per share versus an increase of $3.8 million or $0.18 per share in the prior year’s September quarter.

The year-over-year change is primarily due to the $4 million in unrealized depreciation in investment in the current quarter compared to $1.2 million in unrealized depreciation recorded in the prior year quarter.

For the September 2011 year-end, this number was a decrease of $21.1 million or $1 per share versus an increase of $16.4 million or $0.78 per share in the prior year. The year-over-year change is primarily due to the $38.8 million in unrealized depreciation investment in the current year when compared to $2.3 million in unrealized appreciation recorded in the prior year.

While we believe our overall investment portfolio is generally stable despite recent markdowns, today’s markets move fast and are generally volatile and investors should likewise expect volatility and the aggregate value of our portfolio.

If you look back over our history, generally we have companies that have problems from time to time. And then we have to stop accruing income. After a while, we fixed the problem and get all or most of our money back. And this is one of the strengths that we have in our operating team here at Gladstone. So, we can fix the many problems with the companies.

And now, I’ll turn the program back over to David.

David Gladstone

All right. Thank you, David Watson. And that was a very good presentation. I hope all our listeners out there will read our press release, study our year-end report. That’s called the 10-K which we filed with the SEC yesterday. You can access the press releases and the 10-Ks and 10-Qs on our website at And you can also find them on the SEC website at

I think the big news this quarter is the continuation to make progress with our portfolio companies. They’re getting stronger as the economy gets better. So, we continue to work them out and make them better for everybody.

Also this quarter, we see our backlog of opportunities to lend money increasing and I think that will continue. I don’t see any slowdown coming in that area. Also, we added a lot of new investments in our portfolio of loans during the year, about $136 million and that will help us make more money for the shareholders. It has been -- in my estimation, a very sluggish three years, but I think we’ve finally come around and things will be better over the next three years.

But I want to remind everybody that our biggest challenge today is the long-term debt marketplace for our company. We have a line of credit with very supportive lenders. Those institutions seem to be behind us. The line of credit is working fine and we believe it’s sufficient for our near-term needs, but it is a short-term line of credit.

And we are near to signing a commitment with the lenders and I hope we can -- at our next call in the quarter, we can have that closed and out to you. But at this point in time, I can just say that we’re moving forward with that.

But at the end of the day, we have to find long-term funding solutions for our company. In order to make a lot of long-term investments, we need to raise long-term debt and long-term capital such as the issuance of our preferred stock that we issued just last month.

We found some long-term money with the new preferred but that’s just part of it, we need more than just the $35 million that we sold in that offering. Our investments are long term, so we need long-term liabilities to match those durations. We shouldn’t rely on short-term lines of credit for our company.

So, we’re talking with some insurance companies but we’re still not there yet. The insurance industries still doesn’t seem to be financing small companies like ours and certainly not finance oriented companies like ours. And this lack of long-term debt and long-term equity can stunt the growth or if we can find it, it will accelerate our growth. And that’s our challenge in the near time.

Our portfolio companies, we’re certainly worried that they’re not going to be able find long-term senior loans that they need. There’s a fair number of regional banks that are making some loans based primarily on assets. These asset based lenders are plentiful today, but they’re all short-term lenders and they’re still not making or extending long-term loans to our portfolio companies. Every now and then, we find a bank that will but it’s not plentiful.

I think the banks will get better overtime, especially as the government begins to stop beating them up so much in their audits. We do have our worries and I mention them each time. I’ll just run through them now. And we worry about oil prices. Oil is on the way up. The only thing that would reduce oil prices is if there was a recession. We are worried about inflation, decisions by congress and the president to expand the money supply will ultimately cause more inflation and more problems.

And the spending by the federal government is still really off the charts. And we look toward the so-called stimulus packages in what they’re doing. And they’re really spending goodies for many other supporters of the legislatures. And the government is borrowing today 43% of every dollar that they spend. And next year, it may be as much as 50%. We can’t keep going like that and something has to change and hopefully, it will happen soon.

