Gladstone Capital Corporation (GLAD) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Gladstone Capital Corporation's third quarter ended June 30, 2015, earnings call and webcast. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's presentation, Mr. David Gladstone. Sir, please begin.

All right. Thank you, Howard. Very nice introduction, and good morning, everyone. This is David Gladstone, the Chairman, and this is the quarterly earnings conference call for stockholders and analysts that follow our stock, Gladstone Capital. Common stock's traded on the symbol GLAD and the preferred stock is traded under GLAD with an O on the end. Thank you all for calling in. We're always happy to have this time with shareholders and the analysts that cover our stock. Wish we could do it more often. We like giving updates on the company. We continue to go along at a good pace, our portfolio and our business environment seems to be okay today. As always, you have an invitation, it's open, to visit our office here in McLean, Virginia, which is outside Washington D.C. So if you're in the area, please stop by, say hello. The team is about 60-some people here and I think they are some of the finest people in the business. And now we'll hear from the General Counsel and Secretary, Michael LiCalsi. He's also President of the Administrator and he'll make a statement regarding forward-looking statements.

Good morning, everyone. This conference call may include forward-looking statements within the meaning of the 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, 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 filed with the Securities and Exchange Commission, all of which can be found on our website, www.gladstonecapital.com, or the SEC’s website, www.sec.gov. And the company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. Please also note that past performance or market information is not a guarantee of future results. We ask that you visit our website and sign up for our e-mail notification service. You could also find us on Facebook, keyword, The Gladstone Companies, and follow us on Twitter at @GladstoneComps. I hope our listeners will read our press release issued yesterday and also review our Form 10-Q for our third fiscal quarter ended June 30, 2015, which was also filed yesterday with the SEC. You can access the press release and 10-Q on our website and you can access the 10-Q on the SEC's website as well, www.sec.gov. And the audio presentation of this call will also be archived on our website. And now we will begin with hearing from Gladstone Capital's President, Bob Marcotte.

