Gladstone Investment Corporation
GLADSTONE INVESTMENT CORPORATION\DE (Form: 10-Q, Received: 02/04/2014 16:32:14)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                       to                       

Commission file number: 814-00704

 

 

GLADSTONE INVESTMENT CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   83-0423116

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1521 WESTBRANCH DRIVE, SUITE 100

MCLEAN, VIRGINIA

  22102
(Address of principal executive office)   (Zip Code)

(703) 287-5800

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ¨     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12 b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares of the issuer’s Common Stock, $0.001 par value per share, outstanding as of February 3, 2014, was 26,475,958.

 

 

 


Table of Contents

GLADSTONE INVESTMENT CORPORATION

TABLE OF CONTENTS

 

PART I.  

FINANCIAL INFORMATION:

  
Item 1.  

Financial Statements (Unaudited)

  
 

Condensed Consolidated Statements of Assets and Liabilities as of December 31 and March 31, 2013

     3   
 

Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2013 and 2012

     4   
 

Condensed Consolidated Statements of Changes in Net Assets for the nine months ended December 31, 2013 and 2012

     5   
 

Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2013 and 2012

     6   
 

Condensed Consolidated Schedules of Investments as of December 31 and March 31, 2013

     7   
 

Notes to Condensed Consolidated Financial Statements

     13   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  
 

Overview

     32   
 

Results of Operations

     37   
 

Liquidity and Capital Resources

     45   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     54   
Item 4.  

Controls and Procedures

     54   
PART II.  

OTHER INFORMATION:

  
Item 1.  

Legal Proceedings

     55   
Item 1A.  

Risk Factors

     55   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     55   
Item 3.  

Defaults Upon Senior Securities

     55   
Item 4.  

Mine Safety Disclosures

     55   
Item 5.  

Other Information

     55   
Item 6.  

Exhibits

     55   
SIGNATURES      56   

 

2


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

     December 31,     March 31,  
     2013     2013  

ASSETS

    

Investments at fair value

    

Control investments (Cost of $246,747 and $263,522, respectively)

   $ 201,068      $ 243,803   

Affiliate investments (Cost of $49,406 and $52,566, respectively)

     35,825        36,659   

Non-Control/Non-Affiliate investments (Cost of $63,913 and $10,333, respectively)

     53,834        6,020   
  

 

 

   

 

 

 

Total investments at fair value (Cost of $360,066 and $326,421, respectively)

     290,727        286,482   

Cash and cash equivalents

     15,034        85,904   

Restricted cash

     5,376        626   

Interest receivable

     1,320        1,309   

Due from custodian

     1,347        1,677   

Deferred financing costs

     2,619        2,336   

Other assets

     1,132        1,469   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 317,555      $ 379,803   
  

 

 

   

 

 

 

LIABILITIES

    

Borrowings:

    

Short-term loan at fair value (Cost of $8,501 and $58,016, respectively)

   $ 8,501      $ 58,016   

Line of credit at fair value (Cost of $36,200 and $31,000, respectively)

     36,200        31,854   

Secured borrowing

     5,000        5,000   
  

 

 

   

 

 

 

Total borrowings (Cost of $49,701 and $94,016, respectively)

     49,701        94,870   

Mandatorily redeemable preferred stock, $0.001 par value per share, $25 liquidation preference per share; 1,610,000 shares authorized, 1,600,000 shares issued and outstanding at December 31 and March 31, 2013

     40,000        40,000   

Accounts payable and accrued expenses

     852        1,069   

Fees due to Adviser (A)

     1,024        2,067   

Fee due to Administrator (A)

     239        221   

Other liabilities

     1,074        613   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     92,890        138,840   
  

 

 

   

 

 

 

Commitments and contingencies (B)

    

NET ASSETS

   $ 224,665      $ 240,963   
  

 

 

   

 

 

 

ANALYSIS OF NET ASSETS

    

Common stock, $0.001 par value per share, 100,000,000 shares authorized and 26,475,958 shares issued and outstanding at December 31 and March 31, 2013

   $ 26      $ 26   

Capital in excess of par value

     287,713        287,713   

Cumulative net unrealized depreciation of investments

     (69,339     (39,939

Cumulative net unrealized depreciation of other

     (72     (883

Net investment income in excess of distributions

     3,322        2,691   

Accumulated net realized gain (loss)

     3,015        (8,645
  

 

 

   

 

 

 

TOTAL NET ASSETS

   $ 224,665      $ 240,963   
  

 

 

   

 

 

 

NET ASSET VALUE PER COMMON SHARE AT END OF PERIOD

   $ 8.49      $ 9.10   
  

 

 

   

 

 

 

 

(A)   Refer to Note 4— Related Party Transactions for additional information.
(B)   Refer to Note 11— Commitments and Contingencies for additional information.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

3


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GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

     Three Months Ended
December 31,
    Nine Months Ended
December 31,
 
     2013     2012     2013     2012  

INVESTMENT INCOME

        

Interest income

        

Control investments

   $ 5,259      $ 4,681      $ 16,578      $ 12,659   

Affiliate investments

     708        1,456        2,923        4,800   

Non-Control/Non-Affiliate investments

     1,625        344        2,978        990   

Cash and cash equivalents

     1        1        2        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     7,593        6,482        22,481        18,453   

Other income

        

Control investments

     98        702        3,634        1,208   

Affiliate investments

     1,000        —          1,333        401   

Non-Control/Non-Affiliate investments

     5        —          5        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income

     1,103        702        4,972        1,609   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     8,696        7,184        27,453        20,062   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

        

Base management fee (A)

     1,515        1,440        4,625        3,939   

Incentive fee (A)

     1,100        589        2,822        1,130   

Administration fee (A)

     239        191        638        564   

Interest expense on borrowings

     395        289        1,469        865   

Dividends on mandatorily redeemable preferred stock

     713        712        2,138        2,137   

Amortization of deferred financing fees

     262        194        761        597   

Professional fees

     329        29        609        400   

Other general and administrative expenses

     523        277        1,355        978   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses before credits from Adviser

     5,076        3,721        14,417        10,610   

Credits to fees (A)

     (782     (489     (1,627     (1,189
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses net of credits to fees

     4,294        3,232        12,790        9,421   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INVESTMENT INCOME

     4,402        3,952        14,663        10,641   
  

 

 

   

 

 

   

 

 

   

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS)

        

Net realized (loss) gain:

        

Control investments

     (11,361     96        13,443        848   

Affiliate investments

     (1,754     —          (1,754     —     

Other

     (29     —          (29     (41
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized (loss) gain

     (13,144     96        11,660        807   

Net unrealized (depreciation) appreciation:

        

Control investments

     401        4,244        (26,022     (3,110

Affiliate investments

     983        (2,935     3,432        (4,508

Non-Control/Non-Affiliate investments

     (3,694     (1,263     (6,810     (1,937

Other

     366        605        811        (563
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net unrealized (depreciation) appreciation

     (1,944     651        (28,589     (10,118
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized (loss) gain

     (15,088     747        (16,929     (9,311
  

 

 

   

 

 

   

 

 

   

 

 

 

NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

   $ (10,686   $ 4,699      $ (2,266   $ 1,330   
  

 

 

   

 

 

   

 

 

   

 

 

 

BASIC AND DILUTED PER COMMON SHARE:

        

Net investment income

   $ 0.17      $ 0.15      $ 0.55      $ 0.45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in net assets resulting from operations

   $ (0.40   $ 0.18      $ (0.09   $ 0.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:

        

Basic and diluted

     26,475,958        26,147,157        26,475,958        23,440,737   

 

(A)   Refer to Note 4— Related Party Transactions for additional information.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

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Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(IN THOUSANDS)

(UNAUDITED)

 

     Nine Months Ended December 31,  
     2013     2012  

OPERATIONS:

    

Net investment income

   $ 14,663      $ 10,641   

Net realized gain on investments

     11,689        848   

Net realized loss on other

     (29     (41

Net unrealized depreciation of investments

     (29,400     (9,555

Net unrealized appreciation (depreciation) of other

     811        (563
  

 

 

   

 

 

 

Net (decrease) increase in net assets from operations

     (2,266     1,330   

EQUITY CAPITAL ACTIVITY:

    

Issuance of common stock, net of expenses

     —          31,100   

Distributions to common stockholders

     (14,032     (10,576
  

 

 

   

 

 

 

Net (decrease) increase in net assets from equity capital activity

     (14,032     20,524   

Total (decrease) increase in net assets

     (16,298     21,854   

Net assets at beginning of period

     240,963        207,216   
  

 

 

   

 

 

 

Net assets at end of period

   $ 224,665      $ 229,070   
  

 

 

   

 

 

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

5


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

     Nine Months Ended December 31,  
     2013     2012  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net (decrease) increase in net assets resulting from operations

   $ (2,266   $ 1,330   

Adjustments to reconcile net (decrease) increase in net assets resulting from operations to net cash used in operating activities:

    

Purchase of investments

     (100,134     (80,639

Principal repayments of investments

     46,634        21,137   

Proceeds from the sale of investments

     31,602        3,187   

Increase in investment balance due to paid in kind interest

     (58     —     

Net realized gain on investments

     (11,689     (848

Net realized loss on other

     29        41   

Net unrealized depreciation of investments

     29,400        9,555   

Net unrealized (appreciation) depreciation of other

     (811     563   

Amortization of deferred financing costs

     761        597   

(Increase) decrease in restricted cash

     (4,750     1,297   

(Increase) decrease in interest receivable

     (11     231   

Decrease (increase) in due from custodian

     330        (9,802

Decrease (increase) in other assets

     340        (260

(Decrease) increase in accounts payable and accrued expenses

     (160     132   

(Decrease) increase in fees due to Adviser (A)

     (1,044     578   

Increase (decrease) in administration fee due to Administrator (A)

     18        (27

Increase (decrease) in other liabilities

     461        (470
  

 

 

   

 

 

 

Net cash used in operating activities

     (11,348     (53,398

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from issuance of common stock, net of expenses

     —          31,100   

Proceeds from short-term loans

     56,515        192,047   

Repayments on short-term loans

     (106,030     (223,540

Proceeds from line of credit

     108,500        115,000   

Repayments on line of credit

     (103,300     (90,500

Proceeds from other secured borrowings

     —          5,000   

Purchase of derivative

     (75     —     

Payment of deferred financing costs

     (1,100     (351

Distributions paid to common stockholders

     (14,032     (10,576
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (59,522     18,180   
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (70,870     (35,218

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     85,904        91,546   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 15,034      $ 56,328   
  

 

 

   

 

 

 

 

(A) Refer to Note 4— Related Party Transactions for additional information.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

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Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS

DECEMBER 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

(UNAUDITED)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

CONTROL INVESTMENTS:

       

Acme Cryogenics, Inc.

 

Manufacturing — manifolds and pipes for industrial gasses

 

Senior Subordinated Term Debt (11.5%, Due 3/2015)

  $ 14,500      $ 14,500      $ 14,500   
   

Preferred Stock (898,814 shares) (C)(F)

      6,984        12,037   
   

Common Stock (418,072 shares) (C)(F)

      1,045        1,121   
   

Common Stock Warrants (465,639 shares) (C)(F)

      25        61   
       

 

 

   

 

 

 
          22,554        27,719   

Country Club Enterprises, LLC

 

Service — golf cart distribution

 

Senior Subordinated Term Debt (18.6%, Due 11/2014)

    4,000        4,000        4,000   
   

Preferred Stock (7,079,792 shares) (C)(F)

      7,725        3,275   
   

Guaranty ($2,000)

     
   

Guaranty ($1,033)

     
       

 

 

   

 

 

 
          11,725        7,275   

Danco Acquisition Corp.

 

Manufacturing — machining and sheet metal work

 

Line of Credit, $0 available (4.0%, Due 8/2015) (D)

    3,150        3,150        771   
   

Senior Term Debt (4.0%, Due 8/2015) (D)

    2,575        2,575        631   
   

Senior Term Debt (4.0%, Due 8/2015) (D)

    8,795        8,795        2,155   
   

Senior Term Debt (5.0%, Due 8/2015) (D)(E)

    1,150        1,150        282   
   

Preferred Stock (25 shares) (C)(F)

      2,500        —     
   

Common Stock (1,241 shares) (C)(F)

      3        —     
       

 

 

   

 

 

 
          18,173        3,839   

Drew Foam Company, Inc.

 

Manufacturing — molds and fabricates expanded polystyrene

 

Senior Term Debt (13.5%, Due 8/2017)

    10,913        10,913        10,913   
   

Preferred Stock (34,045 shares) (C)(F)

      3,375        1,542   
   

Common Stock (5,372 shares) (C)(F)

      63        —     
       

 

 

   

 

 

 
          14,351        12,455   

Frontier Packaging, Inc.

 

Manufacturing — packaging products

 

Senior Term Debt (12.0%, Due 12/2017)

    12,500        12,500        12,500   
   

Preferred Stock (1,373 shares) (C)(F)

      1,373        1,492   
   

Common Stock (152 shares) (C)(F)

      152        895   
       

 

 

   

 

 

 
          14,025        14,887   

Galaxy Tool Holding Corp.

 

Manufacturing — aerospace and plastics

 

Senior Subordinated Term Debt (13.5%, Due 8/2017)

    15,520        15,520        15,520   
   

Preferred Stock (5,373,186 shares) (C)(F)

      11,464        4,223   
   

Common Stock (88,843 shares) (C)(F)

      48        —     
       

 

 

   

 

 

 
          27,032        19,743   

Ginsey Home Solutions, Inc.

 

Retail and Service — children and home products

 

Senior Subordinate Term Debt (13.5%, Due 1/2018) (I)

    13,050        13,050        13,050   
   

Preferred Stock (18,898 shares) (C)(F)

      9,393        2,053   
   

Common Stock (63,747 shares) (C)(F)

      8        —     
       

 

 

   

 

 

 
          22,451        15,103   

Jackrabbit, Inc.

 

Manufacturing — agricultural machinery

 

Line of Credit, $1,750 available (13.5%, Due 4/2014)

    1,250        1,250        1,250   
   

Senior Term Debt (13.5%, Due 4/2018)

    11,000        11,000        11,000   
   

Preferred Stock (3,556 shares) (C)(F)

      3,556        3,666   
   

Common Stock (636 shares) (C)(F)

      94        —     
       

 

 

   

 

 

 
          15,900        15,916   

Mathey Investments, Inc.

 

Manufacturing — pipe-cutting and pipe-fitting equipment

 

Senior Term Debt (10.0%, Due 3/2014)

    1,375        1,375        1,375   
   

Senior Term Debt (12.0%, Due 3/2014)

    3,727        3,727        3,727   
   

Senior Term Debt (12.5%, Due 3/2014) (E)

    3,500        3,500        3,500   
   

Common Stock (29,102 shares) (C)(F)

      777        4,120   
       

 

 

   

 

 

 
          9,379        12,722   

Mitchell Rubber Products, Inc.

 

Manufacturing — rubber compounds

 

Subordinated Term Debt (13.0%, Due 10/2016) (D)

    13,560        13,560        13,712   
   

Preferred Stock (27,900 shares) (C)(F)

      2,790        2,415   
   

Common Stock (27,900 shares) (C)(F)

      28        —     
       

 

 

   

 

 

 
          16,378        16,127   

 

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Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)

DECEMBER 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

(UNAUDITED)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

CONTROL INVESTMENTS (Continued):

       

Precision Southeast, Inc.