The amount of money being spent on the war in Iraq and Afghanistan certainly hurts the economy. We support all of our troops over there. They’re the great heroes at this period in history and we wish them a safe return home and certainly, the closedown of the Iraq and Afghanistan war. And of course, the government is talking about raising taxes again. I don’t know how much the economy can stand in more taxes. But we all know that we have a spending problem and not a tax problem today.

In addition, the trade deficit with China, certainly, China’s just one of those nations that continues to subsidize their industries to the disadvantage of our businesses here that aren’t subsidized, they subsidize oil prices significantly by about half. And that means that our companies have a hard time competing with them and that means jobs leaving the United States and go to Asia.

The downturn in housing has been a real drag on the economy. It’s been a disaster obviously for mortgage holders, as well as those who have mortgages that are now underwater. And no one knows, how many home mortgages were ultimately failed, but the estimates are in trillions of dollars. And I think that’s the main cause of the recession today. I’m just glad that we weren’t investors in anything in the housing industry.

We see the problems in Europe and countries like Greece and Italy and that may hurt some of the companies. But we don’t really have any investments in Europe or any of those countries or Asia for that matter. So, U.S. companies that -- our U.S. companies have little contact with Europe or any of those problem areas.

So, we don’t really worry about the European problem that much because we don’t see it hurting our business. Obviously, we didn’t have any investments in the housing industry, but when that blew up, obviously it hurt everybody and hurt us as well. So, we’re wishing the Europeans well in getting their problems fixed.

In spite of all of those negatives, a lot of the small industrial base that we invest in yesterday is really not a disaster. There’s the lingering recession that continues to have an impact on all of the companies, including our portfolio of companies. But it’s not a disaster today as it was two years ago. But like most companies, some of our portfolio companies have not seen increases in revenues or backlogs.

They continue to grow, but very slow. We have others that are seeing incredible increases. And it’s just a mixed bag out there. It’s a very uneven recovery in the economy today. And so we believe the downturn that began in 2008 is on the bottom. I don’t how long it’ll take to go up but it may be a very slow climb out of this. We’ve been in it for about three years now and no one believed it was going to last that long.

Anyway, we’re continuing to do our distributions to common shareholders, $0.07 per share. Each of the months for October, November, December, as you all know and the board will meet again in January to consider the vote for January, February and March and seeing the problems for those being declared and the distribution rate on the common stock today with the common stock price at about $8.36 as it was yesterday. That’s better and a little bit better than the 10% yield, so quite attractive stock.

As some of you know, from my filings, I bought some more shares. And distribution of 7.125% is on our recently issued term preferred stock and that’s about $0.1484 a month or $1.78 annually. And the first distributions will really be coming to everyone in December 2011. The term preferred stock had a closing market price yesterday of $25.19 or up $0.19 from the prior period.

And I apologize for the lookup on this. New York Stock Exchange, if you go to that and you put in GLADPRA, you can get a quote. If you’re on NASDAQ, you have to put in GLAD.PRA. I don’t know why they are different but they are. And even worst, if you’re on Yahoo, you have to put in GLAD-P in order to get the quote and I can’t find it on some of the other slides that I have such as the Wall Street Journal. So, I apologize for that. I’m sure it’ll work its way out of and be a little more consistent as time goes on.

Please go to our website at, sign up for our e-mail notifications. We don’t send out any junk mail, just news about our company. And you can now find us on Facebook. If you want to follow us there, it’s called The Gladstone Companies. And you can follow us also on Twitter under Gladstone, C O M P S GladstoneComps.

In summary, I think we had a reasonably good year last year. We expanded the portfolio by $90 million. That is a new earning asset on books. I think we’re moving forward at a good pace. And with our new equity from the preferred offering, we should have progress again in this fiscal year that will end in September 2012.

Folks, as far as I can see, the economic conditions are looking like they’re changing for the better. I think the economy has bottomed down or starting to gain strength. I know there’s a lot of strength in some of the middle-market companies. I think the next two quarters will be good ones for us. I think it will be telling for the economy. But we are stewards of your money. And we stay in the course and continue to be conservative on our investment approach. And I hope that’s good for everybody.

