Gladstone Capital Corporation F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

| About: Gladstone Capital (GLAD)

Gladstone Capital Corporation (NASDAQ:GLAD)

F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

August 5, 2008 8:30 am ET


David Gladstone – Chairman and CEO

Chip Stelljes – President and Chief Investment Officer

Gresford Gray – CFO


John [ph] – Stifel Nicolaus

Kenneth James – Robert W. Baird

Harold Zirkin – Zirkin Cutler Investments

John Stilmar – FBR Capital Markets

Leroy Carter [ph]


Greetings, ladies and gentlemen, and welcome to the Gladstone Capital third quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. David Gladstone, Chairman for Gladstone Capital. Thank you, Mr. Gladstone. You may now begin.

David Gladstone

And thank you, Doug for that nice introduction. And hello and good morning to all of you out there. This is David Gladstone, Chairman. And this is the quarterly conference call for shareholders and analysts of Gladstone Capital. NASDAQ trading symbol GLAD. And thank you all for calling in. We're always happy to talk to shareholders about their company and wish we had to do this more often.

I hope you all sign up for the e-mail notices so you get information coming directly to you from our company and please remember that if you are in the Washington D.C. area, and you want to stop by and say, hello, you have an open invitation to visit us here in McLean, Virginia, so please stop by, see us, you will see some of the finest people in the business.

Now I'm going to read a statement. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Security 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” that are 10-K and in are 10-Q filings and our prospectuses as filed with the Securities and Exchange Commission.

These can be found on our Web site at and also on the SEC's Web site. 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.

Those of you who are on the call last time know that we are starting a new way of reporting to you so that you can hear from some of your team members here at the firm other than just me. I have no plans of leaving or doing anything like that, but we think you should hear from a lot of the talented team members that we have here at the company and shareholders should hear from just some of them from time to time.

We will start our report with production and our pipeline and then talk about the valuations for the quarter, and this report will come from our President of the fund Chip Stelljes. Chip is also the Chief Investment Officer and oversees all funds. So Chip, take it away.

Chip Stelljes

Okay. Thank you, David. The production for the third quarter ended June 30th did improve with the prior quarter was $44 million in new investments closed. While the longer term prospects in our pipeline are strong the continued instability of the financial and lending markets make the closing of investments more difficult and time consuming this past quarter.

Of the $44 million that we did invest this quarter, $36 million was to three new portfolio companies, and the remaining $8 million was to existing portfolio companies in the form of additional investments or draws on revolver facilities.

During the quarter we received repayments or prepayments of about $41 million due to loan payoff in the normal amortization and pay down of revolvers. This resulted in net production increase of $3 million for the quarter.

Since the end of the quarter we have invested about $13.1 million in new non-syndicated loans and also added about $3 million in additional investments in existing portfolio companies. We expect a few additional deals close soon.

Our pipeline is as strong as ever been. We've seen a noticeable change in the opportunities coming to us. Banks are calling us and so are the LBO funds, and the market has finally come our way in regard to pricing and structure and we intend to make some strong loans during this time.

While our net increase in investments this quarter was low as really due to the high level of prepayments and repayments which we currently we cannot control quite frankly. That being said we don't foresee at a same level of payoff going forward. Our pipeline of investments is large and we have to convert this opportunity to new investments.

The equity we've raised and the additional debt capital available, provide the company with ample funds to pursue the pipeline opportunities. We are expecting a good production year for new assets on the books this year.

At the end of the June quarter, our investment portfolio was valued at about $412 million and our costs was about $445 million, and although the portfolio has appreciated slightly during this quarter our portfolio is still fair valued at approximately 92% of costs.

For the quarter, the portfolio depreciated about 1% which is not very much considering the market conditions. We think we may be at the end of this depreciation trend that has occurred because the market seems to be coming back, but is just a guess at this point.

While we don't like the lower valuation of the portfolio during the quarter, given the strong performance of the underlying companies, we remain confident that the devaluation is reflective of the broader market of loans rather than any substantial change in our portfolio. We expect most of the portfolio to continue paying as agreed, with few problems through the third quarter.

At the end of the quarter we had three loans past due, the first with a cost basis of $1.6 million, second with a cost basis of $6.6 million, and the third with a cost basis of $0.3 million. We are in control of all three of these companies and are working aggressively to fix the companies and improve their profitability.

All three of these situations required new management as the issues were company-specific and not necessarily due to the tough economy. We now have new management teams in place to help turn these companies around.

We've continued concentrating on variable rate loans so that we're not hurt if rates increase, and while our rates are variable, we often have a minimum rate on floor, so that the declining interest rate environment that we've been in doesn't hurt us badly, doesn't hurt our ability to pay dividends. About 65% of our loans are floors.

At June 30th 2008, we had two fixed rate loans with a cost basis of $13.7 million or approximately 3% of the cost basis of our total portfolio of loans and investments. To-date, all of our exited investments have had a positive internal rate of return, and we will have some losses in the future, but work very hard to keep them to a minimum.

