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Gladstone Investment Corporation (NASDAQ:GAIN)

F1Q12 Earnings Call

July 31, 2012 8:30 am ET

Executives

David Gladstone – Chairman of the Board & Chief Executive Director

David A. R. Dullum – President & Director

David Hibbert Watson – Chief Financial Officer & Treasurer

Analyst

John T. Rogers – Janney Capital Markets

David West – Davenport & Company, LLC

[Lee Carter – Private Investor]

Operator

Welcome to the Gladstone Investment Corporation’s first quarter ended June 30, 2012 shareholder’s conference call. All participants will be in listen-only mode for the presentation. After today’s presentation there will be an opportunity to ask questions. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to David Gladstone.

David Gladstone

This is David Gladstone Chairman and this is the quarterly earnings conference call for shareholders and analysts of Gladstone Investments. The common stock trading symbol is GAIN and the preferred stock trading symbol is GAINP. Again, thank you all for calling in, we’re always happy to talk to stockholders about the company and I wish we could do it more often. We’ve been trying to figure out a way we can talk to you more often about the company. We haven’t come up with one yet.

We all hope you take the opportunity to visit the website at www.GladstoneInvestment.com where you can sign up for email notices where you can receive information about your company on a timely fashion. Please remember that if you’re in the area, the Washington DC area, we’re right a stone’s throw from Washington DC and McLean Virginia so stop by, say hello. You’ll see some of the finest people in the business right here in this office.

This is a reminder that we’re holding our annual shareholders meeting next Thursday, August 9th at the Hilton McLean Tyson’s Corner located at 7920 Jones Branch Drive in McLean, Virginia. Please remember if you’re not coming to vote your shares or you can vote your shares and still come. We have a lot of items on the proxy and we’d like to get your approval of those so we don’t have to spend a lot of money calling people at dinner time trying to get them to vote.

Now, before I get started I need to read a 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 and other factors even though they’re based on our current plans and we believe those plans 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 future results that are expressed or implied by these forward-looking statements including those factors listed under the caption, “risk factors” in our 10Ks and 10Qs and other filings that we have, especially our registration statement that is filed with the Securities & Exchange Commission. All of which can be found on our website at www.GladstoneInvestment.com or at the SEC website which is www.SEC.gov.

The company undertakes no obligation to publically 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. So please also note that past performance or market information is not a guarantee of future results.

First of all we’ll hear from Dave Dullum. Dave is the President and a board member of the company. He’ll cover a lot of ground including his future views of this fund. Dave, take it away.

David A. R. Dullum

Just as a reminder, the business of Gladstone Investment is to invest in buyout transactions of businesses in the lower middle market. Our investments are primarily subordinated debt with equity and occasionally some senior debt. This combination produces a mix of assets in our portfolio which is key to our strategy. Our debt investments provide income to grow the dividends while we seek to build shareholder value through capital appreciation of the equity investments.

In this regard, at June 30, 2012 quarter end, our investment assets debt cost consisted of a mix of approximately $198 million or 72% in debt investments which produces income and about $78 million or 28% in equity securities which we expect will produce capital gains. This ratio of 72/28 is slightly higher in equity than our goal of 80/20 at costs. Of course there are a number of factors at any time that affect this ratio including loan payoffs and if there are any debt-to-equity conversions in our portfolio companies.

In the most recent quarter our total interest bearing debt portfolio had a 12.5% cash yield up from 12% in the prior year quarter. This is our primary source for paying our dividends. Additionally, we often negotiate success fees as a component of our debt instruments. We recognize these success fees as income when we receive the cash. Success fees are contractually due upon a change of control or sale of a portfolio company and they’re generally not recognized as income until received.

So during this most recent quarter we received cash and reported success fee income of $400,000. Further, as of June 30, 2012, approximately 79% of our interest bearing debt has success fees attached to that and is due to us with an average contractual rate accruing at 3.4% per annum. In total this has created accrued success fees of approximately $8.1 million or about $0.37 per share although we do not have these success fees accrued on our balance sheet. Mainly, there is no guarantee that we will be able to collect all of our accrued success fees or knowing the timing of such collections due to this contingent nature.

