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Gladstone Capital Corporation (NASDAQ:GLAD)

Q2 2012 Results Earnings Call

August 2, 2012 8:30 AM ET

Executives

David Gladstone – Chairman

Chip Stelljes – President and CIO

David Watson – Chief Financial Officer and Treasurer

Analysts

Troy Ward – Stifel Nicolaus

Lee Carter – Private Investor

J.T. Rogers – Janney Capital Markets

Casey Alexander – Gilford Securities

Operator

Good morning. And welcome to the Gladstone Capital Corporation’s Third Quarter Ended June 30, 2012 Shareholders Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation there will be an opportunity to questions. (Operator Instructions)

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

David Gladstone

All right. Thank you Amy for that nice introduction and hello, and good morning to all of you who called in. This is David Gladstone, Chairman, and this is the quarterly earnings call for shareholders and analysts of Gladstone Capital. Common stocks traded on the symbol GLAD and the term preferred stock trading symbol GLAD with P on end, both which are traded NASDAQ and thank you all for calling in.

We are always happy to talk to shareholders about our company and I wish we could do it more often. We help you to take the opportunity to visit our website at www.gladstonecapital.com where you can sign up for e-mail notices, so you can receive information about your company on a timely fashion.

And please remember that if you're in the Washington D.C. area, you have an open invitation to visit McLean, Virginia. Please stop by and say hello, you’ll see some of the finest people in the business.

Now, I’ll read the statement about forward-looking statements. This conference call may include statements that may constitute forward-looking statements within the meaning of Securities Act of 1933 and 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 and we believe those plans to be reasonable. Many of these forward-looking statements maybe identified by the words such as anticipate, believe, expect, intend, 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 and 10-Q filings, most recent form that we filed and into registration such statement, all of these filed with the Security Exchange Commission and can be found on our website at www.gladstonecapital.com and also on the SEC website at 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. Please also note that past performance or market information is not a guarantee of future results.

Has we do each time, we start with our President, Chip Stelljes. President is also -- Chip is also the Chief Investment Officer of all our Gladstone publicly -- public funds. He'll provide a review of the company's last quarter events and then outlook for the company over the next several quarters. So Chip take it away?

Chip Stelljes

Okay. Good morning. During this quarter the three months ended June 30, 2012 the company’s net production totaled $21.4 million due primarily to the new investments totaling $33 million, invested $16 million in debt and equity in Francis Drilling Fluids, a logistics network provider to oil and natural gas drilling companies and invested $12 million in senior and senior subordinated debt investments in POP Radio, an advertiser supported in-store audio network.

In addition, we invested $3.6 million in existing portfolio companies through revolver draws or additional debt and equity investments, offsetting the new production repayments, which included normally amortization and pay down on revolver a $15.2 million, this includes three early payoffs at par, totaling a combined $8.3 million during the quarter for which we received $200,000 in prepayment fees.

Additionally, we received $800,000 in success fees during the three months ended June 30, 2012, generated from an exit of a proprietary investment earlier in fiscal year 2012. This brings our success fees earnings totaled during fiscal year 2012 up to $2.8 million or approximately $0.13 per common share for the nine months ended June 30, 2012 and we’ll discuss our success fees in more detail later on the call.

We funded this net increase and production from operating income and current withdrawals on our credit facility which matures in January 2013. As subsequent to quarter end we had early payoff of one proprietary investment totalling $12.6 million for which we received an additional $1.2 million in success fees. Furthermore, we invested $300,000 in pre-existing portfolio companies and have received $5000 in repayments.

In addition, we received approval in July 2012 from Securities and Exchange Commission to co-invest with certain affiliated investment funds, including Gladstone Investment Corporation subject to certain conditions, which we believe will enhance our ability to further our investment strategy and objectives.

We continue to be optimistic about our pipeline from new deals over the next several quarters. We are still seeing solid investment opportunities and improving marketplace, which sort of align with our investment strategy and objectives. However, there seems to be a good deal of capital and competition in the market for the most attracted deals.

We were able to access the long-term capital market in November of ‘11 by raising $38.5 million in term preferred stock and believe this along with the extension of our credit facility until 2015, we’ll provide the capital growth portfolio and increase our net investment income over the long-term. We continue to access other long-term capital markets to raise further capital to grow the portfolio.

