Gladstone Investment Corporation (GAINI) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation Third Quarter Ended December 31, 2014 Earnings Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. David Gladstone, Chairman. Sir, you may begin.

All right. Thank you, Amanda, and hello and good morning to all of you out there. This is David Gladstone, your Chairman, and this is the third quarter earnings conference call for shareholders and analysts of Gladstone Investment Corporation, stocks traded on NASDAQ under the symbol GAIN. And there are 2 preferred stocks. One is called GAINO, and the other is GAINP. Thank you all for calling in. We love this time with shareholders and -- able to tell you about what's going on in the company you're invested in. Or if you're a potential shareholder, tell you what's going on, so you can buy some shares. We like to give updates on the company, our portfolio and the business environment. I wish we could do this more often, but we only do it once a quarter. So you have an open invitation if you're ever in the area. We're in McLean, Virginia, outside of Washington, D.C., so stop by and say hello. We're a team of about 60 people now and some of the finest people in the business. Now we're going to hear from the General Counsel, Secretary, he's also President of the Administrator, Michael LiCalsi, who'll make the statement regarding forward-looking statements. Michael?

Good morning, everyone. This conference call may include forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, including those with regard to the future performance of the company. These forward-looking statements inherently involve certain risks and uncertainties and other factors, even though they're based on our current plans, which we believe to be reasonable. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. There are many factors that may cause our actual results to be materially different from any future results that are expressed or implied by these forward-looking statements, including those factors listed under the caption Risk Factors in our Form 10-K filing and our registration statement as filed with the SEC, all of which can be found on our website at www.gladstoneinvestment.com or the SEC's website, www.sec.gov. And 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, except as required by law. And please also note that past performance or market information is not a guarantee of future results. And please take the opportunity to visit our website, www.gladstoneinvestment.com, and sign up for our email notification service. You can also follow us on Facebook, the keyword The Gladstone Companies, and on Twitter, keyword GladstoneComps. The presentation today will be an overview, so we ask that you read our press release issued yesterday and also to review our Form 10-Q for the December 2014 quarter end, which we filed yesterday with the SEC. And you can access that on our website as well as the press release, www.gladstoneinvestment.com. Now let's turn to the President of the fund, David Dullum.