And another measure of the quality of the assets, our average loan writings for the quarter that just ended remain relatively unchanged. The risk rating system we use for our nonsyndicated loan showed an average of 7.3 for this quarter versus an average of 7.1 for the prior year quarter.

The portfolio is a little less risky according to our risk rating model. The average risk rating for unrated syndicated loans was 6.5 this quarter versus an average of 6.0 for the quarter – for the prior year's quarter.

As for our rated syndicated loans, they had an average rating of CCC plus or CAA1 for this quarter and the prior year quarter. Our risk rating system gives you a probability of default rating for the portfolio with the scale of 0 to ten with 0 representing a high probability of default, the risk we see here is staying relatively low.

We are quite satisfied with our current portfolio mix. Beside the quality of assets I just talked about I want to say that the quality of our income is also very good. As we discussed before some companies book a type of income called paid-in-kind, PIK or original issue discount, OID.

This income has to be accrued for the books and for tax but you do not receive the income until much later, or sometimes not at all. We call this kind of income, phantom income, because the company does not receive the cash it has to pay off the phantom income.

A very important point because there are other BDCs that have a very large portion of their income being derived on non-cash sources. That non-cash income has to be paid out of the dividend even though the money has not been received. So they must borrow from banks or raise capital to pay the dividend.

We strive not to have phantom income of sort of our portfolio. We seek to have the money that we receive from interest payments, the money that we have available to pay out in dividends is a very conservative way to run a business like ours.

One of our investments had a provision that gave them in a $500,000 loan agreement that gave them the ability to capitalize their monthly interest payments. This is the company we took over, and so the PIK interest here is about $4,000 a month.

There were no other investments in the quarter ended June that had a similar provisions. So we had about $16,000 in capitalized interest income the quarter ended June 30th 2008 and none in the prior year period. We have a tiny amount of PIK interest.

Since inception we have made loans to approximately 129 companies. We have been repaid or exited from 67 companies. The average return of the exits has been about 13% for syndicated loans and 16% for non-syndicated loans.

We have this month a 7-year great track record and hope to continue it this year. Since we talked to you last quarter, the senior and subordinated debt marketplace for large – middle market companies has continued having tremendous liquidity problems. For a while the market was closed, that is there were no buyers. Now, there are new transactions and sales of old transactions.

As you know, we buy some of these first and second lien loans when the companies issued them. We have about $75 million on our cost basis in senior and second lien syndicated loans.

For the senior syndicated loans of about $200 million or larger, the rates were at about 2% to 2.5% over LIBOR. Now it seems they're closer to 4% to 5% over LIBOR, because of these new loans are at a better rate this causes the old loans to be a lower market price evaluation. But if we hold the loans until they mature and payoff we should get 100% back with no loss.

Of one of these syndicated loans is paying as agreed. LIBOR, as you know is the London Interbank rate which is recognized as the leading indicator of short-term rates. The norm for LIBOR has traditionally been about 5% to 6% range, and it's now about 2.77%. So money is relatively low in cost but most companies even as banks are charging 5% over LIBOR. That is for the larger companies that we help finance sometimes.

The demand for loans in the big capital markets by non-bank lenders like hedge funds and bond funds, rated loans are very low. There are very few buyers of these loans today. The small loan markets in which we invest most of our capital is not seeing much competition from banks. Many banks have tightened up their credit standard. Most banks do not make the kind of loans we made.

We have to compete for our loans with other small private lenders like the mezzanine loan funds, a few hedge funds and some of the smaller BDCs. Our loan request pipeline is very strong. We see a strong outlook and it may materialize into more new loans for us. We will see in the next quarter. Our goal is to be a strong profitable company, not the biggest company.

With that I am turning the presentation back to David.

David Gladstone

Okay. Thanks, Chip. A very good report. Now let's turn to the financials and we will hear from Gresford Gray, our Chief Financial Officer. Gresford, take it over.

Gresford Gray

Thanks, David. Our balance sheet is strong. At quarter-end we have approximately $133 million borrowed on the line of credit, and that's $295 million in equity. So we have less than 1 to 1 leverage. This is a very conservative balance sheet and the risk profile is low.

For the June quarter, net investment income which is before appreciation, depreciation, gains or losses was about $6.7 million versus $5.7 million for the same quarter last year, an increase of about 17%. On a per share basis, net investment income for the quarter was at about $0.32 per share as compared to $0.42 for the same quarter one year ago.

This was a per share decrease of about 24%, attributable to the dilution from share issuances during the previous quarter or in other words, an additional $7.5 million weighted average shares outstanding as compared to the same period of the prior year. This decline should be removed as the money from our last public offering is put to work.

As all of you know, net investment income is the most important number to us because it's the number that is closest to our taxable income and that taxable income is the income we use to pay our dividends.

Now, let's turn to unrealized and realized gains. This is a mixture of appreciation, depreciation, gains and losses. We like to talk about two categories in this section. First, gains and losses because they are cash items, and then second, we talk about appreciation and depreciation which are non-cash items.