 

Manufacturing — injection molding and plastics

 

Senior Term Debt (14.0%, Due 12/2015)

  $ 6,118      $ 6,118      $ 6,118   
   

Preferred Stock (19,091 shares) (C)(F)

      1,909        —     
   

Common Stock (90,909 shares) (C)(F)

      91        —     
       

 

 

   

 

 

 
          8,118        6,118   

SBS, Industries, LLC

 

Manufacturing — specialty fasteners and threaded screw products

 

Senior Term Debt (14.0%, Due 8/2016)

    11,355        11,355        11,355   
   

Preferred Stock (19,935 shares) (C)(F)

      1,994        2,387   
   

Common Stock (221,500 shares) (C)(F)

      221        87   
       

 

 

   

 

 

 
          13,570        13,829   

SOG Specialty K&T, LLC

 

Manufacturing — specialty knives and tools

 

Senior Term Debt (13.3%, Due 8/2016)

    6,200        6,200        6,200   
   

Senior Term Debt (14.8%, Due 8/2016)

    12,199        12,199        12,199   
   

Preferred Stock (9,749 shares) (C)(F)

      9,749        8,872   
       

 

 

   

 

 

 
          28,148        27,271   

Star Seed, Inc.

 

Farming and Agriculture

 

Senior Term Debt (12.5%, Due 4/2018)

    7,500        7,500        7,500   
   

Preferred Stock (1,499 shares) (C)(F)

      1,499        564   
   

Common Stock (600 shares) (C)(F)

      1        —     
       

 

 

   

 

 

 
          9,000        8,064   

Tread Corp.

 

Manufacturing — storage and transport equipment

 

Line of Credit, $404 available (12.5%, Due 6/2014) (G)

    2,846        2,846        —     
   

Senior Subordinated Term Debt (12.5%, Due 2/2015) (G)

    5,000        5,000        —     
   

Senior Subordinated Term Debt (12.5%, Due 2/2015) (G)

    2,750        2,750        —     
   

Senior Subordinated Term Debt (12.5%, Due 2/2015) (G)

    1,000        1,000        —     
   

Senior Subordinated Term Debt (12.5%, Due on Demand) (D)(G)

    510        510        —     
   

Preferred Stock (3,332,765 shares) (C)(F)

      3,333        —     
   

Common Stock (7,716,320 shares) (C)(F)

      501        —     
   

Common Stock Warrants (2,372,727 shares) (C)(F)

      3        —     
       

 

 

   

 

 

 
          15,943        —     
       

 

 

   

 

 

 

Total Control Investments (represents 69.1% of total investments at fair value)

    $ 246,747      $ 201,068   
       

 

 

   

 

 

 

AFFILIATE INVESTMENTS:

       

Behrens Manufacturing, LLC

 

Manufacturing — outdoor utility products and containers

 

Senior Term Debt (13.0%, Due 12/2018) (H)

    9,975        9,975        9,975   
   

Preferred Stock (2,923 shares) (C)(F)(H)

      2,923        2,923   
       

 

 

   

 

 

 
          12,898        12,898   

Cavert II Holding Corp.

 

Manufacturing — bailing wire

 

Preferred Stock (18,446 shares) (C)(F)

      1,844        2,965   
       

 

 

   

 

 

 
          1,844        2,965   

Channel Technologies Group, LLC

 

Manufacturing — acoustic products

 

Preferred Stock (2,279,020 shares) (C)(F)

      2,864        3,092   
   

Common Stock (1,598,616 shares) (C)(F)

      —          764   
       

 

 

   

 

 

 
          2,864        3,856   

Meridian Rack & Pinion, Inc.

 

Manufacturing – automotive parts

 

Senior Term Debt (13.5%, Due 12/2018) (H)

    9,660        9,660        9,660   
   

Preferred Stock (3,381 shares) (C)(F)(H)

      3,381        3,381   
       

 

 

   

 

 

 
          13,041        13,041   

Noble Logistics, Inc.

 

Service — aftermarket auto parts delivery

 

Line of Credit, $0 available (10.5%, Due 1/2015) (D)

    800        800        160   
   

Senior Term Debt (11.0%, Due 1/2015) (D)

    7,227        7,227        1,445   
   

Senior Term Debt (10.5%, Due 1/2015) (D)

    3,650        3,650        730   
   

Senior Term Debt (10.5%, Due 1/2015) (D)(E)

    3,650        3,650        730   
   

Preferred Stock (1,075,000 shares) (C)(F)

      1,750        —     
   

Common Stock (1,682,444 shares) (C)(F)

      1,682        —     
       

 

 

   

 

 

 
          18,759        3,065   
       

 

 

   

 

 

 

Total Affiliate Investments (represents 12.3% of total investments at fair value)

    $ 49,406      $ 35,825   
       

 

 

   

 

 

 

 

8


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)

DECEMBER 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

(UNAUDITED)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

NON-CONTROL/NON-AFFILIATE INVESTMENTS:

     

Alloy Die Casting Corp.

 

Manufacturing – aluminum and zinc metal components

 

Senior Term Debt (13.5%, Due 10/2018) (H)

  $ 12,215      $ 12,215      $ 12,215   
   

Preferred Stock (4,064 shares) (C)(F)(H)

      4,064        4,064   
   

Common Stock (630 share) (C)(F)(H)

      41        41   
       

 

 

   

 

 

 
          16,320        16,320   

Auto Safety House, LLC

 

Retail and Service – School buses and parts

 

Revolving Credit Facility, $1,000 available (7.0%, Due 10/2018) (D)

    5,000        5,000        4,937   
   

Guaranty ($500)

     
   

Guaranty ($250)

     
       

 

 

   

 

 

 
          5,000        4,937   

B-Dry, LLC

 

Service — basement waterproofer

 

Line of Credit, $0 available (6.5%, Due 5/2014) (D)

    750        750        150   
   

Senior Term Debt (14.0%, Due 5/2014) (D)

    6,433        6,443        1,289   
   

Senior Term Debt (14.0%, Due 5/2014) (D)

    2,840        2,840        568   
   

Common Stock Warrants (85 shares) (C)(F)

      300        —     
       

 

 

   

 

 

 
          10,333        2,007   

Funko, LLC

 

Retail — designer and distributor of pop-culture collectibles

 

Senior Subordinated Term Debt (12.0% and 1.5% PIK, Due 5/2019) (D)

    7,558        7,558        7,672   
   

Preferred Stock (1,305 shares) (C)(F)

      1,305        2,235   
       

 

 

   

 

 

 
          8,863        9,907   

Quench Holdings Corp.

 

Service — sales, installation and service of water coolers

 

Common Stock (4,770,392 shares) (C)(F)

      3,397        4,503   
       

 

 

   

 

 

 
          3,397        4,503   

Schylling Investments, LLC

 

Retail and Service — designer and distributor of children’s toys

 

Senior Term Debt (13.0%, Due 8/2017) (D)

    16,000        16,000        16,160   
   

Preferred Stock (4,000 shares) (C)(F)

      4,000        —     
       

 

 

   

 

 

 
          20,000        16,160   
       

 

 

   

 

 

 

Total Non-Control/Non-Affiliate Investments (represents 18.6% of total investments at fair value)

    $ 63,913      $ 53,834   
       

 

 

   

 

 

 

TOTAL INVESTMENTS

      $ 360,066      $ 290,727   
       

 

 

   

 

 

 

 

(A)   Certain of the securities listed above are issued by affiliate(s) of the indicated portfolio company.
(B)   Percentages represent the weighted average cash interest rates in effect at December 31, 2013, and due date represents the contractual maturity date. If applicable, paid-in-kind (“PIK”) interest rates are noted separately from the cash interest rates.
(C)   Security is non-income producing.
(D)   Fair value based primarily on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc. as of December 31, 2013.
(E)   Last Out Tranche (“LOT”) of senior debt, meaning if the portfolio company is liquidated, the holder of the LOT is paid after the other senior debt but before the senior subordinated debt.
(F)   Where applicable, aggregates all shares of such class of stock owned without regard to specific series owned within such class (some series of which may or may not be voting shares) or aggregates all warrants to purchase shares of such class of stock owned without regard to specific series of such class of stock such warrants allow us to purchase.
(G)   Debt security is on non-accrual status.
(H)   New proprietary portfolio investment valued at cost, as it was determined that the price paid during the three months ended December 31, 2013 best represents fair value as of December 31, 2013.
(I)   $5.0 million of the debt security participated to a third party but accounted for as collateral for a secured borrowing for GAAP purposes.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

9


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS

MARCH 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

CONTROL INVESTMENTS:

       

Acme Cryogenics, Inc.

 

Manufacturing — manifolds and pipes for industrial gasses

 

Senior Subordinated Term Debt (11.5%, Due 3/2015)

  $ 14,500      $ 14,500      $ 14,500   
   

Preferred Stock (898,814 shares) (F)

      6,984        11,292   
   

Common Stock (418,072 shares) (C)(F)

      1,045        1,179   
   

Common Stock Warrants (465,639 shares) (C)(F)

      25        369   
       

 

 

   

 

 

 
          22,554        27,340   

ASH Holdings Corp.

 

Retail and Service — school buses and parts

 

Line of Credit, $288 available (3.0%, Due 3/2015) (G)

    7,912        7,856        —     
   

Senior Subordinated Term Debt (2.0%, Due 3/2015) (G)

    6,250        6,050        —     
   

Preferred Stock (4,644 shares) (C)(F)

      2,500        —     
   

Common Stock (1 share) (C)(F)

      —          —     
   

Common Stock Warrants (73,599 shares) (C)(F)

      4        —     
   

Guaranty ($500)

     
       

 

 

   

 

 

 
          16,410        —     

Country Club Enterprises, LLC

 

Service — golf cart distribution

 

Senior Subordinated Term Debt (18.6%, Due 11/2014)

    4,000        4,000        4,000   
   

Preferred Stock (7,304,792 shares) (C)(F)

      7,725        3,467   
   

Guaranty ($2,000)

     
   

Guaranty ($1,370)

     
       

 

 

   

 

 

 
          11,725        7,467   

Danco Acquisition Corp.

 

Manufacturing — machining and sheet metal work

 

Line of Credit, $282 available (4.0%, Due 8/2015) (D)

    2,868       

 

22451

2,868

  

  

    717   
   

Senior Term Debt (4.0%, Due 8/2015) (D)

    2,575        2,575        644   
   

Senior Term Debt (4.0%, Due 8/2015) (D)

    8,795        8,795        2,199   
   

Senior Term Debt (5.0%, Due 8/2015) (D)(E)

    1,150        1,150        287   
   

Preferred Stock (25 shares) (C)(F)

      2,500        —     
   

Common Stock Warrants (420 shares) (C)(F)

      3        —     
       

 

 

   

 

 

 
          17,891        3,847   

Drew Foam Company, Inc.

 

Manufacturing — molds and fabricates expanded polystyrene

 

Senior Term Debt (13.5%, Due 8/2017)

    10,913        10,913        10,913   
   

Preferred Stock (34,045 shares) (F)

      3,375        3,511   
   

Common Stock (5,372 shares) (C)(F)

      63        676   
       

 

 

   

 

 

 
          14,351        15,100   

Frontier Packaging, Inc.

 

Manufacturing — packaging products

 

Senior Term Debt (12.0%, Due 12/2017)

    12,500        12,500        12,500   
   

Preferred Stock (1,373 shares) (C)(F)

      1,373        653   
   

Common Stock (152 shares) (C)(F)

      153        —     
       

 

 

   

 

 

 
          14,026        13,153   

Galaxy Tool Holding Corp.

 

Manufacturing — aerospace and plastics

 

Senior Subordinated Term Debt (13.5%, Due 8/2017)

    15,520        15,520        15,520   
   

Preferred Stock (5,373,186 shares) (F)

      11,464        5,356   
   

Common Stock (48,093 shares) (C)(F)

      48        —     
       

 

 

   

 

 

 
          27,032        20,876   

Ginsey Home Solutions, Inc.

 

Retail and Service — children and home products

 

Senior Subordinate Term Debt (13.5%, Due 1/2018)

    13,050        13,050        13,050   
   

Preferred Stock (18,898 shares) (C)(F)

      9,393        8,783   
   

Common Stock (63,747 shares) (C)(F)

      8        —     
       

 

 

   

 

 

 
          22,451        21,833   

Mathey Investments, Inc.

 

Manufacturing — pipe-cutting and pipe-fitting equipment

 

Senior Term Debt (10.0%, Due 3/2014)

    1,375        1,375        1,375   
   

Senior Term Debt (12.0%, Due 3/2014)

    3,727        3,727        3,727   
   

Senior Term Debt (12.5%, Due 3/2014) (E)

    3,500        3,500        3,500   
   

Common Stock (29,102 shares) (C)(F)

      777        5,817   
       

 

 

   

 

 

 
          9,379        14,419   

Mitchell Rubber Products, Inc.

 

Manufacturing — rubber compounds

 

Subordinated Term Debt (13.0%, Due 10/2016) (D)

    13,560        13,560        13,679   
   

Preferred Stock (27,900 shares) (C)(F)

      2,790        3,051   
   

Common Stock (27,900 shares) (C)(F)

      28        —     
       

 

 

   

 

 

 
          16,378        16,730   

Precision Southeast, Inc.

 

Manufacturing — injection molding and plastics

 

Senior Term Debt (14.0%, Due 12/2015)

    7,775        7,775        7,775   
   

Preferred Stock (19,091 shares) (C)(F)

      1,909        2,273   
   

Common Stock (90,909 shares) (C)(F)

      90        955   
       

 

 

   

 

 

 
          9,774        11,003   

 

10


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)

MARCH 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

SBS, Industries, LLC

 

Manufacturing — specialty fasteners and threaded screw products

 

Senior Term Debt (14.0%, Due 8/2016)

  $ 11,355      $ 11,355      $ 11,355   
   

Preferred Stock (19,935 shares) (C)(F)

      1,994        2,253   
   

Common Stock (221,500 shares) (C)(F)

      221        4,635   
       

 

 

   

 

 

 
          13,570        18,243   

SOG Specialty K&T, LLC

 

Manufacturing — specialty knives and tools

 

Senior Term Debt (13.3%, Due 8/2016)

    6,200        6,200        6,200   
   

Senior Term Debt (14.8%, Due 8/2016)

    12,199        12,199        12,199   
   

Preferred Stock (9,749 shares) (C)(F)

      9,749        11,423   
       

 

 

   

 

 

 
          28,148        29,822   

Tread Corp.

 

Manufacturing — storage and transport equipment

 

Line of Credit, $1,014 available (12.5%, Due 6/2013) (G)

    1,736        1,736        —     
   

Senior Subordinated Term Debt (12.5%, Due 5/2013) (G)

    5,000        5,000        —     
   

Senior Subordinated Term Debt (12.5%, Due 5/2013) (G)

    2,750        2,750        —     
   

Senior Subordinated Term Debt (12.5%, Due 5/2015) (G)

    1,000        1,000        —     
   

Senior Subordinated Term Debt (12.5%, Due on Demand) (D)(G)

    510        510        —     
   

Preferred Stock (3,332,765 shares) (C)(F)

      3,333        —     
   

Common Stock (7,716,320 shares) (C)(F)

      501        —     
   

Common Stock Warrants (2,372,727 shares) (C)(F)

      3        —     
       

 

 

   

 

 

 
          14,833        —     

Venyu Solutions, Inc.

 

Service — online servicing suite

 

Senior Subordinated Term Debt (11.3%, Due 10/2015)

    7,000        7,000        7,000   
   

Senior Subordinated Term Debt (14.0%, Due 10/2015)

    12,000        12,000        12,000   
   

Preferred Stock (5,400 shares) (C)(F)

      6,000        24,970   
       

 

 

   

 

 

 
          25,000        43,970   
       

 

 

   

 

 

 

Total Control Investments (represents 85.1% of total investments at fair value)

    $ 263,522      $ 243,803   
       

 

 

   

 

 

 

 

11


Table of Contents

GLADSTONE INVESTMENT CORPORATION

CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)

MARCH 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS)

 

Company (A)

 

Industry

 

Investment (B)

  Principal     Cost     Fair Value  

AFFILIATE INVESTMENTS:

     

Cavert II Holding Corp.

