As filed with the Securities and Exchange Commission on
July 13, 2011
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.
20549
1933 Act File
No. 333-162592
Form N-2
REGISTRATION
STATEMENT
UNDER
THE SECURITIES ACT OF
1933
o PRE-EFFECTIVE
AMENDMENT NO.
þ POST-EFFECTIVE
AMENDMENT NO. 4
GLADSTONE CAPITAL
CORPORATION
(Exact name of registrant as
specified in charter)
1521 WESTBRANCH DRIVE, SUITE 200
MCLEAN, VA 22102
(Address of principal executive
offices)
Registrant’s telephone number, including area code:
(703) 287-5800
DAVID GLADSTONE
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
GLADSTONE CAPITAL CORPORATION
1521 WESTBRANCH DRIVE, SUITE 200
MCLEAN, VIRGINIA 22102
(Name and address of agent for
service)
COPIES TO:
THOMAS R. SALLEY
DARREN K. DESTEFANO
CHRISTINA L. NOVAK
COOLEY LLP
ONE FREEDOM SQUARE
RESTON TOWN CENTER
11951 FREEDOM DRIVE
RESTON, VIRGINIA 20190
(703) 456-8000
(703) 456-8100
(facsimile)
Approximate date of proposed public
offering: From time to time after the effective
date of this registration statement.
If any securities being registered on this form will be offered
on a delayed or continuous basis in reliance on Rule 415
under the Securities Act of 1933, as amended, other than
securities offered in connection with a dividend reinvestment
plan, check the following
box. þ
The Registrant hereby amends this Registration Statement on
such date or dates as may be necessary to delay its effective
date until the Registrant shall file a further amendment which
specifically states that this Registration Statement shall
thereafter become effective in accordance with Section 8(a)
of the Securities Act of 1933, as amended, or until this
Registration Statement shall become effective on such date as
the Commission, acting pursuant to Section 8(a), may
determine.
|
The
information in this prospectus is not complete and may be
changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these
securities and is not soliciting an offer to buy these
securities in any state where the offer or sale is not
permitted. |
SUBJECT TO COMPLETION, DATED
JULY 13, 2011
PROSPECTUS
$300,000,000
COMMON
STOCK
PREFERRED STOCK
SUBSCRIPTION RIGHTS
WARRANTS
DEBT SECURITIES
PREFERRED STOCK
SUBSCRIPTION RIGHTS
WARRANTS
DEBT SECURITIES
We may offer, from time to time, up to $300,000,000 aggregate
initial offering price of our common stock, $0.001 par
value per share, preferred stock, $0.001 par value per
share, subscription rights, warrants representing rights to
purchase shares of our common stock, or debt securities, or a
combined offering of these securities, which we refer to in this
prospectus collectively as our Securities, in one or more
offerings. The Securities may be offered at prices and on terms
to be disclosed in one or more supplements to this prospectus.
In the case of our common stock and warrants or rights to
acquire such common stock hereunder, the offering price per
share of our common stock by us, less any underwriting
commissions or discounts, will not be less than the net asset
value per share of our common stock at the time of the offering
except (i) in connection with a rights offering to our
existing stockholders, (ii) with the consent of the
majority of our common stockholders, or (iii) under such
other circumstances as the Securities and Exchange Commission
may permit. You should read this prospectus and the applicable
prospectus supplement carefully before you invest in our
Securities.
Our Securities may be offered directly to one or more
purchasers, including existing stockholders in a rights
offering, through agents designated from time to time by us, or
to or through underwriters or dealers. The prospectus supplement
relating to the offering will identify any agents or
underwriters involved in the sale of our Securities, and will
disclose any applicable purchase price, fee, commission or
discount arrangement between us and our agents or underwriters
or among our underwriters or the basis upon which such amount
may be calculated. See “Plan of Distribution.” We may
not sell any of our Securities through agents, underwriters or
dealers without delivery of a prospectus supplement describing
the method and terms of the offering of such Securities. Our
common stock is traded on The Nasdaq Global Select Market under
the symbol “GLAD.” As of July 12, 2011, the last
reported sales price for our common stock was $9.59.
