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Edited Transcript of GAIN earnings conference call or presentation 14-May-19 12:30pm GMT

Q4 2018 Gladstone Investment Corp Earnings Call

MCLEAN May 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Gladstone Investment Corp earnings conference call or presentation Tuesday, May 14, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. R. Dullum

Gladstone Investment Corporation - President

* David John Gladstone

Gladstone Investment Corporation - Chairman & CEO

* Julia Ryan

Gladstone Investment Corporation - CFO & Treasurer

* Michael B. LiCalsi

Gladstone Commercial Corporation - General Counsel & Secretary

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Conference Call Participants

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* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Equities Research

* Ryan Lan Carr

Jefferies LLC, Research Division - Equity Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Gladstone Investment Corporation's Fourth Quarter and Year Ended March 31, 2019 Earnings Call and Web Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, David Gladstone. You may begin.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [2]

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Well, thank you all for calling in. This is your Chairman for Gladstone Investment. This is the fiscal year 2019 year ending conference call to shareholders and analysts of the Gladstone Investment. It's traded on NASDAQ, symbol GAIN, and we have some preferred stocks under GAINM and GAINL. And again, thank you all for calling in. We're always happy to talk with our shareholders and analysts and provide a view of the current business environment.

Our 2 goals obviously are to help you understand what happened during the last year and during the last quarter and give you a view of the future. We have changed these reports to exclude most of the history of the company and exclude the section on how this company is different from other BDC investment companies because it's seeking capital gains and incomes, so not just income. Hope you like the new report.

And now we'll hear from our General Counsel and Secretary, Michael LiCalsi. Michael?

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Michael B. LiCalsi, Gladstone Commercial Corporation - General Counsel & Secretary [3]

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Thanks, David. Good morning, everyone.

Today's call may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties and other factors even though they're based on our current plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors listed on our Forms 10-Q, 10-K and other documents that we file with the SEC. You can find all these on our website, which is www.gladstoneinvestment.com or the SEC's website, which is www.sec.gov.

And we undertake no obligation to publicly update or revise any of these forward-looking statements 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 any future results. And we ask that you take the opportunity to visit our website, once again, gladstoneinvestment.com, sign up for our e-mail notification service. You can also find us on Twitter. The handle there is @GladstoneComps. And on Facebook, keyword there is The Gladstone Companies.

Today's call is simply an overview of our results through March 31, 2019. So we ask that you review our press release and Form 10-K, both issued yesterday for more detailed information.

Now with that, I'll turn it back over to the President of Gladstone Investment, David Dullum. Dave?

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David A. R. Dullum, Gladstone Investment Corporation - President [4]

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Hi, Mike, thanks, and good morning, everyone.

So I'm pleased actually to report that we did have very solid operating results for this quarter and for the fiscal year-end, which is 03/31/19. It has been a very active fiscal year in that we exited 4 of our buyout portfolio companies, which generated a net realized gain of about $98 million. We also made 2 new buyout investments for about roughly $58 million.

Our net asset value, which is our book value, increased to about $12.40 per share at 03/31/19, and that is up from $10.85 per share at 03/31/18. So over the year, we had a pretty nice increase. This increase in NAV really resulted in part from an increase in the equity values of our buyout portfolio companies along with some of the successfully -- successful exits that we did have at pretty significant realized gains. And during this fiscal year, we were able to increase our monthly distributions to an annual run rate of $0.82 per common share, and we also maintained our semiannual supplemental distributions with payments totaling $0.12 per common share. That was $0.06 each.

Now subsequent though to the fiscal year-end and in April, our Board did approve an increase in these semiannual payments, which will be made first one in June, and that's up from $0.06 to $0.09 per common share.

So as a result of these significant net realized gains that were generated, we also took the decision to retain a large portion of these gains, therefore, we'd have to pay the required tax and declare what we call a deemed distribution to common shareholders. Now we believe that this is a prudent way to maintain capital for reinvestment and growth of the portfolio and also to minimize the need for secondary common stock offerings to raise capital, if we may need to. So in the near term, it also allows us to pay down on our line of credit and therefore reduce the interest cost to gain.

Now I want to, further to this point though, say that as we successfully exit these companies, we will lose interest income obviously on the debt portion of some of those investments. So we are mindful of the level of income to -- which we need to keep our monthly distributions at current levels and also, hopefully, grow them as we make new investments. And again, I really do need to stress this because this is consistent with our strategy of being a buyout-oriented fund, but we are very mindful of providing these meaningful dividend yields to shareholders on a monthly basis.