For the quarter-ended June, we have a capital loss of about $86,000 from the payoff of two loans. In particular, the capital loss resulted from the unamortized investment acquisition costs related for the two loans. The loans themselves were paid off at PAR.

The unrealized depreciation, the non-cash item reported during the quarter ended is primarily determined by our use of opinions of value on our loans that we received from Standard & Poor's Securities evaluations or S&P, who does a good job of giving us their opinion of the prices on our loans. They have good experience in this area because they follow thousands of loans.

We asked S&P to give us opinions of value for all of the loans in our portfolio that don't have a readily determinable market value every quarter. S&P gives us an independent opinion of the exact dollar value for each loan we ask them to review.

This eliminates the worry our shareholders may have that we are not writing down poor performing loans. Because this is a valuation opinion from an independent third-party, you will see a lot of volatility in this number.

At this time last year, our portfolio was just slightly above par whereas this June our portfolio is valued at a depreciated amount due mainly to the general instability of the loan markets, and to a lesser extent the use of a modified valuation procedure for our noncontrolled investments. You will see that overall our portfolio held its value at about 92% of par, further demonstrating our investment quality.

For the quarter ended June 30th, our assets have a net unrealized depreciation of about $3.8 million as compared to the prior year which was a net unrealized appreciation of $0.3 million.

During the quarter ended June 30th we revised our valuation methodology as follows

For portfolio investments in noncontrolled companies with a bundle of debt and equity securities we valued the debt portion with S&P and valued the equity portion based on the total enterprise value of the issuer, which was calculated using a liquidity waterfall approach.

Prior to this change, we valued the debt component of bundled securities at the principal balance, so that so long as the total enterprise value was in excess of our loans amount. This change in evaluation methodology accounted for part of our change in our unrealized appreciation in the amount of approximately $1 million.

As you know, depreciation does not have an impact on the ability of the company to pay distributions to shareholders. All of our loans except three are paying as agreed, but S&P thought they were in need of some depreciation due to market conditions.

Now, let's turn to net increase or decrease in net assets resulting from operations. This term is a combination of net investment income, appreciation, depreciation, gains and losses. It adds up everything.

For the quarter ended we had a net increase in net assets resulting from operations of about $2.8 million versus a net increase of about $6 million last year this time. This June quarter, we are at about $0.13 per share versus last year at $0.44 per share.

For the quarter that just ended, this difference is primarily related to the depreciation of the portfolio this time versus the small appreciation of the portfolio last time. Investors should expect this kind of volatility in the portfolio.

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

David Gladstone

Okay. Thank you, Gresford. It was a good presentation. I want to remind all our listeners that the valuations are just best guesses of what the loan could be sold for if we had an orderly sale. All of our valuations are general valuations. If you really wanted to know the value of a loan you would need to purchase from an expert appraiser, an appraisal of the company, to get a better value of the company our investment in that company.

These kind of appraisals cost $15,000 to $25,000 each and obviously we can't justify spending that much money to do that every quarter for every loan. To substitute for that detailed and expensive valuation, we use the generally accepted techniques to value the loan. I think this is reasonably accurate for the portfolio although I must admit I was surprised how much depreciation the folks at Standard & Poor's have depreciated the portfolio over the last year.

But I guess I should be happy because we've had less depreciation than a lot of the other companies in our field. Also please note that we renewed our line of credit with a group of banks it was a difficult time to have a renewal but happily we got through that, and the banks came through for us, and increased the line by $50 million. The credit market right now is our biggest worry.

Today, at this time we just think that things got to get much better as time goes on, and hopefully, there will be much better when we renew the line again next year. We do worry a lot about the credit markets and how they will impact our portfolio companies as well. They have similar problems trying to get loans from banks.

We continue to worry about the costs of oil. Our economy just can't stand the high price of oil. This causes the recession to be much longer than any of us expected. The high oil prices take money out of the pockets of middle class spenders and then they don't have money for restaurants or to buy durable or non-durable goods.

And certainly, they don't have any money to save for a rainy day. However, it's our belief at this point in time that the oil price bubble has burst and it's come down substantially since even a few weeks ago. So we are hopeful that the oil bubble will continue to burst some more, and come down in price. We are no longer worried about inflation especially where the government takes accounting of it, but we do worry that inflation will be back in 2009.

And certainly the amount of money being spent on the war in Iraq is hurting our economy. And all the teams here at this company supports our troops in Iraq and anywhere else they serve. They are certainly our true heroes in this period of history. They risk their life everyday for us, and I hope they all come home safe.

Even worse than spending on the war of course, that's a small drop in the bucket compared to the pork barrel spending of federal, state, and local governments. They seem to be just out of control and all of this excess spending and taxing to have money available to spend has caused dollar to depreciate and just killed it in terms of the euro and other currencies.