Good morning, everyone. As many of you know, Gladstone [indiscernible] is the lending fund of The Gladstone Companies. We provide cash flow-based loans to privately held U.S.-based businesses in the lower middle market, which we define as having $20 million to $100 million in revenues and $3 million to $15 million in earnings before interest and taxes and depreciation. Our loans are used to fund private equity buyouts or to make acquisitions or to recapitalize or refinance a company's existing capital structure. Gladstone Capital was one of the first BDCs focused on lending to the low to middle market and today that dedication, experience and consistency are a core part of our value proposition. We approach the market with an investor perspective and strive to deliver market-oriented capital solutions to support each business's unique capital and growth profile. The majority of our loans today are to businesses backed by private equity sponsors or owner-operators with significant equity and include a combination of secured first- and second-lien loans and many include equity co-investments. We target to make investments of $8 million at the $20 million, but will opportunistically consider smaller positions in broadly syndicated loans from time to time. With that introduction, I want to take this time to update our shareholders and analysts on our operating results, our portfolio performance and commentary on the marketplace. With respect to our investment activity. After pacing well ahead of plan for the first half of our fiscal year through March 31 with originations of over $90 million, we did not make any new investments on the quarter ended June 30, 2015, as several of the proprietary deals we had anticipated closing were delayed and closed after the end of the quarter. In anticipation of funding these new investments, we sold $9 million of our syndicated loan portfolio, and as a result, our net earning assets on the quarter declined by $14 million. Since the end of the quarter, we have closed 2 new proprietary investments totaling $20.2 million. We invested $7.2 million in a secured second-lien debt and equity co-investment in the buyout of Mikawaya by a private equity sponsor. Mikawaya is a producer of Japanese pastries and specialty frozen desserts, which has been family-owned and operated for over 100 years. The company is a dominant player in their niche and is poised to expand beyond their traditional customer base. Additionally, we closed a $13 million secured first-lien term loan to StrataTech Education, which is a leading operator of a posteducation -- postsecondary skill trade schools. The company has a strong record of student outcomes and placements, regulatory compliance and is backed by 2 experienced private equity sponsors. In addition to these recently closed deals, we have a healthy pipeline of pending opportunities, which we anticipate to provide strong investment momentum as we go through our fourth quarter. With respect to the portfolio overview and performance. Over the past several quarters, the cumulative effect of our focus on secured first lien and unitranche investment is continuing to impact our portfolio mix and results. We are currently at a 60-40 mix of secured first lien to secured second-lien debt it in our -- based on the fair value of our loan portfolio. We do not have any unsecured subordinated debt exposures at this time. The combination of the higher-yields available in the lower middle market and our recent focus on modestly leveraged senior secured assets is expected to produce a more attractive and predictable return to support our shareholder distributions regardless of where we are in the credit cycle. On the whole, the fair value of the existing portfolio decreased slightly by $1.1 million on the quarter as unrealized depreciation of $17.6 million exceeded unrealized appreciation of $16.5 million. The largest driver of the appreciation on the quarter was the continued appreciation of our equity investment in Funko, a toy company that markets licensed pop culture collectibles, which is continuing to report very strong operating performance. The largest drivers of the unrealized depreciation in the quarter included $5.9 million depreciation of RBC Acquisition, also known as Reliable Biopharmaceutical, and a $2 million depreciation of our investment in B+T Group, a telecommunications tower engineering services business. Both of these latter [ph] companies experienced soft financial results during the first half of 2015, which are expected to improve over the balance of the year. During the quarter, we also exited Sunburst Media, an underperforming radio operator during the quarter, realizing cash proceeds of $4.7 million and a realized loss of $1.3 million, which was $1 million -- the recovery was $1 million higher than the valuation of last quarter. We believe that over the last few quarters, we have demonstrated successful dispositions of a number of our legacy assets and hope to have one or two more exits to report next quarter. With respect to our oil and gas exposure. There were no material changes in the quarter. Our industry exposure represents $53.1 million or 15.4% of our portfolio at fair value and continues to perform well given its limited exposure to commodity prices, drilling activity and conservative leverage with weighted average leverage of 2.8x EBITDA and average fixed charge coverage of 2.4x. All companies are covenant-compliant with ample liquidity and are backed by strong and experienced private equity sponsors. Cumulative net unrealized depreciation associated with our oil and gas loan portfolio totaled $1 million as of June 30 and the fair value represents 