Thanks, Michael, and good morning to everyone. Generally, I'd like to briefly review what it is that we actually do here at GAIN, and this helps really to keep us focused on what our long-term goals are for GAIN while we update here and discuss the near-term results. So Gladstone Investment provides capital for the buy-out of businesses generally with annual sales between $20 million to $100 million. Our investment in any one company is comprehensive in that it usually consists of senior and subordinated debt in combination with equity. This combination of debt and equity produces the mix of assets which is the basis of our strategy for Gladstone Investment. Whereby the debt portion of our investment provides the income to pay and grow our monthly distributions, and then we look to the equity portion to increase the value and provide capital gains going forward from time to time. We might think about how are we different from other BDCs and other finance companies in that while we take a large equity position in the companies that we purchase, and that differs from other public BDCs, business development companies, that are predominantly debt-focused. So for instance, the proportion of equity and debt for the investments in our portfolio is approximately 30% to 70%. Most other BDCs' portfolios are around 10% to 90% in their proportion of equity to debt. As to other private equity funds, which are generally 10-year term private partnerships with a longer liquidity horizon for the investors, we are different in that, as a publicly traded entity, our structure allows daily liquidity for shareholders, frankly, just by going to the stock exchange and trading the stock. So also, we are able to keep an investment longer in our portfolio as we do generate income prior to the exit for an equity gain. Now I would like, this time, to talk a little bit about our exit strategies. We've not necessarily done this previously, but I believe it's important, so we get a better understanding of our profile. Although we are able to hold our investments that I mentioned for long periods of time, our quarterly equity valuations of our portfolio can be volatile and not always actually representative of the true underlying exit value of those companies. So it is necessary, therefore, that we look to the realized equity portion of our assets as a contributor to the overall future value of our company, and we must manage these exits accordingly. Since inception in 2005, we have actually exited 4 of our management-supported buy-out investments, which generated over $54 million in realized capital gains, each one, in turn, actually generating a realized capital gain. The buy-out market today is currently quite frothy, and the prices being paid for good companies continues to be quite steep. So in this environment, we will carefully assess and manage the risk-reward merits of liquidity in our equity positions, keeping in mind that while it is tempting to sell a portfolio company in this market, it would reduce our asset base, and then we are challenged to incrementally replace that investment in a high-purchase value environment. So the sum of this is just we need to focus on managing exits, which we have done in the past and will continue doing, going forward. And with the continued growth in our operating income and the periodic realized gains, our board did declare a distribution of $0.06 per share per month for January, February and March, which is a run rate of $0.72 per share per annum, which, in fact, will cover -- we cover with our NII. Additionally, we also had a onetime special distribution of $0.05 per share in December 2014. So this represents a third calendar year in a row that a onetime special cash distribution has been made to our common stockholders. Let's talk about our deal origination and see how that works. So we have a very high priority on our deal origination. We have a broad and deep geographic footprint with offices in New York City, Los Angeles, Chicago and, of course, here in McLean, outside of Washington, D.C. We primarily focus our efforts, our calling efforts, on what we call independent sponsors, middle market investment bankers and other sources that help us create proprietary investment opportunities. We do not depend on others to negotiate or structure our investments. Generally, our investments will include partnering with a management team and other sponsors in the purchase of a business. And actually, our strategy of providing a financing package, which includes both the debt and the majority of the equity, is a competitive advantage as it gives the seller, and the independent sponsor, if one is involved, and the management team that would be looking to be involved in the business, a high degree of comfort that this purchase will happen, at least, from the financing perspective. In addition to these outright purchases, occasionally, we might find opportunities to partner with a business owner who will sell a portion of their company to us and using that capital to grow the business. So where do we focus our attention from an industry perspective? Generally, first of all, we invest in companies that at least $3 million of consistent operating cash flow or what we generally refer to as earnings before interest, taxes, depreciation and amortization, EBITDA, and potential to expand that cash flow. Areas of interest, industry interest, to us are light and specialty manufacturing; specialty consumer products and services; industrial products and services; and from time to time, aerospace and energy. And we have no concentration, of course, at this time in those areas. Looking into the activity of the fund for this past quarter, we are very pleased with what we did, and like I mentioned, that we invested $79.3 million in new deals and in an existing portfolio company. The third quarter, which ended December 31, 2014, was strong in originations as we invested $44 million in 2 new deals. In October, we purchased Old World Christmas through a combined debt and equity investment of $24.4 million. Old World Christmas, which is headquartered in Spokane, Washington, is the designer of an extensive collection of glass -- excuse me, blown glass Christmas ornaments, tabletop figurines, vintage-style light covers and nostalgic greeting cards, which are distributed primarily into the independent gift channel. In December, the second deal we did, we purchased B&T group through a combined debt and equity investment of $19.6 million. B&T is headquartered in Tulsa, Oklahoma, and it's a full service provider of structural engineering, construction and technical services to the wireless tower industry. Looking forward on our potential investments and our pipeline, the goal is to continue to find opportunities that fit our investment parameters, which are cash-on-cash equity returns of at least 2x and yields on our debt investments in the mid-to-high teens. Again, emphasizing that interest on these debt investments will allow coverage of our distributions to shareholders. As demonstrated by the 2 new investments I mentioned, we are able to keep adding to our asset base. We have a positive origination trend going into our fourth quarter, which is ending March 31, 2015, as we are fairly close to executing on a few new investments. So we continue expanding our marketing efforts and growing our presence in the marketplace to support our activity in the pipeline for new investments. Now please keep in mind, and it's demonstrated by the past 2 quarters, that deal flow, of course, and the closings of those companies is erratic. So in summary, our goal for this fund is to maximize distribution to shareholders, with solid growth in both equity and the income portion of our assets. So this concludes my part of the presentation. I'd like to turn it over to our CFO and Treasurer, Melissa Morrison, to go into a bit more detail. Melissa?