At the end of our third quarter we had eight portfolio companies either fully or partially on non-accrual status. We added the remaining revolver and seen the term debt of Sunshine Media Holdings to non-accrual status effective April 1, 2012 based on company’s performance and increase the length of time projected for them to execute their business plan.

We remain focused on managing our current portfolio, so we can decrease the number of companies on non-accrual either through sales or restructures over the several quarters. Investments classified as non-accruing had cost basis of $62.4 million, or about 16.3% of the cost basis of all debt investments in our portfolio as of June 30, 2012.

From a fair value perspective, the non-accruals fair value represents $5.3 million about 1.9% of the fair value basis for all debt investments in the portfolio at quarter end.

When we think to mitigate our interest rate risk by having a high concentration of variable rate loans in the portfolio, so when rates begin to increase, we should have higher income. And while our loan rates are variable, they usually have a minimum rate of 4, so the effects of declining interest rates are mitigated.

We target to have a large part of our portfolio with variable rate, a company with minimum floors with the remainder of the portfolio being at fixed rates. For the quarter ended June 30, 2012, approximately 88% of our loans at cost have floors, 6% of our loans do not have floors or ceilings, and the remaining 6% of our loans have relatively high fixed rates.

The weighted average floor our variable rate loans is 2.4%, in relation to one-month LIBOR with an average margin of 8.9%, resulting in all an average rate of 11.3% our income producing investments.

Quality of our income continues to be good. We generate -- limit income generated from paid in time or original issue discount structures. These generate non-cash income, which has to be accrued for booked in tax, but is generally not received until much later, and sometimes not at all.

This type of non-cash income is subject to our 90% payout requirement, so we would be paying out cash in distribution to our non-cash income. As of September 30, 2011, we had no investments that will pick income and we had minimal pick income during the three and nice months ended June 30, 2012. We recorded OID income in the third quarter of 2012 of $100,000, which is consistent with our prior quarters.

Success fees are contractual due upon the change of control by portfolio company and generally through the sale of that company and really not recognized until they received in cash.

We doing a success fees of $800,000 during the quarter ended June 30, 2012, a $2.8 million for entire first nine months of the fiscal year 2012 and exist of certain portfolio companies. We don’t include success fees in our reported yields that are not consistent and which give our actual current cash run rate.

As of June 30, 2012 approximately 35.4% of our interest-bearing debt investment have success fees related to them, and those have an average contractual accrual rate of 2.5% per annum on the principal balance sheet.

That set June 30, 2012 we had current contractual obligations in aggregate of $12.8 million in success fees on our prudent debt investments. I would now recorded this contingent income on our balance sheet for U.S. U.S. generally accepted accounting principle, we hope it will show up in future earnings, there are no guarantees that we’ll be able to collect all these success fees or know the timing of such collections due to their contingent nature.

As for as the marketplace, the senior and senior subordinated debt marketplace for large and middle-market companies continues to improve, albeit inconsistently. We believe the encouraging economic trends in this marketplace coupled with some descent liquidity.

Market for loans to companies at the low end of the middle market in which we seek to invest our capital are seeing more competition, but again not really from banks, competition is generally coming from other public fund like ours and many small private funds.

Our new propriety deal pipeline continues to be good. We hope to show you some more quality investment additions to the Gladstone Capital portfolio over the next several quarters.

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

David

All right, good report. Now, let's turns financial Skoda we’re here from David Watson, our Chief Financial Officer and Treasurer, David.

David Gladstone

All right. Good report. Now let’s turn to financials for that we hear from David Watson, our Chief Financial Officer and Treasurer. David?

David Watson

Great. Good morning, everyone. Yesterday we released our third fiscal quarter earnings press release and Form 10-Q, which had -- which I hope you had a chance to review. On this call I will cover some our financial highlights and I will start with the income statement.

For our third quarter ended June 30, 2012, net investment income was $4.9 million versus $4.5 million for the same quarter last year, which is an increase of 7.4%. This increase was primarily due to an increase in interest and other investment income of $1 million.

Interest income increased by $0.5 million or 5.2% during the three months ended June 30, 2012 as compared to the prior year period. This was due to an increase in the overall portfolio size and an increase in the weighted average yield, as compared to the prior year period.