Operator, if you’ll come on now. Let’s open up the lines to the analysts and shareholders who want to ask us some questions.

Question-and-Answer Session


Thank you. (Operator Instructions) And the first question comes from Troy Ward with Stifel Nicolaus.

Troy Ward – Stifel Nicolaus

Thank you. Good morning, gentlemen.

David Gladstone

Good morning.

Troy Ward – Stifel Nicolaus

Hey, David, you talked about -- you felt like you’ve really turned the corner. It feels like the worst is behind you. But if we look at the portfolio, again, this quarter you had two additional companies on non-accrual. And as we look at, if you exclude the $90 plus million of syndicated loans, you have about $290 million of self-originated assets. Of those, 14% are on non-accrual and almost 16% are marked less than $0.50 on the $1.

That’s 30% of the portfolio that your team has underwritten. Are you showing some pretty extreme levels of stress? How should we think about the underwriting process at Gladstone? Has anything changed to make us think that credit quality should be better going forward? And what can you do to, quite honestly retrieve some of the value in this portfolio?

David Gladstone

Well, I’d only point to the past and we’ve had very few losses over the years. If you go back and look at the losses, yes, we put companies in non-accrual maybe faster than some others.

We certainly don’t do what others had done which is convert all the debt to equity in order to make their numbers look good. We leave them in debt positions so that we can work on them and continue to work and get them fixed. As you know, Chip mentioned that we have the one that came off non-accrual as we fixed it.

I think most of the problems that we had on our portfolio have come out of the broadcast area, which are dependent on advertising. Advertising has had a much slower comeback than other parts of the economy. And so, as a result, those have performed poorly. There are others in the portfolio that have performed very well.

And I think you’ll see over the next year, some of those companies that we’ve taken over and fixed are actually going to get sold or will be put out for sale. And you’ll see some tremendous capital gains from that portfolio as well.

So, you have to remember that we did go through the worst recession we’ve ever seen. And I know we can -- we are compared to some of the other BDCs out there that have very small portfolios before the recession and have now made hay in the good times of the recession bottoming out and more power to them.

We’re in favor of everybody making money. But I think you’ll see that the newer transactions that we have will continue to grow. And those that have gone through the recession and that we’ve taken over, we fixed. And then, Chip, you have a couple of deals that we’ve taken over and that we’re now in a position to sell, you want to comment on those?

Chip Stelljes

Yes. I mean, not specifically. But, yeah, it leads to companies in the portfolio that we took over during the downturn, both of which we’re going to make, in my opinion, substantially more money on those deals. And we would have made it big not the original business planning. We’ve just been mezzanine holder of them. So, you see some of that in the valuations. And I’ll also just note on valuations. Valuations for us are primarily where we’re looking.

So, where you might see a large valuation of portfolio company we may look at it and say that’s the history. But we know what the current plan is and we’re comfortable with the management team. We use S&P and S&P tends to look backwards at trailing 12 months of performance.

And we have to look as stewards of the money. We have to look at forward performance and plans and what the company is trying to achieve. We’re working hard on the ones that have had issues.

Troy Ward – Stifel Nicolaus

Great. That’s good color. Thanks, guys. David -- I think Chip, the one you mentioned that came off non-accrual, was that the KMBQ?

David Gladstone

Mainly it is there.

Troy Ward – Stifel Nicolaus

And will you end up with a positive IRR on that transaction?

David Gladstone

No, I don’t know. We’ve got to, first of all, get them paying interest which is the first to order business and then see if we can get them to pay off the loan. But I suspect it will positive once you do that.

Troy Ward – Stifel Nicolaus

Okay. Great. And then one last one, sticking with the credit quality. Obviously, Sunshine Media is and you had some commentary in your prepared remarks. It’s still a sizeable investment. It’s still on occurring status. Can you just give us a little more color on what’s going on there? It’s marked at $0.30 or close to $0.30 on the $1. Are you still receiving current interest on it and it’s marked at $0.30 or close to $0.30 on the $1. Are you still receiving current interest on it and do you anticipate this going on non-accrual?