Thank you. Good morning, everyone. The big news this quarter is that we originated 2 new deals totaling over $44 million, and we raised $41 million in new preferred equity. These actions have enabled us to expand our balance sheet and raise capital for future new deals. At the end of the December quarter, we had $412 million in total assets on our balance sheet, consisting of $394 million in investments at fair value, $5 million in cash and $13 million in other assets. Our portfolio at fair value increased by over 13% quarter-over-quarter. Our portfolio's allocation at cost is currently $333 million in debt investments to $124 million in equity investments, which is 73% to 27% debt to equity. The equity portion is where we have in the past, and hope to continue, to produce capital gains. As for our liabilities, at December 31, 2014, we had $96 million in borrowings outstanding on our $185 million credit facility, $81 million in term preferred stock and $9 million in other liabilities. Listeners will remember that in June 2014, we amended our credit facility, which allowed us to extend the maturity date of our line of credit to June 2017 plus 2 1-year extensions. We were also able to reduce our cost of capital by decreasing the interest rate from LIBOR plus 3.75% to LIBOR plus 3.25%. In addition, in September 2014, we upsized our credit facility capacity from $105 million to $185 million by adding additional lenders. In November 2014, we successfully completed a public offering of approximately 1.7 million shares of 6.75% Series B preferred stock at a public offering price of $25 per share. Gross proceeds totaled $41.4 million, and net proceeds after deducting underwriting discounts and operating expenses borne by us were $39.7 million. While these capital-raising activities were successful, we will need to continue to monitor additional ways to raise capital over the upcoming months in order to support our deal origination activities while also meeting our BDC leverage requirements. Our net asset value per share was $8.55 per share as of December 31, 2014, which was up $0.06 from September 30, 2014, primarily due to the $2 million net unrealized appreciation recorded in the December 2014 quarter end, related to certain portfolio companies' improved financial and operational performance, partially offset by declines in financial and operational performance in a few other portfolio companies. Moving over to the income statement. For the December 2014 quarter end, total investment income was $11.5 million versus $9.1 million in the prior quarter, an increase of 27.5%. Total expenses, including credits, were $5.7 million versus $4.9 million in the prior quarter, resulting in net investment income of $5.8 million versus $4.2 million for the prior quarter, an increase in net investment income of 38.9%. The increase in our investment income was due to an increase in other income of $1.3 million, which primarily resulted from $1.3 million in dividend income that we received during the December 2014 quarter. We also received $500,000 in success fees. Over the 9 months ended December 31, 2014, other income totaled $3.8 million and accounted for 12.4% of our total investment income. And we believe this run rate is a great indicator of the other income we expect to receive in our fourth quarter ending March 31, 2015. Our net expenses increased by $900,000 or 17.6% quarter-over-quarter due to a variety of factors, including increases in the incentive fee earned by the advisers as well as our interest expense. We also had an increase in our preferred dividend expense, which was due to the aforementioned November offering. In total, our net investment income, which was $0.22 per common share for the quarter ended December 31, is a $0.06 per common share increase when compared to the prior quarter ended September 30, 2014. In regards to the debt investment in our portfolio, 82% of our loans have variable rates, and they all have a minimum or floor. The remaining 18% are at fixed rates. The weighted average yield on interest-bearing debt investment remained consistent quarter-over-quarter at 12.5%. This strong yield excludes success fees on our debt investments. Success fees, as we have talked about before on these calls, are contractually due generally upon a change in control of the portfolio company, although there are times when the portfolio company can elect to pay it earlier. We generally only recognize success fees in our income statement when they are received in cash. For comparison purposes, if we had accrued these success fees as we would if it was paid in-kind interest, like other BDCs do, then our weighted average yield on interest-bearing assets would approximate 15.5% during the December quarter. As of December 31, 2014, the success fees accruing off balance sheet totaled $23.5 million or approximately $0.89 per common share. From a credit priority standpoint, 76% of the loans in our portfolio are senior in priority, with the remaining 24% being senior subordinated in the capital structure of the respective portfolio companies. Overall, Gladstone investment had a strong origination quarter, which helped equate to strong financial results. We increased our distribution rate on our common stock over a year ago and have maintained that increased distribution while still remaining committed to covering our distributions by net investment income, as we have done consistently over our last 4 fiscal years. Due to a buildup of excess earnings from prior years, we paid a $0.05 onetime special distribution in December 2014. Let's turn to realized and unrealized changes in our assets, which are below net investment income. Realized gains and losses come from actual sales or disposals of our investments. Unrealized appreciation and depreciation come from our requirement to mark our investments to fair value on our balance sheet. The change in fair value from one period to the next is recognized in our income statement. Unrealized appreciation and depreciation is a noncash event. During the 3 months ended December 31, we recorded minimal realized activity related to previous exits. For our unrealized activity, our net unrealized appreciation was $2 million for the 3 months ended December 31. For the quarter ended December 31, our debt investments had net depreciation of $1.7 million, and our equity investments had net appreciation of $3.7 million. For the December quarter end, our entire portfolio was fair valued at 86.2% of cost, which is up from 84.2% of cost last quarter. Now let's turn to our bottom line, net increase and net assets from operations. This term is a combination of net investment income, unrealized activity and realized gains and losses. For the December 2014 quarter end, this number was an increase of $7.6 million or $0.29 per share versus an increase of $2.7 million or $0.10 per share in the September '14 quarter. The quarter-over-quarter change is primarily due to the aforementioned increase in both total investment income and unrealized appreciation over the 2 quarters. All of our portfolio companies are current in payment, except one, which continues to remain on non-accrual, representing 0% of the fair value and 3.2% of the cost basis of our total debt investment as of December 31. And with that, now I'll turn the call back to David.