So now a few of our portfolio companies have been underperforming, so proactively, we made operational changes. We provided significant restructurings to improve the capital structures of these companies. And while these restructures may result in some realized losses in the short term, it does provide these companies the best chance for improving results and successes to protect and enhance shareholder value in the long term. We've done this in the past, and we've proven this to work. And so we believe also that these steps are properly reflected in our portfolio valuation and are taken into account -- into consideration when we do prepare our own internal plans and our projections of future income and operating results.

It is worth emphasizing that our differentiated investment approach of being a provider of the significant portion of the equity and most of the debt in our transactions does give us an advantage in that we have some influence on these companies when we buy them. So thus, our involvement with the management teams are similar to traditional private equity fund, where we do work with our portfolio companies, able to provide the assistance and making changes as necessary. And again, this will happen from time to time. We had some companies we've had to do this with over the last year and we, in the future, probably will have to do the same thing. But we have that capability and that's a very important part to keep in mind for how we operate.

Now we are pleased with the results of this year, but also we thought we'd review the past fiscal years from 03/31/14 to 03/31/19 because we believe that we've created a pretty strong track record in that, one, we've grown our total assets from about $331 million over $635 million at fair value. This is by the way inclusive of the numerous exits and the significant realized gains that we have had along the way.

Our regular monthly distributions to shareholders as I mentioned have grown from $0.66 per share in fiscal '14 to now $0.82 per share on an annual run rate in fiscal '19. Our NAV per share has increased from $8.34 to $12.40. We had 30 companies in our portfolio at 03/31/19 and through that date, we have exited 16 of our buyout companies since our inception in 2005. In aggregate, these exits have generated about $186 million in net realized gains and over $23 million in other income on exits. What's interesting about this is that these aggregate, what we call, cash-on-cash returns for the equity portion of these exits was approximately 4.6x. That's pretty much higher than our target, but we feel very good about that. It is this equity growth and the activities that has allowed us to deliver on our objective of generating capital gains from the equity portion of our assets, also has enabled us to pay several supplemental distributions to common shareholders and, as previously mentioned, in April, we did increase this now to $0.09 per common share.

Now as we look forward the portfolio today and the access to capital, we believe we're in a very good position to build on the success of these past years. Subsequent to year-end, though, we exited our investments to other investments, one in TREAD Corporation and the other in Jackrabbit, both in the aggregate, which resulted in net proceeds to us of about $24 million, and that included the repayment of our debt investments to these companies at par. So while the buyout environment continues to be extremely competitive, and we do tend to be conservative in our approach to value. We are focused on our plan of buying companies that are accretive obviously to both the income-generating portion of our assets as well as the equity portion of our assets.

We are experiencing some increase in our evaluation activity of these new buyout opportunities and hopefully, in the near future, we'll be able to announce some new acquisitions. We anticipate that we will continue paying the semiannual supplemental distributions as these portfolio companies tend to mature, and we're able to manage exits and realize additional capital gains. These distributions are generally expected to be made from net capital gains and undistributed net investment income.

We and our Board of Directors will evaluate the ability to make additional supplemental distributions and their amount and their timing as well as further GAIN distributions of capital gains similar to those which were recently declared.

So with that, I'm going to turn it over to our CFO, Julia Ryan. She will give you more detail on the actual performance for this past quarter. Julia?

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Julia Ryan, Gladstone Investment Corporation - CFO & Treasurer [5]

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Good morning, everybody. Operating results remained consistent quarter-over-quarter. While interest income decreased about $0.5 million this quarter, it was largely due to placing Meridian on nonaccrual. Other income increased $1.6 million given the variable nature and timing of dividends and success fee income.

Net expenses increased by $1.7 million in the current quarter, which was primarily driven by lower credits from the adviser and was partially offset by a decrease in interest expense, given proceeds from sales in December and therefore, a lower average borrowing outstanding and the income-based incentive fee as a result of lower net investment income, coupled with the increase in net assets which drives the hurdle. When adjusting net investment income to exclude the capital gains-based incentive fee accrual, adjusted net investment income per weighted average common share was $0.23 in the current quarter. We continue to believe that adjusted net investment income is a useful and representative indicator of operations exclusive of any capital gains-based incentive fees, as net investment income does not include realized or unrealized divestment activity, which is associated with such fee.

During the quarter ended December 31 -- sorry, March 31, 2019, we recognized net realized losses on investments of $19.5 million, which are primarily results of the restructures Dave noted earlier. We also recorded net unrealized appreciation of investments of $30 million in the current quarter, which consisted of about $20 million of reversals of previously unrealized depreciation upon those restructures. And $10 million of net unrealized appreciation of existing portfolio companies, which was predominantly due to an improvement in operating performance of certain portfolio companies.