This prospectus contains information you should know before
investing, including information about risks. Please read it
before you invest and keep it for future reference. Additional
information about us, including our annual, quarterly and
current reports, has been filed with the Securities and Exchange
Commission. This information is available free of charge on our
corporate website located at
http://www.gladstonecapital.com.
See “Additional Information.” This prospectus may not
be used to consummate sales of securities unless accompanied by
a prospectus supplement.
An investment in our Securities involves certain risks,
including, among other things, risks relating to investments in
securities of small, private and developing businesses. We
describe some of these risks in the section entitled “Risk
Factors,” which begins on page 8. Shares of closed-end
investment companies frequently trade at a discount to their net
asset value and this may increase the risk of loss to purchasers
of our Securities. You should carefully consider these risks
together with all of the other information contained in this
prospectus and any prospectus supplement before making a
decision to purchase our Securities.
The Securities being offered have not been approved or
disapproved by the Securities and Exchange Commission or any
state securities commission nor has the Securities and Exchange
Commission or any state securities commission passed upon the
accuracy or adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
,
2011
TABLE OF
CONTENTS
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We have not authorized any dealer, salesman or other person
to give any information or to make any representation other than
those contained or incorporated by reference in this prospectus
or any accompanying supplement to this prospectus. You must not
rely upon any information or representation not contained or
incorporated by reference in this prospectus or the accompanying
prospectus supplement as if we had authorized it. This
prospectus and any prospectus supplement do not constitute an
offer to sell or a solicitation of any offer to buy any security
other than the registered securities to which they relate, nor
do they constitute an offer to sell or a solicitation of an
offer to buy any securities in any jurisdiction to any person to
whom it is unlawful to make such an offer or solicitation in
such jurisdiction. The information contained in this prospectus
and any prospectus supplement is accurate as of the dates on
their respective covers only. Our business, financial condition,
results of operations and prospects may have changed since such
dates.
PROSPECTUS
SUMMARY
The following summary contains basic information about this
offering. It likely does not contain all the information that is
important to an investor. For a more complete understanding of
this offering, we encourage you to read this entire document and
the documents to which we have referred. Except where the
context suggests otherwise, the terms “we,”
“us,” “our,” the “Company” and
“Gladstone Capital” refer to Gladstone Capital
Corporation; “Adviser” refers to Gladstone Management
Corporation; “Administrator” refers to Gladstone
Administration, LLC; “Gladstone Commercial” refers to
Gladstone Commercial Corporation; “Gladstone
Investment” refers to Gladstone Investment Corporation;
“Gladstone Land” refers to Gladstone Land Corporation;
“Gladstone Securities” refers to Gladstone Securities,
LLC; and “Gladstone Companies” refers to our Adviser
and its affiliated companies.
GLADSTONE
CAPITAL CORPORATION
General
We were incorporated under the General Corporation Laws of the
State of Maryland on May 30, 2001. Our investment objective
is to achieve a high level of current income by investing in
debt securities, consisting primarily of senior notes, senior
subordinated notes and junior subordinated notes, of established
private businesses that are substantially owned by leveraged
buyout funds, individual investors or are family-owned
businesses, with a particular focus on senior notes. In
addition, we may acquire from other funds existing loans that
meet this profile. We also seek to provide our stockholders with
long-term capital growth through appreciation in the value of
warrants or other equity instruments that we may receive when we
make loans. We operate as a closed-end, non-diversified
management investment company, and we have elected to be treated
as a business development company, or BDC, under the Investment
Company Act of 1940, as amended, which we refer to as the 1940
Act. In addition, for tax purposes we have elected to be treated
as a regulated investment company, or RIC, under the Internal
Revenue Code of 1986, as amended, which we refer to as the Code.
