GAIN

Business Context and Reporting Period

Company: Gladstone Investment Corporation (Gladstone)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Model: Closed-end, non-diversified management investment company operating as a Business Development Company (BDC) and Regulated Investment Company (RIC). The company invests in debt and equity securities of private businesses.

Key Financial Metrics

Material Changes vs. Prior Period

• Portfolio Restructuring: The company sold 29 of its 32 senior syndicated loans for approximately $69.2 million in proceeds, recording a realized loss of $34.6 million. This was done to repay the prior credit facility with Deutsche Bank.
• Investment Composition: Total investments at fair value decreased by $86.9 million (27.7%) from the prior year, primarily due to the sale of syndicated loans. The portfolio is now heavily concentrated in Control and Affiliate investments.
• Liquidity Position: Cash and cash equivalents increased significantly to $84.6 million from $7.2 million at the end of the prior quarter, driven by loan sales and a short-term loan transaction.
• Debt Reduction: Borrowings under the line of credit decreased from $129.3 million in Q2 2008 to $46.9 million in Q2 2009 following the refinancing and repayment of the prior facility.
• Unrealized Gains/Losses: The company recorded net unrealized appreciation of $23.0 million, largely due to the reversal of previously recorded unrealized depreciation on the sold syndicated loans. However, Control and Affiliate investments experienced unrealized depreciation of $11.5 million and $2.3 million, respectively.

Guidance, Outlook, and Risks

• RIC Status Compliance: The company fell below the 50% asset diversification threshold required to maintain Regulated Investment Company (RIC) status following the sale of syndicated loans. To maintain status, the company utilized a short-term loan to purchase U.S. Treasury securities. Management notes that if they make new investments before regaining compliance, their RIC status could be threatened.
• Capital Constraints: The new credit facility with BB&T is capped at $50.0 million (reduced from $125.0 million previously). Limited borrowing capacity and market conditions have constrained the ability to make new investments.
• Distribution Reduction: Due to lower net investment income and capital constraints, the monthly cash distribution was reduced by 50% to $0.04 per share.
• Valuation Risks: Approximately 7.1% of the portfolio was valued using internally-developed discounted cash flow (DCF) methodologies due to market illiquidity. Management warns that fair value estimates may differ significantly from realized values.
• Outlook: The near-term strategy focuses on retaining capital and building value in existing portfolio companies rather than new investments, pending improved market conditions and capital availability.

Investor Verification Checklist

• RIC Compliance: Verify the company's current status regarding the 50% asset diversification test and any subsequent investments made that could jeopardize tax-exempt RIC status.
• Credit Facility Renewal: Monitor the status of the $50 million credit facility maturing in April 2010 and the ability to refinance or extend it given current market conditions.
• Portfolio Valuation: Review the specific valuation methodologies (DCF vs. market quotes) used for the remaining illiquid assets, particularly Control investments which saw significant unrealized depreciation.
• Distribution Sustainability: Assess whether the reduced distribution rate of $0.04 per share is sustainable given the current net investment income and the potential for further realized losses on asset sales.
• Concentration Risk: Note that three portfolio companies (A. Stucki, Chase II, and Acme Cryogenics) represent 45.7% of the total investment portfolio fair value.