The annualized weighted average yield on our interest-bearing debt investment or accruing debt investment was 11.3% for the third quarter of 2012, as compared to 10.8% for the third quarter of 2011. The increase in the yield of our accruing debt investment is primarily due to the addition of new high-yielding proprietary investments subsequent to June 30, 2011. The early payoff with some of our syndicate loans that generally bear lower interest rates and finally the placement of certain loans on non-accrual that had lower interest rates.

Other investment income totaled $1 million for the three months ended June 30, 2012, an increase of approximately 120% over the prior year period and consisted primarily of success fees of $800,000 from the early payoff at par of a proprietary investment earlier in 2012.

Partially offsetting these increases to net investment income were increases of $0.9 million in aggregate of interest and dividend expense, due to increased borrowings under the credit facility and payment of $0.7 million in term preferred dividends during the three months ended June 30, 2012. Our weighted average borrowings increased during the three months ended June 30, 2012 by $17.2 million over the prior year period.

For the nine months ended June 30, 2012, net investment income was $14.5 million versus $13.6 million for the same period last year, an increase of 6.6%. This was primarily due to an increase in the weighted average principal balance of our portfolio by $49 million or 70.6% when compared to the prior year period. Partially offsetting these increases to net investment income was an increase of $3.8 million in aggregate of interest and dividend expense due to the same reasons described for three months period.

On a weighted average common share basis, net investment income for the current quarter was $0.23 per share compared to $0.22 for the quarter ended June 30, 2011. Net investment income per weighted average common share for the nine months ended June 30, 2012 was $0.69 per share compared to $0.65 per share for the nine month period in the prior year.

So, 100% of common and preferred stock distributions paid in the first three quarters of fiscal 2012 were covered by our net investment income. This highlights our commitment to prudent growth.

Let's turn to realized and unrealized changes in our assets. Realized gains and losses come from actual sales or disposables of investments.

Unrealized appreciation and depreciation come from our requirement to mark our investments to fair value on our balance sheets 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 investment activity, we had minimal realized net gain activity for the third quarter of fiscal 2012 and 2011. For the nine months ended June 30, 2012, we had a net realized loss of $8.1 million, which primarily resulted from the sale of KMBQ Corporation and Newhall Holdings during the first quarter ended December 31, 2011.

From an unrealized standpoint, for the June 2012 quarter end, we had net unrealized depreciation of $11.1 million of our entire portfolio. Our investment portfolio was valued at approximately $299 million versus the cost basis of $395 million or approximately 76% of cost. This fair value to cost percentage is lower than last quarter, which was at 77%, resulting from continued declines in certain of our portfolio company’s financial and operational performance in the early payoff of some good loans.

The cumulative net unrealized depreciation of our investments does not impact our current ability to pay distributions to stockholders. But does indicate that the asset value is lower and that there maybe future realized losses that could ultimately reduce our distributions. Also during the quarter, we had another component of unrealized appreciation and depreciation, which related to the fair value of our credit facility.

For the quarter ended June 30, 2012, we recorded an unrealized appreciation of $4.5 million, which decreases our net assets. This value was primarily based on estimates provided by independent third-party.

So, our bottom line is the net decrease in net assets resulting from operations. This term is a combination of net investment income, net unrealized depreciation or appreciation and net realized gains or losses.

For the June 2012 quarter end, the net decrease in net assets resulting from operations decreased to $10.6 million or $0.50 per common share versus $14.3 million or $0.68 per common share in the prior year's June quarter. The year-over-year change is primarily due to the $18.8 million in net unrealized depreciation recorded in the third quarter of 2011 on our investments.

For the nine months ended June 30, 2012, the net decrease in net assets resulting from operations decreased to $13.5 million or $0.64 per common share versus $20.6 million or $0.98 per common share in the prior year’s period. The year-over-year change is primarily due to the $35.1 million in unrealized depreciation and recorded in the nine months ended June 30, 2011 on our investments.

Moving over to the balance sheet, as of June 30, the third quarter of our fiscal year, we had approximately $322 million in total assets at fair value, consisting of $299 million in investments at fair value and $23 million in cash and other assets.