98.1% of costs. On the whole, the cumulative net unrealized depreciation investments increased slightly to $53.8 million for the quarter ended June 30 and it represents the bulk of the increase -- decrease in NAV from $9.55 a share to $9.49 a share for the quarter. Despite some successes on the quarter, our nonaccrual investments and underperforming assets are still higher than we consider acceptable. This quarter, we added Saunders and Associates as a nonaccrual investment as adverse end market conditions for its electronic products and unfavorable exchange rates have compressed the company's revenue. The fair value of Saunders and Associates investment was reduced by $1 million to $1.2 million during the quarter. As of June 30, 2015, our combined nonaccrual debt cost basis is $49.2 million or 13% of the cost base of all debt investments in the portfolio and has a combined fair value of $10.7 million or 3.5% of the fair value of all debt investments. We are currently working to exit these underperforming assets and we are looking forward to being able to update you in the near future. With respect to portfolio yields, moving over to our portfolio income profile. The weighted average yield on our interest-bearing debt investments, excluding reserves in our portfolio, was 11.2% as of June 30, which is relatively the same as the 11.1% as of March. For the quarter, total investment income was up 7.7% or $700,000 compared to the prior quarter. Our debt portfolio is well positioned for an interest rate increase with 84% of the portfolio in floating rate investments and 16% in fixed rate investments. Our floating rate investments typically have a LIBOR floor and the weighted average floor on our variable loans today is 1.9% while the average weighted margin is 9.2% as of June 30. Our proprietary loans, which total 83% of the portfolio at cost, had a weighted average yield of 10.9%, while our syndicates, which total 17% of the portfolio at cost, had a weighted average yield of 11%. The net effect of 100 basis point increase in 1-month LIBOR and the applicable floors would reduce our portfolio net interest income by $775,000 or approximately $0.04 a share. The other income in our portfolio has been significant at times over the last several quarters, which is primarily due to what we call success fees, and to a less extent -- lesser extent, dividend income. For the quarter ended June 30, 2015, we recognized $510,000 in dividend income and $318,000 in success fee income. In total, other income was up quarter-over-quarter by $345,000. Success fees are typically due on the change of control and are highly contingent in nature, therefore, we accrue our success fee receivables off balance sheet. As of June 30, the off-balance sheet success fee receivable totaled $9.1 million or about $0.43 per common share. In addition to what we believe to be a favorable risk profile of a recently originated senior secured first-lien unitranche investment, the asset shift in the portfolio was also made in conjunction with the amendment, extension and expansion of our credit facility. The revised facility, which closed in the June 30 quarter, reduced our borrowing cost and increased the advanced rates against our secured first-lien assets. With respect to the investment climate and backlog of opportunities and outlook. Inclusive of the 2 deals we closed after the end of the quarter, we've averaged just over $30 million of proprietary originations per quarter, which is consistent with the current level of market activity we are seeing across the lower middle market and our current pipeline of proprietary deal opportunities. We continue to see a proliferation of smaller, newly formed PE funds looking to take on smaller investment opportunities with an increased emphasis on buildup and acquisition investment strategies. These trends are well suited to our low and middle market focus, value proposition and focus on delivering senior secured unitranche financing solutions. From a liquidity perspective going into the balance of 2015, the competitive dynamics for the middle market loans appears positive including several factors: the cumulative effect of the regulatory pressures on leveraged lending by the commercial banks; the limited funds flow into the broader loan markets, which reduces loan asset demands and potential pressure on middle market spreads; and weak BDC stock prices generally trading below net asset value per share, which serves to lessen the competitive pressure to book middle market loans. Competition continues to be most pronounced in the large and middle market companies with more than $10 million of EBITDA where the commercial banks and the broadest array of nonbank lenders operate. In the face of this competitive profile, our strategy is to continue to leverage our long-standing reputation in the low end of the middle market and investor-oriented financing approach continues to gain traction. We're focused on investing in our coverage of and relationships with private equity-sponsored community and expect to be able to continue to source attractively priced financing solutions in this market. We're -- our continuing priorities for the balance of fiscal year -- our fiscal year ending September 30, 2015, will be managing our remaining legacy credits in the portfolio to orderly liquidation, utilizing the enhanced availability under a recently amended line of credit and sales of our syndicated loan position or select first-lien positions to support future growth of our proprietary deal portfolio. And now, our Chief Financial Officer, Melissa Morrison, will provide an update on the fund's third fiscal quarter's financial results. Melissa?