The trade deficit with China and some other nations is just terrible. China and other countries do subsidize their industries to the disadvantage of our businesses. They subsidize oil prices substantially. They have much lower prices of oil and gas in China than we do here.

My guess is that China's high growth period is slowing down now and China is becoming less of a competitive threat. We see some of our small businesses building products here rather than going to China and actually one that I know of has moved part of its production back to the United States from China.

The downturn in the housing industry and the related disaster in the home mortgage defaults is going to continue to hurt our economy for at least another year and no one knows how many home mortgages will fail, but we originally thought it would be more like $200 billion and have revised our estimate up to about $400 billion, of course, their –- people out there that think it's much higher than that.

We just have to see whether we have to revise ours up, or they come down. That really is enough to cause a slowdown in the economy, but I don't think it's going to cause a deep depression, certainly not a deep recession.

In the first quarter, didn't fall enough to be counted as a recessionary quarter, but we certainly have all felt the slowdown and the housing problem will turnaround probably this year or sometime next year and housing prices certainly have fallen enough, that qualified buyers can come in and buy them.

Prices have come down now, about as much as they shot up, so perhaps we’re in a trading range of makes some sense. Also much of the housing trade is out of work, and really they can't apply for government help because so many of them are here without visas. I am not sure really we have a good count of how many people are out of work these days.

Certainly, the money flowing back to Latin America from the United States has been down substantially as measured by any number of companies out there. In spite of all of these negatives that we keep bringing up each time we talk to you, the industrial base of the U.S. still is not in trouble.

Small businesses have kept their costs low, profits are not going up as fast as they were but they are still there. Manufacturers are not operating at full capacity, so they got plenty of room, and all of them have slowed down hiring, some of them are not hiring, and of course, few are laying off people. Backlogs have come down.

We have seen backlogs in the portfolio and companies that have shown up have come down in many of the companies. We really don't see a recession in the classical sense, that is the quarter ending June didn't seem to register as a recession either we're again we're in this slow down that's going in. I think the downturn has been different than any other downturns in the past because it's hit people where they lived.

The housing industry is in shambles so their house price have come down, and also the price of gas and food has gone up so much, and I think this time the press has been exuberant in reporting only the negatives in the news, I just wish the press would balance some of the reporting, some of the good things that are going on out there.

We're guessing that the downturn has begun – that's began at the beginning of the summer last year, just about over. We think this market is stabilizing and will begin to turn up, probably in the next six months. And if that's true it means the next few years for us will be exceedingly good.

We do have our dividends of course, our distributions per share of $0.14 a month, for the month of August and September are already declared, and if you annualize those that means we are paying at a $1.68 a year, and we are working on some changes that that I hope will let us build our earnings and payouts even more.

With distribution rate and with the stock price at about $15.13 as it closed yesterday, the yield on this distribution is now very, very high. I just I don't understand why the stock has fallen so much, and we have a great portfolio, have a good pipeline, and really have no plans to cut our payments to shareholders, so we are a little bit at a loss at why it's trading at such a high yield

I would remind you please go to the Web site and sign up for e-mail notifications. We don't send out any junk mails, just news on your company.

Again, as far as we can see out things look okay. We think the economy has reached bottom. We think the start to gain strength now and move up. Obviously, we can only see out for a couple of quarters. And we certainly want to be careful. We are stewards of your money, and we want to stay the course, and we continue to be conservative in our investment approach and that's our goal here is to make sure that we continue to do the right thing for you.

And Doug, if you will come on now we will open it up and take some questions.



(Operator instructions) Our first question comes from the line of Troy Ward with Stifel Nicolaus. Please go ahead with your question.

John – Stifel Nicolaus

Good morning, David. This is John [ph] just filling in for Troy. I notice on the last conference call there were some comments that you viewed originations on a yearly basis. I understand that the March and this quarter were slow due to longer expected deal timing and challenges in the financial markets. Would you consider this quarterly origination number grow a typical run rate that we could expect that the environment was just stable moving forward?

David Gladstone

It wasn't that low. I mean the 40 some million that we put out was good, it was the repayment that we got, we didn't expect some of those, some were delightful to have. We had some that had been valued at below par, so we were glad to see those payments come in, and some are more lower interest rates as well. But our point here I think is that this business has always been what everyone describes as lumpy, and I think you will see as the year progresses a higher amount of new loans. Forecasting pay-offs is one of the most difficult thing we can do, and I don't know how to put that into your model. I have put it in mind several times and been surprised by how many pay-offs we get in the quarter or certainly in a year.

As you know, prior to this downturn the pay-offs are running exceedingly high. We put a loan on a book. It stayed there for 18 months, share good progress, and we get paid out by the banks. We aren't seeing that now, but what we are seeing is some turnover in the portfolio from the LBO funds selling their business, and of course, we paid off when that sale occurs. But, Troy – and John I wish I could help you on the projections here. I just not sure how to put it in. I think that production will be at that amount or stronger and, Chip, do you want to comment on that?

