GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (Gladstone Investment)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Three months ended June 30, 2012

Business Overview: Gladstone Investment is a closed-end, non-diversified management investment company operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). It invests primarily in debt and equity securities of established private U.S. businesses, focusing on subordinated loans, mezzanine debt, preferred stock, and common stock.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income: Total investment income increased 12.2% to $5.9 million, driven by a 24.9% rise in interest income due to a larger loan portfolio and higher-yielding investments. This was partially offset by a 53.7% decrease in other income, primarily due to the absence of dividend income from the Cavert recapitalization in the prior year.
• Expenses: Total expenses net of credits increased 51.4% to $2.7 million. The primary driver was a 509.8% increase in interest and dividend expense, largely due to the first distribution on the Term Preferred Stock issued in March 2012 ($0.7 million).
• Net Income: Net investment income decreased 7.5% to $3.2 million. The company reported a net decrease in net assets from operations of $3.0 million, compared to an increase of $4.2 million in the prior year period. This shift was caused by a net unrealized depreciation of $5.7 million on investments, compared to net unrealized appreciation in the prior year.
• Portfolio Valuation: The portfolio fair value was 83.2% of cost at June 30, 2012, reflecting cumulative net unrealized depreciation of $46.5 million. Significant unrealized depreciation occurred in investments in Danco Acquisition Corp., Noble Logistics, Inc., Tread Corp., and Venyu Solutions, Inc.

Guidance, Outlook, Risks, and Unusual Items

• RIC Status and Asset Diversification: The company fell below the 50% asset diversification threshold required to maintain RIC status. To comply, it utilized a short-term loan of $76.0 million to purchase U.S. Treasury Bills at quarter-end. This strategy limits the ability to use debt capital for new investments due to asset coverage ratio constraints under the 1940 Act.
• Liquidity and Capital Resources: The company has a $60.0 million Credit Facility with $28.3 million available. It also holds $113.4 million in cash and cash equivalents. However, the common stock trades at a discount to NAV (approx. 17.7% discount as of July 27, 2012), constraining equity issuance capabilities without stockholder approval.
• Recent Developments:
  • Issued 1.6 million shares of 7.125% Series A Cumulative Term Preferred Stock in March 2012 for net proceeds of $38.0 million.
  • Invested $9.5 million in Packerland Whey Products, Inc. during the quarter.
  • Subsequent to quarter-end, invested $22.5 million in Ginsey Holdings, Inc.
  • Received SEC relief to expand co-investment capabilities with affiliated funds.
• Risks: Risks include the potential loss of RIC status if the 50% asset test is not met consistently, credit risk in the portfolio (two loans on non-accrual status: ASH Holdings Corp. and Country Club Enterprises, LLC), and market volatility affecting the valuation of private securities.

Investor Verification Checklist

• RIC Compliance: Verify the company's ability to maintain the 50% asset diversification test without relying on short-term loans that constrain leverage.
• Portfolio Valuation: Review the specific reasons for the $5.7 million unrealized depreciation, particularly regarding Danco Acquisition Corp. and Noble Logistics, Inc.
• Non-Accrual Loans: Assess the credit quality and recovery prospects of the $16.8 million in loans on non-accrual status (ASH and CCE).
• Preferred Stock Impact: Evaluate the impact of the $40.0 million Term Preferred Stock on asset coverage ratios and future distribution capacity for common shareholders.
• Equity Issuance: Monitor the status of stockholder approval for issuing common stock below NAV, which is required to raise equity capital given the current market discount.