Thanks, Bob, and good morning to everyone. I will now provide an update on some of GLAD's financial results and overall portfolio for the quarter ended June 30, 2015. Starting with our income statement. Net investment income was $4.8 million or $0.23 per share for the quarter, which increased by 31% from the prior quarter. Interest income on our debt investments increased quarter-over-quarter by $367,000 or 4.2% as the new originations added last quarter impacted this quarter's result. Other income increased by $345,000 to $828,000 on the quarter as success fees declined and dividend income increased compared to the quarter ended March 31. We expect other income to remain meaningful, but variable from quarter-to-quarter. Interest expense remained flat quarter-over-quarter as the weighted average balances outstanding on our line of credit increased by $9.5 million, but were offset by a decline in the borrowing rate effective April 30 from 4.1% in the March quarter to 3.8% in the June quarter. Nonfinancing costs, net of credit, during the quarter decreased by $391,000 or 12.3% compared to the prior quarter to $2.8 million or 3% of average total assets. Net investment income of $4.8 million for the quarter covered our common distributions declared of $4.4 million by 109.5%, which reflects the increase in total investment income and decrease in total expenses. As we have demonstrated over the last several years, our adviser remains committed to crediting its fees so that annual net investment income covers our shareholder distribution. The low net investment income on our income statement is where we reflect realized and unrealized changes in the fair value of our portfolio. During the quarter ended June 30, 2015, the net realized losses were primarily due to our exit of Sunburst Media for net proceeds of $4.7 million, resulting in a net realized loss of $1.3 million. For the quarter ended June 30, we recorded net unrealized depreciation of $1.1 million on investments. Over our entire portfolio, the net unrealized depreciation, excluding reversals for Sunburst, for the 3 months ended June 30, consisted of approximately $1.5 million of net depreciation on our debt investment and $1.8 million of net depreciation on our equity investments. Our cumulative net unrealized depreciation of our investments as of June 30, 2015, does not have an impact on our current ability to pay distributions to stockholders. However, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution to stockholders. From a vintage perspective, the Gladstone Capital portfolio as of June 30, 2015, consisted of 11 companies originated prior to 2009 and 35 companies that were originated in 2009 and later. The newer vintage portfolio investment originating over the last 6 years represent 68% of the total portfolio cost basis are currently valued at 102.8% of costs and do not include any nonaccrual loans. We are continuing to work the remaining older vintage assets in the portfolio. Our older vintage portfolio companies that originated prior to 2009 totaled $61.6 million in cumulative net unrealized depreciation as of June 30 compared to portfolio companies that originated after 2008 totaling $7.8 million in cumulative net unrealized appreciation. We believe this vintage analysis of our investment portfolio reflects a marked distinction from the valuation of those assets originated over the last 6 years and shows the overall improvement in our portfolio and ability to manage through various economic cycles. Moving over to Gladstone Capital's balance sheet as of June 30, 2015. We had approximately $369 million in total assets, consisting of $347 million in investments at fair value and $22 million in cash and other assets. Liabilities totaled approximately $169 million, consisting of $104.6 million in borrowings at cost on our line of credit, $61 million in term preferred stock and $3 million in other liabilities. During the June quarter, we closed on a material amendment of our credit facility, which provides for decreased interest margin and commitment fees and extended the revolving period by 3 years to January 2019 with a 1-year extension option to 2020. In addition, other terms and conditions were amended to expand the scope of eligible collateral and improved borrowing availability against secured first-lien loans. The amendment improved our cost structure effective April 30 and revised our credit agreement to better match our core investment focus, making us more competitive in the future. In addition, in June, we expanded the line of credit by $30 million by adding 3 new lenders, bringing the current facility commitment to $170 million with the ability to expand up to $250 million. While our leverage on our balance sheet has increased over the last few quarters, our annualized cost of debt capital has decreased considerably by 2.5% since our fiscal year ended September 30, 2014. This is primarily due to the increased usage of floating rate debt under our credit facility and the recently amended terms. Overall, our net asset value primarily decreased quarter-over-quarter due to the increase in the cumulative net unrealized depreciation. Net asset value decreased from $9.55 per share as of March 31, 2015 to $9.49 per share as of June 30, 2015. From an available capital perspective, as of today, assuming we continue to draw to fund eligible investments, we have about $38 million in aggregate cash and availability on our $170 million credit facility to fund additional investments. Additional investment capacity will be accessed from a combination of sources: several pending syndicated loan repayments, which are expected to close in the September quarter; the opportunistic sell-down of syndicated loan positions of seasoned and performing proprietary senior loan and revolver positions; and the completion of the ongoing exit plan for a number of investments. In addition to the foregoing, management continues to evaluate other new sources of capital including the use of the at-the-market issuance program put in effect earlier this year, market conditions permitting. We believe as a BDC, we are still conservatively leveraged as we adhere to the leverage restrictions requiring us to be no more than 1:1 debt-to-equity. Now I will review our portfolio. The current asset mix at fair value is 88% debt to 12% equity, and secured first-lien investments represent 53% over the total portfolio and second-lien investments represent 35% with no subordinated unsecured investments in our portfolio. We currently have 46 companies in the portfolio, which is down from 50 at the prior quarter end due to the aforementioned sell-downs and exits. Our portfolio is highly diversified by industry classification with 19 different industries and by geographic region. Since January 2014, we have closed to date on 11 new or follow-on proprietary deals, representing $146.6 million of PE-sponsored investments with a weighted average leverage of 3.4x EBITDA and a weighted average yield of 10.7%. We continue to avoid industries in the housing, banking, high-tech and venture capital, commodity products or highly cyclical industries. In summary. We were able to liquidate some of our syndicated portfolio in order to provide capital for several new originations that closed in July as well as exit one of our legacy investments. We maintained our portfolio yield during the quarter while decreasing our cost of capital with our credit facility amendment. We believe that this quarter sets us up for a strong end of year and we expect to continue to show accretive results to our shareholders while maintaining our long-standing track record of shareholder distribution. And now I'll turn the call back over to David.