Our borrowings totaled $87.3 million at cost on our line of credit and $38.5 million in our 7.25% Series 2016 Term Preferred Stock, which was issued in November of 2011. Due to the Term Preferred Stock’s mandatory redemption feature, we classified a preferred stock as a liability on our balance sheet.

For the quarter ended June 30, 2012, we had approximately $187 million in net assets, as compared to $240 million in net assets as of our fiscal year ended September 30, 2011. This represents a NAV per common share of $8.91 as of June 30, 2012, as compared to $10.16 as of September 30, 2011.

At the time of this call, we have about $49.1 million available on our $137 million line of credit and we have $8.4 million in cash. So we have the ability to deploy more capital for the right opportunities in line with our investment objectives and strategies.

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

David Gladstone

All right. Thanks, David Watson. That was a good report. I hope all our listeners will read our press release and review our quarterly reports on Form 10-Q that we just filed with the SEC. You can access the press release, the 10-Q, and other information on our website at www.gladstonecapital.com and also on the SEC's website.

The big news this quarter of course is good production increase in the quarter. Three new investments totaling $33 million and these new investments are good investments plus are good pipeline. We feel like we are moving in the right direction.

We did receive of course $8,000 in success fees from investments that paid off at par, which brings our total success fees for the fiscal year to $2.8 million. And after the quarter end of June 30, 2012, we successfully exited proprietary deal for $12.6 million at par and got $1.2 million in success fees, which will be reported of course more in detail in the September 30, 2012 discussion that we have late November, probably early December.

At these points, the good news for shareholders are very strong. And I think we're on the right way of road today. Our biggest challenge today is our access to long-term debt marketplace. We have a line of credit, very supportive lending institutions and our line of credit is working fine and we believe it's sufficient for the near-term.

However 2011, we issued some new Term Preferred Stock as a substitute for long-term debt in order to make a lot of new long-term investments. We will need to raise additional long-term debt, long-term capital such as the issuance of our Term Preferred Stock and perhaps even common stock.

Now, for our portfolio companies, we also worry that they are not able to get long-term senior loans at reasonable rates. There are a fair number of regional banks, making new loans, based primarily in the assets of the business. These asset based lenders are certainly more clinical today than they have been in the last few years and we hope the banks will continue to extend long-term loans to our portfolio companies.

I think the banks will be better over the coming years, but we still have a lot to worry about. The economy is not strong. It’s very weak today. It’s slowing down, so we are all worried about that. Oil prices continued to be a risk for the economy and high gas prices hurt all the autos and trucks of all our businesses. We just need to develop much more gas and oil here in the United States.

Inflation is on the way, we all know that. The government keeps printing money. The only reason, we have not seen a lot of inflation or turmoil in the global marketplace is that people all over the world, because of that turmoil are buying dollars and that’s been to the benefit of Americans. I don’t know how long that will continue. But spending by the federal government is still unsustainable.

Federal deficit is now $14 trillion and rising, which doesn’t include a lot of off balance sheet social liabilities, such as the $40 trillion we have in all of our social programs that we had due. The government can't continue to print money and now they are borrowing over 45% of every dollar to spend for the remaining 2012 that may even be as high as 50%.

The amount of all the money being spent on the war in Afghanistan still hurts the economy. Thank goodness, it's winding down and we hope to see all of our troops coming home soon. They are the true heroes of this period of history. They’ve risked their lives for us. And I hope every time you see a soldier in airport or wherever, I hope you will say hello and thank them for their courageous work.

And of course, the government is talking about raising taxes, just the another crushing blow on the economy. We know that we have a spending problem rather than a tax problem. And I was just reading that there are 144 million Americans today that want some kind of government subsidy.

We are reaching, what I would consider tipping point and that we are having one person working for every one person that's not working and taking money from the government. So it’s becoming a one-to-one ratio and that always spells problems in companies as well as countries.

The trade deficit with China and certain other nations is extremely high and certainly unsustainable. China continues to subsidize all their industries to the disadvantage of our businesses. They subsidize their oil prices significantly. This means our companies can compete with theirs. And so job leave the United States and go to Asia.

The outsourcing of the job is becoming our taxes -- making our taxes to high and regulations on business really and saying so all of these outsourcing jobs are leaving simply because of too much regulation and too much taxes. And we’ve got to change that.