Chip Stelljes

We are getting current interest from Sunshine. Sunshine remains a work in progress. We have -- as we have mentioned in the past call, we’re being repositioned with the media company subject to the advertising type revenues that David talked about. We have a very strong management team in here. We’ve taken out the control equity investor in the deal.

I’ll tell you just about being -- specifically about portfolio companies. This company has a low profitability but is doing a lot of the right things to improve the business. And almost all of the capital that we committed to Sunshine is from new initiatives that we’ll build the business. It’s not eating operating cash. It’s just that a good deal of leverage, that’s the valuation. But, I mean we have some confidence that the right things are being done there.

Troy Ward – Stifel Nicolaus

Great. And then one for David Watson, just a quick modeling question. What’s in that other expense line item? It’s grown over the last couple of years from about $270,000 to $800,000. And this year, it’s up around $1.2 million. How should we look at that? What’s in it, first of all and how should we look at it going forward? I mean, it’s not super material but it’ll be a couple -- if this increase continues, it’ll be a couple cents to the model.

David Watson

Yeah. The other expense, the $1.2 million for the year, fiscal year ended 2011, Troy?

Troy Ward – Stifel Nicolaus

Yes. That’s the line item.

David Watson

Okay. That’s actually down a little bit from last year where it was at $1.3 million.

Troy Ward – Stifel Nicolaus

I’m sorry. I had it in my model at $800,000. Maybe I had back something out as I include -- considered it one time. So, what do you think about that line of item going forward? Do you think it’ll stay -- do you think you’ll stay relatively flat in that range?

David Watson

I believe so, Troy.

Troy Ward – Stifel Nicolaus

Okay. Great. Thanks guys.


Thank you.

David Gladstone

All right. Next question, please?


Thank you. And the our next question comes from Jeff Rudner from UBS.

Jeff Rudner – UBS

Good morning, David. Good morning, guys. David, just stepping back a little bit, looking at the dividend and the comments made and, obviously, the net investment income being at $0.23 for the quarter, which amply covered the $0.21 dividend. When you cut the dividend back in 2009 from $0.14 a month to $0.07 a month, obviously, everybody understood what the necessity was for that.

Now that things seem to be improving and the net investment income for the first quarter now should be even a little bit above the $0.23, do you anticipate the possibility of raising the dividend, albeit gradually, as you go through 2012?

David Gladstone

Jeff, that is the question that everybody asks. And the answer, of course, is always the same. We’re going to raise it as fast as we possibly it can based on earnings. Right now, earnings are dependent on new transactions being put on the books, new portfolio of companies, of course.

And that’s an unknown that we just never know how to model into our models of how much we’re going to be able to put on the books each quarter. As the largest shareholder, I can assure you that I want to increase the dividend as much as I possibly can. So, we’re working toward that. Whether that means that we might be able to do it in this fiscal year, I’m hopeful.

Jeff Rudner – UBS

Okay. Thank you.

David Gladstone

Next question.


(Operator Instructions) And we do have a question from J.T. Rogers with Janney Montgomery Scott.

J.T. Rogers – Janney Montgomery Scott

Hi. Good morning, everyone. I have a quick question. You all referenced problems in the media portfolio. I was wondering if you could comment about maybe trends that you’re seeing in advertising spending in some of the smaller markets that you all invest in, if that is…

Chip Stelljes

Yes. The media marketplace is then one of the areas that was damaged the greatest. While we didn’t invest in the housing industry, many of the advertisements on both radio and magazines have been related to the housing industry. So, we took our leaks from that portfolio -- in that part of the portfolio from a different way of looking at it. Also, much of the media portfolio, it was tied to automobile advertising and the dealers. And of course, that went through the ringer as well.

So, you got two of the biggest advertisers in the business which is automobiles and that just destroyed the media area altogether. So, some of the smaller marketplaces are coming back now. The automobile people are backflow for us. If you watched the TV, you see every other ads seems to be an automobile add. And the same thing is happening with the smaller marketplaces. They are now coming back.