We seek to invest in small and medium-sized private
U.S. businesses that meet certain criteria, including some
but not necessarily all of the following: the potential for
growth in cash flow, adequate assets for loan collateral,
experienced management teams with a significant 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 seek to lend
to borrowers that need funds to finance growth, restructure
their balance sheets or effect a change of control. Our loans
typically range from $5 million to $20 million,
although this investment size may vary proportionately as the
size of our capital base changes, generally mature in no more
than seven years and accrue interest at a fixed or variable rate
that exceeds the prime rate. Because we expect that the majority
of our portfolio loans will consist of term debt of private
companies that typically cannot or will not expend the resources
to have their debt securities rated by a credit rating agency,
we expect that most of the debt securities we acquire will be
unrated. We cannot accurately predict what ratings these loans
might receive if they were rated, and thus cannot determine
whether or not they could be considered “investment
grade” quality. However, for loans that lack a rating by a
credit rating agency, investors should assume that these loans
will be below what is today considered “investment
grade” quality. Investments rated below investment grade
are often referred to as high yield securities or junk bonds,
and may be considered high risk compared to investment grade
debt instruments.
Our
Investment Adviser and Administrator
Our Adviser is our affiliate and investment adviser and is led
by a management team which has extensive experience in our lines
of business. Excluding our chief financial officer, all of our
executive officers serve as either directors or executive
officers, or both, of Gladstone Commercial, a publicly traded
real estate investment trust; Gladstone Investment, a publicly
traded BDC and RIC; our Adviser; and our Administrator. Our
treasurer is also an executive officer of Gladstone Securities,
a broker-dealer registered with the Financial Industry
Regulatory Authority, or FINRA. Our Administrator employs our
chief financial officer, chief compliance officer, internal
counsel, controller, treasurer and their respective staffs.
1
Our Adviser and Administrator also provide investment advisory
and administrative services, respectively, to our affiliates
Gladstone Commercial; Gladstone Investment; Gladstone Partners
Fund, L.P., or Gladstone Partners, a private partnership fund
formed primarily to co-invest with us and Gladstone Investment;
Gladstone Land, a private agricultural real estate company owned
by David Gladstone, our chairman and chief executive officer;
and Gladstone Lending Corporation, or Gladstone Lending, a
proposed fund that would primarily invest in first and second
lien term loans that has filed a registration statement on
Form N-2
with the Securities and Exchange Commission, or SEC. In the
future, our Adviser and Administrator may provide investment
advisory and administrative services, respectively, to other
funds, both public and private.
We have been externally managed by our Adviser pursuant to a
contractual investment advisory arrangement since
October 1, 2004. Our Adviser was organized as a corporation
under the laws of the State of Delaware on July 2, 2002,
and is a registered investment adviser under the Investment
Advisers Act of 1940, as amended. Our Adviser is headquartered
in McLean, Virginia, a suburb of Washington D.C., and our
Adviser also has offices in New York, Illinois and Virginia.
Our
Investment Strategy
We seek to achieve a high level of current income by investing
in debt securities, consisting primarily of senior notes, senior
subordinated notes and junior subordinated notes, of established
private businesses that are substantially owned by leveraged
buyout funds or individual investors or are family-owned
businesses, with a particular focus on senior notes. In
addition, we may acquire from others existing loans that meet
this profile. We also seek to provide our stockholders with
long-term capital growth through the appreciation in the value
of warrants or other equity instruments that we may receive when
we make loans. We seek to invest primarily in three categories
of loans of private companies:
| • | Senior Loans. We seek to invest a portion of our assets in senior notes of borrowers. Using its assets and cash flow as collateral, the borrower typically uses senior notes to cover a substantial portion of the funding needed to operate. Senior lenders are exposed to the least risk of all providers of debt because they command a senior position with respect to scheduled interest and principal payments and assets of the borrower. However, unlike senior subordinated and junior subordinated lenders, these senior lenders typically do not receive any stock, warrants to purchase stock of the borrowers or other yield enhancements. As such, they generally do not participate in the equity appreciation of the value of the business. Senior notes may include revolving lines of credit, senior term loans, senior syndicated loans and senior last-out tranche loans. | |
| • | Senior Subordinated Loans. We seek to invest a portion of our assets in senior subordinated notes, which include second lien notes. Holders of senior subordinated notes are subordinated to the rights of holders of senior debt in their right to receive principal and interest payments or, in the case of last out tranches of senior debt, liquidation proceeds from the borrower. As a result, senior subordinated notes are riskier than senior notes. Although such loans are sometimes secured by significant collateral (assets of the borrower), the lender is largely dependent on the borrower’s cash flow for repayment. Additionally, lenders may receive warrants to acquire shares of stock in borrowers or other yield enhancements in connection with these loans. Senior subordinated notes include second lien loans and syndicated second lien loans. | |
| • | Junior Subordinated Loans. We also seek to invest a small portion of our assets in junior subordinated notes, which include mezzanine notes. Holders of junior subordinated notes are subordinated to the rights of the holders of senior debt and senior subordinated debt in their rights to receive principal and interest payments from the borrower and assets of the borrower. The risk profile of junior subordinated notes is high, which permits the junior subordinated lender to obtain higher interest rates and more equity and equity-like compensation. |
We may also receive yield enhancements in connection with many
of our loans, which may include warrants to purchase stock,
stock or success fees.