The continued downturn in housing industry, although it seems to be coming through an end and there is still a lot of mortgages and default and continues to drag down our economy. That, of course, was one of the main reasons for the recessions that we are in. I am hopeful that something will come along and move that little further along certainly interest rates could be any lower for those who are buying houses today.

European debt crisis may hurt some companies, but we really don’t have any investments in Europe and our investments in U.S. companies don’t have that much contact with Europe. So, we’re not going to get hurt by that. But certainly, some of our banks could be damaged by that.

And of course, all important number, unemployment in the U.S. is far too high number used by the government, don’t include those who are working part-time but seeking full-time work. And that those people who have stop looking for work are not counted as well. So more realistic number at least the one that we use to use for our unemployment is somewhere between 15% and 18% these days.

In spite of all of those negatives, the industrial base of the U.S. what’s left of it is not a disaster. There is a lingering recession out there. Its having an impact on our portfolio of companies, but not the disaster it was a few years ago. Like most companies, some of our portfolio companies have not seen any increases in revenue or in their backlogs, how others are seeing good increases. And if you add them in the portfolio, just seeing very dramatic increases. So, it’s a very uneven economy that we are in today.

We all believe that the downturn that begin in 2008 has reached bottom. I know there is a chance of the economy slipping into the slight recession. But I don’t think it’s going to be anything like it was in the past. But its still seems to be improving even though it’s relatively poor today.

In July 2012, the Board declared a dividend for monthly distribution of our common shares of $0.07 per common share for each of the months of July, August and September. Obviously, I have paid up the July 1 and the August 1 will come out soon. And the Board meets again in October to rode on the monthly distribution through October, November and December 2012.

The current distribution rate for our common stock with a common stock price trading as it closed yesterday at $8.04. The yield on the distribution now is extremely high at 10.44%. It’s a wonderful company that we’d able to get 10% or more on our stock is kind of unbelievable, but that’s what the number is.

Our monthly distribution of 7.125% on our term preferred shares translates into a $1.78 annually. So the term preferred was closing market price yesterday at 25.50, and that’s just below a 7% yield. Obviously there is no upside on the dividend. It’s not going to be increased. But at the same time, it’s a very strong coverage ratio of the earnings that we have.

So, please go to our website www.gladstonecapital.com sign up for email notifications. We are sending out good news about your company these days and not any jump mail. Also you can find us on Facebook under the Gladstone’s companies and you can follow us on Twitter under Gladstone COMCS.

I think, we moving forward at a good pace now. I hopefully have some progress again for the fiscal year end 2013. And 2012, looks like it’s wrapping up. It’s a really good year. Of course, we can see the U.S. economy is going through a slow period. It’s falling back a bit. But we think the economy has reached bottom and we’re worried about it of course, but I think we’re -- its going to be okay during the next 12 months.

We’re stewards of your money. So we will stay close, continue to be conservative and disciplined in our investment approach, also driving to deliver some shareholder value on your investments, as well as in the company dividend.

All right, Amy, will come on now, let’s open up the line to analyst and shareholders who want to ask some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Troy Ward with Stifel Nicolaus. Go ahead, sir.

Troy Ward – Stifel Nicolaus

Thank you. And good morning, gentlemen.

David Gladstone

Good morning.

Troy Ward – Stifel Nicolaus

Hey, David. Real quick, the co-investment order from the SEC. Can you just give us little bit a color on how you believe you can use that at Glad to better the performance?

David Gladstone

Sure. As many of you know, we had a -- an order from the SEC. Sometime ago, that allowed us to co-invest with other entities, but not with Gladstone Investment or some of the other public companies. And this time, we went and ask the SEC, if they were left with two public traded EDC’s co-invest along with some others that we are contemplating.

And as a result, where there is an overlap in goals and objectives of the two companies. Where there is a company that tips both of those objectives and strategies, then we could co-invest and probably will co-invest. And what that what will do is give us an opportunity to do some transactions that are larger than we would normally do, because there will be split between the two companies. So there is a little bit of extra opportunity there. It was just something that we thought we should go ahead and do and we will just see how it works out, Troy.