Now looking at the balance sheet. As of year-end, total assets increased to over $635 million compared to about $620 million last quarter primarily as a result of net increases in the fair value of our portfolio companies.

Liquidity remains strong with over $137 million available under our line of credit and asset coverage of over 300%. Net asset totaled about $407 million or $12.40 per share, which is down $0.13 from last quarter primarily as a result of the taxes on the deemed distribution, and those were partially offset by the unrealized depreciation, net of realized losses.

As a reminder, while our balance sheet may show over distributed net investment income of $7.3 million, this is a direct result of the roughly $22 million capital gains-based incentive fee accrual that is not due to be paid and that was accrued under GAAP.

As of year-end and on a book basis, undistributed net investment income plus net realized gains totaled over $6 million or about $0.19 per common share, which is already net of the $50 million deemed distribution. This is the amount that would be available for distribution to shareholders in future periods even if the entire capital gains-based incentive fee accrual were to be paid.

And this covers my part of today's call. And now back to you, David.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [6]

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All right. Thank you, Julia. That was a good report. Dave, yours was excellent as well. And Michael, all of you've done a good job of informing our shareholders. And that presentation, including the 10-K that was filed yesterday, should bring everyone up to date on this company. This team has reported some great accomplishments during the fiscal year, including significant investment exits with realized gains and 2 new buyout investments and a good number of add-on investment transaction. The team is in a good position to continue these successes during the next fiscal year ending March 31, 2020.

In summary, this buyout fund is an attractive investment for investors seeking continuous monthly distributions as well as some supplemental distributions from potential capital gains and other income. Team hopes to continue to show you a strong return on your investment in this fund.

As noted, this fund is different from income-only funds. It gives income and as well as they are hard at work triggering capital gains to pay out every 6 months or so.

The Board in April declared a regular dividend of $0.068 per share per month, so that the run rate now is $0.816 per share per year. Stock trading as it was yesterday at $12.04, that's about a 6.8% return on the regular dividend if the company keeps paying out dividends [as they plan to do]. In addition, the Board declared a $0.09 per share extra dividend for June and we hope the Board will do the same $0.09 per share in December for a total of $0.18. That gives you a run rate of $0.996, almost $1 per share. So at that rate, it's about 8.3% payout to stockholders if the company can keep doing what it's doing today. And there's no guarantee, but that's their goal.

And now let's not forget the $1.52 deemed dividend per share for stockholders at the end of March. It is not cash, of course, but it benefits our shareholders in that after tax, the money goes to work to earn more income and benefits for shareholders by helping pay more dividends. And of course, the stock price is up. It's not up quite as much since Mr. Market held a sale yesterday of our stock at $12.04. I don't know why it's trading so low, since our NAV is at $12.40, but that's where we are. But anyway, the money in the company now from the deemed dividend will help us move up the dividend, hopefully, over time. And of course, I don't want to forget that at March 31, 2019, we reported a booming year, outpacing many others in this field. And it sets up the company good for the year ending March 31, 2020.

I like these deemed dividends. I know people kind of can't quite figure out what they are, but because it raises my cost bases by the amount of money paid out and -- not paid out, and I get a tax deduction of $0.21 per share. And now there is more money in the company working for me as a stockholder. And I'm excited about that future. And if the stock in my IRA, I do plan -- I know some of you know this, but I plan for the stock that I have in my IRA to get the administrator of my IRA to file a Form 990-T and have that $0.21 per share paid to my plan by the United States government.

So I'm happy, and I hope you are too. Now the team has to work harder to have 2020 be even bigger than last year. No guarantees of course, but that's what the fund is working for.

And now Gigi, would you come on and tell people how they can ask some questions for us today?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Henry Coffey from Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [2]

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I guess if I make the observation, "Wow, this has been amazing," my analyst colleagues will think I've lost my objectivity. But it has been very, very impressive since we picked up the stock, and congratulations all around. Couple of detailed questions. The credit for the -- the credit related to lower net receivable write-downs that shows up in the net interest expense, can you tell us what that was in the fourth quarter as well as what it was for the full year?

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [3]

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Henry, where are you reading from, I'm trying to follow it.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [4]

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No. It wasn't -- isn't there a -- in your overhead, don't you have a either a credit or a loss on related loans and receivables?

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [5]

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Now we may have reversed some interest income there, but it can't be much. Not -- I missed it, I'm sorry.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [6]

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We'll go back -- I'll reach out after the call.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [7]

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Okay.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [8]

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And then if you could articulate a little bit about what the actual realized losses in the portfolio were in the quarter, that would be helpful.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [9]

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So Dave?