 

Manufacturing — bailing wire

 

Senior Subordinated Term Debt (11.8%, Due 4/2016) (D)

  $ 2,200      $ 2,200      $ 2,258   
   

Subordinated Term Debt (13.0%, Due 4/2016) (D)

    4,671        4,671        4,805   
   

Preferred Stock (18,446 shares) (C)(F)

      1,844        2,803   
       

 

 

   

 

 

 
          8,715        9,866   

Channel Technologies Group, LLC

 

Manufacturing — acoustic products

 

Line of Credit, $0 available (7.0%, Due 5/2013) (D)

    1,250        1,250        1,248   
   

Senior Term Debt (8.3%, Due 12/2014) (D)

    5,596        5,596        5,589   
   

Senior Term Debt (12.3%, Due 12/2016) (D)

    10,750        10,750        10,737   
   

Preferred Stock (1,599 shares) (C)(F)

      1,599        275   
   

Common Stock (1,598,616 shares) (C)(F)

      —          —     
       

 

 

   

 

 

 
          19,195        17,849   

Noble Logistics, Inc.

 

Service — aftermarket auto parts delivery

 

Line of Credit, $0 available (10.5%, Due 1/2015) (D)

    800        800        360   
   

Senior Term Debt (11.0%, Due 1/2015) (D)

    7,227        7,227        3,252   
   

Senior Term Debt (10.5%, Due 1/2015) (D)

    3,650        3,650        1,643   
   

Senior Term Debt (10.5%, Due 1/2015) (D)(E)

    3,650        3,650        1,643   
   

Preferred Stock (1,075,000 shares) (C)(F)

      1,750        —     
   

Common Stock (1,682,444 shares) (C)(F)

      1,682        —     
       

 

 

   

 

 

 
          18,759        6,898   

Packerland Whey Products, Inc.

 

Manufacturing — dairy, meat, and protein supplements

 

Preferred Stock (248 shares) (C)(F)

      2,479        367   
   

Common Stock (247 shares) (C)(F)

      21        —     
       

 

 

   

 

 

 
          2,500        367   

Quench Holdings Corp.

 

Service — sales, installation and service of water coolers

 

Preferred Stock (388 shares) (C)(F)

      2,950        1,679   
   

Common Stock (35,242 shares) (C)(F)

      447        —     
       

 

 

   

 

 

 
          3,397        1,679   
       

 

 

   

 

 

 

Total Affiliate Investments (represents 12.8% of total investments at fair value)

    $ 52,566      $ 36,659   
       

 

 

   

 

 

 

NON-CONTROL/NON-AFFILIATE INVESTMENTS:

     

B-Dry, LLC

 

Service — basement waterproofer

 

Line of Credit, $0 available (6.5%, Due 5/2014) (D)

  $ 750      $ 750      $ 450   
   

Senior Term Debt (14.0%, Due 5/2014) (D)

    6,433        6,443        3,866   
   

Senior Term Debt (14.0%, Due 5/2014) (D)

    2,840        2,840        1,704   
   

Common Stock Warrants (85 shares) (C)(F)

      300        —     
       

 

 

   

 

 

 
          10,333        6,020   
       

 

 

   

 

 

 

Total Non-Control/Non-Affiliate Investments (represents 2.1% of total investments at fair value)

    $ 10,333      $ 6,020   
       

 

 

   

 

 

 

TOTAL INVESTMENTS (H)

    $ 326,421      $ 286,482   
       

 

 

   

 

 

 

 

(A)   Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company.
(B)   Percentages represent the weighted average interest rates in effect as of March 31, 2013, and due date represents the contractual maturity date.
(C)   Security is non-income producing.
(D)   Fair value based primarily on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc. as of March 31, 2013.
(E)   LOT of senior debt, meaning if the portfolio company is liquidated, the holder of the LOT is paid after the other senior debt and before the senior subordinated debt.
(F)   Where applicable, aggregates all shares of such class of stock owned without regard to specific series owned within such class, some series of which may or may not be voting shares or aggregates all warrants to purchase shares of such class of stock owned without regard to specific series of such class of stock such warrants allow us to purchase.
(G)   Debt security is on non-accrual status.
(H)   Aggregate gross unrealized depreciation for federal income tax purposes is $78,959; aggregate gross unrealized appreciation for federal income tax purposes is $38,650. Net unrealized depreciation is $40,309 based on a tax cost of $326,792.

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

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GLADSTONE INVESTMENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2013

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA AND AS OTHERWISE INDICATED)

 

NOTE 1. ORGANIZATION

Gladstone Investment Corporation (“Gladstone Investment”) was incorporated under the General Corporation Law of the State of Delaware on February 18, 2005, and completed an initial public offering on June 22, 2005. The terms “the Company,” “we,” “our” and “us” all refer to Gladstone Investment and its consolidated subsidiaries. We are an externally advised, closed-end, non-diversified management investment company that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, we have elected to be treated for tax purposes as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”). We were established for the purpose of investing in debt and equity securities of established private businesses in the United States (“U.S.”). Debt investments primarily come in the form of three types of loans: senior term loans, senior subordinated loans and junior subordinated debt. Equity investments primarily take the form of preferred or common equity (or warrants or options to acquire the foregoing), often in connection with buyouts and other recapitalizations. To a much lesser extent, we may also invest in syndicated loans. Our investment objectives are: (a) to achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time, and (b) to provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. We aim to maintain a portfolio allocation of approximately 80% debt investments and 20% equity investments, at cost.

Gladstone Business Investment, LLC (“Business Investment”), a wholly-owned subsidiary of ours, was established on August 11, 2006 for the sole purpose of owning our portfolio of investments in connection with our line of credit. The financial statements of Business Investment are consolidated with those of Gladstone Investment. We also have significant subsidiaries whose financial statements are not consolidated with ours. Refer to Note 13— Unconsolidated Significant Subsidiaries for additional information regarding our unconsolidated significant subsidiaries.

We are externally managed by Gladstone Management Corporation (the “Adviser”), an affiliate of ours and a Securities and Exchange Commission (“SEC”) registered investment adviser, pursuant to an investment advisory agreement and management agreement. Administrative services are provided by Gladstone Administration, LLC (the “Administrator”), an affiliate of ours and the Adviser, pursuant to an administration agreement.

 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Statements and Basis of Presentation

We prepare our interim financial statements in accordance with accounting principles generally accepted in the U.S. (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Articles 6 and 10 of SEC Regulation S-X. Accordingly, we have omitted certain disclosures accompanying annual financial statements prepared in accordance with GAAP. The accompanying condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. Under Article 6 of Regulation S-X, and the authoritative accounting guidance provided by the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies, we are not required to consolidate any portfolio company investments, including those in which we have a controlling interest. In our opinion, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of financial statements for the interim periods have been included. The results of operations for the three and nine months ended December 31, 2013, are not necessarily indicative of results that ultimately may be achieved for the year. The interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended March 31, 2013, as filed with the SEC on May 14, 2013.

Our fiscal year-end Condensed Consolidated Statement of Assets and Liabilities presented in this Form 10-Q was derived from audited financial statements, but does not include all disclosures required by GAAP.

Investment Valuation Policy

We carry our investments at fair value to the extent that market quotations are readily available and reliable and otherwise at fair value as determined in good faith by our board of directors (our “Board of Directors”). In determining the fair value of our investments, the Adviser has established an investment valuation policy (the “Policy”). The Policy has been approved by our Board of Directors, and each quarter our Board of Directors reviews the Policy to determine if changes thereto are advisable and also reviews whether the Adviser has applied the Policy consistently and votes whether to accept the recommended valuation of our investment portfolio. Such determination of fair values may involve subjective judgments and estimates.

 

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The Adviser uses valuation techniques in accordance with GAAP to value our portfolio. From time to time, the Adviser may accept an appraisal of a business in which we hold securities. These appraisals are expensive and occur infrequently, but provide a third-party valuation opinion that may differ in results, techniques and scope used to value our investments. When the Adviser obtains these specific third-party appraisals, the Adviser uses estimates of value provided by such appraisals and its own assumptions, including estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date, to value our investments.

The Policy, summarized below, applies to publicly traded securities, securities for which a limited market exists and securities for which no market exists.

Publicly traded securities: The Adviser determines the value of a publicly traded security based on the closing price for the security on the exchange or securities market on which it is listed and primarily traded on the valuation date. To the extent that we own a restricted security that is not freely tradable, but for which a public market otherwise exists, the Adviser will use the market value of that security adjusted for any decrease in value resulting from the restrictive feature. As of December 31 and March 31, 2013, we did not have any investments in publicly traded securities.

Securities for which a limited market exists: The Adviser values securities that are not traded on an established secondary securities market, but for which a limited market for the security exists, such as certain participations in, or assignments of, syndicated loans, at the quoted bid price, which are non-binding. In valuing these assets, the Adviser assesses trading activity in an asset class and evaluates variances in prices and other market insights to determine if any available quoted prices are reliable. In general, if the Adviser concludes that quotes based on active markets or trading activity may be relied upon, firm bid prices are requested; however, if firm bid prices are unavailable, the Adviser bases the value of the security upon the indicative bid price (“IBP”) offered by the respective originating syndication agent’s trading desk, or secondary desk, on or near the valuation date. To the extent that the Adviser uses the IBP as a basis for valuing the security, it may take further steps to consider additional information to validate that price in accordance with the Policy, including but not limited to reviewing a range of indicative bids to the extent the Adviser has ready access to such qualified information.

In the event these limited markets become illiquid such that market prices are no longer readily available, the Adviser will value our syndicated loans using alternative methods, such as estimated net present values of the future cash flows or discounted cash flows (“DCF”). The use of a DCF methodology follows that prescribed by the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 820, “ Fair Value Measurements and Disclosures ,” which provides guidance on the use of a reporting entity’s own assumptions about future cash flows and risk-adjusted discount rates when relevant observable inputs, such as quotes in active markets, are not available. When relevant observable market data does not exist, an alternative outlined in ASC 820 is the valuation of investments based on DCF. For the purposes of using DCF to provide fair value estimates, the Adviser considers multiple inputs, such as a risk-adjusted discount rate that incorporates adjustments that market participants would make, both for nonperformance and liquidity risks. As such, the Adviser develops a modified discount rate approach that incorporates risk premiums including, among other things, increased probability of default, higher loss given default or increased liquidity risk. The DCF valuations applied to the syndicated loans provide an estimate of what the Adviser believes a market participant would pay to purchase a syndicated loan in an active market, thereby establishing a fair value. The Adviser applies the DCF methodology in illiquid markets until quoted prices are available or are deemed reliable based on trading activity.

Securities for which no market exists: The valuation methodology for securities for which no market exists falls into four categories: (A) portfolio investments comprised solely of debt securities; (B) portfolio investments in controlled companies comprised of a bundle of securities, which can include debt and equity securities; (C) portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities; and (D) portfolio investments comprised of non-publicly traded, non-control equity securities of other funds.

 

(A) Portfolio investments comprised solely of debt securities: Debt securities that are not publicly traded on an established securities market, or for which a market does not exist (“Non-Public Debt Securities”), and that are issued by portfolio companies in which we have no equity or equity-like securities, are fair valued utilizing opinions of value submitted to the Adviser by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”) and its own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. The Adviser may also submit paid-in-kind (“PIK”) interest to SPSE for its evaluation when it is determined that PIK interest is likely to be received.

 

(B)

Portfolio investments in controlled companies comprised of a bundle of securities, which can include debt and equity securities: The fair value of these investments is determined based on the total enterprise value (“TEV”) of the portfolio company, or issuer, utilizing a liquidity waterfall approach under ASC 820 for our Non-Public Debt Securities and equity or

 

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  equity-like securities (e.g., preferred equity, common equity or other equity-like securities) that are purchased together as part of a package, where we control or could gain control through an option or warrant security; both the debt and equity securities of the portfolio investment would exit in the mergers and acquisitions market as the principal market, generally through a sale or recapitalization of the portfolio company. We generally exit the debt and equity securities of an issuer at the same time. Applying the liquidity waterfall approach to all of our investments in an issuer, the Adviser first calculates the TEV of the issuer by incorporating some or all of the following factors:

 

    the issuer’s ability to make payments;

 

    the earnings of the issuer;

 

    recent sales to third parties of similar securities;

 

    the comparison to publicly traded securities; and

 

    DCF or other pertinent factors.

In gathering the sales to third parties of similar securities, the Adviser generally references industry statistics and may use outside experts. TEV is only an estimate of value and may not be the value received in an actual sale. Once the Adviser has estimated the TEV of the issuer, it will subtract the value of all the debt securities of the issuer, which are valued at the contractual principal balance. Fair values of these debt securities are discounted for any shortfall of TEV over the total debt outstanding for the issuer. Once the values for all outstanding senior securities, which include all the debt securities, have been subtracted from the TEV of the issuer, the remaining amount, if any, is used to determine the value of the issuer’s equity or equity-like securities. If, in the Adviser’s judgment, the liquidity waterfall approach does not accurately reflect the value of the debt component, the Adviser may recommend that we use a valuation by SPSE, or, if that is unavailable, a DCF valuation technique.

 

(C) Portfolio investments in non-controlled companies comprised of a bundle of securities, which can include debt and equity securities: The Adviser values Non-Public Debt Securities that are purchased together with equity or equity-like securities from the same portfolio company, or issuer, for which we do not control or cannot gain control as of the measurement date, using a hypothetical secondary market as our principal market. In accordance with ASC 820 (as amended by the FASB’s Accounting Standards Update No. 2011-04, “ Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS” ),” (“ASU 2011-04”)), the Adviser has defined our “unit of account” at the investment level (either debt or equity) and as such determines our fair value of these non-control investments assuming the sale of an individual security using the standalone premise of value. As such, the Adviser estimates the fair value of the debt component using estimates of value provided by SPSE and its own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. For equity or equity-like securities of investments for which we do not control or cannot gain control as of the measurement date, the Adviser estimates the fair value of the equity based on factors such as the overall value of the issuer, the relative fair value of other units of account, including debt, or other relative value approaches. Consideration is also given to capital structure and other contractual obligations that may impact the fair value of the equity. Furthermore, the Adviser may utilize comparable values of similar companies, recent investments and indices with similar structures and risk characteristics or DCF valuation techniques and, in the absence of other observable market data, its own assumptions.

 

(D) Portfolio investments comprised of non-publicly traded, non-control equity securities of other funds: The Adviser generally values any uninvested capital of the non-control fund at par value and values any invested capital at the net asset value (“NAV”) provided by the non-control fund.

Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly and materially from the values that would have been obtained had a ready market for the securities existed. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned. There is no single standard for determining fair value in good faith, as fair value depends upon circumstances of each individual case. In general, fair value is the amount that the Adviser might reasonably expect us to receive upon the current sale of the security in an orderly transaction between market participants at the measurement date.

Refer to Note 3— Investments for additional information regarding fair value measurements and our application of ASC 820.

Interest Income Recognition

Interest income, adjusted for amortization of premiums, amendment fees and acquisition costs and the accretion of discounts, is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days or more past due, or if our qualitative assessment indicates that the debtor is unable to service its debt or other obligations, we will place the loan on non-accrual status and cease recognizing interest income on that loan until the borrower has demonstrated the ability and intent to pay contractual amounts due. However, we remain contractually entitled to this interest. Interest payments received on non-accrual

 

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loans may be recognized as income or applied to the cost basis, depending upon management’s judgment. Generally, non-accrual loans are restored to accrual status when past-due principal and interest are paid, and, in management’s judgment, are likely to remain current, or due to a restructuring, the interest income is deemed to be collectible. As of December 31, 2013, our loans to Tread Corp. (“Tread”) were on non-accrual, with an aggregate debt cost basis of $12.1 million, or 4.6% of the cost basis of all debt investments in our portfolio, and an aggregate fair value of $0. As of March 31, 2013, ASH Holdings Corp. (“ASH”) and Tread were on non-accrual, with an aggregate debt cost basis of $24.9 million, or 10.4% of the cost basis of all debt investments in our portfolio, and an aggregate fair value of $0.

