GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (GAIN)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2014
Business Overview: Gladstone Investment is an externally advised, closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). The company invests in debt and equity securities of established private U.S. businesses, targeting current income and long-term capital appreciation.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased 33.0% for the three months ended December 31, 2014, compared to the prior year period, driven by a larger portfolio size and increased interest income.
• Realized Gains/Losses: The company recorded a net realized loss of $0.2 million for the three months ended December 31, 2014, a significant improvement from the $13.1 million realized loss in the same period in 2013 (which included exits of ASH and Packerland).
• Unrealized Appreciation: Net unrealized appreciation of investments was $2.0 million for the quarter, reversing the $2.3 million depreciation recorded in the prior year quarter. This was driven by improved valuations in portfolio companies such as Funko, LLC and Cambridge Sound Management, LLC.
• Expense Increases: Total expenses (net of credits) increased 33.3% year-over-year for the quarter, primarily due to higher base management fees, incentive fees, and interest/dividend expenses resulting from increased borrowings and the issuance of Series B Term Preferred Stock.
• Portfolio Expansion: The portfolio grew to 32 companies with a fair value of $394.1 million, up from $314.4 million at the prior fiscal year-end.

Guidance, Outlook, and Risks

• Capital Raising: In November 2014, the company completed a public offering of 1.656 million shares of 6.75% Series B Term Preferred Stock, raising $41.4 million in gross proceeds. The company also expanded its revolving credit facility to $185.0 million.
• Distributions: The Board declared monthly distributions of $0.06 per common share for the nine months ended December 31, 2014, plus a one-time special distribution of $0.05 per share in December 2014. Future distributions are based on estimated taxable income.
• Stock Price Discount: As of February 3, 2015, the common stock traded at $7.37, representing a 13.8% discount to the NAV of $8.55. The company has stockholder authorization to issue shares below NAV for one year.
• Risks:
  • Market Volatility: Recent volatility in oil and natural gas prices poses a risk to portfolio companies dependent on these sectors.
  • Non-Accrual Status: Loans to Tread Corp. remain on non-accrual status with a cost basis of $10.7 million and a fair value of $0.
  • Regulatory Constraints: As a BDC, the company must maintain an asset coverage ratio of at least 200% to issue senior securities.

Investor Verification Checklist

• Non-Accrual Exposure: Verify the status and potential recovery value of the $10.7 million Tread Corp. loan currently on non-accrual.
• Preferred Stock Obligations: Review the mandatory redemption dates and dividend obligations for Series A (due 2017) and Series B (due 2021) Term Preferred Stock.
• Valuation Methodology: Confirm the assumptions used in Level 3 fair value measurements, particularly for the 32 portfolio companies where 86.2% of the portfolio is valued below cost.
• Debt Covenants: Monitor compliance with the Credit Facility covenants, specifically the minimum net worth and asset coverage requirements.
• Success Fees: Assess the likelihood of collecting the $23.5 million in unrecognized success fees, which are contingent on future events.