All right. That's very nice reports from Melissa and Bob and Michael. We love to have these good reports each quarter. The quarter ended June 30, 2015, I love the idea that we've maintained our investment momentum. Obviously, they closed the 2 deals subsequent to the quarter, but we were working on those all during the quarter for another $20 million. Extending and amending the credit facility also helps knock 0.5 point or so of your borrowing level and that always falls to the bottom line. And maintaining a good, healthy pipeline of new proprietary investments, our group here has been working hard on that and we continue to see that coming on. So all in all, it was a good quarter. Our main focus now is to sell these underperforming assets and to continue to generate attractive loans. So as we take money out of the older deals and put them into new ones, you should see some good results from that. Since we do our own originations, we have a good number of experienced professionals here that do all that kind of work. BDCs like ours have an advantage of being able to execute on all facets of the business, so many borrowers are looking for us to take -- looking to us to take advantage of the capital availability by actively shopping around. But most of the smart businesses, they're not just looking for low rates or money, they are also looking for a partner and a partner that can help them succeed and I think this is where we succeed in helping out these small businesses. With all the business experience that we have and the strong relationships we have in the financial sources marketplace, we bring a powerful package to each of these businesses. These are the same resources that are so critical to work on problems and businesses that we've had and come up with an orderly exit of any of these underperforming investments. Last, the success of the long-term capital will always be play a priority in our originations of deals. We live on the difference between what we can borrow at on the one hand and what we can lend it out on the other and we continue to look to raise long-term debt and preferred and common equity as needed over the long term that will help us succeed in the spreads that we look for. Recent economic indicators appear to be improving some such as the housing area, the employment -- employers are hiring and although the U.S. manufacturing sector is still struggling and we see services coming on very strong and we continue to invest in both of those areas. We are monitoring the few trends that we see out there, the volatility in oil and gas industry pricing. So it seems like one month they're up and the next month they're down, but there is a stability that's going on now. It's reasonably stable even though it fell off a little bit last week. But the area seems to be in the $50 a gallon -- a barrel in terms of this current reasonable stability in the prices. There's still a lot of uncertainty around the timing in the Federal Reserve's increasing interest rates, although I think they've told everybody in the world that probably this quarter coming up in September is going to be the one that they move things and best guess is 0.25%, which won't mean much in terms of us or anybody else. Stronger domestic data and rising inflation has provided a little bit of investors' greater confidence in the Feds raising the short-term rates by the end of the year, my guess is September. China is still having real economic concerns. Their capital marketplaces are under tremendous pressure. Public finances are stretched and bad debts are rising. Places like Greece, well, Greece is desperately working to conclude the bailout and avert the financial collapse that almost happened. And while we don't invest directly in any foreign companies, global economy now affects everyone, so we worry about what goes on in Greece and in China and every place else even though we're not directly connected to that. The fiscal crisis and the federal government is still on top of bond and federal deficits, so over $18 trillion, and continues to climb. The government says they can't continue at this rate unless they increase taxes and that seems to be the only thing that they think about is increasing taxes. It would be nice if somebody thought about cutting expenses, but that doesn't seem to be on the mindset of any of the politicians. Many of the private companies like those we invest in has far too much regulation from both federal and state regulators. It's around health care, financial markets, energy, environment, these are hindering headwind the performance of these, and quite frankly, reducing the number of jobs that are out there to be filled. Despite the economic issues, we continue to be in a great time to invest if you can find the right middle-market business to invest in, so we work hard at making sure we find those. But one has to be very, very selective. There are plenty of small businesses looking for money, but not all of them are going to fit into the way that we look at the world. Gladstone Capital has remained committed to supporting these small businesses, and at the same time, being loyal to our shareholders. So we're always balancing out what we can do for the small businesses versus what we can do for our shareholders. In July of 2015, our Board of Directors did declare the monthly distribution to common stockholders of $0.07 per common share and the regular distributions on our preferred stock for the July, August and September. And the board will meet again in October to consider the vote in monthly distributions on October, November, December. Through the date of this call, we've made about 149 sequential monthly and quarterly distributions to our shareholders and we've never missed a distribution. The BDC is typically known for attractive dividend yields and easy liquidity. Those are both things that the public investor can excess in these BDCs and get to the private companies that are out there in the marketplace. It's practically the only way of getting there. At the current distribution rate, our common stock with a common stock price of about $7.86. Yesterday, the distribution run rate is now producing a yield over 10%, about 10.7%. Think it's a pretty solid yield on top of that, I don't think it's in danger of being cut. So the end of the day, I think it's a great opportunity to buy the stock. The BDC industry median distribution level is running somewhere in the 9% to 9.5% to 10%, so we're a little bit over that. On the other hand, our net asset value is now $9.49. And so when you buy the stock, you're getting a great value at a deep discount. You're buying $9.49 worth of assets for $7.86, so we're trading at 82%. So that's quite a discount for the opportunity out there in today's marketplace. So I think it's a great place to get current yield as well as some protection on the downside. Our monthly distribution is 6.75% on our preferred stock. That's a wonderful yield. And the probability of ever missing that dividend would seem to be very, very far away. So you've got 2 terrifically yielding stocks, one is common, one is preferred. Both of them would fit well in almost anybody's portfolio that wants current income. In summary. The portfolio has positive momentum. We continue to remove ourselves from deals that haven't worked out and at the same time put new deals on. And so we're moving the risk profile from those that have risk to those that have much less risk. We hope to continue to show you a strong return on your investment in our fund. And now if the operator will come on, we'll take some calls from those of you who are on the line that would like to ask a question.