Troy Ward – Stifel Nicolaus

Okay. Great. And then in the June quarter, I guess I was a little bit surprise to see investment in -- it was property, I think was the name of it. Historically, you’ve been in some very difficult industries, have gone through some change with media publishing, broadcasting. As you look at the portfolio today, you specifically looking at -- in specific industries like radio or conversely there are some places, where you won’t invest, because you feel like you have enough exposure?

David Gladstone

Chip, going to take this one.

Chip Stelljes

Yeah. Troy, the main is misleading is not a radio business. The company has contracts nationally with grocery stores and CBSs of the world, in order to pipe in these again advertising and products that are primarily carried in those stores. And they have a substantial market share exceeding 90%, not long-term contract with those locations.

And so it’s really not a radio business, that we were obviously printed into the back. It’s an advertising driven business. They held up very well during the downturn. And the company has really high value add to advertisers that demonstrated at the check out counter.

So, we thought it was a good investment. We did it with a very strong equity firm that know this industry. And so again the names are little misleading. It’s not a radio business and we are not concentrating on adding any additional radio to the portfolio.

Troy Ward – Stifel Nicolaus

Right. Great. Thanks, Chip. And then just moving into little bit of credit quality, the non-accrual bucket, everybody knows, has increased pretty significantly. In the quarter end year-to-date, Chip said it is 16% of all debt investments. I think you said are non-accrual. One of our biggest concerns is we look at this non-accrual bucket is they marked it just $0.08 on the dollar, 8% of original cost.

It’s been our experience that when you see this level of deterioration, it’s pretty rare that we see any significant recovery of this value. Can you speak little bit David, about your kind of that bucket and how you plan to recapture some of that 50 plus million that’s been written down.

David Gladstone

Sure. Overtime, we’ve been pretty good at doing workout. The recession has taken these workout so longer period of time than we’ve anticipated. And we’ve seen some pretty strange things going in the marketplace.

But we do have pretty good record of recovery. I think when we reach a point in time, when standard employees and our other methodology for valuing these is a pretty brutal on anything that comes along and I’ve noticed that the depreciation that we have been recognizing, it seems to be much higher than we would have seen in other companies that I have run as well as some of our competition.

I don’t throw cold water on anybody else’s valuations but I do say that we are being extremely conservative, when you take a company that for whatever reason misses couple of quarters and doesn’t make what it suppose to make and you see the risk rating go down as well as the valuation go down by 50% or 60%, it’s a bit harsh. I know we will recover some if not all on some of these. And we’ll just have to see. I don’t want to make any promises, but I think we will be just fine.

Troy Ward – Stifel Nicolaus

Just a bit more color there because when I think of the valuation I get that on something that’s still accruing. But how the valuation cause something to go on non-accrual. I mean it would seems like to me these are experience real stress if there are non-accrual and it’s not just a mark?

David Gladstone

Well, it’s both. And obviously, a company’s performance causes the markdown as well as values in the marketplace will cause it to go down, so it’s both. And we’ve seen some pretty significant changes in the marketplace as well as in our portfolio. So I can’t -- I am not going to into each one of these that we’ve markdown, but it is a significant markdown.

For example, a company that temporarily is not making money that is they are actually losing some money. We’ve typically mark those at zero. And I think we could sell those for something, so there were question as what. And its better for us to mark them down and be extremely conservative than it would be for us to try to set them at some value that we think someone who is a good turnaround audits would come in and pay that in order to get the company because we do own the company most of the time in those cases.

So its -- you will see one of the companies coming along. I don’t know what we’ll sell it for that went through the ringer. And hopefully in the next six months, that get sold and we just see how good our workout group is.

Troy Ward – Stifel Nicolaus

Okay. Great. Thanks. I’ve got another question, but I’ll get back in the queue behind some others. Thanks.

David Gladstone

Okay.

Operator

Your next question is from Mr. [Lee Carter], Private Investor. Go ahead, sir.

Lee Carter – Private Investor

Your book is about 75% or 77% of original investment. Is part of that markdown from those bonds that you bought that didn’t have the base on them?

David Gladstone

No. That’s not part of it. What you are referring to is some old syndicated loans that we had, that we had to sell at a discount, some of its based on the equity ownership that we have in some of these companies that we mark down pretty severely when the company is in a turnaround mode, usually, the zero.