As to the equity that we own in each business, while we are not producing cash income, we do expect them to appreciate and add value over time. As an example, since mid 2010 when we started taking some gains we have realized capital gains of about $28.5 million through the stock owners in various portfolio companies. So as we grow our portfolio we will seek to increase the interest income obviously to pay dividends but also seek asset appreciation through growth in our equity value of the stocks we own.

We certainly believe this is reflected in our net asset value or book value per share which has grown modestly over the last year from about $9.06 as of June 30, 2011 to about $9.10 as of June 30, 2012. And at the same time we were able to increase the dividend payout rate by over 11% for that same period. Our primary goal is grow our dividend shareholders while increasing the total asset value.

So how do we do this? Well, we generally obtain our investment opportunities by partnering with the management team, private equity funds and other sponsors of buyouts. Our combination of debt and equity we believe gives us a competitive advantage in this arena because it provides to very important and necessary portions of the capital structure in a buyout transaction.

In addition, we may find opportunities to provide capital in support of business owners and the management teams who are not seeking to sell their company outright but perhaps to sell a portion of their company to us. In this case we will invest in debt and in equity in exchange for a significant ownership in that business and in other cases where the owners of the business have a need to strengthen their balance sheet for growth, we would invest in debt and equity for this purpose. We look upon this as we call it growth capital investing.

Our activity now over the last four months and since our March fiscal year end we added three new buyouts to our portfolio. During the fiscal first quarter which ended June 30 we made one investment of $9.5 million in a company called Packerland Whey products. Packerland is a process of raw fluid whey which is specializing in the production of protein supplements for dairy and beef cattle. Then in July after the quarter end we invested $22.5 million in a company called Ginsey Holdings which is a designer and marketer of a broad line of branded juvenile and adult bathroom products.

In the next day or two we also expect to fund $21 million in a new portfolio company that is in the business of foam molding and fabricating for packaging, construction, and insulated shipping contained applications. I will not mention the name here as we have not completed this but will be done so in the next day or two. Including this expected funding in the aggregate we’ll be investing $35 million in debt and $18 million in equity in these three buyouts for a total of $52 million.

During the quarter we invested $3.3 million in four of our existing portfolio companies and received $2.9 million in repayments. After the quarter end we invested $2.6 million and received principle repayments of $500,000 from our existing portfolio companies. As a result, at the end of the quarter we had $276 million invested in portfolio companies at cost with additional activity after quarter end we will have approximately $322 million invested in portfolio companies at cost.

We were able to maintain our dividend to stockholders for the quarter ended June 30, 2012 of $0.05 per month per common share and our board also declared a dividend of $0.05 per month per common share through September of this year. We hope to continue the favorable dividend payouts for the foreseeable future.

As to the current portfolio, in general the companies are performing though not without challenges. We’ve experienced decreased valuations over the past few quarters, though for the past 12 months our portfolio valuations have increased by $2.4 million. This frankly is why we work very diligently through our investment management approach to really limit losses, continue to increase equity value and most importantly, or as importantly, reserve the cash flow from these portfolio companies.

These activities, as I have mentioned in the past, include one, strategic and business planning and this is where we really work with outside resources to really assist the portfolio companies in continuing to review their competitive positioning and talent among other key business metrics. Also and most importantly, we will provide operating management support when necessary. We are able to tap experienced operating management talent from either our staff or from a pool of talent we’ve cultivated over the years.

This activity helps portfolio companies streamline operations and evaluate add on acquisitions when they come up. We also conduct conferences for the CEOs of our portfolio companies. This facilitates interaction between the portfolio company’s management teams so they can exchange ideas such as best practices in purchasing, pricing, organizational help, and manufacturing disciplines. We believe these activities to be extremely important not only for the competitive strength while adding value to our portfolio but frankly it’s helpful in maintaining the underlying value of our portfolio companies.

Regarding the opportunities that we see out there in the market for companies in the buyout area, we think these opportunities right now are pretty good in both quality and quantity. General economic conditions do create some uncertainty obviously but we continue to see improved stability and middle market companies returning to profitability. This improvement is causing an increase in the supply of quality businesses for sale as owners are taking advantage of these positive results.