[Operator Instructions] Our first question or comment comes from the line of David Chiaverini.

Have a couple of questions for you. First, can you comment on the revenue and EBITDA growth in the portfolio by vintage?

I don't have any numbers on that. Do you have any, Bob or Melissa? We don't, but let us do some work on that and see if we can put something up on our website.

Got it, got it. Okay. And then second question, do you have the ability to -- are you able to disclose the magnitude of the potential sales and perhaps what percent of the legacy investments may be sold?

Well, that's a very difficult question to answer because you never know when you're going to be able to get rid of one of the legacy assets. You're constantly casting around for people that might want to buy it. In fact, in the radio station we mentioned, by the way, I probably financed 100 radio stations. This is the first time we've had losses in that sector and it just never came back. So the decision was do you want to stay in the deal and hope that they can turn the business around and fix it? Or do you want to exit at a discount, take a loss, but get your money and put it into something that has good strength and good upside. And we made that decision and lost a little bit of money, but brought in $4.7 million that was turned around and put in good, solid new business. So those kind of decisions are hard to make. I'm one that never likes to lose, but we've had some losses and we've had to take them in order to continue the momentum of growth in the company. But I don't have any. . .

Yes, I think David, the way I would respond to this, some of those businesses are, as David mentioned, in radio. There are certainly buyers of businesses that can in plug in those operations into a existing platform, or in some cases some cases, if they're too small, effectively what you end up doing is downsizing it to something that's not really supported by institutional capital. A couple of those are relatively small and they are in the works and I think we've shown the exit of Sunburst was part of that. I think you'll note that there was a paydown from the sale of a portion of the Heartland assets. So the radio portfolio is moving as part of the process. Some of the other credits, frankly, probably either need to be restructured more significantly or are going to go through a more significant exit experience. There are really probably a couple of the larger ones that are in the works. The smaller ones are still somewhat problematic because they don't have quite the marketability of larger credits and it takes a longer period of time. They're all on the table and they're all in various stages of process right now. I really can't comment specifically on any particular scale and scope.

Understood. Those are good comments. And is it reasonable to expect that any sales that you do end up realizing that the proceeds will be roughly around the fair values recorded at June 30?

Yes, it depends on the situation. In the case of the radio station, I think we sold at about $1 million more than we had it valued at. So as a result, there was a step up in one rather than a step down. But I can't guarantee that we wouldn't sell something below where we have it fair valued. Fair value, as you know, in this business, is an extremely difficult thing to do. Valuing private companies that don't have any relationship to these major companies out there is very difficult. We've hired an additional group to come in and help us with this. We've got Standard & Poor's that helps us do the valuations of the debt side of the business and we now have another group that's now working with us on the equity side of it to see if we can get better results. And it's a focus of both the government and also our accounting professionals in order to make sure that we get as best as we can. But I can tell you from experience, it's a very difficult thing to do. After doing this for many, many years, sometimes I guess right and sometimes I guess wrong in terms of valuation.

I would say also, add to that, David, a number of the credits, when you look at fair values on debt and positions that are in the teens to 20s, certainly well south of 50, those are pretty extreme valuations so we tend -- I think our experience has been conservative when the markets are fairly low. What happens when these credits get into trouble? We tend to be in a situation where we either need to take it over or we put in a new management and any lift can be pretty significant movement to the underlying cash flows and valuation. So we are taking action on a significant number of these and it tends to move the numbers fairly quickly. But overall, I think we still feel pretty good about where we're marked and the likelihood proceeds would exceed where we are today.

Okay, that's helpful. And my final question is just on the nonlegacy investments. It sounds like the health of those investments is pretty good. Is that fair to say?

Yes, I mean, I would emphasize the point that Melissa went through. I mean, $150 million of senior secured assets with less than averaging 3.5x of leverage is a pretty healthy position. Most of those situations we're talking about highly diversified businesses. They tend to have some measure of growth in the current environment, in the current economic conditions. They have significant amounts of equity below them and they're all sponsored deals. So there's equity -- professional equity managers with interests below us. So I think we feel pretty good about it. Housing, they're not in cyclical industries, but we're kind of taking a bet that next year's going to be good. They are stable, growing, well secured, relatively low-leveraged assets.

Our next question or comment comes from the line of Christopher Testa from National Securities.

Just on the oil and gas exposure. I know you had mentioned that it's stabilized. David. Could you give me an idea on what the attachment point and leverage is in the oil and gas portfolio relative to -- the remainder of the portfolio?

Bob, why don't you take that?

Yes, I think I mentioned in my comments, Chris, that the overall leverage through our position on a weighted average basis is 2.8x of leverage across those 3 investments. Included in those energy investments, for example, because of the broader industry designation, there are certainly sectors within the energy complex that are subject to swings there. For example, in our list of assets is a company called SPL. I'll give you an example, that is a test and measurement company that is providing assay services and distillation measurement and accounting services for energy content of energy flows, which certainly are continuing regardless of the commodity price. That business, when we closed, the EBITDA is up probably 30% over the last year since we've gone in it and it has significantly deleveraged. So not all energy-related assets necessarily are impacted by the movement of commodity. In fact, that's one that is deleveraging in the current environment.

Okay, great. That's helpful. And is the Saunders investment -- first, when was that originated? And is that a sponsored or a nonsponsored deal?