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David A. R. Dullum, Gladstone Investment Corporation - President [10]

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Yes. Henry, it's Dave Dullum. So a couple of our companies, Henry, I mentioned we had to do some, we call it, restructuring, mainly around either transferring some of the debt investments we have to some sort of quasi equity. This is where the EBITDA is either -- it's bigger -- they've got positive EBITDA, but not enough necessarily to cover all of the interest. So for the near term, what we do is take a hard look at it. And obviously, we're concerned about the businesses operating and performing going forward.

So the ability we have, as I mentioned, is to be able to make some of those adjustments in the capital structure of those businesses. We generally then are going to bring in either someone from the outside to help work with the management team, et cetera, and try to get it turned around. We've done that multiple times in the past, and that is the nature of our business to some degree. When you buy businesses, you have things that do happen. So in general, it's around a couple of those companies that we had to do that with.

By the way, it was not net new per se because some of those companies had already been written down, but we actually went ahead and took the opportunity to do the restructure, which then generated a realized loss. Obviously, we had the benefit of being able to offset that against some pretty significant realized gains. So that netted out to the number that I mentioned. So that's basically a part of what we do on a -- we don't like to have to do it necessarily, but we can do it as we need to make these companies perform and then ultimately, we'll recoup it later on, we hope.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [11]

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Were those companies identified specifically in the 10-K? We can obviously go look it up there.

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Julia Ryan, Gladstone Investment Corporation - CFO & Treasurer [12]

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Yes, Henry. They were -- it was SOG and The Mountain.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [13]

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SOG, and what was that name of the other one, Julie?

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Julia Ryan, Gladstone Investment Corporation - CFO & Treasurer [14]

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The Mountain.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [15]

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It's a T-shirt company.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [16]

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And I know you had been working without second one for a while. Great quarter.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [17]

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And just to follow up on that before we go to the next question. Sometimes the restructures are to make management -- a new management coming in have a lower basis so they can make some money. If you just throw more money in and leave the debt outstanding, when the people come in, they've got quite a lot to get over before they can get any return on their investment. So that's one of the reasons we do that.

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Operator [18]

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(Operator Instructions) And our next question is from Ryan Barr from Jefferies.

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Ryan Lan Carr, Jefferies LLC, Research Division - Equity Associate [19]

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This is Ryan Carr on for Kyle Joseph. Congratulations on the good quarter, guys. So I had a question related to your restructuring. So you said that you restructured SOG and The Mountain in the quarter. Obviously, we're paying attention to the nonaccruals, which remain elevated relative to historical. What's your outlook on regaining some of the investments that you've restructured and what's the time line for that? And then in terms of the nonaccruals that they've been elevated this year, do you have any outlook moving forward on a resolution to that?

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David A. R. Dullum, Gladstone Investment Corporation - President [20]

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Yes. I can't give you a definitive answer certainly on the restructures. Again, typically, we're doing those where we know that the company is going to be tight cash-wise, if you will, for a period of time. Hopefully, we would like to think that there's a chance to see those get turned around in a year or so. And if we are able to start generating some income, we'll do that. As far as the nonaccruals the -- I think we're going to see that improve near the end of this year, given some of the other companies that were impacted in that regard. So I just have to tell you that it's -- we work it hard and we don't think we're going to see any further elevation as you say on nonaccruals, and I really am expecting that we'll see an improvement on that certainly by the end of this calendar year.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [21]

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Other questions?

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Operator [22]

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And we have another question from Henry Coffey from Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [23]

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Yes. David, I know in the past you've given us a fairly healthy perspective on how you think the large macro environment is going to affect your companies, can you give us a sense on how you think the current arm wrestling with China is going to affect you? Or do you think your companies are not overly exposed to these kinds of things? Or what are your general thoughts?

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [24]

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If you look at this company, it's got a couple of situations in China, where we bring in product from China and sell it. Also looking at moving some of that out of China and move it to other countries, like everyone else is thinking about it, haven't done much about it. In other companies, for example, Gladstone Land, there's really nothing to worry about there. Only almonds are the only thing that they sell a lot of to China. But not anything else. The 2 -- the other REIT is in good shape in terms of not having a lot of Chinese business going through its buildings. And finally, if you think about Gladstone Land -- I mean Gladstone Capital, we've got some companies there that are bringing stuff in from China. So yes, there can be some pain but not much, not enough to down our companies because of what's going on between them.

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Operator [25]

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At this time, I am showing no further questions. I would like to turn the call back over to David Gladstone for closing remarks.

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David John Gladstone, Gladstone Investment Corporation - Chairman & CEO [26]

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All right. Thank you very much, everybody, for calling in and listening to this. And we'll see you again next quarter.

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Operator [27]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.