GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (Gladstone Investment)

Filing Type: Form 10-Q (Quarterly Report)

Period Ended: September 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.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Portfolio Growth: Total investments at fair value increased from $225.7 million at March 31, 2012, to $266.7 million at September 30, 2012, driven by new investments in Packerland Whey Products, Drew Foam Companies, and Ginsey Holdings.
• Net Asset Decline: Net assets decreased by approximately $10.0 million during the six-month period, primarily due to net unrealized depreciation of $9.6 million on investments and $1.2 million on other items, partially offset by net investment income and realized gains.
• Expense Increase: Total expenses net of credits increased by 77.5% compared to the prior year period. This was driven by a 448% increase in interest and dividend expense (due to the issuance of Term Preferred Stock in March 2012) and a significant increase in the incentive fee.
• Unrealized Depreciation: The portfolio experienced significant unrealized depreciation, with the fair value of the portfolio trading at 84.1% of cost. Major contributors to depreciation included Danco Acquisition Corp., Tread Corp., and Noble Logistics, Inc.

Guidance, Outlook, Risks, and Unusual Items

• RIC Status Compliance: The Company fell below the 50% asset diversification threshold required to maintain RIC status. To comply, it utilized a short-term loan to purchase $80.0 million in 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.
• Capital Raising: Subsequent to the reporting period (October 2012), the Company completed a common stock offering raising $30.0 million and extended its Credit Facility maturity by one year to 2015.
• Non-Accrual Loans: Two portfolio companies, ASH Holdings Corp. and Country Club Enterprises, LLC, were on non-accrual status with an aggregate fair value of $4.0 million.
• Success Fees: The Company has an off-balance sheet success fee receivable of approximately $11.0 million, contingent on future liquidity events.
• Market Risk: The portfolio is exposed to interest rate risk, with 78.6% of debt investments at variable rates with a floor and 21.4% at fixed rates.

Investor Verification Checklist

• RIC Compliance Strategy: Verify the sustainability of the short-term loan strategy used to meet the 50% asset diversification test and its impact on leverage capacity.
• Unrealized Depreciation Drivers: Review the specific performance metrics of Danco Acquisition Corp., Tread Corp., and Noble Logistics, Inc., which drove significant valuation declines.
• Success Fee Realization: Assess the likelihood and timing of collecting the $11.0 million in contingent success fees.
• Debt Covenants: Confirm continued compliance with the 200% asset coverage ratio required by the 1940 Act and the Credit Facility, especially given the recent equity offering.
• Non-Accrual Exposure: Monitor the status of ASH Holdings and Country Club Enterprises to determine potential future realized losses.