Chip Stelljes

Yes, I think I was the one who made the comment that we certainly encourage – we certainly look at it as a yearly business, I mean, total new investments, three new investments, any one of those could have fallen over into the following quarter and the number would look differently, but it doesn't materially change the net investment income if it's three days difference. So we try to look at it on a yearly basis. I am hoping this is a sign of an uptick in our ability to close deal, but I think it will as David said always be a little lumpy, some quarter over to come to you with more and some less, and hopefully over years period of time ends up being a good production and year for us.

John – Stifel Nicolaus

Thank you. Just a question as to credit quality. And looking at some of your media investments particularly some of those that were purchased from Wells Fargo, could you provide some more color on the performance of those investments, and how they are impacted by slowing ad revenues in today's economy.

David Gladstone

A couple of points here. The smaller radio stations that we typically invest in have done exceedingly well. They never seen the decline that you see in the large station. They are not dependent on – what I will call national advertising, and as a result, national ad budgets have come down, and so have radio and TV revenues. The smaller stations are based on local revenue. We've got local businesses that need to be on the radio and so, we have not seen precipitous drop by any means in the small radio area. The portfolio that we have from – that we bought from Wells Fargo had a couple bad loans that we discounted substantially and probably should have discounted a little bit more than we did. We have taken over a couple of those. And as a result, put new management in, and I think they will turn around within a reasonable amount of time; it will take six months, maybe year and a half, to get those back paying as agreed. But, each of them, again we have valued them at very little, because they have obviously defaulted on the loan.

And in some cases, we have gone through foreclosure, and taken the assets over and put new management in, and clean the business up. It will take us six months to 18 months to get those back on their feet. And once they are back on their feet normally what we will do is sell the business to group that wanted to buy the business. So, I think if you look at the portfolio you would find a couple of the deals did not work out the way that we thought they were going to work out. Even though we looked at in and counted them as poor performers and paid less than par for the money. I am not sure that answers your question.

John – Stifel Nicolaus

No, I appreciate. Thanks a lot, guys.

David Gladstone

Okay. Next question, Doug.


Our next question comes from the line of Kenneth James with Robert W. Baird. Please go ahead with your question.

Kenneth James – Robert W. Baird

Hi, good morning.

David Gladstone

Good morning.

Kenneth James – Robert W. Baird

In terms of some of the market conditions that are kind of impeded new deal closings over last couple quarters, how much of it would you attribute to kind of things are going on between the sponsors and the sellers in terms of disagreements on price in the new kind of environment, and how much of it is deals being brought to you that you're uncomfortable with the pricing, or the amount of leverage has an adjusted lower?

David Gladstone

Well, it's really some of both, and Chip, do you want to answer that question?

Chip Stelljes

Yes, I mean, we went through a period of time where letters of intent were being renegotiated along the lines of your first comment, and that did cause some dislocation. I think we are past that point now that letters of intent that are that are put down by sponsors are reflective of this marketplace. The real question is whether a seller even wants to sell right now. So I think we are past that period of time. So I think that's reflected in the – going to close three new deals this quarter. I think there has also been just some rationalizing in the marketplace that we are pricing loans considerably higher than they were before, and it has taken the marketplace six months or more to get used to that, and not think it's going to swing back the other direction.

So to go ahead and count that in their equation how they price a buyout for financing, I think that's freed up a little bit. The challenge is that the one stop cash flow lender marketplace has dried up and so you now have probably two lenders in every transaction versus one before, and which is just another party at the table that has got to get through their process. They got their own portfolio issues to worry about. That's the dynamic is going on right now.

Kenneth James – Robert W. Baird

Okay. And in terms of –- pricing in terms of what sellers could anticipate as they dropped up until of their last quarter hasn't – it didn't seem to be a consensus that there had been a big compression in deal multiples. Do you think that changed at all this quarter?

Chip Stelljes

It is interesting, we don't see it in the numbers, but we see it in the purchase prices that are being offered. I think the question is whether the sellers accept those or not. If you look at one of our exits this quarter, I mean the company was sold for about 11 times, so they were able to get a very high purchase price. So I think the numbers get skewed, because the transactions that are closing are very, very good companies at high prices and a number of the average companies are not on the market, or not going to close. And the newer buyers that have come in are not sponsors; they are not private equity funds. They are – many of these people that are operators in the business and they are buying out a competitor, or they're buying out someone that's in a different geographic location. So they have a much different reasons for buying. It's not a financial reasons, its operations part of their business that they’re looking at.

Kenneth James – Robert W. Baird

Okay. And in terms of the prepayments you got this quarter any more color there on those companies acquired? Just little curious maybe why the prepayment fees weren't higher?

David Gladstone

We don't have a lot of prepayment fees in the $75 million of loans that we have senior and secondary syndicated loans. So they are very often are no prepayments in them. I am not sure. What did we get about $500,000? We get about $500,000 in extra income from the prepayments in this quarter. It weren't a lot. The biggest problem for us has been the $75 million that we have in, in LIBOR loans with no floors.