Also, senior bank financing is available and reasonably priced which accommodates leverage transactions which of course is where we’re involved. So as a result, we are finding opportunities where the valuations, in other words what we would look to pay for a company, relative to their trailing EBITDA or operating cash flow at multiplies that are around five to 6.5 times for good companies. We also are seeing higher valuations but these we’ve tended to avoid and will try to do so as we look at the risk versus return ratios.

To keep our pipeline growing we have stepped up our marketing and deal generating activity to stress our competitive advantage of being able to provide the subordinated debt and the equity to complete a transaction. However, we do continue to be cautious about the economy and are diligent in our pursuit of new investments.

We believe that our marketing efforts and presence in the marketplace should allow us to continue on a growth trend with additional new investments over the next year somewhat demonstrated by the activity I mentioned at the beginning of the call. Our outlook for this fund is to maximize distributions to shareholders which we’ve increased a total of 11% over the past 12 months while achieving solid and good growth of both equity values and assets in the portfolio through the proprietary investments in the lower middle market company buyout arena.

With that, David this concludes my part of the presentation.

David Gladstone

Now, let’s hear from the CFO and Treasurer David Watson on the fund’s financial performance for this quarter.

DH

I’ll start with the balance sheet. At the end of the June quarter, we had $350 million in assets, $230 million in investment debt carry value, $113 million in cash and cash equivalents, and $7 million in other assets. Included in the cash and cash equivalents is $85 million of US treasurer securities which we purchased through the use of borrowed funds at quarter end to satisfy our asset diversification requirements.

We had $149 million in liabilities consisting of $40 million in term preferred stock, $31 million in borrowings outstanding on our three year credit facility, and $76 million borrowed via the short term loan and $2 million in other liabilities. In all, as of June 30, 2012 we had $201 million in net assets or $9.10 per share so we were less than one-to-one leverage on our senior secured borrowings.

Currently, assuming the aforementioned new portfolio company funding today or tomorrow, we have investments at fair value of approximately $275 million, cash of $5.1 million and $44 million in borrowings on our credit facility. We believe this to be a safe and conservative balance sheet for a company like ours and we believe that our overall risk profile is low.

Moving over to the income statement, for the June quarter end total investment income was $5.9 million versus $5.3 million in the prior year quarter while total expenses including credit were $2.7 million versus $1.8 million in the prior year quarter leaving net investment income which is before appreciation, deprecation gains or losses of $3.2 million versus $3.5 million for the quarter last year, a decrease of 7.5%. This decrease was primarily due to an increase in dividend expense of $0.7 million from our termed preferred stock issued in March of 2012 and a decrease in other income of $0.5 million due to dividends received in the prior year quarter from our recapitalization of [Caperts].

These decreases are partially offset by an increase in interest income due to a larger interest bearing portfolio and higher yield on our debt investments resulting from the new investment activity since June 30, 2011 which increased our interest income by $1.1 million during the current quarter.

I think it is important to point out that our weighted average yield on interest bearing debt investments increased to 12.5% in the current quarter up from 12% in the prior year quarter. This is primarily resulting from exists from three lower interest bearing investments which had an aggregate weighted average interest rate of 9.7% at the time of their respective exits and the addition of four higher yielding debt investments who had a weighted average interest rate of 13.2% as of June 30, 2012.

From a quarter-over-quarter standpoint our net investment income was down $0.3 million from the $3.5 million that we recorded in the 3/31/2012 quarter. This is primarily due to increased capital cost related to the term preferred offering not being offset by increased interest income as it took time to put the non-yielding cash we received from the term preferred offering to work in new investments given that expense increased $0.5 million but interest income only increased by $0.01 million during the quarter. Now that we have put all the non-yielding cash to work this decrease in our earnings should be temporary.

Let’s turn to realized and underlying changes in our assets. Realized gains and losses come from actual sales or disposals of investments. Unrealized appreciation and depreciation comes 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. Unrealized appreciation and depreciation is a non-cash event.

Regarding our realized activity for the June, 2012 quarter end we recorded a realized loss of $46,000 related to post closing adjustments to previous investment exits. As for our unrealized activity for the June 2012 quarter end we had net unrealized depreciation of $5.7 million over our entire portfolio which was primarily due to decreased performance at certain of our portfolio companies and to a lesser extent a decrease in multiples which resulted in some depreciation in our equity investments.