So, it’s an overall analysis. And again, I think if you give us a couple of more quarters, we’ll show you that some of those were coming back pretty strong. It’s just a painful period of time when the economy is down so bad and folks are wondering which way things are going. Are we going back into recession or are we going to climb back out of this? And so at this point in time, it’s just a rugged period for us to get through to some of our companies.

Lee Carter – Private Investor

So what you’re saying is on the workouts, we probably could see in the next two, three quarters increase in book value?

David Gladstone

I think so. I think you’ll see some appreciation there and we also are putting off some new deals on the portfolio -- in the portfolio and those are performing. The new ones that we put on are performing reasonably well. It’s an unsettling period of time but at the same time, we’ve got some awfully good entrepreneurs.

And as some people know, we often will replace our management teams that’s not performing with the new management team and that usually takes another year after they arrive before they can get their hands around it. And we’ve seen a couple of companies that we’ve replaced the management team with very significant changes at the company and growth in the company, and who knows, we may quote a couple of these over the next year on -- back on accrual. We just have to see what happens.

Lee Carter – Private Investor

Thank you.

David Gladstone

You’re welcome. Next question, please.

Operator

(Operator Instructions) We have a follow-up from Troy Ward with Stifel Nicolaus.

Troy Ward – Stifel Nicolaus

Hi, David. I just -- I wanted to hop back in the queue. The final questions maybe a bit uncomfortable but I genuinely will like your view on it. Your investment performance quite honestly has been near the bottom at the BTC sector for return of equity for both the three year and the five-year timeframe.

Given the considerable credit issues that you’re still facing in the portfolio, your near-term ROE probably isn’t going to turn significantly positive in the near-term as well. Have you considered making any significant changes to the business model, either changes in personnel or even evaluating strategic alternatives to address this underperformance?

David Gladstone

No, as you know, our underperformance was damaged significantly during the last five and even for the three-year period by our friends at Deutsche Bank who didn’t renew our line. We had to sell off a whole portfolio of loans and take significant losses. And what happens in those cases as you all know is that you have to sell off your extremely good loans. Those are the yellow ones that you can sell on a big downturn.

And as a result of selling those off, I would cry sometimes knowing that all of those loans paid of in full and performed at normally after we sold them off. But we are now taking those loans that we have left and the new ones that we’re putting on the books. And my guess is that next year this time or certainly for the year ending 2013, we will see some real progress in the portfolio.

So while we are at the bottom of the list, as you say it in terms of return on equity, we have maintained the dividend since our demise under Deutsche Bank’s rule. And I think you’ll see the dividend continue to strengthen and go-forward.

Troy Ward – Stifel Nicolaus

Great. I appreciate the color, David. Thank you.

Operator

Our next question is from Mr. J.T. Rogers with Janney Capital Markets. Go ahead, please.

J.T. Rogers – Janney Capital Markets

Good morning, David. Just had a question on what kind of leverage doubles you are comfortable with at a company level. It seems like you have adequate availability under the line of credit. Just wondering, how levered you’d be comfortable. What kind of leverage you’d be willing to take Gladstone Capital to?

David Gladstone

Yeah, that’s always one we debate every day. And I think you’ll see us put a few more deals on the books. And then we’ll have to look at the marketplace to see what we want to do. We’re getting a lot of leverage going these days. I don’t know how much more room. David Watson that we have on the line, he just mentioned it before.

David Watson

$49 million.

David Gladstone

So we’ve got $49 million for use that in co-investments with Gladstone Investments. You can probably do around $100 million worth of transaction. So unless Chip gets really busy, that’s probably going to last us for two or three quarters and pretty new deals on the book. So we’ll just have to see how it works out as time goes on.

The market place may change certainly. Interest rates have come down dramatically. And we’re hoping that we can qualify for some lower interest rate loans and maybe even some additional preferred stock. We just have to look at the numbers before we make any of those judgments.

J.T. Rogers – Janney Capital Markets

Great. And then when you get to that in the next two or three quarters and sort of hit -- looking at points that were plenty of times debt equity. What -- what is your thought process there. Would you consider raising equity of these prices or would you slow down your origination effort?

David Gladstone

Well, there are two things going on. First of all, as you know, we can lever to one to one. So for every equity dollar we have, we can either borrow our portfolio stocks. By the way, there is a bill in Congress to eliminate preferred stock in that competition. I have no idea whether those guys will approve it or not.