As you know, LIBOR over the last year has gone from 5.7 down to 2.8. And that's a big swing. A 2.9% would on that $75 million is about $1.6 million over the nine months that we have lost in income, and that will come back. The loans are paying as agreed, but it's just the low interest rate that hurt us and with the increase in number of shares out for about 50% it cause our decline luckily, we put a lot of the money to work, but it caused a decline in our per share number earnings to about 24%.

So again, it just takes putting the money out of good rates and getting rid of some of these low interest rate loans. These lower interest rate loans will come back but do we have the time to wait for it to come back. That's one of the things that we worry about here, juggling every day whether to sell them at like $0.92 on the dollar or $0.93 on the dollar and take you hit. But put the money to work at a higher rate. Kenneth, do you have another question?

Kenneth James – Robert W. Baird

Sure. I have one more. What's the kind of the blended rate you think you are getting on say the $40 million in new investments you had this quarter? And were they more tilted towards per senior, or senior subordinated?

Chip Stelljes

You had two broadcasting deals that had a good bit of senior component to it. We're trying to get better than the 11% to 12% on every new deal we do, whether it be senior or junior. That so you should expect us not to book anything underneath that.

Kenneth James – Robert W. Baird

Okay. Thank you.

David Gladstone

And what you also see, Kenneth, is lot more income on the back which you didn't see before, because it was such a hyper market. Now, the people are willing to give you some upside on at the end of the loan, either in the form of a success fee or warrants or whatever so. I would say the long-term looks exceedingly good for the company.

Kenneth James – Robert W. Baird

Okay, thank you very much.

David Gladstone

Alright. Next question, Doug.


Our next question comes from the line of Harold Zirkin with Zirkin Cutler Investments. Please go ahead with your question.

Harold Zirkin – Zirkin Cutler Investments

Good morning, David. Thank you for taking my question. Three quick ones. In the opening remarks it was stated that you had “ample funds” available for investment. Could you describe what ample funds is?

David Gladstone

We have a line of credit, substantially large what do we into that now for (inaudible). We got $300 million line and so we borrowed 133, so that differences what we have available for us to go into and put out. Also, when repayments come in of these lower yielding loans we can put that to work. So I think we have enough to last this (inaudible) down. If Chip and his team gets really busy and puts a lot of money out then we will have to increase the line of credit or come back to the capital marketplace or sell off the $75 million and put it to work. There your alternatives as we put the money to work. But that's ample that's what we mean by ample.

Harold Zirkin – Zirkin Cutler Investments

So $167 million is what the definition is?

David Gladstone

Right. That's from the depth side, and obviously, you can sell-off the $75 million and put that to work at a much higher rate. I don't know if we explain that. But assume for the sake of argument that you're getting – I don't know one and a half or three and a half over a LIBOR and you can sell that loan at $0.90 on the dollar. If you’re going from a million dollar loan making the $60,000 but putting it to work hopefully the way Chip's talking about at a 11%, so there is substantial step-up in terms of income. The bad news is you've written off part of your capital, and you won’t get that back. It’s an age old problem of depreciated asset. Should it be sold or to put it something that's a higher yielding asset.

Harold Zirkin – Zirkin Cutler Investments

You said, we have three non-performers that you have $7.5 million into based on the numbers that were announced. What are those being carried on your books for now? And yes, you have new management and what are the chances of getting something back out of those three loans?

David Gladstone

I think we'll get all of them. They're going to add them up for you rather than shout them out, so go ahead and ask your next question. Somebody is going through the –

Harold Zirkin – Zirkin Cutler Investments

The last question is you're investing new money trying to get a 11%, 12%, you adequately and appropriately mentioned the fact that your stock is very, very low right now, and has a dividend yield of about 11%. Some of your competitors have started buying their own stock back. Any thoughts on that regard?

David Gladstone

Yes, we have debated that internally quite a bit. I think our lenders would take a very dim view of us using their money, but bought back stock and reducing our equity and they would look at that and say that it's not a good thing to do. The only one I heard that announced was American Capital is they were going to buyback. I am not sure they bought back much. At the end of the day it's very difficult to take money that you think all in returns will be in the 15% to 20% and buyback your shares. The question for you is would you want us to buyback shares or would you want us to put the money to work at another higher rate? I don't know, it’s the something we debate about every week. We sit around at the lunch table and talk about it. If the lender would give us permission to borrow more money and buyback shares we might do it. At this point in time, we are not contemplating that.

Harold Zirkin – Zirkin Cutler Investments

It might be an interesting message for the 11% short position.

David Gladstone

Well, it's – the short drop there, that's for sure, and we're mighty angry at the Security and Exchange Commission. They seem to bail out the big guys by stopping short positions on them, but let the rest of the world kind of suffer through its – it short sellers, and I don't know these short sellers are going to have to eat dividends for the next ten years, because we don't plan to cut any dividend. I mean that's my goal. And they want to stick around and pay the dividend I guess it is up.