Our entire portfolio was fair valued at 83% of cost as of June 30, 2012, slightly down from 85% as of March 31, 2012 and our stock is trading at 81% of net asset value per share. This means that the current price of our stock is 34% below the cost basis of our net assets.

Now let’s turn to net decrease or net increase in net assets from operations. This term is a combination of net investment income, unrealized net appreciation or depreciation, and realized gains and losses. For the June 2012 quarter end, this number was a decrease of $3 million or $0.13 per share versus an increase of $4.2 million or $0.19 per share in the prior year’s June quarter. The year-over-year change is primarily due to net unrealized depreciation in the current quarter versus net gains in the prior quarter.

While we believe our overall investment portfolio is stable despite certain depreciation over the last six months and continues to meet expectations, today’s markets move fast and are generally volatile and investors should expect continued volatility in the aggregate value of our portfolio. Currently, all of our portfolio companies are current in payment except for two ASH and [PPE] which remain on non-accruals this quarter.

Regarding interest rate risk, 76.5% of our loans have variable rates but they all have a minimum or floor in the rate charge so with the low interest rates that we have experienced over the last several years these floors have minimized the negative impact on our ability to make distributions. The weighted average floor on our variable rate loans is 3.1% with an average margin of 10% resulting in an all in average rate of 13.1%. The remaining 23.5% of our loans are fixed with an average rate of approximately 11.7%.

On the other side of the balance sheet with borrowings outstanding we have an existing straight cap of $50 million of debt on our credit facility in order to have some protection on our cost of funding of interest rates if interest rates rise over the next couple of years.

With that we look forward to maintaining momentum and hope to continue to increase our income generating assets to increase our recurring income and to increase our distributions to stockholders. Now, I will turn the call back over to Dave.

David Gladstone

I hope each of our listeners will read our press release and also obtain a copy of our quarterly report called a 10Q which had been filed with the SEC and can now be accessed on our website at www.GladstoneInvestment.com and also on the SEC website.

I think the big news for this quarter is that we’re still actively investing in new portfolio companies and I think the rest of the fiscal year will show us continuing to increase the assets and hopefully increase the income and maybe that will get us to a point where we can increase the dividend. We have been active in the capital markets where we were able to get some long term capital in March with $40 million term preferred stock offering. Additionally, we have a favorable line of credit with BB&T and Keybank and room to borrow under the loan so we’re looking for new investments these days.

We still have some worries out there in the marketplace. We’re always worried about the economy, it’s not growing, it seems to be contracting a bit these days so it’s a difficult time to invest because so many [inaudible] and the mix analysis. We’ll ask questions about the things that I’m going to mention now one very transaction that we look at. For example, what if oil prices spike because of something going on in the economy? Oil prices are too high today and supply is too dependent on countries that don’t wish us well. All of these high gas prices and cars and trucks hurt every business in the United States. So we need to develop much more oil and gas here in the United States and we hope that we’ll continue to drill here and also find more and more gas so that we don’t have to worry about bringing gas and oil into the country.

We still worry about inflation, the decision by our Congress and President of the US to expand the money supply will ultimately cause serious inflation. There’s just no way of getting around them printing that much money and the idea that we can borrow and spend our way to prosperity has been disproven so many times it seems ridiculous that we have to say it again especially if you look at the Great Depression. In 1929 the government caused the ’29 Depression to last many years longer than needed by over spending. If you look back at the recession of 1920/21 the government stayed out of the way and the country recovered relatively quick.

Spending by the federal government is still out of control in my estimation. The government can’t continue to print this much money and we’re now borrowing at least 43%, probably closer to 50% of the dollars that we’re spending by the federal and state governments. The amount of money being spent on the war in Afghanistan thankfully is coming slowly to a close and we hope it will stop next year or the year after. All of us support our troops of course, they’re true heroes they’re the ones that go out and risk their lives for us every day and we pray for their safe return home.