All right, Melissa. Thank you for that good report. Thanks to Michael and Dave for their good reports. Gladstone Investment's third quarter was a great quarter. We're able to report some great accomplishments such as the strong origination activity, the Series B preferred stock offering and our onetime extra dividend. Net investment income of $0.22 a share exceeded our distribution run rate of $0.18 per share, and we believe we can continue the success going forward, especially for the quarter ending March 31, 2015. Each year in April, Dave Dullum and now Melissa Morrison, our CFO, work on the projections in an effort to figure out what we're going to have for income for the next year. And right now, it's a daunting task because you never want to increase the dividend and then not earn the dividend. Our board is very conservative. They don't want to raise the dividend and then not earn it or, worse yet, have to cut it. So it's a bit too early in the process to predict the dividend for the fiscal year ending March 31, 2016. We just have to wait and see what happens when we go through all of that analysis in April. So looking at the outlook for this company and, really, for all of the companies in the United States, it's just been a very sluggish recovery. We still have the same economic concerns that we mention each quarter. There's still a great deal of uncertainty around the Federal Reserve's monetary policy and the impact it will have on future interest rates. And while we have variable interest rates on most of our loans, increasing rates won't hurt us, but it's really not good for the economy or for the people borrowing money from us. The volatility in oil and gas industry is just continuing to be a mystery of what's going to happen there. Low oil prices are a terrific benefit to the economy, but how long will all of that last? Fiscal crisis in the federal government is still top of my mind and, I think, top of mind to a lot of people. The federal deficit now is $18 trillion and continues to climb, as the government spending just seems to see no end. And also, many private companies like those in which we invest feel there's far too much regulations around health care, financial services, the energy area and certainly, commissions and those kind of things. So I think that hinders performance probably more than anything in today's economy. This company, Gladstone Investment, is in a very strong position today to move forward with strength in its balance sheet now and large equity interest in some of these companies where we own 60%, 70%, 80%. I hope we can exit 1 or 2 of them in this calendar year, 2015, and we have excess earnings that we roll forward and use to pay distributions. And we have equity interest in companies that, if they're sold in the future, and hopefully being big capital gains as we've had in the past. In order to fund new deals, we do need to access future capital-raising efforts in order to provide further liquidity. We're just going to have to do something somewhere along the way to relieve our leverage because it's getting pretty high now. Despite the past, current economic issues, our fund has continued to make consistent monthly distributions and made good progress increasing the distributions during this last fiscal year. And this fiscal year, again, is up primarily because of the extra dividend. In January 2015, our Board of Directors declared a monthly distribution on our common stock of $0.06 per common share for each of the months of January, February and March 2015. And the board will meet again in April to consider and vote upon the distributions for the next 3 months after that. That's in April. And that will be a good time to look at projections for the year ending March 31, 2016, just see where we're going. Through the date of this call, we've made 115 sequential monthly cash distributions on our common -- to our common stockholders and some extra bonus dividends almost every year. The current distribution rate for common stock with common stock price at about $7.37 yesterday, the yield on a distribution is about 9.8%. Our distribution of -- our distributions of 7.125% on our Series A preferred stock is about $0.1484 monthly or $1.78 annually. The preferred stock closed yesterday at $26.45 on NASDAQ under the symbol GAINP, and that gives you a yield of about 6.7%. Distribution of 6.7% on our Series B preferred stock, which translates into just a little bit over $0.14 a month or $1.69, that preferred stock had a closing market price yesterday of $25.40 on the NASDAQ and under the ticker symbol GAINO. That's about a 6.65% yield on that stock today. Again, we believe Gladstone Investment is a very attractive investment for all investors seeking continuous monthly distributions with the potential of some special distributions along the way if we hit these bigger capital gains. And we'll continue to be disciplined in our investment approach and our focus on making conservative investments in these American businesses that we love to follow so much. We expect a strong quarter for March 31, 2015. We'll talk to you next time on that. So now let's have some questions from our analysts and loyal stockholders. So if you'll come on, please, operator, and tell them how they can ask some questions.

[Operator Instructions] I'm showing no questions at this time. I would like to turn the call back to David Gladstone for any closing remarks.

Okay. We have no questions. That's unusual. We usually get 2, 3, 4 questions. And so we'll move on now. And thank you all for calling in. And please read the Ks and Qs and our filings. And we'll go from there, so that's the end of this call.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.