Harold Zirkin – Zirkin Cutler Investments

That's the end of my question. Thank you very much for answering them.

David Gladstone

Okay. The fair value on these about $2.2 million on those that you mentioned the – actually it's $8.5 million at cost, and so we valued a net $2.2 million. That should answer that question.

Harold Zirkin – Zirkin Cutler Investments

Thank you very much.

David Gladstone

Do we have another question?


Yes, we do. Our next question comes from the line of John Stilmar with FBR Capital Markets. Please go ahead with your question.

John Stilmar – FBR Capital Markets

Good morning, gentlemen. Thank you for taking my question. David, your last comments for kind of took the wind out of my sails in terms of where to go with topic, but I will just kind of pull up for a second. Looking at this quarter you had very good top-line revenue, 10.1% if I remember correctly. But my question is in order for us to get back to sort of the Gladstone story, which is strong, cash on cash returns covering the dividend. I think 12% probably gets us there pretty clearly. Can you help me think about what your guys view is in terms of getting an all in yield back to those levels minus any changes in (inaudible)?

David Gladstone

The only way to get back is to continue to put money out of good rates, and hopefully cash in some of the ones that we have on the book and get those, those incomes into the company. There is no other magic formula for doing that. As I have mentioned both alternatives, one is to borrow money from the bank and then (inaudible) substantially higher rate which we’re doing. And the other is to cash in the $75 million of senior syndicated and secondly syndicated loans, and make a small hit and put that money to work. But there is no other way to go out of that problem. And I think you’re seeing that in many of the business development companies that are out there who had their assets depreciated down so much, and their stock price fall so much that they’re just in a no operation day-to-day mode. I don't know how we can do anything different than what we just mentioned.

John Stilmar – FBR Capital Markets

Okay. Would you think about potential shift maybe even going you've been very strong credit manager, being – and also being at the upper part of the credit spectrum? What do you think about moving down the credit spectrum, maybe and going into some larger transactions and picking up a little yield or sort of steady as she goes and just looking from marginal opportunities to build higher incremental yield?

David Gladstone

We see a lot of – what I'll call mezzanine unsecured deals that are in these larger buyout and have rejected all of them to-date. I won't say that some day we won’t see one that rely which is haven’t been able to just sum up the risk and reward on those. While those – the reward is higher certainly 15% to 18% sometimes on a current basis or certainly with paid-in-kind income, John, we just have not felt comfortable doing those kind of transactions so we stayed with our smaller deals in which we can get the kind of returns we want today. This is really – in this environment that we’re in today, this is the moment in time in which we can get the kind of terms and conditions we want.

However, as Jeff mentioned a few moments ago, there are lot of people that are not taking those deals and they are hoping that the marketplace will come back and they won’t have to pay that higher rate. I think that’s a wish that kind of be 3 years to 5 years out, my own perception of the world. And that many of those will come back. We are seeing it across all of our deals to buyout world, the real estate world. All people are trying to adjust now to what is effectively what the market was three years ago even five years ago before the bull market in debt came along. I just don't think there is going to be any change in the near-term in the higher rates down. Those people who want to do transactions are going to have to pay the higher rates and we will get our pro rata share of those transactions, and continue to build the portfolio. We raised a little bit too much money that first – the quarter ending December we were in great shape. We put the money to work that we raise and in that quarter, and then we raise some in the spring or late winter. And we just have not gotten back and put that money all to work because of the pay-off that have come in, we haven't been able to build back up. I think you will see by the end of September will be close if not there and certainly by December we will be back covering our dividend as we have in the past. These dividend coverages can all be made up by any kind of small capital gains that comes along. We've expected a couple of them at have just been held up because the marketplace has changed drastically. But we will see. I still am very bullish at this point in time. I think this is the moment that you want to be in our stock and some of the other BDCs as well, because I think we're going to ride back up now that the marketplace is beginning to stabilize. Any other question, John?

John Stilmar – FBR Capital Markets

The last question and then thank you very much for that. The last question has to do with the – I think I have missed some of your earlier comments with regards to the portfolio and how you think about different industries? Are there newer industries that are out there or ones that you want to deemphasize or emphasize or is it really related to specific structures and transactions that will determine that? But are there any industries that you are seeing a little more stress versus last time? Are there any industries that you are seeing are actually improving or maybe aren't as bad as you thought previously?

David Gladstone

I think the only thing we have stayed away from has been retail. Retail has been quite damaged in recent months. Certainly the restaurant area has been beat up pretty badly, because people don't have as much disposable income. We obviously have stayed away from automotive, and that is the new car area and we obviously stayed away from anything in housing. These big ticket personal items have always been one that we've been fearful of and now it sort of rolled over into the retail sector, not so much disposables, but certainly in clothing is more difficult and restaurants are more difficult. So we haven’t sort of stayed away from that area as well. I haven't seen any industry be very strong right now that we've particularly zeroed in on and said gee, let's jump on this one. Energy seems to be coming down now, being wound down, we were never heavy in the energy area. But I think that's have its day and we will see that come down over the next six months to year. All of this is all are guessing game and you've right to ask the question, and we look at each deal standing on its own and it wouldn't be unusual for us to find something in one of these industries that was so atypical of the industry that we would like to do it.