PIK interest, computed at the contractual rate specified in the loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain our status as a RIC, this non-cash source of income must be included in our calculation of distributable income for purposes of complying with our distribution requirements, even though we have not yet collected the cash. During the three and nine months ended December 31, 2013, we recorded PIK income of $29 and $68, respectively. We did not hold any loans in our portfolio that contained a PIK provision as of December 31, 2012 and no PIK income was recorded during the three and nine months ended December 31, 2012.

Other Income Recognition

We generally record success fees upon receipt of cash. Success fees are contractually due upon a change of control in a portfolio company. We recorded $1.1 million and $3.4 million of success fees during the three and nine months ended December 31, 2013, respectively. During the three months ended December 31, 2013, we received $0.8 million and $0.2 million in success fees related to the debt repayments of Channel Technologies Group, LLC (“Channel”) and Cavert II Holding Corp. (“Cavert”), respectively. During the three and nine months ended December, 30, 2012, we recorded $0 and $0.8 million of success fees, respectively, representing prepayments received from Mathey Investments, Inc. (“Mathey”) and Cavert.

We accrue dividend income on preferred and common equity securities to the extent that such amounts are expected to be collected and if we have the option to collect such amounts in cash or other consideration. No dividend income was recorded during the three months ended December 31, 2013. For the nine months ended December 31, 2013, we recorded $1.4 million in dividend income related to the exit of Venyu Solutions, Inc. (“Venyu”). We recorded $0.7 and $0.8 million in dividend income during the three and nine months ended December 31, 2012, respectively, on accrued preferred shares of Acme Cryogenics, Inc. (“Acme”) and Drew Foam Companies, Inc. (“Drew Foam”).

Both dividends and success fees are recorded in Other income in our accompanying Condensed Consolidated Statements of Operations .

Recent Accounting Pronouncements

In June 2013, the FASB issued ASU 2013-08, “Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements,” which amends the criteria that define an investment company and clarifies the measurement guidance and requires new disclosures for investment companies. Under ASU 2013-08, an entity already regulated under the 1940 Act is automatically an investment company under the new GAAP definition, so we anticipate no impact from adopting this standard on our financial position or results of operations. We are currently assessing whether additional disclosure requirements will be necessary. ASU 2013-08 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013.

 

NOTE 3. INVESTMENTS

ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820 provides a consistent definition of fair value that focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. ASC also establishes the following three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

 

  Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets;

 

  Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active or inactive markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and

 

  Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect assumptions that market participants would use when pricing the asset or liability and can include the Adviser’s assumptions based upon the best available information.

 

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As of December 31 and March 31, 2013, all of our investments were valued using Level 3 inputs. We transfer investments in and out of Level 1, 2 and 3 securities as of the beginning balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the three and nine months ended December 31, 2013 and 2012, there were no transfers in or out of Level 1, 2 and 3.

The following table presents the financial assets carried at fair value as of December 31 and March 31, 2013, by caption on our accompanying Condensed Consolidated Statements of Assets and Liabilities and by security type for each of the three applicable levels of hierarchy established by ASC 820 that we used to value our financial assets:

 

     Total Recurring Fair Value Measurement  
     Reported in  Condensed Consolidated Statements  
     of Assets and Liabilities  
     December 31, 2013      March 31, 2013  

Control Investments

     

Senior debt

   $ 91,475       $ 73,391   

Senior subordinated debt

     60,783         79,748   

Preferred equity

     42,527         77,032   

Common equity/equivalents

     6,283         13,632   
  

 

 

    

 

 

 

Total Control Investments

     201,068         243,803   

Affiliate Investments

     

Senior debt

     22,701         24,471   

Senior subordinated debt

     —           7,063   

Preferred equity

     12,361         5,125   

Common equity/equivalents

     763         —     
  

 

 

    

 

 

 

Total Affiliate Investments

     35,825         36,659   

Non-Control/Non-Affiliate Investments

     

Senior debt

     35,319         6,020   

Senior subordinated debt

     7,672         —     

Preferred equity

     6,299         —     

Common equity/equivalents

     4,544         —     
  

 

 

    

 

 

 

Total Non-Control/Non-Affiliate Investments

     53,834         6,020   
  

 

 

    

 

 

 

Total Investments at fair value using Level 3 inputs

   $ 290,727       $ 286,482   

Cash Equivalents using Level 1 inputs

     10,000         65,000   
  

 

 

    

 

 

 

Total Investments and Cash Equivalents

   $ 300,727       $ 351,482   
  

 

 

    

 

 

 

In accordance with ASU 2011-04, the following table provides quantitative information about our Level 3 fair value measurements of our investments as of December 31 and March 31, 2013. In addition to the techniques and inputs noted in the table below, according to our valuation policy, the Adviser may also use other valuation techniques and methodologies when determining our fair value measurements. The below table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to our fair value measurements. The weighted average calculations in the table below are based on the principal balances for all debt-related calculations and on the cost basis for all equity-related calculations for the particular input.

 

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    Quantitative Information about Level 3 Fair Value Measurements
    Fair Value as
of December 31,
2013
    Fair Value
as of March 31,
2013
    Valuation
Technique/

Methodology
  Unobservable
Input
 

Range / Weighted

Average as of

December 31, 2013

 

Range / Weighted

Average as of

March 31, 2013

Senior debt

  $ 119,486      $ 69,544      TEV   EBITDA
multiples (B)
  3.5x – 6.6x / 5.1x   4.6x – 7.3x / 5.6x
        EBITDA (B)   $1,514 – $6,465 / $3,562   ($997) – $6,640 / $3,752
    30,009        34,338      SPSE (A)   EBITDA (B)   $451 – $3,568 / $1,643   $29 – $3,225 / $1,248
        Risk
Ratings (C)
  3.4 – 7.9 / 3.5   3.7 – 6.9 / 5.1

Senior subordinated debt

    47,070        66,070      TEV   EBITDA
multiples (B)
  4.1x – 6.3x / 4.9x   4.5x – 9.7x / 6.5x
        EBITDA (B)   $309 – $6,357 / $4,255   ($2,866) – $8,695 / $4,400
    21,385        20,741      SPSE (A)   EBITDA (B)   $6,300 – $9,969 / $7,613   $5,169 – $6,026 / $5,738
        Risk
Ratings (C)
  5.3 – 5.8 / 5.5   4.1 – 6.2 / 4.8

Preferred equity

    61,187        82,157      TEV   EBITDA
multiples (B)
  3.5x – 8.4x / 5.2x   4.2x – 9.7x / 5.9x
        EBITDA (B)   $309 – $11,527 / $4,556   ($2,866) – $8,695 / $4,344

Common equity/equivalents

    11,590        13,632      TEV   EBITDA
multiples (B)
  3.4x – 8.4x / 5.6x   3.7x – 7.8x / 6.2x
        EBITDA (B)   $309 – $11,527 / $4,358   ($2,866) – $6,026 / $1,959
 

 

 

   

 

 

         

Total

  $ 290,727      $ 286,482           
 

 

 

   

 

 

         

 

(A)   SPSE makes an independent assessment of the data the Adviser submits to them (which includes the financial and operational performance, as well as the Adviser’s internally assessed risk ratings of the portfolio companies – see footnote (C) below) and its own independent data to form an opinion as to what they consider to be the market values for our securities. With regard to its work, SPSE has stated that the data submitted to us is proprietary in nature.
(B)   Adjusted earnings before interest expense, taxes, depreciation and amortization (“EBITDA”) is an unobservable input, which is generally based on the most recently available trailing twelve month financial statements submitted to the Adviser from the portfolio companies. EBITDA multiples, generally indexed, represent the Adviser’s estimate of where market participants might price these investments. For our bundled debt and equity investments, the EBITDA and EBITDA multiple inputs are used in the TEV fair value determination, and the issuer’s debt, equity, and/or equity-like securities are valued in accordance with the Adviser’s liquidity waterfall approach. In limited cases, the revenue from the most recently available trailing twelve month financial statements submitted to the Adviser from the portfolio companies and the related revenue multiples, generally indexed, are used to provide a TEV fair value determination of our bundled debt and equity investments.
(C)   As part of the Adviser’s valuation procedures, it risk rates all of our investments in debt securities. The Adviser uses a proprietary risk rating system for all debt securities. The Adviser’s risk rating system uses a scale of 0 to >10, with >10 being the lowest probability of default. The risk rating system covers both qualitative and quantitative aspects of the portfolio company business and the securities we hold.

A portfolio company’s EBITDA and EBITDA multiples are the significant unobservable inputs generally included in the Adviser’s internally-assessed TEV models used to value our proprietary debt and equity investments. Holding all other factors constant, increases (decreases) in the EBITDA and/or the EBITDA multiples inputs would result in a higher (lower) fair value measurement. Per our valuation policy, the Adviser generally uses an indexed EBITDA multiple. EBITDA and EBITDA multiple inputs do not necessarily directionally correlate since EBITDA is a company performance metric and EBITDA multiples can be influenced by market, industry, size and other factors.

Changes in Level 3 Fair Value Measurements of Investments

The following tables provide the changes in fair value, broken out by security type, during the three and nine months ended December 31, 2013 and 2012 for all investments for which we determine fair value using unobservable (Level 3) factors. When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, such determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable, or Level 3, inputs, observable inputs (that is, components that are actively quoted and can be validated to external sources). In these cases, we categorize the fair value measurement in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement. Accordingly, the gains and losses in the tables below include changes in fair value, due in part to observable factors that are part of the valuation methodology.

 

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Fair Value Measurements of Investments Using Significant Unobservable Inputs (Level 3)

 

           Senior           Common        
     Senior     Subordinated     Preferred     Equity/        
     Debt     Debt     Equity     Equivalents     Total  

Three months ended December 31, 2013:

          

Fair value as of September 30, 2013

   $ 134,868      $ 74,740      $ 62,509      $ 15,095      $ 287,212   

Total gains (losses):

          

Net realized (losses) gains (A)(D)

     (2,856     (6,050     (4,233     24        (13,115

Net unrealized appreciation (depreciation) (B)

     973        122        (10,060     (6,495     (15,460

Reversal of previously-recorded depreciation upon realization (B)

     2,272        5,875        4,979        24        13,150   

New investments, repayments and settlements (C) :

          

Issuances / Originations

     32,131        309        11,689        44        44,173   

Settlements / Repayments

     (17,893     (6,541     —          —          (24,434

Sales (D)

     —          —          (747     (52     (799

Transfers (E)

     —          —          (2,950     2,950        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of December 31, 2013

   $ 149,495      $ 68,455      $ 61,187      $ 11,590      $ 290,727   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended December 31, 2013:

          

Fair value as of March 31, 2013

   $ 103,882      $ 86,811      $ 82,157      $ 13,632      $ 286,482   

Total gains (losses):

          

Net realized (losses) gains (A)(D)

     (2,856     (6,050     20,571        24        11,689   

Net unrealized (depreciation) appreciation (B)

     (2,433     (979     (16,640     (5,126     (25,178

Reversal of previously-recorded depreciation (appreciation) upon realization (B)

     2,274        5,875        (12,395     24        (4,222

New investments, repayments and settlements (C) :

          

Issuances / Originations

     68,821        9,239        21,994        138        100,192   

Settlements / Repayments

     (20,193     (26,441     —          —          (46,634

Sales (D)

     —          —          (31,550     (52     (31,602

Transfers (E)

     —          —          (2,950     2,950        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of December 31, 2013

   $ 149,495      $ 68,455      $ 61,187      $ 11,590      $ 290,727   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended December 31, 2012:

          

Fair value as of September 30, 2012

   $ 97,257      $ 93,740      $ 64,300      $ 11,389      $ 266,686   

Total (losses) gains:

          

Net realized gains (A)(D)

     —          —          —          96        96   

Net unrealized (depreciation) appreciation (B)

     (3,471     (9,631     5,514        7,634        46   

New investments, repayments and settlements (C) :

          

Issuances / Originations

     14,650        1,500        1,373        153        17,676   

Settlements / Repayments

     (647     (8,701     —          —          (9,348

Sales (D)

     —          —          (1,767     (129     (1,896
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of December 31, 2012

   $ 107,789      $ 76,908      $ 69,420      $ 19,143      $ 273,260   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended December 31, 2012:

          

Fair value as of March 31, 2012

   $ 94,886      $ 70,661      $ 46,669      $ 13,436      $ 225,652   

Total (losses) gains:

          

Net realized gains (A)(D)

     —          —          —          848        848   

Net unrealized (depreciation) appreciation (B)

     (11,547     (6,601     3,630        4,963        (9,555

New investments, repayments and settlements (C) :

          

Issuances / Originations

     33,120        28,315        18,926        278        80,639   

Settlements / Repayments

     (8,670     (12,467     —          —          (21,137

Sales (D)

     —          —          (2,305     (882     (3,187

Transfers (F)

     —          (3,000     2,500        500        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of December 31, 2012

   $ 107,789      $ 76,908      $ 69,420      $ 19,143      $ 273,260   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(A)   Included in Net realized gain (loss) on our accompanying Condensed Consolidated Statements of Operations for the periods ended December 31, 2013 and 2012.
(B)   Included in Net unrealized appreciation (depreciation) on our accompanying Condensed Consolidated Statements of Operations for the periods ended December 31, 2013 and 2012.
(C)   Includes increases in the cost basis of investments resulting from new portfolio investments, the amortization of discounts, PIK and other non-cash disbursements to portfolio companies, as well as decreases in the cost basis of investments resulting from principal repayments or sales, the amortization of premiums and acquisition costs, and other cost-basis adjustments.
(D)   Included in Net realized gains (losses) and Sales are post-closing adjustments recorded in the current period related to exits from prior periods.
(E)   Transfers represent $3.0 million of preferred equity of Quench Holding Corp. (“Quench”), at cost, as of September 30, 2013, which was converted into common equity during the quarter ended December 31, 2013.
(F)   Transfers represent $3.0 million of senior subordinated term debt of Tread, at cost, as of June 30, 2012, which was converted into preferred and common equity during the quarter ended September 30, 2012.

 

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Investment Activity

During the nine months ended December 31, 2013, the following significant transactions occurred:

 

    In April 2013, we invested $17.7 million in Jackrabbit, Inc. (“Jackrabbit”) through a combination of debt and equity. Jackrabbit, headquartered in Ripon, California, is a manufacturer of nut harvesting equipment.

 

    In May 2013, we invested $8.8 million in Funko, LLC (“Funko”) through a combination of debt and equity. Funko, headquartered in Lynnwood, Washington, is a designer, importer and marketer of pop-culture collectibles. This was our first co-investment with one of our affiliated funds, Gladstone Capital Corporation (“Gladstone Capital”), pursuant to an exemptive order granted by the SEC in July 2012.

 

    In June 2013, we invested $9.0 million in Star Seed, Inc. (“Star Seed”) through a combination of debt and equity. Based in Osborne, Kansas, Star Seed provides its customers with a variety of specialty seeds and related products.

 

    In August 2013, we invested $20.0 million in Schylling, Inc. (“Schylling”) through a combination of debt and equity. Schylling, headquartered in Rowley, Massachusetts, is a premier provider of high quality specialty toys.

 

    In August 2013, Venyu was sold. As a result of the sale, we received net cash proceeds of $32.2 million, resulting in a realized gain of approximately $24.8 million and dividend income of $1.4 million. In addition, we received full repayment of our debt investment of $19 million in principal repayment and $1.9 million in fee income.

 

    In October 2013, we invested $16.3 million in Alloy Die Casting Co. (“ADC”) through a combination of debt and equity. ADC, headquartered in Buena Park, California, is a manufacturer of high quality, finished aluminum and zinc castings for aerospace, defense, aftermarket automotive and industrial applications. Gladstone Capital also participated as a co-investor by providing $7.0 million of debt and equity financing at the same price and terms as our investment.

 

    In October 2013, we received full repayment of our debt investments in Channel in the aggregate amount of $16.2 million. We also received prepayment and success fee income in the amount of $0.8 million. Simultaneously, we invested $1.3 million in additional preferred and common equity securities in Channel.