It was originated in 2008. It was a sponsored deal and they have effectively done very well in the rest of the fund and the sponsor has no longer raising new funds so they are basically turning the keys over to us. So it'll be a situation where we will determine where that's going to go. So it's one of those situations where, over time, sponsors go out of the business and we have to work our way through it.

Okay. And just touching on the capital management given where your leverage is, I know you've bumped up the capacity to $100 million -- $170 million on the revolver. How -- are you willing to issue equity below NAV? I'm trying to figure out how you get to kind of utilizing the increased capacity on the revolver and kind of maintaining leverage. If you can give me some guidance on where...

Well, what's going on right now -- yes, Chris, what's going on right now is we're changing out some of the deals that we have. For example, we still have some syndicated. So we'll sell those and put them into different deals. As you heard, we are also selling some of our -- some that aren't working as well in order to get them. And so we're changing out stuff right now and we've got room on our line to do some more. Don't anticipate doing anything more than our current work with our rights -- not rights offering, but our ATM program. And we don't want to take on a lot right now. We are still expecting one of our investments to sell and we've got a pretty good capital gain out of it, but that's always a wish rather than something you can plan on. So working the portfolio first before we start talking about selling stock yet well below net asset value.

Yes, I will probably add the fact that, Chris, there's a number of credits that aren't inside into our credit facilities and we don't get any borrowing ability, so it's very dilutive to our availability. So those are high on our list to potentially move out. Order of magnitude, there's a significant, and you'll see probably from some of the other BDCs out there, some significant number of refinancings and recapitalizations going on, a number of them in our syndicated positions, a number of them in our proprietary positions and a number of them that we are proactively managing whether they're syndicated or proprietary. So there's a fair bit of fluidity. I think we demonstrated it last quarter and I think we have the ability to continue to demonstrate that to supplement where we are today. I think the idea of turning through some of the assets that don't fit our long-term position is our priority and the primary course of action in managing any future proprietary investments.

Okay, that's helpful. And my last question would be just with your input investment roll forward, you have the first-lien debt, you have in this Q, $194.6 million as of 3/31. But last Q, the other filing, it was at $181.5 million and the second-lien debt was also a different number. Can you just give me some color on why those numbers have changed or why those are off?

Well, first of all, you would take some of the deals that we had a first lien on that we sold and those that went away. So that ran and we're replacing them. You'll see these 2 deals that we've put on the books, we'll show you something in the next quarter. So we're swapping on some things out obviously.

Yes, and Chris, I think, the other thing that happened and you picked up and so there was a very small reclassification. Occasionally, when we do a unitranche facility, we will structure it as an A loan and a B loan, and in theory, both of them are senior secured. But in prior quarters, there was a time where the B loan was classified as a second lien even though we control the entire thing and it's just a script in the underlying credit. Today, because essentially it is all first lien and it's all controlled by us, it is appropriately being recharacterized as a senior secured loan, much like any other BDC and as it's treated on our new credit facility.

That's correct.

If we hold and A and a B tranche, which total 3x of leverage, our lenders treat it as a senior secured asset and we've now linked up our senior secured asset in our credit facility with our financial statement. So you see a slight revision of one or two credits that were in that category from the prior quarters.

Chris, just to elaborate. Our financial statement, we reflect the legal definition of lien. And as Bob said, in some cases, we were subordinated to ourselves, so we had previously been subordinated. But now -- or second lien and now we're showing the true legal definition.

Our next question or comment comes from the line of Mitchel Penn from Janney.

In the Q, you guys, in investment income, talked about an allowance. It says interest income from these new investments was partially offset by allowances on uncertain interest receivables for about $200,000. Can you just tell me what is that?

Mitch, yes, there are times when we establish reserves from some of our interest receivables and the company is not on nonaccrual at that time. There are times when we end up receiving this interest or the portfolio company ends up moving to nonaccrual status. Ultimately, we just have to see how the financial results of the portfolio company plays out. Obviously, there's different facts and circumstances around each portfolio company.

Which companies are those?

Which reserves have moved?

Yes.

Currently, there is a reserve from Saunders from previous quarters, Reliable and that's it. Yes, just Saunders and Reliable at this point.

Okay, great. Can you just update us on Legend and Precision?

Legend is a small radio operator in the Mountain States, continues to perform. It's current on all of its underlying interests. It's probably in the category of slightly larger than some of our other radio assets. So the marketability and the exit alternatives, as I alluded to earlier, are probably a little bit stronger. We're assessing where that might ultimately go. Certainly, we expressed an intent to exit a number of our small-market radio and in the past have been successful in bringing local banks and attracting SBA-guaranteed financing to refinance those. So that has worked and might be an alternative in the not-too-distant future for Legend. Who's your other -- the other question was?

