GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (Gladstone Investment)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2012
Business Overview: Gladstone Investment is a closed-end, non-diversified management investment company organized 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. The portfolio consists of approximately 80% debt and 20% equity at cost.

Key Financial Metrics

Material Changes vs. Prior Period

• Operating Results: Net increase in net assets from operations for the nine months ended Dec 31, 2012, was $1.33 million, a significant decrease from $22.38 million in the prior year period. This decline was driven primarily by a net unrealized depreciation of $9.56 million on investments, compared to net unrealized appreciation of $7.05 million in the prior year.
• Investment Income: Total investment income increased 29.7% year-over-year for the nine-month period to $20.06 million, driven by a larger loan portfolio and higher-yielding debt investments.
• Expenses: Total expenses net of credits increased 80.7% to $9.42 million for the nine-month period. This was largely due to a 445.8% increase in interest and dividend expense (driven by the issuance of Term Preferred Stock in March 2012) and a substantial increase in the incentive fee.
• Portfolio Valuation: The portfolio fair value was 84.5% of cost at period end. Significant unrealized depreciation occurred in specific portfolio companies, including Tread Corp., Danco Acquisition Corp., and Noble Logistics, Inc., due to decreased performance.

Guidance, Outlook, Risks, and Unusual Items

• RIC Status Compliance: The Company fell below the 50% asset diversification threshold required to maintain RIC status during the quarter. To comply, it utilized a short-term loan to purchase $50.0 million in U.S. Treasury Bills at quarter-end. This loan was repaid on January 3, 2013. Management noted that without this strategy or other capital raising, future RIC status could be threatened if new investments are made while below the threshold.
• Capital Raising: In October 2012, the Company completed a common stock offering of 4.4 million shares at $7.50 per share (below NAV), raising net proceeds of approximately $31.1 million. This was used to repay borrowings and increase equity capital to support asset coverage ratios.
• Non-Accrual Loans: As of December 31, 2012, loans to ASH Holdings Corp. and Tread Corp. were on non-accrual status with an aggregate fair value of $0. Tread was placed on non-accrual during the quarter.
• Success Fees: The Company has an off-balance sheet success fee receivable of approximately $12.3 million, contingent on future liquidity events.
• Management Changes: George Stelljes III, Chief Investment Officer and Co-Vice Chairman, notified the Company of his intent to resign, though no effective date was set at the time of filing.

Investor Verification Checklist

• RIC Status Sustainability: Verify the Company's ability to maintain the 50% asset diversification test without recurring reliance on short-term financing at quarter-end.
• Non-Accrual Exposure: Assess the impact of the $23.7 million cost basis in non-accrual loans (ASH and Tread) on future realized losses and cash flow.
• Unrealized Depreciation: Review the valuation methodology for significant write-downs in Tread, Danco, and Noble Logistics to understand the risk of further impairment.
• Preferred Stock Obligations: Confirm the impact of the $40 million Term Preferred Stock (7.125% dividend) on net investment income available for common shareholders.
• Equity Issuance Dilution: Evaluate the dilutive effect of the recent common stock offering priced below NAV on future per-share returns.