 

    In October 2013, ASH, which was on non-accrual, was sold to certain members of its existing management team. As a result of the sale, we received $12 in net cash proceeds, recognized a realized loss of $11.4 million and have retained a $5.0 million accruing revolving credit facility in ASH.

 

    In November 2013, Packerland Whey Products, Inc. (“Packerland”) was sold to other existing owners at Packerland. As a result of the sale, we received $0.7 million in net cash proceeds and recognized a realized loss of $1.8 million.

 

    In December 2013, we received full repayment of our remaining debt investments in Cavert in the aggregate amount of $6.1 million. We also received prepayment and success fee income in the amount of $0.2 million. As of December 31, 2013, we have an equity investment of preferred stock in Cavert with a cost basis of $1.8 million and fair value of $3.0 million.

 

    In December 2013, Quench was recapitalized, resulting in all preferred stock holders, including our preferred stock investment of $3.0 million, being converted into common stock.

 

    In December 2013, we invested $12.9 million in Behrens Manufacturing, LLC (“Behrens”) through a combination of debt and equity. Behrens, headquartered in Winona, Minnesota, is a manufacturer and marketer of high quality, classic looking, utility products and containers. Gladstone Capital also participated as a co-investor by providing $5.5 million of debt and equity financing at the same price and terms as our investment.

 

    In December 2013, we invested $13.0 million in Meridian Rack & Pinion, Inc. (“Meridian”) through a combination of debt and equity. Meridian, headquartered in San Diego, California, is a provider of aftermarket and OEM replacement automotive parts, which it sells through both wholesale channels and online at www.BuyAutoParts.com. Gladstone Capital also participated as a co-investor by providing $5.6 million of debt and equity financing at the same price and terms as our investment.

 

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Investment Concentrations

As of December 31, 2013, our investment portfolio consisted of investments in 26 portfolio companies located in 14 states across 13 different industries with an aggregate fair value of $290.7 million, of which Acme, Galaxy Tool Holding Corp. (“Galaxy”), and SOG Specialty K&T, LLC (“SOG”), collectively, comprised approximately $74.7 million, or 25.7%, of our total investment portfolio at fair value. The following table outlines our investments by security type as of December 31 and March 31, 2013:

 

     December 31, 2013     March 31, 2013  
     Cost     Fair Value     Cost     Fair Value  

Senior debt

   $ 181,517         50.4   $ 149,495         51.4   $ 135,745         41.6   $ 103,882         36.3

Senior subordinated debt

     80,294         22.3        68,455         23.5        103,547         31.7        86,811         30.3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total debt

     261,811         72.7        217,950         74.9        239,292         73.3        190,693         66.6   

Preferred equity

     89,775         24.9        61,187         21.0        81,710         25.0        82,157         28.7   

Common equity/equivalents

     8,480         2.4        11,590         4.1        5,419         1.7        13,632         4.7   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total equity/equivalents

     98,255         27.3        72,777         25.1        87,129         26.7        95,789         33.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Investments

   $ 360,066         100.0   $ 290,727         100.0   $ 326,421         100.0   $ 286,482         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Investments at fair value consisted of the following industry classifications as of December 31 and March 31, 2013:

 

     December 31, 2013     March 31, 2013  
     Fair Value      Percentage of
Total Investments
    Fair Value      Percentage of
Total Investments
 

Chemicals, Plastics, and Rubber

   $ 56,302         19.4   $ 59,170         20.7

Leisure, Amusement, Motion Pictures, Entertainment

     43,431         14.9        29,822         10.4   

Diversified/Conglomerate Manufacturing

     43,030         14.8        32,698         11.4   

Machinery

     26,550         9.1        32,662         11.4   

Automobile

     25,253         8.7        7,467         2.6   

Farming and Agriculture

     23,980         8.2        —           —     

Aerospace and Defense

     19,743         6.8        20,876         7.3   

Home and Office Furnishings, Housewares, and Durable Consumer Products

     19,605         6.7        23,512         8.2   

Containers, Packaging, and Glass

     17,853         6.1        23,019         8.0   

Personal and Non-Durable Consumer Products

     9,907         3.4        —           —     

Cargo Transport

     3,066         1.1        6,897         2.4   

Buildings and Real Estate

     2,007         0.8        6,020         2.2   

Beverage, Food, and Tobacco

     —           —          369         0.1   

Electronics

     —           —          43,970         15.3   

Oil and Gas

     —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Investments

   $ 290,727         100.0   $ 286,482         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The investments, at fair value, were included in the following geographic regions of the U.S. as of December 31 and March 31, 2013:

 

     December 31, 2013     March 31, 2013  
     Fair Value      Percentage of
Total Investments
    Fair Value      Percentage of
Total Investments
 

West

   $ 126,101         43.4   $ 81,400         28.4

Northeast

     70,760         24.3        58,319         20.4   

South

     53,161         18.3        125,518         43.8   

Midwest

     40,705         14.0        21,245         7.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Investments

   $ 290,727         100.0   $ 286,482         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The geographic region indicates the location of the headquarters for our portfolio companies. A portfolio company may have additional business locations in other geographic regions.

 

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Investment Principal Repayments

The following table summarizes the contractual principal repayments and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, as of December 31, 2013:

 

          Amount  

For the remaining three months ending March 31:

  

2014

   $ 8,602   

For the fiscal year ending March 31:

  

2015

     57,106   
  

2016

     21,788   
  

2017

     43,314   
  

2018

     51,983   
  

Thereafter

     79,018   
     

 

 

 
  

Total contractual repayments

   $ 261,811   
  

Investments in equity securities

     98,255   
     

 

 

 
  

Total cost basis of investments held as of December 31, 2013:

   $ 360,066   
     

 

 

 

Receivables from Portfolio Companies

Receivables from portfolio companies represent non-recurring costs that we incurred on behalf of portfolio companies and are included in other assets on our accompanying Condensed Consolidated Statements of Assets and Liabilities . We maintain an allowance for uncollectible receivables from portfolio companies, which is determined based on historical experience and management’s expectations of future losses. We write off the accounts receivable to the established provision when collection efforts have been exhausted and the receivables are deemed uncollectible. As of December 31 and March 31, 2013, we had gross receivables from portfolio companies of $0.9 million and $1.2 million, respectively. The allowance for uncollectible receivables was $178 and $44 as of December 31 and March 31, 2013, respectively.

 

NOTE 4. RELATED PARTY TRANSACTIONS

Investment Advisory and Management Agreement

We entered into an investment advisory and management agreement with the Adviser (the “Advisory Agreement”). The Adviser is controlled by our chairman and chief executive officer. In accordance with the Advisory Agreement, we pay the Adviser certain fees as compensation for its services, such fees consisting of a base management fee and an incentive fee, each as described below. On July 9, 2013, our Board of Directors approved the renewal of the Advisory Agreement through August 31, 2014.

The following table summarizes the management fees, incentive fees and associated credits reflected in our accompanying Condensed Consolidated Statements of Operations :

 

     Three Months Ended
December 31,
    Nine Months Ended
December 31,
 
     2013     2012     2013     2012  

Average gross assets subject to base management fee

   $ 303,000      $ 288,000      $ 308,333      $ 262,600   

Multiplied by prorated annual base management fee of 2%

     0.5     0.5     1.5     1.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Base management fee (A)

     1,515        1,440        4,625        3,939   

Credit for fees received by Adviser from the portfolio companies (A)

     (782     (489     (1,627     (1,189
  

 

 

   

 

 

   

 

 

   

 

 

 

Net base management fee

   $ 733      $ 951      $ 2,998      $ 2,750   
  

 

 

   

 

 

   

 

 

   

 

 

 

Incentive fee (A)

   $ 1,100      $ 589      $ 2,822      $ 1,130   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(A) Reflected as a line item on our accompanying Condensed Consolidated Statements of Operations.

Base Management Fee

The base management fee is computed and payable quarterly and is assessed at an annual rate of 2.0%. It is computed on the basis of the value of our average gross assets at the end of the two most recently completed quarters, which are total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings. As a BDC, we make available significant managerial assistance to our portfolio companies and provide other services to such portfolio companies. Although neither we nor our Adviser receive fees in connection with managerial assistance, the Adviser provides other services to our portfolio companies and receives fees for these other services. 50% of certain of these fees and 100% of others are credited against the base management fee that we would otherwise be required to pay to our Adviser. Effective beginning the third quarter ended December 31, 2013, 100% of all these fees are credited against the base management fee that we would otherwise be required to pay to our Adviser; however, pursuant to the terms of the Advisory Agreement, a percentage of certain of such fees is retained by the Adviser.

 

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Incentive Fee

The incentive fee consists of two parts: an income-based incentive fee and a capital gains-based incentive fee. The income-based incentive fee rewards the Adviser if our quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of our net assets (the “hurdle rate”). We will pay the Adviser an income-based incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:

 

    no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle rate (7.0% annualized);

 

    100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in any calendar quarter (8.75% annualized); and

 

    20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized).

The second part of the incentive fee is a capital gains-based incentive fee that will be determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date) and equals 20% of our realized capital gains as of the end of the fiscal year. In determining the capital gains-based incentive fee payable to the Adviser, we will calculate the cumulative aggregate realized capital gains and cumulative aggregate realized capital losses since our inception, and the aggregate net unrealized capital depreciation as of the date of the calculation, as applicable, with respect to each of the investments in our portfolio. For this purpose, cumulative aggregate realized capital gains, if any, equals the sum of the differences between the net sales price of each investment, when sold, and the original cost of such investment since our inception. Cumulative aggregate realized capital losses equals the sum of the amounts by which the net sales price of each investment, when sold, is less than the original cost of such investment since our inception. Aggregate net unrealized capital depreciation equals the sum of the difference, if negative, between the valuation of each investment as of the applicable calculation date and the original cost of such investment. At the end of the applicable year, the amount of capital gains that serves as the basis for our calculation of the capital gains-based incentive fee equals the cumulative aggregate realized capital gains less cumulative aggregate realized capital losses, less aggregate net unrealized capital depreciation, with respect to our portfolio of investments. If this number is positive at the end of such year, then the capital gains-based incentive fee for such year equals 20% of such amount, less the aggregate amount of any capital gains-based incentive fees paid in respect of our portfolio in all prior years. No capital gains-based incentive fee has been recorded since our inception through December 31, 2013, as cumulative net unrealized capital depreciation has exceeded cumulative realized capital gains net of cumulative realized capital losses.

Additionally, in accordance with GAAP, a capital gains-based incentive fee accrual is calculated using the aggregate cumulative realized capital gains and losses and aggregate cumulative unrealized capital depreciation included in the calculation of the capital gains-based incentive fee plus the aggregate cumulative unrealized capital appreciation. If such amount is positive at the end of a period, then GAAP requires us to record a capital gains-based incentive fee equal to 20% of such amount, less the aggregate amount of actual capital gains-based incentive fees paid in all prior years. If such amount is negative, then there is no accrual for such year. GAAP requires that the capital gains-based incentive fee accrual consider the cumulative aggregate unrealized capital appreciation in the calculation, as a capital gains-based incentive fee would be payable if such unrealized capital appreciation were realized. There can be no assurance that such unrealized capital appreciation will be realized in the future. No GAAP accrual for a capital gains-based incentive fee has been recorded since our inception through December 31, 2013.

Administration Agreement

We have entered into an administration agreement (the “Administration Agreement”) with the Administrator, whereby we pay separately for administrative services. The Administration Agreement provides for payments equal to our allocable portion of the Administrator’s overhead expenses in performing its obligations under the Administration Agreement, including, but not limited to, rent and the salaries and benefits expenses of our chief financial officer and treasurer, chief compliance officer, internal counsel and secretary and their respective staffs. Our allocable portion of administrative expenses is generally derived by multiplying the Administrator’s total allocable expenses by the percentage of our total assets at the beginning of the quarter in comparison to the total assets at the beginning of the quarter of all companies managed by the Adviser under similar agreements. On July 9, 2013, our Board of Directors approved the annual renewal of the Administration Agreement through August 31, 2014.

 

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Related Party Fees Due

Amounts due to related parties on our accompanying Condensed Consolidated Statements of Assets and Liabilities were as follows:

 

     December 31, 2013     March 31, 2013  

Base management fee due (from) to Adviser

   $ (87   $ 625   

Incentive fee due to Adviser

     1,100        1,454   

Other due to (from) Advisor

     11        (12
  

 

 

   

 

 

 

Fee due to Adviser (A)

   $ 1,024      $ 2,067   
  

 

 

   

 

 

 

Fee due to Administrator (A)

   $ 239      $ 221   
  

 

 

   

 

 

 

Total related party fees due

   $ 1,263      $ 2,288   
  

 

 

   

 

 

 

 

(A)   Reflected as a line item on our accompanying Condensed Consolidated Statements of Assets and Liabilities.

 

NOTE 5. BORROWINGS

Line of Credit

On April 30, 2013, we, through our wholly-owned subsidiary, Business Investment, entered into a fifth amended and restated credit agreement with Key Equipment Finance Inc., as administrative agent, lead arranger and a lender (the “Administrative Agent”), Branch Banking and Trust Company as a lender and managing agent, and the Adviser, as servicer, to increase the commitment amount of the revolving line of credit (the “Credit Facility”) from $60.0 million to $70.0 million and to extend the revolving period, which was extended to April 30, 2016 and, if not renewed or extended by April 30, 2016, all principal and interest will be due and payable on or before April 30, 2017 (one year after the revolving period end date). In addition, there are two one-year extension options to be agreed upon by all parties, which may be exercised on or before April 30, 2014 and 2015, respectively. Subject to certain terms and conditions, the Credit Facility may be expanded up to a total of $200.0 million through the addition of other lenders to the facility. Advances under the Credit Facility generally bear interest at 30-day LIBOR, plus 3.75% per annum, with an unused fee of 0.50% on undrawn amounts. We incurred fees of approximately $0.3 million in connection with this amendment.

On June 12, 2013, we further increased the borrowing capacity under the Credit Agreement from $70.0 million to $105.0 million by entering into Joinder Agreements pursuant to the Credit Agreement, by and among Business Investment, the Administrative Agent, the Adviser and each of Alostar Bank of Commerce and Everbank Commercial Finance, Inc.

The following tables summarize noteworthy information related to our Credit Facility:

 

     As of
December 31, 2013
     As of
March 31, 2013
 

Commitment amount

   $ 105,000       $ 60,000   

Borrowings outstanding at cost

     36,200         31,000   

Availability

     68,800         29,000   

 

     For the Three Months Ended
December 31,
    For the Nine Months Ended
December 31,
 
     2013     2012     2013     2012  

Weighted average borrowings outstanding

   $ 19,460      $ 11,924      $ 31,174      $ 17,305   

Effective interest rate (A)

     6.3     6.1     5.1     5.3

Commitment (unused) fees incurred

   $ 109      $ 61      $ 243      $ 163   

 

(A)   Excludes the impact of deferred financing fees.

Interest is payable monthly during the term of the Credit Facility. Available borrowings are subject to various constraints imposed under the Credit Facility, based on the aggregate loan balance pledged by Business Investment, which varies as loans are added and repaid, regardless of whether such repayments are prepayments or made as contractually required.

The Administrative Agent also requires that any interest or principal payments on pledged loans be remitted directly by the borrower into a lockbox account with The Bank of New York Mellon Trust Company, N.A as custodian. The Administrative Agent is also the trustee of the account and remits the collected funds to us once a month.