Precision.

Precision, yes. Precision is a supplier into the aluminum manufacturing marketplace. Precision has been improving substantially over the course of the last year. We are seeing significant EBITDA growth. There was a point in time where that was pretty challenged. The company is current, paying interest and deleveraging relatively quickly. We extended the maturity date to early 2016, as you'll see in our schedule of investment, and we have every expectation that given the performance and the diversity that, that business is something that is marketable. I expect ultimately to see a liquidity event on that in the not-too-distant future.

Our next question or comment comes from the line of Casey Alexander from Gilford Securities.

On Funko, was that a directly placed investment? Or was it a private equity-sponsored investment? And if so, can -- would you share with us who the private equity sponsor is on that one?

Well, I'm not sure we can do that at this point in time. It was -- it had an equity sponsor, not as well known as you would expect in that area and it one that we originated. We took the lead on it in both of our companies. It happens to be in Gladstone Capital as well as Gladstone Investment, so we split the deal between the two and it has done exceedingly well.

It's a small West Coast operator that, I think, it was more of a pledged fund as opposed to an established private equity platform.

Our next question or comment comes from the line of Bill Brown [ph].

A couple of questions. First of all, I think, David, you alluded to a potential portfolio company that's hopefully looking at potentially large capital gain. I assume -- is this the one that you referred to in the last conference call that you had hoped, at that time, would exit in July, August? And if so, any more color on the time frame?

They're still working it down to 2 proposals. They haven't selected one, so we'll see. But all of that's up in the air. Please don't put that down as something that absolutely will happen. The group that's involved in it is working it very hard, but that's still something up in the air, but we're very hopeful that, that will happen in August.

And as follow-up to that, just on this issue, I'm just curious of the company policy. I know generally when you make a new proprietary investment, you send out a press release. When you exit a company, I know generally, you don't. Is it -- does it depend on the magnitude of the sale? Or is it just you figure the sales are not something that merits a press release?

Well, neither of them are required press releases. We've tried to give people an idea. There was a time when we did no press releases either way. And the people, the analysts, for example, I think one of them actually assumed that we did nothing during the quarter. Then at the end of the quarter, when we announced the 3 or 4 deals that we're in, he was embarrassed. So as a result, we've gone with the rest of the community and we announce these deals that we put together when we do them so that people can see the progress. Unfortunately, this is an exceedingly lumpy business in which you, one quarter you might have any number and then the next quarter you don't have any. So it doesn't make much sense to have the press release other than the fact that most analysts want to know when you've done a next deal.

Got it. So it's likelihood that if there's a sale, you probably would not have a press release?

Well, if it was big enough and was material, then you have to. For example, if we sold something and got $5 million worth of capital gains. We'd have to be able to press release that. I think that would reach materiality and we'd have to put something out.

Got it. And a second question relates to the adviser credits that were put in this quarter. I'm just curious, I know in the prior couple of calls, you had talked about how the adviser had committed to making sure the company could cover the dividend over an annual basis and then I thought the intent was to do the credits, if necessary, at the end of the year. I'm curious why -- what happened in terms of you doing them this quarter?

Well, the bottom -- go ahead, Melissa.

Sure. So the end of our fiscal year is September 30 and so when assessing and looking at our projections of NII and also our projections of cash distributions, we wanted to make sure that we would, indeed, be covered by that fourth quarter. So in some cases, although we switched to an annual basis instead of a quarterly basis of calculating those credits or determining those credits, we thought in the third quarter it was more prudent to add in an additional credit.

Unless there's a large capital gain, we know there will be a credit this year and we're just being mindful that we need to make sure that everyone knows we're going to try to do everything we can to cover it. A lot of people in the analytical world don't like the idea of these and they give us negative ratings because we haven't done it. I actually like it because it tells the people who are entitled to the credits that we are going to think of our shareholders first. So they know it's coming right out of their bonus if they don't make the numbers work and I think that's very healthy for a company like ours to tell those people that are sitting at the top that you either make it for the shareholders or you don't get it. There are a lot of situations, and I don't know how many they are, but I asked a couple of the analysts years ago, I said, how many people are crediting part on their incentive fee back to make sure they cover the dividend? And the answer was two and one was Gladstone Capital and the other was Gladstone Investments. So we seem to be the only ones that are dedicated and put our money where our mouth is to make sure that we cover the dividend each year.

[Operator Instructions] I'm showing no additional audio questions at this time, sir. I'll turn it back over to you for any closing remarks.

Well, we don't have any closing remarks except thank you all for listening, and we'll see you again next quarter. That's the end of this call.

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