GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (GAIN)
Filing Type: Form 10-K (Annual Report)
Period Ended: March 31, 2017
Business Model: Externally managed, closed-end, non-diversified Business Development Company (BDC) and Regulated Investment Company (RIC). The Company invests in debt and equity securities of established private U.S. businesses, primarily in the Lower Middle Market (EBITDA $3M–$20M).
Portfolio Composition: As of March 31, 2017, the portfolio consisted of 35 companies across 18 industries. The mix was 72.0% debt securities and 28.0% equity securities at cost. The five largest investments represented 27.4% of the total portfolio fair value.

Key Financial Metrics

Material Changes vs. Prior Period

• Operational Performance: Net increase in net assets from operations rose 80.1% to $44.8 million, driven primarily by a swing from a net realized loss of $4.6 million in 2016 to a net realized gain of $15.6 million in 2017.
• Realized Gains: The 2017 realized gains were largely due to the exit of Acme Cryogenics ($18.8M gain) and Behrens Manufacturing ($5.8M gain), partially offset by a $10.2M loss from the restructuring of D.P.M.S., Inc. (Danco).
• Portfolio Activity: The Company invested $54.4 million in two new portfolio companies and exited three existing companies. The portfolio count decreased from 36 to 35 companies.
• Liquidity and Debt: Total borrowings decreased by approximately $25.3 million to $74.8 million. The Company redeemed all Series A Term Preferred Stock ($40.0 million) and issued Series D Term Preferred Stock ($57.5 million).
• Expenses: Total expenses, net of credits, decreased 2.6% to $29.5 million, primarily due to a reduction in the incentive fee.

Guidance, Outlook, and Risks

• Capital Markets: The Company completed a common stock offering in May 2017 (post-period) raising $19.7 million gross. The stock has traded at a discount to NAV, constraining equity issuance without stockholder approval (which was obtained for one year).
• Dividends: The Company declared monthly distributions of $0.0625 per common share for the fiscal year. In April 2017, the Board declared a monthly distribution of $0.064 and a supplemental distribution of $0.06 for June 2017.
• Key Risks:
  • Interest Rate Risk: 92.9% of the debt portfolio is variable rate (LIBOR-based). Rising rates increase borrowing costs and portfolio company debt service obligations.
  • Credit Risk: Investments in Lower Middle Market companies are considered high risk. Two loans (Alloy Die Casting and Tread Corporation) were on non-accrual status with an aggregate cost basis of $15.6 million.
  • Liquidity: The Credit Facility has a revolving period end date of November 15, 2019. Failure to renew or refinance could force asset sales.
  • Valuation: Investments are primarily Level 3 fair value measurements, relying on subjective inputs and management estimates.

Investor Verification Checklist

• Non-Accrual Status: Verify the current status and recovery prospects of the $15.6 million in loans on non-accrual (Alloy Die Casting and Tread Corporation).
• Realized Gains Sustainability: Assess whether the $15.6 million in realized gains in 2017 is repeatable, given the significant one-time exits (Acme, Behrens).
• Debt Covenants: Confirm continued compliance with the Credit Facility covenants, specifically the minimum net worth ($210M) and asset coverage (200%) requirements.
• Equity Issuance: Monitor the ability to raise equity capital given the historical trading discount to NAV and the expiration of the stockholder authorization for below-NAV sales in August 2017.
• Success Fees: Note that $24.2 million in contractual success fees remain unrecognized and contingent on future liquidity events.