Of course the government is now talking about taxing again and of course they’ll only [inaudible] but who believes that? The middle class pays the bulk of the taxes in this country and I know they’ll hit them with more taxes as time goes on. The trade deficit with China continues to have a certain impact on us. It’s just terrible because China continues to subsidize their industries, they continue to play with their currency and it’s all to the disadvantages of our business here. That means our companies can’t compete with them and jobs leave the United States and go overseas where taxes and regulations are much stronger.

We continue to see the downturn in housing. It doesn’t seem to be getting any worse but it certainly doesn’t seem to be getting any better. No one knows how many home mortgages will ultimately fail. There’s trillions of dollars out there and we’re hopeful that that problem will be solved in the next year or so. That was the main cause of our big recession that we’ve had and we hope that quick recovery will come in the next couple of years.

The economic problems in the Euro zone continue to hurt some companies. We were lucky that most of our companies have no investments in Europe and we certainly have no investments and so as a result we think the European problem that is one that will hurt the banks in the United States but not our companies directly. And of course, the unemployment in the United States is way too high and numbers used by the government quite frankly don’t include those who are working part-time but seeking full-time work and those who have stopped looking for work at all. A more realistic number if you believe the numbers that are put together by others is closer to 18%.

In spite of all of that we see some – although there are negatives, we see a lot of positives in the US today. It’s not a disaster, there’s a lingering recession having an impact on our portfolio companies. Thank goodness it’s not as much of a disaster as it was in 2009 and ’10. Like most companies some of our portfolio companies have not seen a good increase in revenues or backlogs. However, some of the others are seeing tremendous increases and we’re just seeing unbelievable increases. It’s a very uneven recovery now depending on which industry you’re in and who the customers are that you’re selling to.

We believe that the downturn that began in 2008 has reached a bottom. I don’t think there’s going to be a double dip although there are some people beginning to call for that now but I doubt it will happen and if it does it will be a small dip of 1% or 2% downturn. By the way, the distribution declared by the board for July was $0.05 per month for July, August, and September. This is a run rate of $0.60 a year. The board is going to meet again in October to consider and vote upon the dividend for October, November, and December.

At the current distribution rate the common stock is about $7.40 yesterday so the yield is 8.1%. It’s a very high yield considering the strength of this company. Our monthly distribution of $7.125 on our term preferred translates into an annual income of $1.78 on the preferred stock. So a good 7% yield, a little over 7% yield on the preferred stock because it’s trading at $25.29 yesterday and you can see that stock under the symbol GAINP.

Again, our annual meeting will be held on Thursday, August 9th at the Hilton in McLean. Please note your shares so those pesky calls that you’ll get at dinner time don’t happen. If you just get on www.ProxyVote.com and vote your shares, you can do it over the Internet and of course you can call your broker and they can help you do that as well.

Please go to our website and sign up for notification service. We’re not sending out junk mail. You can also follow us on Twitter using the name GladstonComps and you can find us on Facebook keyword The Gladstone Company.

In summary, as far as we can see the next six months looks okay. Although the economy is weak we don’t see any reason for us to get worried about it at this point in time but we can only see a couple of quarters out so we want to be careful. We’re stewards of your money and looking for new investments now and hope that some of the ones that we have, have some great news for you in the future.

Now let’s stop and have the analyst and some of the shareholders ask us questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John T. Rogers – Janney Capital Markets.

John T. Rogers – Janney Capital Markets

It looks like you had a nice ramp in origination activity in the last quarter and so far this quarter. I was wondering if you’re seeing that continue through year end or is this maybe just a temporary lift in originations and we expect it to go back down to a lower run rate.

David Hibbert Watson

As you well know this business is hard to predict. So it’s a relatively lumpy business as we say. We try to smooth it the best we can. We keep working filling the pipeline. We certainly have a number of investment opportunities we’re working on in various stages with indications of interest. A few that are in kind of a letter of intent phase. So over the next six to nine months we think we’re pretty close to our basic plan but certainly we would not be able to say for sure that exactly what we’ve done the last few months we can exactly replicate but we’re working at it.

John T. Rogers – Janney Capital Markets

What leverage levels at the BDC level are you comfortable with? And, how much do you see coming from the line of credit versus other sources of debt?