But the point, the second point that I want to make is that some of our lower interest rate loans had been paying off. And those loans as that money comes back in or put into high-yielding loans. So while we only have $49 million under the line of credit, we may see payoffs in the next six months at a very high rate and as a result be able to put that money to work at a better price.

So there is two things going on. There is a transition in the portfolio as well as a change in what’s going on in the marketplace.

J.T. Rogers – Janney Capital Markets

Okay. Thanks a lot.

Operator

Our next question is from Casey Alexander with Gilford Securities. Go ahead, please.

Casey Alexander – Gilford Securities

Yeah. Good morning. This is a follow-up to Troy’s last question. I mean, the last eight quarters have seen close to a $3 decline in NAV and that is subsequent to these so called Deutsche Bank event. At the same point in time, that investors have experienced a $3 decline in NAV through the nine months, you guys have taken $3.5 million in incentive fees while you are marketing down book value eight straight quarters in a row.

Are you sure that for the benefit of investors since you’ve almost entirely missed an underwriting cycle here from the origination standpoint, virtually the vast majority of the money that you have put to work have been in syndicated loans that you’ve purchased, shouldn’t you really be seriously considering reevaluating this business model?

David Gladstone

Well, first of all, let’s go back in and rewind and take a look at that. The $3 in NAV that you’re marking to is the loan that were left over after we sold off the really good loans. So we were left with, in fact, desirable loans. That’s the first point.

The second point is, I think, the loans that we’re putting on the books are really good ones and we’re going slow because we do have workouts. And second of all we’ve given back a lot of the incentive fee.

And so I don’t know if I have asked this question to several people that have seen company’s performance and incentive fee give back that we’ve done over the years has been unusual. I know -- only know of two BTCs that have ever given back any of the incentive fee and that’s been our two BTCs.

So yes, we are not excited about the fact that we’ve had some problems over the last three years but I wouldn’t ascribe it all to mismanagement or the business model. The deals that we put on the books with the money that you talk about in syndicated loans has been there as a marker because we were doing workouts. And we didn’t want to take that money and try to do two things at once.

So at this point in time, the goal is to fix the deals that we’ve got and continue to add to the portfolio and continue to pay $0.07 and hopefully, this year, we’ll have a little extra. And next year, maybe, we’ll get a little extra beyond that. So just have to work with this during this period of time. I’m sorry you’re unhappy with it.

Casey Alexander – Gilford Securities

Let me ask a question to Chip. I mean, the portfolios mark a $298 million versus a $394 million cost. But what would you calculate real realizable par value of the portfolio is now. It’s certainly not cost. What do you think a realizable par value is at this point in time based upon your judgment of the portfolio?

Chip Stelljes

As you know, we have our portfolio mostly valued by third party, and it’s -- you may not always agree with what we think that individual portfolio company is valued at. However, in general, I don’t think we have enough data to doubt independent third party of their statured value. So I wouldn’t steer on the value that we -- what we value the portfolio today.

One of our efforts is always to try to work on these companies to do better than they are currently valued if we end up in negative situations. So that changes day-to-day with the ability for us to maneuver within these companies and improve them operationally, find acquirers who are interested in the business. And so those are the efforts that we are working over the next several quarters to improve those numbers.

David Gladstone

Yeah. The valuation model that we use, I would say, is conservative. That may be not what everybody would like to see but it’s the number that we have to put in the perspective and trying to guess if you in, other number would be illegal. The SEC would -- if we’re saying one thing in our financial statements and another thing to the market place through calls like this, I think they would probably lock us up.

Casey Alexander – Gilford Securities

Okay. Thank you.

David Gladstone

Are there questions?

Operator

There are no further questions in the queue. I would like to turn the conference back over to Mr. Gladstone for any closing remarks.

David Gladstone

All right. Well, we thank you very much and we’re looking forward to the year ahead. We feel comfortable with our dividend strategy that we have today. We’re certainly earning the dividend. We have cash coming in and add them up. And I think you will see that the next year will be a lot brighter than the past three years. And hopefully, all of us have a good meeting in late November, early December on the end of the year. That’s the end of this conference call.

Operator

The conference has now concluded. Thank you for attending today’s presentation. Please disconnect your lines.

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