The media advertisement for automobiles in the newspapers and the magazines I think is still low. And it’s been replaced somewhat by some of the media advertisements from the medical profession and the legal profession. But it’s still not strong. And so, what we’ve seen in things like our yellow page directories is, yes, it’s coming back but it’s very slow. And people are reticent to spend money at this point in time. Still, today, it’s just slowness.

So, nothing out there, J.T. that I can point to that says it’s going to be a quick turnaround and advertising in yellow books and magazines and radios are going to flourish again. It’s helped a lot that we have a political campaign right now for the presidency, as well as congressmen and senators. That will be on radio, TV, billboards. We have billboards, as you know. So, all of those have had an impact.

And I think this year that we’re in, this election year that we’re coming in to, is going to be a good one for most of the media portfolio. But it’s still -- it’s still not where it was before the recession. And it’s one of the areas that we worry about but not much you can do other than continue to work hard and put thing together.

J.T. Rogers – Janney Montgomery Scott

Well, thanks, David. That’s helpful. And just one other question. You have been with various shareholders friendly with the credit to base to your incentive and base management fees. Would you all now out earning the dividend? I was wondering if you were reconsidering or considering changing your policy in terms of the credit to base management fee?

David Gladstone

We haven’t gone through that. We go through it once a year and real detail with our Board of Directors and we did it in June -- actually in July, the July Board Meeting. So, we didn’t make any changes then but we always look at it. And right now, that’s not on the agenda.

J.T. Rogers – Janney Montgomery Scott

Okay. Well, thanks a lot.

David Gladstone

Next question, please?


We have a follow-up with Troy Ward with Stifel Nicolaus.

Troy Ward – Stifel Nicolaus

Hi, David, real quick. Can you just give us again -- as we think of the overall funding in the portfolio with a $92 million syndicated portfolio, I’m having a little trouble understanding the real value of that portfolio for shareholders. I mean, as we saw in the last downturn, I mean, that provides liquidity until times get tough and then the liquidity is not there. I mean, you had to sell out of those portfolios -- that portfolio last time at a loss. What is the rationale for holding $90 million as syndicated loans?

David Gladstone

As you just mentioned, the important thing is liquidity. First of all, you say it’s not liquid but it really is. Our proprietary portfolio is absolutely liquid. There is no way to sell that stuff whereas we sold it actually at a 10% premium to where it was valued at. But nonetheless, it provided a way for us to pay off the banks in real trouble times.

I know it’s not something everybody thinks about. It provided a way for us to pay off the banks in real troubled times. I know it’s not something everybody thinks about every day, but I do and that is matching the book. And so, I’d like to match the book with something that I know I can work with.

And if, God forbid, [Peabank] was bought by Deutsche Bank and we needed to get out of that situation, we would have the ability to do that pretty easily even though we might take a hit in terms of the down stroke in terms of the valuation and what we might get for that syndicated loan portfolio. But it does provide us with the opportunity to liquidate that.

And my goal is to build up the right-hand side of the balance sheet with long-term debt and long-term equity as opposed to revolving lines of credit. And we are very thankful with our line of credit, but we know that things can change there overnight. You could have the government put all of these loans to BDCs on some kind of watch list as they have done a few of the BDCs.

And we’re not on anybody’s watch list that I know of. And at this point in time, I think we’ll stay off of it because of the way we structured our loan. But if you talk to some of the lenders, they worry that the government might put these on credit watch of some kind and so as a result, make them put a lot more equity on it.

With the syndicated loans, it helps us with our banks. They understand syndicated loans. They’ve had some in their own portfolio. So, it makes us easier to work with. And if you noticed, a couple of the BDCs out there do nothing but syndicated loans. And they’ve positioned themselves that way.

So, all of the above are the reasons we’re, again, syndicated loans. So, would I like to be 100% in proprietary loans? The answer is yes. I think we get much more bang for our buck there. But at the end of the day, I’m going to keep a good slog of syndicated loans just for liquidity purposes.

Troy Ward – Stifel Nicolaus

Right. Thank you, David.