David Gladstone

We always get nervous once we pass the 50% of equity and start to worry as we move up closer to one-to-one leverage obviously. So maybe you might get to .7 times and start to feel uneasy and move on up. But, if you knew you were going to do an offering of more preferred, or you had a debt offering, or you were expanding your line of credit we might have room to go a little further than that. But generally speaking you’re going to see us be very conservative. We’re not going to be at .9 to 1 unless something crazy goes on in the economy.

John T. Rogers – Janney Capital Markets

So up to .7 including debt to equity – you would do that on the line of credit or would you look for another source?

David Gladstone

All of those things, the line of credit, the preferred stock, any debt issuances we do, and including any guarantees that we might make of a portfolio company, all of those count as senior securities and they go into the formula. So you look at your equity side based on the appreciation or depreciation that’s going on and then you measure that against what you’ve got in that other bucket which is the debt, and preferred, and any kind of guarantees.

John T. Rogers – Janney Capital Markets

Then just wondering if you’ve started talking with your lenders about expanding availability or been approaching other lenders about expanding the revolving line of credit?

David Gladstone

As you know, we have other lenders in our other lines of credit and we’ve begun to talk to them about increasing our line as well. I’m not sure where we’ll go with that but at some point in time you can only borrow or used preferred for so many ways and then you have to go to capital marketplace for common stock.

Operator

Your next question comes from David West – Davenport & Company, LLC.

David West – Davenport & Company, LLC

I noticed in your press release you recently gained some recent approval to do some co-investing with other groups. Can you talk about that recent approval and maybe where you stand in that process? Is that likely to be a tool that you’ll use?

David Gladstone

Well, it’s final now and as you probably remember we had a co-investment approval with our partnership that we never got raised. It was a little bit difficult time to be raising money so we just expanded that and got it so that the two business development companies can co-invest where their goals and objectives are the same, their strategies fit. If we had something that fit into both of those then we would do co-investing and that would probably allow us in some cases to do a larger transaction than we’ve done in the past. But it really doesn’t change anything for us other than the ability to do a little bit larger transaction and to quite frankly, make in this company, almost every transaction qualify within the definitions used by the SEC and the Registered Investment Company Act.

David West – Davenport & Company, LLC

Turning to the valuations on the portfolio, you mentioned in some cases some lower multiples being assumed. Was that driven from your use of third-party S&P advisory services?

David Gladstone

I’m not sure what you mean.

David West – Davenport & Company, LLC

You utilize S&P in your valuation as a third-party looking at the valuations of your portfolios. You mentioned in the call that some of the valuation, the lower valuation of the portfolio was driven by lower assumed multiples. Was that largely driven by S&P?

David Gladstone

No that was actually we subscribe to some services that provide us with multiples are going on in the marketplace. So if buyout multiple has moved and we look at the multiple we had on that when we purchased it we adjust it by that amount. Just to use a simple example, if we bought something at five times EBITDA and the marketplace has now moved to seven times, we don’t move up to seven times it’s just when the market moves from one place to another we use that delta, that percentage change to change that original number of 5% up or down depending on what’s going on in the marketplace. Those multiples are all market driven and not really coming from Standard & Poors.

David West – Davenport & Company, LLC

Just as a reminder, this may have been something done last quarter but on Country Club Enterprises CCE, the value looks like it’s up from the prior quarter but I think that’s because of some new financing you provided. Is that correct?

David Gladstone

No it’s the multiple and the company is back earning strong again this year. So when you have earnings – obviously when we don’t have earnings we end up valuing them down pretty significantly. This one happens to be coming back very strongly this year that we’re in so as a result its value has gone up due to performance.

Operator

Your next question comes from [Lee Carter – Private Investor].

[Lee Carter – Private Investor]

You usually talk about the owner control 15 or 17 companies. How many of those might be not earning money and how many might come to fruition over the next year or is there no way of saying that?

David A. R. Dullum

It’s hard to say. We always continue to evaluate the opportunity to sell a company generally, as we like to say, driven by the management team if they believe the time is right and we sort of follow the management team. It’s hard to predict where we would be in that right now when we don’t have any. I can tell you we’re in active conversation from that perspective. Then obviously they all, with the exception of the two that we mentioned and referenced that are in what we call non-accrual, everybody is earning relative to what we invested. Hopefully that answered the question.