Generally, our Credit Facility contains covenants that require Business Investment to, among other things, maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions) and restrict certain material changes to our credit and collection policies without the lenders’ consent. Our Credit Facility generally also limits payments on distributions to the aggregate net investment income for each of the twelve month periods ending March 31,

 

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2014, 2015, 2016 and 2017. Business Investment is also subject to certain limitations on the type of loan investments it can apply toward available credit in the borrowing base, including restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life and lien property. Our Credit Facility further requires Business Investment to comply with other financial and operational covenants, which obligate Business Investment to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of obligors required in the borrowing base of the credit agreement. Additionally, we are subject to a performance guaranty that requires us to maintain (i) a minimum net worth (defined in our Credit Facility to include our mandatory redeemable term preferred stock) of $170.0 million plus 50% of all equity and subordinated debt raised after April 30, 2013, which equates to $170.0 million as of December 31, 2013, (ii) “asset coverage” with respect to “senior securities representing indebtedness” of at least 200%, in accordance with Section 18 of the 1940 Act and (iii) its status as a BDC under the 1940 Act and as a RIC under the Code. As of December 31, 2013, and as defined in the performance guaranty of our Credit Facility, we had a minimum net worth of $264.7 million, an asset coverage of 336% and an active status as a BDC and RIC. Our Credit Facility requires a minimum of 12 obligors in the borrowing base and, as of December 31, 2013, Business Investment had 20 obligors. As of December 31, 2013, we were in compliance with all covenants.

Short-Term Loan

Similar to previous quarter ends, to maintain our status as a RIC, we purchased $10.0 million of short-term U.S. Treasury Bills (“T-Bills”) through Jefferies & Company, Inc. (“Jefferies”) on December 27, 2013. As these T-Bills have a maturity of less than three months, we consider them to be cash equivalents and include them in cash and cash equivalents on our accompanying Condensed Consolidated Statement of Assets and Liabilities as of December 31, 2013. The T-Bills were purchased on margin using $1.5 million in cash and the proceeds from an $8.5 million short-term loan from Jefferies with an effective annual interest rate of approximately 1.35%. On January 2, 2014, when the T-Bills matured, we repaid the $8.5 million loan from Jefferies and we received back the $1.5 million margin payment sent to Jefferies to complete the transaction.

Secured Borrowing

In August 2012, we entered into a participation agreement with a third-party related to $5.0 million of our senior subordinated term debt investment in Ginsey Home Solutions, Inc. (“Ginsey”). We evaluated whether the transaction should be accounted for as a sale or a financing-type transaction under the applicable guidance of ASC 860. Based on the terms of the participation agreement, we are required to treat the participation as a financing-type transaction. Specifically, the third-party has a senior claim to our remaining investment in the event of default by Ginsey which, in part, resulted in the loan participation bearing a rate of interest lower than the contractual rate established at origination. Therefore, our accompanying Condensed Consolidated Statements of Assists and Liabilities reflects the entire senior subordinated term debt investment in Ginsey and a corresponding $5.0 million secured borrowing liability. The secured borrowing has a stated interest rate of 7.0% and a maturity date of January 3, 2018.

Fair Value

We elected to apply ASC 825, “Financial Instruments,” specifically for our Credit Facility and short-term loan, which was consistent with the application of ASC 820 to our investments. Generally, the Adviser estimates the fair value of our Credit Facility using estimates of value provided by an independent third party and its own assumptions in the absence of observable market data, including estimated remaining life, counterparty credit risk, current market yield and interest rate spreads of similar securities as of the measurement date. Additionally, due to the seven-day duration of the short-term loan, cost was deemed to approximate fair value. At each of December 31 and March 31, 2013, all of our borrowings were valued using Level 3 inputs. The following tables present the short-term loan and Credit Facility carried at fair value as of December 31 and March 31, 2013, by caption on our accompanying Condensed Consolidated Statements of Assets and Liabilities for Level 3 of the hierarchy established by ASC 820 and a roll-forward of the changes in fair value during the three and nine months ended December 31, 2013 and 2012:

 

     Level 3 – Borrowings  
     Total Recurring Fair Value Measurement
Reported in
Condensed Consolidated
Statements of Assets and Liabilities
 
     December 31, 2013      March 31, 2013  

Short-Term Loan

   $ 8,501       $ 58,016   

Credit Facility

     36,200         31,854   
  

 

 

    

 

 

 

Total

   $ 44,701       $ 89,870   
  

 

 

    

 

 

 

 

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Fair Value Measurements of Borrowings Using Significant Unobservable Inputs (Level 3)

 

     Short-Term
Loan
    Credit
Facility
    Total  

Three months ended December 31, 2013:

      

Fair value at September 30, 2013

   $ 22,005      $ 34,341      $ 56,346   

Borrowings

     8,501        37,000        45,501   

Repayments

     (22,005     (34,800     (56,805

Net unrealized depreciation (A)

     —          (341     (341
  

 

 

   

 

 

   

 

 

 

Fair value at December 31, 2013

   $ 8,501      $ 36,200      $ 44,701   
  

 

 

   

 

 

   

 

 

 

Nine months ended December 31, 2013:

      

Fair value at March 31, 2013

   $ 58,016      $ 31,854      $ 89,870   

Borrowings

     56,515        108,500        165,015   

Repayments

     (106,030     (103,300     (209,330

Net unrealized depreciation (A)

     —          (854     (854
  

 

 

   

 

 

   

 

 

 

Fair value at December 31, 2013

   $ 8,501      $ 36,200      $ 44,701   
  

 

 

   

 

 

   

 

 

 

Three months ended December 31, 2012:

      

Fair value at September 30, 2012

   $ 71,525      $ 57,209      $ 128,734   

Borrowings

     44,512        24,000        68,512   

Repayments

     (71,525     (55,500     (127,025

Net unrealized depreciation (A)

     —          (605     (605
  

 

 

   

 

 

   

 

 

 

Fair value at December 31, 2012

   $ 44,512      $ 25,104      $ 69,616   
  

 

 

   

 

 

   

 

 

 

Nine months ended December 31, 2012:

      

Fair value at March 31, 2012

   $ 76,005      $ —        $ 76,005   

Borrowings

     192,047        115,000        307,047   

Repayments

     (223,540     (90,500     (314,040

Net unrealized appreciation (A)

     —          604        604   
  

 

 

   

 

 

   

 

 

 

Fair value at December 31, 2012

   $ 44,512      $ 25,104      $ 69,616   
  

 

 

   

 

 

   

 

 

 

 

(A)   Included in net unrealized (depreciation) appreciation on our accompanying Condensed Consolidated Statement of Operations for periods ended December 31, 2013 and 2012.

The fair value of the collateral under our Credit Facility was approximately $279.3 million and $263.7 million as of December 31 and March 31, 2013, respectively. The fair value of the collateral under the short-term loan was approximately $10.0 million and $65.0 million as of December 31 and March 31, 2013, respectively.

 

NOTE 6. INTEREST RATE CAP AGREEMENTS

We have entered into multiple interest rate cap agreements with BB&T and Keybank National Association that effectively limit the interest rate on a portion of our borrowings under the line of credit pursuant to the terms of our Credit Facility. The agreements provide that the interest rate on a portion of our borrowings is capped at a certain interest rate when 30-day LIBOR is in excess of that certain interest rate. The fair value of the interest rate cap agreements is recorded in other assets on our accompanying Condensed Consolidated Statements of Assets and Liabilities . We record changes in the fair value of the interest rate cap agreements quarterly based on the current market valuations at quarter end as net unrealized appreciation (depreciation) of other on our accompanying Condensed Consolidated Statements of Operations . Generally, the Adviser estimates the fair value of our interest rate cap agreements using estimates of value provided by the counterparty and its own assumptions in the absence of observable market data, including estimated remaining life, counterparty credit risk, current market yield and interest rate spreads of similar securities as of the measurement date. As of December 31 and March 31, 2013, our interest rate cap agreements were valued using Level 3 inputs. The following table summarizes the key terms of each interest rate cap agreement:

 

                        As of December 31,
2013
    As of March 31,
2013
 
Interest
Rate Cap (A)
  Notional
Amount
    LIBOR
Cap
    Effective
Date
  Maturity Date   Cost     Fair
Value
    Cost     Fair
Value
 
December 2011   $ 50,000        6.0   May 2012   October 2013   $ —   (B)     $ —        $ 29      $ 2   
July 2013     45,000        6.0      October 2013   April 2016     75        4        —          —     

 

(A)   Indicates date we entered into the interest rate cap agreement.
(B)   In October 2013, upon expiration of the December 2011 cap, we recognized a realized loss of $29.

The use of a cap agreement involves risks that are different from those associated with ordinary portfolio securities transactions. Cap agreements may be considered to be illiquid. Although we will not enter into any such agreements unless we believe that the other party to the transaction is creditworthy, we do bear the risk of loss of the amount expected to be received under such agreements in the event of default or bankruptcy of the agreement counterparty.

 

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NOTE 7. MANDATORILY REDEEMABLE PREFERRED STOCK

In March 2012, we completed a public offering of 1,600,000 shares of 7.125% Series A Cumulative Term Preferred Stock (our “Term Preferred Stock”) at a public offering price of $25.00 per share. Gross proceeds totaled $40.0 million and net proceeds, after deducting underwriting discounts and offering expenses borne by us, were $38.0 million. We incurred $2.0 million in total offering costs related to these transactions, which have been recorded as deferred financing costs on our accompanying Condensed Consolidated Statements of Assets and Liabilities and will be amortized over the redemption period ending February 28, 2017.

The shares have a redemption date of February 28, 2017, and are traded under the ticker symbol GAINP on the NASDAQ Global Select Market. The Term Preferred Stock is not convertible into our common stock or any other security. The Term Preferred Stock provides for a fixed dividend equal to 7.125% per year, payable monthly. We are required to redeem all of the outstanding Term Preferred Stock on February 28, 2017, for cash at a redemption price equal to $25.00 per share, plus an amount equal to accumulated but unpaid dividends, if any, to, but excluding, the date of redemption. In addition, three other potential redemption triggers are as follows: 1) upon the occurrence of certain events that would constitute a change in control of us, we would be required to redeem all of the outstanding Term Preferred Stock, 2) if we fail to maintain an asset coverage ratio of at least 200%, we are required to redeem a portion of the outstanding Term Preferred Stock or otherwise cure the ratio redemption trigger and 3) at our sole option, at any time on or after February 28, 2016, we may redeem some or all of the Term Preferred Stock.

For the nine months ended December 31, 2013 and 2012, our Board of Directors declared and paid a monthly distribution of $0.1484375 per share, or $1.3359375 per share in aggregate, to preferred stockholders.

In accordance with ASC 480, “Distinguishing Liabilities from Equity,” mandatorily redeemable financial instruments should be classified as liabilities on the balance sheet and, therefore, the related dividend payments are treated as dividend expense on our accompanying Condensed Consolidated Statements of Operations at the ex-dividend date. The fair value of the Term Preferred Stock, which we consider to be a level 1 liability within the fair value hierarchy, based on the last reported closing sale price as of December 31 and March 31, 2013, was approximately $41.8 million and $42.7 million, respectively.

Aggregate Term Preferred Stock distributions declared and paid for the three and nine months ended December 31, 2013, were approximately $0.7 million and $2.1 million, respectively. The tax character of distributions paid by us to preferred stockholders is from ordinary income.

 

NOTE 8. COMMON STOCK

We filed a registration statement on Form N-2 (File No. 333-181879) with the SEC on June 4, 2012, and subsequently filed a Pre-effective Amendment No. 1 to the registration statement on July 17, 2012, which the SEC declared effective on July 26, 2012. On June 7, 2013, we filed Post-Effective Amendment No. 2 to the registration statement, which the SEC declared effective on July 26, 2013. The registration statement permits us to issue, through one or more transactions, up to an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock, including through a combined offering of two or more of such securities.

On October 5, 2012, we completed a public offering of 4.0 million shares of our common stock at a public offering price of $7.50 per share, which was below our then current net asset value (“NAV”) per share. Gross proceeds totaled $30.0 million and net proceeds, after deducting underwriting discounts and offering expenses borne by us, were $28.3 million, which was used to repay borrowings under our Credit Facility. In connection with the offering, the underwriters exercised their option to purchase an additional 395,825 shares at the public offering price to cover over-allotments, which resulted in gross proceeds of $3.0 million and net proceeds, after deducting underwriting discounts, of $2.8 million.

 

NOTE 9. NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE

The following table sets forth the computation of basic and diluted net (decrease) increase in net assets resulting from operations per weighted average common share for the three and nine months ended December 31, 2013 and 2012:

 

     Three Months Ended December 31,      Nine Months Ended December 31,  
     2013     2012      2013     2012  

Numerator for basic and diluted net (decrease) increase in net assets resulting from operations per common share

   $ (10,686   $ 4,699       $ (2,266   $ 1,330   

Denominator for basic and diluted weighted average common shares

     26,475,958        26,147,157         26,475,958        23,440,737   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic and diluted net (decrease) increase in net assets resulting from operations per average common share

   $ (0.40   $ 0.18       $ (0.09   $ 0.06   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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NOTE 10. DISTRIBUTIONS TO COMMON STOCKHOLDERS

To qualify to be taxed as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code, we are required to distribute to our stockholders 90% of our “investment company taxable income,” which is generally our net ordinary income plus the excess of our net short-term capital gains over net long-term capital losses. The amount to be paid out as a distribution is determined by our Board of Directors each quarter and is based on our estimated taxable income by management. Based on that estimate, three monthly distributions are declared each quarter.

Our Board of Directors declared the following monthly distributions to common stockholders for the nine months ended December 31, 2013 and 2012:

 

Fiscal Year

   Record Date    Payment Date    Distribution
per Common
Share
 

2014

   April 22, 2013    April 30, 2013    $ 0.050   
   May 20, 2013    May 31, 2013      0.050   
   June 19, 2013    June 28, 2013      0.050   
   July 17, 2013    July 31, 2013      0.050   
   August 19, 2013    August 30, 2013      0.050   
   September 16, 2013    September 30, 2013      0.050   
   October 22, 2013    October 31, 2013      0.060   
   November 14, 2013    November 29, 2013      0.060   
   November 18, 2013    November 29, 2013      0.050 (A)  
   December 16, 2013    December 31, 2013      0.060   
        

 

 

 
   Nine months ended December 31, 2013:    $ 0.53   
        

 

 

 

2013

   April 20, 2012    April 30, 2012    $ 0.050   
   May 18, 2012    May 31, 2012      0.050   
   June 20, 2012    June 29, 2012      0.050   
   July 20, 2012    July 31, 2012      0.050   
   August 22, 2012    August 31, 2012      0.050   
   September 19, 2012    September 28, 2012      0.050   
   October 22, 2012    October 31, 2012      0.050   
   November 19, 2012    November 30, 2012      0.050   
   December 19, 2012    December 31, 2012      0.050   
        

 

 

 
   Nine months ended December 31, 2012:    $ 0.450   
        

 

 

 

 

(A)   A bonus dividend on our common stock of $0.05 per share was declared by our Board of Directors.

Aggregate common distributions declared quarterly and paid for the nine months ended December 31, 2013 and 2012 were approximately $14.0 million and $10.6 million, respectively, which were declared based on estimates of net investment income for the respective fiscal years. The tax characterization of the common distributions declared and paid for the fiscal year ended March 31, 2014, will be determined at fiscal year end and cannot be determined at this time. For the fiscal year ended March 31, 2013, taxable income available for common distributions exceeded distributions declared and paid, and, in accordance with Section 855(a) of the Code, we elected to treat $3.1 million of the common distributions paid in fiscal year 2014 as having been paid in the prior year.

 

NOTE 11. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

We are party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. We are required to establish reserves for litigation matters where those matters present loss contingencies that are both probable and estimable. When loss contingencies are not both probable and estimable, we do not establish reserves. Based on current knowledge, we do not believe that loss contingencies, if any, arising from pending investigations, litigation or regulatory matters will have a material adverse effect on our financial condition, results of operation or cash flows. Additionally, based on current knowledge, we do not believe such loss contingencies are probable and estimable and therefore, as of December 31, 2013, we have not established reserves for such loss contingencies.

 

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Financial Commitments and Obligations

As of December 31, 2013, we have lines of credit commitments to certain of our portfolio companies that have not been fully drawn. Since these lines of credit have expiration dates and we expect many will never be fully drawn, the total line of credit commitment amounts do not necessarily represent future cash requirements.