David Gladstone

Other questions?


(Operator Instructions) Okay. We have a question from Dixon Braden from Morgan Keegan.

Dixon Braden – Morgan Keegan

Hi. Good morning, gentlemen

David Gladstone

Good morning.

Dixon Braden – Morgan Keegan

I was just a little curious, if you could walk me through the rationale behind your preferred offering. It seems kind of small, a little bit extensive. Were you not able to expand that credit facility or were you in negotiations to expand that facility? Just a little color there would be helpful.

David Gladstone

All right. The existing facility is being worked on now. I think we’ll have a term sheet soon. And I think the closing will happen maybe this quarter, but probably most likely next quarter.

So, we’ll end up with a transaction, I think, will be very similar to the one that we have in Gladstone Investment because two of the lenders are the same and one of them is the lead in this Gladstone Capital. No guarantees, of course, but that’s what I believe will happen. And we are getting indications that that’s what’s going to happen.

The problem with the line of credit even though it may turn out to be a two or three year line of credit is that it’s just that it’s short term and what we need is long term. The only long term that we came across that we could issue was the preferred stock.

And our common stock has been beaten down to such a low rate that issuing common at a 10% yield plus some kind of discount for the market would have been astronomically a high capital. We’ve seen some of the BDCs issued that kind of common stock and they’d end up having to cut their dividend.

And while that may be good for them and their long-term outlook, we don’t think cutting the dividend as something that we can do for our shareholders. So, as a result, we run the company with the idea that we search for their cheapest long-term capital we can find. We had engaged several underwriters to work on some debt side for us. We were not able to find any long-term debt that made sense for us. Yes, we found a long-term debt. It was very expensive even more expensive than the preferred.

Actually, the preferred if you compare it to other preferred that have been done in this period of time of 7.125% rate of return was exceedingly cheap compared to what we were told term-preferred or what others have paid in the eight handled some even nine. So, we’ve avoided the expensive capital in order to generate long-term capital and five years doesn’t seem like that long but it is in the marketplace today.

Five-year term that would give us a chance to build up the portfolio, it will be, I think, at the rate that we’re doing transactions today. It should be very accretive to the common shareholders. It should move the earnings per share up over time. And as a result, will put some pressure on our board to declare either an extra dividend or increase the common dividend. At this point in time, it was the best we could find out there and we’re very grateful to the underwriters who made that road show happen for us.

Dixon Braden – Morgan Keegan

Okay. Great. Just one quick question, if I can on your deployment trends. In 2012, you said there -- you’re pretty comfortable with the -- what you’re observing right now in the marketplace. You did say you’re looking for about, what, $140 million next year or something. Would that be fair?

David Gladstone

I wish I could tell you. The problem with that, of course, is that we have a great pipeline. It is very strong and robust today. We have a good feel for the marketplace. There is competition. Your friends that you’ve worked with in the BDC community are competing with us. We see one or two of them from time to time.

It does seem to be a very large marketplace today with plenty of room for us to put loans on the books. It’s just a matter of -- in competitive environment where we’re willing to go at a lower rate and take the risk profile and -- sometimes, we market that and others take it and go with it. And God bless my hope they win. But trading 140 is the number. It would be very hard for me to say.

Dixon Braden – Morgan Keegan


David Gladstone

I’m sorry. I can’t do better than that.

Dixon Braden – Morgan Keegan

No problem. Well, thank you very much for taking my questions.

David Gladstone

Okay. Next question.


The next question comes from Mark Hughes from Lafayette Investments.

Mark Hughes – Lafayette Investments

Just a follow-up on kind of the credit qualities issue, given the size of the accumulated net realized losses as well as the cumulative net unrealized depreciation on the investments, you’re not making loans to IBM in AAA credits or any AA credits. We realize many of your companies will get in trouble periodically.

But I’m a little bit surprised that the magnitude of the losses, of realized and unrealized, when companies are getting in trouble. Maybe some of this unrealized depreciation does come back. But can you talk a little bit about how you protect yourself when a company gets in trouble?