[Lee Carter – Private Investor]

I just thought there might be a substantial capital gain in gain sometime because one or two of the companies are probably doing in excess of the market?

David Gladstone

We do have some companies that are very strong in the portfolio but we’re not ready to sell them. Just because they pick up and start earning a lot of money, if the management team wants to continue to build it our goal is to build that company and have a later capital gain rather than one today. So the idea is to keep building on some of these. The other three that we have sold or partially sold on one, were all driven by management saying they wanted to sell the company at that point in time. We follow management generally speaking. I don’t know that we’ll ever have a situation in which we will mandate that they do it.

There’s another exit strategy on a lot of these that are being used today by some of the buyout funds and that’s what is called a dividend recap. All that means is once a company has gotten very profitable and they’re paying down the debt one way of not selling it but getting a return is just to borrow money and dividend it out to both us as an owner and the management team as the other owner. That works very well for some of us to take money out of these companies. But, we haven’t done that yet and I expect that somewhere along the way you’ll hear us talk about that. But that’s the other way of not selling but getting a return.

[Lee Carter – Private Investor]

I noticed and I don’t know if it’s a gain, I get confused on occasion, you’re now out on the west coast, will they offer you different kinds of opportunities than you have?

David Gladstone

No. We opened the LA office and I think it’s the same thing we’ve always done, it’s just we’re closer to some of the transactions that are going on in the California marketplace and the upper northwest. It’s just another opening of a marketing office if you want to think about it that way.

Operator

Your next question comes from John T. Rogers – Janney Capital Markets.

John T. Rogers – Janney Capital Markets

Just a couple of questions on the portfolio. A couple of people mentioned before CCU fair value is marked back up to par. I was wondering if you all were expecting that to come back on accrual status any time in the near future?

David A. R. Dullum

Obviously we keep working with all our companies to keep them and get them back on accrual and we certainly would hope so. Other companies performed, as we mentioned, very well and David mentioned the valuation reflected that. We just keep working it so as soon as we believe that the strength is there we will put it back on accruals so keep looking for it.

John T. Rogers – Janney Capital Markets

Two companies that saw weakness in the quarter Danco they’re undergoing conversion to the long run parts machining. How is that progressing? Are they continuing to see margin pressure? I just wanted to get an update on that.

David A. R. Dullum

I would actually say they are improving overall. Their mix of business is less focused on their key customers. I think we’ve mentioned it’s going to process for a company called Intuitive Surgical that makes the da Vinci robotic machine. Actually, they’re coming out with a new version of that machine and actually we started making parts for the new version as well. So between all that transition and their backlog is picking up looking good, doing some work internally on the operation side of things, so we feel good about that business. It’s been in a bit of a slump frankly but it’s headed we think in the right direction.

David Gladstone

We continue to work with these guys as we mentioned earlier. All our portfolio companies, we take it very seriously, they’re all good companies sometimes they just need a little bit of help and we try to work with them to bring that in and that’s what I think we’re seeing there.

John T. Rogers – Janney Capital Markets

Was the decline in fair value there a result of multiple decline rather than weakening performance or cash flow?

David A. R. Dullum

Yes it’s been weakening. Of course, our valuation reflects a trailing 12 so with them coming out of the slump you’re seeing that [inaudible] haven’t dropped off some of the tail end of the decline and starting to move them in that direction. So it’s performance based but again, we are working it the right direction.

John T. Rogers – Janney Capital Markets

Then just one last one, Noble Logistics we saw a little bit of weakening in the fair value this quarter and I was wondering what’s going on there?

David A. R. Dullum

Again, a similar thing we went through a slight decline again on the trailing 12. We recently improved the management team there, added a new gentlemen as the president and CEO and that business is now headed again in the right direction. So just a temporary point in time in terms of the valuation.

Operator

(Operator Instructions) As there is nothing more at the present time I would like to turn the call back over to David Gladstone for any closing remarks.

David Gladstone

Thank you all for calling in and we hope to see you at the shareholders’ meeting next week. Please a reminder, please vote your shares so that we can move that swiftly through the process. That’s the end of this call.

Operator

Thank you. That does conclude today’s teleconference. You may now disconnect your phone lines. Thank you for participating.

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