In addition to the lines of credit to certain portfolio companies, we have also extended certain guarantees on behalf of some of our portfolio companies. As of December 31, 2013, we have not been required to make any payments on the guarantees discussed below, and we consider the credit risk to be remote and the fair values of the guarantees to be minimal.

 

    In October 2008, we executed a guarantee of a vehicle finance facility agreement (the “Ford Finance Facility”) between Ford Motor Credit Company (“Ford”) and ASH. The Ford Finance Facility provides ASH with a line of credit of up to $0.5 million for component Ford parts used by ASH to build truck bodies under a separate contract. Ford retains title and ownership of the parts. The guarantee of the Ford Finance Facility will expire upon termination of the separate parts supply contract with Ford or upon replacement of us as guarantor. In connection with this guarantee, we received a premium of $20 from ASH.

 

    In February 2010, we executed a guarantee of a wholesale financing facility agreement (the “Floor Plan Facility”) between Agricredit Acceptance, LLC (“Agricredit”) and Country Club Enterprises, LLC (“CCE”). The Floor Plan Facility provides CCE with financing of up to $2.0 million to bridge the time and cash flow gap between the order and delivery of golf carts to customers. The guarantee was renewed in February 2011, 2012 and 2013 and expires in February 2014, unless it is renewed again by us, CCE and Agricredit. In connection with this guarantee and its subsequent renewals, we recorded aggregate premiums of $0.4 million from CCE.

 

    In April 2010, we executed a guarantee of vendor recourse for up to $2.0 million in individual customer transactions (the “Recourse Facility”) between Wells Fargo Financial Leasing, Inc. and CCE. The Recourse Facility provides CCE with the ability to provide vendor recourse up to a limit of $2.0 million on transactions with long-time customers who lack the financial history to qualify for third-party financing. The terms to maturity of these individual transactions range from October 2014 to October 2016. In connection with this guarantee, we received aggregate premiums of $0.1 million from CCE.

 

    In October 2013, we executed a guarantee of a vehicle finance facility agreement (the “Compass Finance Facility”) between Compass Bank and ASH. The Compass Finance Facility provides ASH with a line of credit of up to $0.3 million for component Ram parts used by ASH to build truck bodies under a separate contract. The guarantee will expire upon maturity of the Compass Finance Facility on October 16, 2014. In connection with this guarantee, we received a premium of $10 from ASH.

The following table summarizes the dollar balance of unused line of credit commitments and guarantees as of December 31 and March 31, 2013:

 

     December 31, 2013      March 31, 2013  

Unused line of credit commitments

   $ 3,154       $ 1,584   

Guarantees

     3,783         3,870   
  

 

 

    

 

 

 

Total

   $ 6,937       $ 5,454   
  

 

 

    

 

 

 

Escrow Holdbacks

From time to time, we will enter into arrangements relating to exits of certain investments whereby specific amounts of the proceeds are held in escrow to be used to satisfy potential obligations, as stipulated in the sales agreements. We record escrow amounts in restricted cash on our accompanying Condensed Consolidated Statements of Assets and Liabilities . In August 2013, the sale of Venyu resulted in $4.9 million in escrow amounts, of which $0.7 million is held on behalf of the other sellers. The $0.7 million amount held on behalf of the other sellers is recorded in other liabilities on our accompanying Condensed Consolidated Statements of Assets and Liabilities . We establish a contingent liability against the escrow amounts if we determine that it is probable and estimable that a portion of the escrow amounts will not be ultimately received at the end of the escrow period. The aggregate contingent liability recorded against the escrow amounts was $68 and $41 as of December 31 and March 31, 2013, respectively.

 

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NOTE 12. FINANCIAL HIGHLIGHTS

 

     Three Months Ended December 31,     Nine Months Ended December 31,  
     2013     2012     2013     2012  

Per Common Share Data

        

NAV at beginning of period (A)

   $ 9.12      $ 8.93      $ 9.10      $ 9.38   

Net investment income (B)

     0.17        0.15        0.55        0.45   

Net Realized (loss) gain on sale of investments and other (B)

     (0.50     0.01        0.44        0.04   

Net unrealized (depreciation) appreciation of investments and other (B)

     (0.07     0.02        (1.07     (0.43
  

 

 

   

 

 

   

 

 

   

 

 

 

Total from investment operations (B)

     (0.40     0.18        (0.08     0.06   

Cash distributions from net investment income (C)

     (0.23     (0.15     (0.53     (0.45

Net dilutive effect of issuance of common stock, net of expenses, below NAV (D)

     —          (0.31     —          (0.34
  

 

 

   

 

 

   

 

 

   

 

 

 

NAV at end of period (A)

   $ 8.49      $ 8.65      $ 8.49      $ 8.65   
  

 

 

   

 

 

   

 

 

   

 

 

 

Per common share market value at beginning of period

   $ 7.05      $ 7.84      $ 7.31      $ 7.57   

Per common share market value at end of period

     8.06        6.96        8.06        6.96   

Total return (E)

     17.84     (9.34 )%      18.48     (2.27 )% 

Common stock outstanding at end of period

     26,475,958        26,475,958        26,475,958        26,475,958   

Statement of Assets and Liabilities Data :

        

Net assets at end of period

   $ 224,665      $ 229,070      $ 224,665      $ 229,070   

Average net assets (F)

     227,838        227,740        234,285        210,927   

Senior Securities Data (G) :

        

Total borrowings, at cost

   $ 49,701      $ 74,012      $ 49,701      $ 74,012   

Mandatorily redeemable preferred stock

     40,000        40,000        40,000        40,000   

Asset coverage ratio (H)

     336     292     336     292

Average coverage per unit (I)

   $ 3,360      $ 2,922      $ 3,360      $ 2,922   

Ratios/Supplemental Data :

        

Ratio of expenses to average net assets (J)(K)

     8.91     6.54     8.20     6.71

Ratio of net expenses to average net assets (J)(L)

     7.54        5.68        7.28        5.96   

Ratio of net investment income to average net assets (J)

     7.73        6.94        8.34        6.73   

 

(A)   Based on actual common shares outstanding at the end of the corresponding period.
(B)   Based on weighted average per basic common share data.
(C)   Distributions are determined based on taxable income calculated in accordance with income tax regulations, which may differ from amounts determined under GAAP.
(D)   On October 5, 2012, we completed a public offering of 4.0 million shares of our common stock at a public offering price of $7.50 per share, which was below our then current NAV per share. Gross proceeds totaled $30.0 million and net proceeds, after deducting underwriting discounts and offering expenses borne by us, were $28.3 million. In connection with the offering, the underwriters exercised their option to purchase an additional 395,825 shares at the public offering price to cover over-allotments, which resulted in gross proceeds of $3.0 million and net proceeds, after deducting underwriting discounts, of $2.8 million.
(E)   Total return equals the change in the market value of our common stock from the beginning of the period, taking into account dividends reinvested in accordance with the terms of our dividend reinvestment plan. Total return does not take into account distributions that may be characterized as a return of capital. For further information on the estimated character of our distributions to common stockholders, please refer to Note 10— Distributions to Common Stockholders .
(F)   Calculated using the average balance of net assets at the end of each month of the reporting period.
(G)   The 1940 Act currently permits BDCs to issue senior securities representing indebtedness and senior securities that are stock, to which we refer as “senior securities.”
(H)   As a BDC, we are generally required to maintain an asset coverage ratio (as defined in Section 18(h) of the 1940 Act) of at least 200% on our senior securities representing indebtedness and our senior securities that are stock. Our mandatorily redeemable preferred stock is a senior security that is stock.
(I)   Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per one thousand dollars of indebtedness.
(J)   Amounts are annualized.
(K)   Ratio of expenses to average net assets is computed using expenses before credits from the Adviser.
(L)   Ratio of net expenses to average net assets is computed using total expenses net of any credits received from the Adviser.

 

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NOTE 13. UNCONSOLIDATED SIGNIFICANT SUBSIDIARIES

In accordance with the SEC’s Regulation S-X, we have subsidiaries that are not required to be consolidated. We have certain unconsolidated subsidiaries, specifically Galaxy Tool Holdings, Inc. (“Galaxy”), SOG Specialty K&T, LLC (“SOG”), Danco Acquisition Corp. (“Danco”) and Venyu, as of March 31 and December 31, 2013 and for the nine months ended December 31, 2013 and 2012, that meet at least one of the significance conditions of the SEC’s Regulation S-X. Accordingly, summarized, comparative financial information, in aggregate, is presented below for our significant unconsolidated subsidiaries.

 

     For the Nine Months Ended December 31,  

Income Statement (A)

   2013     2012  

Net Sales

   $ 74,730      $ 74,274   

Gross Profit

     24,950        27,911   

Net loss

     (301     (10,729

 

(A)   Reflects only five months of summarized income statement information of Venyu in 2013, as it was exited in August 2013 and is no longer in our portfolio as of December 31, 2013.

 

NOTE 14. SUBSEQUENT EVENTS

Short-Term Loan

On December 27, 2013, we purchased $10.0 million of T-Bills through Jefferies. The T-Bills were purchased on margin using $1.5 million in cash and the proceeds from a $8.5 million short-term loan from Jefferies with an effective annual interest rate of approximately 1.35%. On January 2, 2014, when the T-Bills matured, we repaid the $8.5 million loan from Jefferies and received the $1.5 million margin payment sent to Jefferies to complete the transaction.

Distributions

On January 7, 2013, our Board of Directors declared the following monthly cash distributions to common and preferred stockholders:

 

Declaration Date   Record Date   Payment Date   Distribution per
Common Share
    Distribution per Term
Preferred Share
 
January 7, 2014   January 22, 2014   January 31, 2014   $ 0.06      $ 0.1484375   
January 7, 2014   February 19, 2014   February 28, 2014     0.06        0.1484375   
January 7, 2014   March 17, 2014   March 31, 2014     0.06        0.1484375   
     

 

 

   

 

 

 
Total for the Quarter:   $ 0.18      $ 0.4453125   
     

 

 

   

 

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

All statements contained herein, other than historical facts, may constitute “forward-looking statements.” These statements may relate to, among other things, our future operating results, our business prospects and the prospects of our portfolio companies, actual and potential conflicts of interest with Gladstone Management Corporation and its affiliates, the use of borrowed money to finance our investments, the adequacy of our financing sources and working capital, and our ability to co-invest, among other factors. In some cases, you can identify forward-looking statements by terminology such as “estimate,” “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others: further adverse changes in the economy and the capital markets; (2) risks associated with negotiation and consummation of pending and future transactions; (3) the loss of one or more of our executive officers, in particular David Gladstone, Terry Lee Brubaker or David A.R. Dullum; (4) changes in our investment objectives and strategy; (5) availability, terms and deployment of capital; (6) changes in our industry, interest rates, exchange rates or the general economy; (7) the degree and nature of our competition; (8) our ability to maintain our qualification as a RIC and as business development company; and (9) those factors described in the “Risk Factors” section of our Annual Report on Form 10-K filed with the SEC on May 14, 2013. We caution readers not to place undue reliance on any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements and future results could differ materially from historical performance. We have based forward-looking statements on information available to us on the date of this report. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Quarterly Report on Form 10-Q. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we have filed or in the future may file with the Securities and Exchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

The following analysis of our financial condition and results of operations should be read in conjunction with our accompanying Condensed Consolidated Financial Statements and the notes thereto contained elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013, filed with the SEC on May 14, 2013. Historical financial condition and results of operations and percentage relationships among any amounts in the financial statements are not necessarily indicative of financial condition or results of operations for any future periods.

OVERVIEW

General

We are an externally-managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for United States (“U.S.”) federal income tax purposes, we have elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). As a BDC and a RIC, we are also subject to certain constraints, including limitations imposed by the 1940 Act and the Code.

We were incorporated under the General Corporation Law of the State of Delaware on February 18, 2005. We were established for the purpose of investing in debt and equity securities of established private businesses in the U.S. Debt investments primarily come in the form of three types of loans: senior term loans, senior subordinated loans and junior subordinated debt. Equity investments primarily take the form of preferred or common equity (or warrants or options to acquire the foregoing), often in connection with buyouts and other recapitalizations. To a much lesser extent, we also invest in senior and subordinated syndicated loans. Our investment objectives are (a) to achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time and (b) to provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. We aim to maintain a portfolio allocation of approximately 80% debt investments and 20% equity investments, at cost.

We focus on investing in small and medium-sized private U.S. businesses that meet certain criteria, including some but not all of the following: the potential for growth in cash flow, adequate assets for loan collateral, experienced management teams with a significant

 

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ownership interest in the borrower, profitable operations based on the borrower’s cash flow, reasonable capitalization of the borrower (usually by leveraged buyout funds or venture capital funds) and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the borrower, a public offering of the borrower’s stock or by exercising our right to require the borrower to repurchase our warrants, though there can be no assurance that we will always have these rights. We lend to borrowers that need funds to finance growth, restructure their balance sheets or effect a change of control. We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity. If we are participating in an investment with one or more co-investors, our investment is likely to be smaller than if we were investing alone.

Our common stock and 7.125% Series A Cumulative Term Preferred Stock (our “Term Preferred Stock”) are traded on the NASDAQ Global Select Market (“NASDAQ”) under the symbols “GAIN” and “GAINP,” respectively.

We are externally managed by our investment advisor, Gladstone Management Corporation (our “Adviser”), an SEC registered investment adviser and an affiliate of ours, pursuant to an investment advisory and management agreement (the “Advisory Agreement”). The Adviser manages our investment activities. Our Board of Directors, which is composed of a majority of independent directors, supervises such investment activities. We have also entered into an administration agreement (the “Administration Agreement”) with Gladstone Administration, LLC (our “Administrator”), an affiliate of ours and the Adviser, whereby we pay separately for administrative services.

Business Environment

The strength of the global economy, and the U.S. economy in particular, continues to be uncertain and volatile, and we remain cautious about a long-term economic recovery. The effects of the previous recession and the disruptions in the capital markets in particular, have impacted our liquidity options and increased our cost of debt and equity capital. In addition, the recent federal government shutdown combined with the uncertainty surrounding the ability of the federal government to address its fiscal condition in both the near and long term have increased domestic and global economic instability. Many of our portfolio companies, as well as those that we evaluate for possible investments, are adversely impacted by these political and economic conditions. If these conditions persist, it may adversely affect their ability to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial public offering.

New Investment and Realized Gains/Losses from Exits

While conditions remain challenging, we are seeing an increase in the number of new investment opportunities consistent with our investing strategy of providing a combination of debt and equity in support of management and sponsor-led buyouts of small and medium-sized companies in the U.S. These opportunities along with the capital raising efforts discussed below have allowed us to invest approximately $281.4 million in 17 new proprietary debt and equity deals since October 2010. During the three months ended December 31, 2013, we invested a total of $42.3 million in three new deals.

These new investments, as well as the majority of our debt securities in our portfolio, have a success fee component, which enhances the yield on our debt investments. Unlike paid-in-kind (“PIK”) income, we do not recognize the fee into income until it is received in cash. As a result, as of December 31, 2013, we had an off-balance sheet success fee receivable of $16.2 million, or approximately $0.61 per common share. Due to their contingent nature, there are no guarantees that we will be able to collect all of these success fees or know the timing of such collections.

The improved investing environment in the second quarter presented us with an opportunity to realize gains and other income from our investment in Venyu Solutions, Inc. (“Venyu”) as a result of its sale in August 2013. As a result of the sale, we received net cash proceeds of $32.2 million, resulting in a realized gain of $24.8 million and dividend income of $1.4 million. In addition, we received full repayment of our debt investments of $19.0 million and $1.8 million in success fee income. This represents our fourth management-supported buyout liquidity event since June 2010, and in the aggregate, these four liquidity events have generated $54.5 million in realized gains and $13.1 million in other income, for a total increase to our net assets of $67.6 million. We believe each of these transactions was an equity investment success and support our investment strategy of striving to achieve returns through current income on the debt portion of our investments and capital gains from the equity portion. These successes, in part, enabled us to increase the monthly distribution 50% since March 2011, allowed us to declare a one-time special distribution in fiscal year 2012, and to declare a $0.05 per common share one-time special distribution in November 2013.