And are there ways you can do this better so that maybe the loss is $0.20 on the $1 instead of $0.70, $0.80 or $0.90 on the $1? How do you go about protecting yourself so that the hit isn’t so extensive when a company gets in trouble?

David Gladstone

Well, Mark, it’s a good question. And at the end of the day, it depends on the ability of the company to generate cash flow. And when hard times come, especially companies that are in media business or in the service business, it can get hammered pretty hard as well as the manufacturers for that matter.

But we do have a security interest in the assets. Sometimes it is the second behind the bank that’s providing the revolving line of credit. And in some cases, it’s the first on the line of credit. When we do these transactions, we look for the amount of equity that’s already in the company, as well as what might be contributed by someone else, such as a buyout fund. And usually, there is a substantial amount of equity in the buyout being put -- placed into the company.

And one of the companies that I think Chip mentioned, he has a situation in which he took over the company in which the buyout firm had put some 30% of the purchase price in equity and they lost it all. We have turned those companies, two of them around in which the equity was lost. And we’ve turned those around now. And then hopefully we will list them for sale this year and recover all of our income, as well as all of our debt that we owed on those.

At the end of the day, there is no good way to salvage a company that has an operating problem that can’t be fixed. If we can fix the operating problem, sure, you can bring them back to life. And sometimes, as it did in KMBQ, it takes you two years. Maybe it was even longer than that one. That one got in trouble. We’ve kind of suffered with it for a year or so before we took it over.

But at the end of the day, it just takes a longer term especially when you don’t have a turnaround in the economy. The economy usually in these recessions has an 18 months and then you’re back in growth mode. This time, we’re three years into this and still not in a growth mode.

So, even though you take over a company and you work it hard, you may not get it back to the position that it can pay you, but in the two that Chip mentioned a few minutes ago. I think we didn’t mention their names. Both of them are now paying as agreed. They’re strong. They’re moving forward and at the end of the day, we’ll have all of our money back plus some capital gains. They’ll offset some of the losses.

I would remind you that over the 10 years and I’m doing from this memory. The track record is such that we have lost a net loss of about 0.5% per year. If you match that up with our overall earnings which tend to be, 11% would be a good number.

You can see the returns then are dramatic. The problem, of course, is that most people can’t wait 10 years. They don’t want to look at a 10 year average. They want to know what you’re going to do for me this year or last year. What they did do for me last year and of course the last three years had been exceedingly difficult for everybody. And at that point, I just have to say, you can’t protect yourself from a disaster and this economy has been a disaster. It’s the worst I’ve ever seen.

I lived through 1980s. I lived through the 1990s and certainly 2001 didn’t touch us very much but it was a bad recession. And this has just been an extraordinary difficult period of time. I’ll remind you that depreciation, you should look that from the perspective of someone like Standard & Poor’s who is looking at this and saying that it’s worth $0.25 on a $1 or even $0.75.

We had one in our other company that was valued at $0.75 on the $1 six months ago and it paid off. When we got our 100 cents back plus all of our interest and I’m not saying that Standard & Poor’s is wrong in their evaluation because that wouldn’t be right for me to say. I just think they’re very conservative and they have to be now after their problems in the housing industry where they were giving out a fairly nice and then high evaluations.

So, we may be under a cloud from S&P being more conservative, but I think if you look overall, if we had to liquidate the portfolio tomorrow, they wouldn’t be far from wrong. And that’s just because we’ve got some deals that are in workout. We now have seven that we have to fix. And I think you’ll see some of them getting fixed in this fiscal year. And others will take a little more time. And I can’t give you a better answer than that, Mark. I’m sorry.

Mark Hughes – Lafayette Investments

Thank you very much.

David Gladstone

Next question.


Actually, there are no more questions at the present time. So, this concludes our question-and-answer session. I’d like to hand the conference back over to David Gladstone for any closing remarks.

David Gladstone

All right. Well, we thank all of you for your good questions and the time that we had with you. And we appreciate it. And we’ll see you next quarter. That’s the end of this call.


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

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