Again, I mentioned this because I say it a lot in the meeting is that we like these companies that have proprietariness of some kind either patents or a dominance of a certain marketplace such that others are not likely to come into it. And that’s what we look for, and that maybe one out there in the housing business we are not running to it, and maybe one in the auto area we are not running to it either. So as a result, we have just stayed away from that. I think the logistics area is still beat up and we like to do something in logistics, but we’re not quite sure of it. That mode of investing in that area is the right time either. But that's a general overview.

John Stilmar – FBR Capital Markets

Great, David. I like to have one final question. The final question is this. You obviously have – portfolio churn is not necessarily a bad thing in today's environment, and you've been – let's call it, a blessing and a curse of getting a lot more repayments in the past two quarters than you had anticipated. Certainly what is your sort of expectation on a go-forward basis? We kind of gotten through that period of greater portfolio churn and the constraint of the capital market should really play into your portfolio, meaning slower repayments in the back part of year. I realize it’s a guessing game, I realize it’s anybody's guess, but I am wondering what you're sort of base case sort of thought processes?

David Gladstone

This is just a pure guess, but I would say in the $10 million to $15 million a quarter would be a round number that you could use whether that's a right number or not, it’s anybody's guess. And we certainly don’t have any crystal ball that tells us that we are going to get those kind of pay-off. But we’ve all played around with numbers than – again, if you go back to one quarter, you have a lot of production and a lot of pay-off than next quarter you might have a lot of production and no pay-off, it's just all over the board. I can’t predict it for you. But that is sort of a wild guess.

John Stilmar – FBR Capital Markets

Absolutely. I thank you for entertaining it. Thanks for letting me ask my questions.

David Gladstone

Okay. Next question, please?


(Operator instructions) We do have a one final question. Our next question comes from the line of Leroy Carter [ph] who is a private investor. Please proceed with your question.

Leroy Carter

Hi, David.

David Gladstone

Hey, Le.

Leroy Carter

Things are going along pretty good. The question I have – there is an announcement on there that you went into a gravel pit, which could be pretty dynamic. Is that – what is that – is that a debt structure or what for you?

David Gladstone

That's a debt structure and we're in at a very low amount of debt to equity, and also high collateral value. Its highway rocket, it's all of the standard things that you need in an area for construction of roads, as well as some other things. It has an enormous amount of equity in it from three very well respected investors and we just think that they're – they – found not a gold mine obviously, but they're mining something that is just perfect for them and they are all into that area, they understand that area. I think we've been looking at that for probably two years now as an area to put some money into and we finally found one that was had enough equity, had enough smarts, and also a low enough debt to equity structure that would fit into our portfolio. I think that one will pay handsomely over the next three or five years.

Leroy Carter

Great. Second question I have with on the $75 million syndicated loans that you got, have they decreased in value or increased in value in the last six months?

David Gladstone

No, they decreased in value. And the marketplace for those senior syndicated loans and the second lien loans have needs to be driven by any number of forces mainly I think a lot of hedge funds and others were using high leverage in a 10, 15, and 20 to 1 in the order to buy those. Those folks have all gone away. There are very few buyers now, and that's the reason for the depreciation of all of those loans. If you follow the loan marketplace, we have a couple of ways of following that one being a newsletter that comes out everyday. All of those loans have depreciated pretty dramatically just because there are fewer buyers than there were even a year or a year and half ago. And on the same time, they are paying as they always did, and we expect to get paid in full.

The difference, of course, is that they have to be mark-to-market, and so, Standard & Poor's and our folks look at the price is out there and these are indicative bid, not that there is anybody ready to buy them at that price, but these are the desks, the whole loan desks or the syndication desk at some of the brokerage houses and we will go off and get it many closes we can. And then S&P looks at it as well and decides whether that's a reasonable (inaudible) on it, and it's just a measurable marketplace and so everything has gone down. The bad thing about of course is that there, the senior debt for example, would be a 250 to 300 over LIBOR and the new loans that are out today are 450 to 550 over LIBOR. So you have to depreciate these loans to yield as much as the new loans that are getting done. And that drives the pricing on these if you follow that. It's the inverse just like in a bond marketplace.

Leroy Carter

Thus far the ones that you have sold and looks like you have been able to make really very fine investments. How much – there is $75 million less, David, how much have you sold roughly?

David Gladstone

It’s not much. Maybe $10 million to $15 million.

Leroy Carter

Alright. That’s fine. I appreciate talking to you. Thank you.

David Gladstone

Okay. Doug, do we have anybody else with the question?


There are no other questions in queue at this time.

David Gladstone

Alright. Thank you all for tuning in and we will see you next quarter. That’s the end of our message.


Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.

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