With the four liquidity events that have generated $54.5 million in realized gains since June 2010, we have overcome our cumulative realized losses since inception that were primarily incurred during the recession and in connection with the sale of performing loans at a realized loss to pay off a former lender. As a result, we are now in a cumulative net realized gain position. We took the opportunity during the three months ended December 31, 2013, to strategically sell two of our portfolio companies, ASH Holding Corp. (“ASH”)

 

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and Packerland Whey Products, Inc. (“Packerland”) to existing members of their management teams and other existing owners, respectively, which resulted in realized losses of $11.4 million and $1.7 million, respectively. These sales, while at a realized loss, were accretive to our net asset value in aggregate by $5.7 million, reduced our distribution requirements related to our cumulative realized gains and reduced our non-accruals outstanding.

Capital Raising Efforts

Despite the challenges that have existed in the economy for the past several years, we have been able to meet our capital needs through enhancements to our revolving line of credit (our “Credit Facility”) and by accessing the capital markets in the form of public offerings of preferred and common stock. For example, in March 2012, we issued 1.6 million shares of our Term Preferred Stock for gross proceeds of $40.0 million, and, in October 2012, we issued 4.4 million shares of common stock for gross proceeds of $33.0 million. In October 2012, we extended the maturity date on our Credit Facility an additional year to 2015, and subsequently, in April and May 2013, we further extended the maturity date another six months into 2016 and increased the commitment amount from $60 million to $105 million.

Although we have been able to access the capital markets over the past two years, we believe market conditions continue to affect the trading price of our common stock and thus our ability to finance new investments through the issuance of equity. On February 3, 2014, the closing market price of our common stock was $7.88, which represented a 7.2% discount to our December 31, 2013, net asset value (“NAV”) per share of $8.49. When our stock trades below NAV, our ability to issue equity is constrained by provisions of the Investment Company Act of 1940 (the “1940 Act”), which generally prohibits the issuance and sale of our common stock at an issuance price below the then current NAV per share without stockholder approval, other than through sales to our then-existing stockholders pursuant to a rights offering.

At our Annual Meeting of Stockholders held on August 8, 2013, our stockholders ratified a proposal authorizing us to issue and sell shares of our common stock at a price below our then current NAV per share, subject to certain limitations, including that the number of shares issued and sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale, provided that our Board of Directors makes certain determinations prior to any such sale. This August 2013 shareholder authorization is in effect for one year from the date of stockholder approval. Prior to the August 2013 shareholder authorization, we sought and obtained shareholder approval concerning a similar proposal at the Annual Meeting of Stockholders held in August 2012, and with our Board of Directors’ approval, we issued shares of our common stock in October and November 2012 at a price per share below the then current NAV per share. The resulting proceeds, in part, have allowed us to grow the portfolio by making new investments, generate additional income through these new investments, provide us additional equity capital to help ensure continued compliance with regulatory tests and increase our debt capital while still complying with our applicable debt-to-equity ratios.

Regulatory Compliance

Due to the limited number of investments in our portfolio, our current asset composition has affected our ability to satisfy certain elements of the rules of the Code, for maintenance of our status as a RIC under the Code. To maintain our status as a RIC, in addition to other requirements, as of the close of each quarter of our taxable year, we must meet the asset diversification test, which requires that at least 50% of the value of our assets consist of cash, cash items, U.S. government securities or certain other qualified securities (the “50% threshold”). During the nine months ended December 31, 2013, we were at times below the 50% threshold.

Failure to meet the 50% threshold alone will not result in our loss of RIC status. In circumstances where the failure to meet the 50% threshold is the result of fluctuations in the value of our assets, including as a result of the sale of assets, we will still be deemed to have satisfied the 50% threshold and, therefore, maintain our RIC status, provided that we have not made any new investments, including additional investments in our existing portfolio companies (such as advances under outstanding lines of credit), since the time that we fell below the 50% threshold. As of December 31, 2013, we satisfied the 50% threshold with our asset composition, but as a precaution to ensure compliance, we also purchased short-term qualified securities, which were funded through a short-term loan agreement. Subsequent to the December 31, 2013, measurement date, the short-term qualified securities matured and we repaid the short-term loan. See “—Recent Developments— Short-Term Loan ” for more information regarding this transaction. Subsequent to December 31, 2013, we have continuously remained in compliance with the 50% threshold, even with the maturity of the short-term qualified securities; however, we continue to remain close to the 50% threshold.

Until the composition of our assets satisfies the required 50% threshold by a significant margin, we will continue to seek to employ similar purchases of qualified securities using short-term loans that would ensure us to satisfy the 50% threshold. There can be no assurance, however, that we will be able to enter into such a transaction on reasonable terms, if at all.

 

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Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act, which require us to have an asset coverage ratio (as defined in Section 18(h) of the 1940 Act), of at least 200% on our senior securities representing indebtedness and our senior securities that are stock, which we refer to collectively as “senior securities.” As of December 31, 2013, our asset coverage ratio was 336%. The ratio is impacted, in part, by our need to obtain a short-term loan at quarter end to satisfy the 50% threshold for our RIC status. Between the quarter end measurement dates, when we do not have a short-term loan outstanding, our leverage and asset coverage ratio improve. However, until the composition of our assets is above the required 50% threshold on a consistent basis by a significant margin, we will have to continue to obtain short-term loans on a quarterly basis. This strategy, while allowing us to satisfy the 50% threshold for our RIC status, limits our ability to use increased debt capital to make new investments, due to our asset coverage ratio limitations under the 1940 Act. Our common stock offering in October 2012, was undertaken, in part, to provide us additional equity capital to help ensure continued compliance with the 200% asset coverage ratio.

Investment Highlights

During the three months ended December 31, 2013, we disbursed $42.3 million in new debt and equity investments and extended $1.9 million of investments to existing portfolio companies through revolver draws or additions to term notes. From our initial public offering in June 2005 through December 31, 2013, we have made 210 investments in 105 companies for a total of approximately $896.9 million, before giving effect to principal repayments on investments and divestitures.

Investment Activity

During the nine months ended December 31, 2013, the following significant transactions occurred:

 

    In April 2013, we invested $17.7 million in Jackrabbit, Inc. (“Jackrabbit”) through a combination of debt and equity. Jackrabbit, headquartered in Ripon, California, is a manufacturer of nut harvesting equipment.

 

    In May 2013, we invested $8.8 million in Funko, LLC (“Funko”) through a combination of debt and equity. Funko, headquartered in Lynnwood, Washington, is a designer, importer and marketer of pop-culture collectibles. This was our first co-investment with one of our affiliated funds, Gladstone Capital Corporation (“Gladstone Capital”), pursuant to an exemptive order granted by the SEC in July 2012.

 

    In June 2013, we invested $9.0 million in Star Seed, Inc. (“Star Seed”) through a combination of debt and equity. Based in Osborne, Kansas, Star Seed provides its customers with a variety of specialty seeds and related products.

 

    In August 2013, we invested $20.0 million in Schylling, Inc. (“Schylling”) through a combination of debt and equity. Schylling, headquartered in Rowley, Massachusetts, is a premier provider of high quality specialty toys.

 

    In August 2013, Venyu was sold. As a result of the sale, we received net cash proceeds of $32.2 million, resulting in a realized gain of approximately $24.8 million and dividend income of $1.4 million. In addition, we received full repayment of our debt investment of $19 million in principal repayment and $1.9 million in fee income.

 

    In October 2013, we invested $16.3 million in Alloy Die Casting Co. (“ADC”) through a combination of debt and equity. ADC, headquartered in Buena Park, California, is a manufacturer of high quality, finished aluminum and zinc castings for aerospace, defense, aftermarket automotive and industrial applications. Gladstone Capital also participated as a co-investor by providing $7.0 million of debt and equity financing at the same price and terms as our investment.

 

    In October 2013, we received full repayment of our debt investments in Channel Technologies Group, LLC (“Channel”) in the aggregate amount of $16.2 million. We also received prepayment and success fee income in the amount of $0.8 million. Simultaneously, we invested $1.3 million in additional preferred and common equity securities in Channel.

 

    In October 2013, ASH, which was on non-accrual, was sold to certain members of its existing management team. As a result of the sale, we received $12 in net cash proceeds, recognized a realized loss of $11.4 million and have retained a $5.0 million accruing revolving credit facility in ASH.

 

    In November 2013, Packerland was sold to other existing owners at Packerland. As a result of the sale, we received $0.7 million in net cash proceeds and recognized a realized loss of $1.8 million.

 

    In December 2013, we received full repayment of our remaining debt investments in Cavert II Holding Corp. (“Cavert”) in the aggregate amount of $6.1 million. We also received prepayment and success fee income in the amount of $0.2 million. As of December 31, 2013, we have an equity investment of preferred stock in Cavert with a cost basis of $1.8 million and fair value of $3.0 million.

 

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    In December 2013, Quench Holdings Corp. (“Quench”) was recapitalized, resulting in all preferred stock holders, including our preferred stock investment of $3.0 million, being converted into common stock.

 

    In December 2013, we invested $12.9 million in Behrens Manufacturing, LLC (“Behrens”) through a combination of debt and equity. Behrens, headquartered in Winona, Minnesota, is a manufacturer and marketer of high quality, classic looking, utility products and containers. Gladstone Capital also participated as a co-investor by providing $5.5 million of debt and equity financing at the same price and terms as our investment.

 

    In December 2013, we invested $13.0 million in Meridian Rack & Pinion, Inc. (“Meridian”) through a combination of debt and equity. Meridian, headquartered in San Diego, California, is a provider of aftermarket and OEM replacement automotive parts, which it sells through both wholesale channels and online at www.BuyAutoParts.com. Gladstone Capital also participated as a co-investor by providing $5.6 million of debt and equity financing at the same price and terms as our investment.

Recent Developments

Credit Facility Extension and Expansion

On April 30, 2013, we, through our wholly-owned subsidiary, Business Investment, entered into a fifth amended and restated credit agreement with Key Equipment Finance Inc., as administrative agent, lead arranger and a lender (the “Administrative Agent”), Branch Banking and Trust Company as a lender and managing agent, and the Adviser, as servicer, to increase the commitment amount of the Credit Facility from $60.0 million to $70.0 million and to extend the revolving period, which was extended to April 30, 2016 and, if not renewed or extended by April 30, 2016, all principal and interest will be due and payable on or before April 30, 2017 (one year after the revolving period end date). In addition, there are two one-year extension options to be agreed upon by all parties, which may be exercised on or before April 30, 2014 and 2015, respectively. Subject to certain terms and conditions, the Credit Facility may be expanded up to a total of $200.0 million through the addition of other lenders to the facility. Advances under the Credit Facility generally bear interest at 30-day LIBOR, plus 3.75% per annum, and the Credit Facility includes an unused fee of 0.50% on undrawn amounts. We incurred fees of approximately $0.3 million in connection with this amendment.

On June 12, 2013, we further increased the borrowing capacity under the Credit Agreement from $70.0 million to $105.0 million by entering into Joinder Agreements pursuant to the Credit Agreement by and among Business Investment, the Administrative Agent, the Adviser and each of Alostar Bank of Commerce and Everbank Commercial Finance, Inc.

Short-Term Loan

For each quarter end since December 31, 2009 (the “measurement dates”), we satisfied the 50% threshold to maintain our status as a RIC, in part, through the purchase of short-term qualified securities, which were funded primarily through a short-term loan agreement. Subsequent to each of the measurement dates, the short-term qualified securities matured, and we repaid the short-term loan, at which time we again fell below the 50% threshold.

For the December 31, 2013 measurement date, we purchased $10.0 million of short-term United States Treasury Bills (“T-Bills”) through Jefferies & Company, Inc. (“Jefferies”) on December 27, 2013. The T-Bills were purchased on margin using $1.5 million in cash and the proceeds from an $8.5 million short-term loan from Jefferies with an effective annual interest rate of approximately 1.35%. On January 2, 2014, when the T-Bills matured, we repaid the $8.5 million loan from Jefferies and received the $1.5 million margin payment sent to Jefferies to complete the transaction.

 

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RESULTS OF OPERATIONS

Comparison of the Three Months Ended December 31, 2013, to the Three Months Ended December 31, 2012

 

     For the Three Months Ended December 31,  
     2013     2012     $ Change     % Change  

INVESTMENT INCOME

        

Interest income

   $ 7,593      $ 6,482      $ 1,111        17.1

Other income

     1,103        702        401        57.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     8,696        7,184        1,512        21.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

        

Base management fee

     1,515        1,440        75        5.2   

Incentive fee

     1,100        589        511        86.8   

Administration fee

     239        191        48        25.1   

Interest and dividend expense

     1,108        1,001        107        10.7   

Amortization of deferred financing costs

     262        194        68        35.1   

Other

     852        306        546        178.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses before credits from Adviser

     5,076        3,721        1,355        36.4   

Credits to fees

     (782     (489     (293     59.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses net of credits to fees

     4,294        3,232        1,062        32.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INVESTMENT INCOME

     4,402        3,952        450        11.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

REALIZED AND UNREALIZED (LOSS) GAIN:

        

Net realized (loss) gain on investments

     (13,115     96        (13,211     NM   

Net realized loss on investments

     (29     —          (29     NM   

Net unrealized (depreciation) appreciation of investments

     (2,310     46        (2,356     NM   

Net unrealized depreciation of other

     366        605        (239     (39.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized (loss) gain on investments and other

     (15,088     747        (15,835     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

   $ (10,686   $ 4,699      $ (15,385     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

BASIC AND DILUTED PER COMMON SHARE:

        

Net investment income

   $ 0.17      $ 0.15      $ 0.02        13.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in net assets resulting from operations

   $ (0.40   $ 0.18      $ (0.58     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

NM = Not Meaningful

Investment Income

Total investment income increased by 21.0% for the three months ended December 31, 2013, as compared to the prior year period. This increase was primarily due an overall increase in interest income in the three months ended December 31, 2013, as a result of an increase in the size of our loan portfolio, as well as an increase in other income, which primarily consisted of success fee income resulting from the prepayment of debt investments in Channel and Cavert during the three months ended December 31, 2013.

Interest income from our investments in debt securities increased 17.1% for the three months ended December 31, 2013, as compared to the prior year period. The level of interest income from investments is directly related to the principal balance of our interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the three months ended December 31, 2013, was approximately $237.5 million, compared to approximately $202.7 million for the prior year period. This increase was primarily due to approximately $97.7 million in new investments originated after December 31, 2012, including Jackrabbit, Funko, Star Seed, Schylling, ADC, Behrens, and Meridian, as well as the recapitalization of Galaxy Tool Holding Corp (“Galaxy”), partially offset with the exit of Venyu and the repayments of debt investments of Cavert and Channel. As of December 31, 2013, our loans to Tread Corp. (“Tread”) were on non-accrual, with an aggregate weighted average principal balance of $14.1 million during the three months ended December 31, 2013. ASH, which was on non-accrual as of September 30, 2013, was sold to certain members of its existing management team. As a result of the sale, we retained a $5.0 million accruing revolving credit facility in ASH, which is no longer on non-accrual as of December 31, 2013. As of December 31, 2012, loans of two portfolio companies, ASH and Tread, were on non-accrual, with an aggregate weighted average principal balance of $23.1 million during the three months ended December 31, 2012. The weighted average yield on our interest-bearing investments for both the three months ended December 31, 2013 and 2012, excluding cash and cash equivalents and receipts recorded as other income, was 12.7%.

 

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The following table lists the investment income for our five largest portfolio company investments based on fair value during the respective periods:

 

     As of December 31, 2013     Three months ended December 31, 2013  

Portfolio Company

   Fair Value      % of Portfolio     Investment
Income
     % of Total
Investment Income