THE
OFFERING
We may offer, from time to time, up to $300,000,000 of our
Securities, on terms to be determined at the time of the
offering. Our Securities may be offered at prices and on terms
to be disclosed in one or more prospectus
2
supplements. In the case of offering of our common stock and
warrants or rights to acquire such common stock hereunder in any
offering, the offering price per share, less any underwriting
commissions or discounts, will not be less than the net asset
value per share of our common stock at the time of the offering
except (i) in connection with a rights offering to our
existing stockholders, (ii) with the consent of the
majority of our common stockholders, or (iii) under such
other circumstances as the SEC may permit. If we were to sell
shares of our common stock below our then current net asset
value per share, such sales would result in an immediate
dilution to the net asset value per share. This dilution would
occur as a result of the sale of shares at a price below the
then current net asset value per share of our common stock and a
proportionately greater decrease in a stockholder’s
interest in our earnings and assets and voting interest in us
than the increase in our assets resulting from such issuance.
Our Securities may be offered directly to one or more
purchasers, including existing stockholders in a rights
offering, by us or through agents designated from time to time
by us, or to or through underwriters or dealers. The prospectus
supplement relating to the offering will disclose the terms of
the offering, including the name or names of any agents or
underwriters involved in the sale of our Securities by us, the
purchase price, and any fee, commission or discount arrangement
between us and our agents or underwriters or among our
underwriters or the basis upon which such amount may be
calculated. See “Plan of Distribution.” We may not
sell any of our Securities through agents, underwriters or
dealers without delivery of a prospectus supplement describing
the method and terms of the offering of our Securities.
Set forth below is additional information regarding the offering
of our Securities:
| The Nasdaq Global Select Market Symbol | GLAD | |
| Use of Proceeds | Unless otherwise specified in a prospectus supplement, we intend to use the net proceeds from the sale of our Securities first to pay down existing short-term debt, then to make investments in small and mid-sized companies in accordance with our investment objective, with any remaining proceeds to be used for other general corporate purposes. See “Use of Proceeds.” | |
| Dividends and Distributions | We have paid monthly distributions to the holders of our common stock and generally intend to continue to do so. The amount of the monthly distributions is determined by our Board of Directors on a quarterly basis and is based on our estimate of our annual investment company taxable income and net short-term taxable capital gains, if any. See “Price Range of Common Stock and Distributions.” Certain additional amounts may be deemed as distributed to stockholders for income tax purposes. Other types of securities we might offer will likely pay distributions in accordance with their terms. | |
| Taxation | We intend to continue to elect to be treated for federal income tax purposes as a RIC. So long as we continue to qualify, we generally will pay no corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders. To maintain our RIC status, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our taxable ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, out of assets legally available for distribution. See “Material U.S. Federal Income Tax Considerations.” | |
| Trading at a Discount | Shares of closed-end investment companies frequently trade at a discount to their net asset value. The possibility that our shares may trade at a discount to our net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our shares will trade above, at or below net asset value, |
3
| although during the past two years, our common stock has traded consistently, and at times significantly, below net asset value. | ||
| Certain Anti-Takeover Provisions | Our Board of Directors is divided into three classes of directors serving staggered three-year terms. This structure is intended to provide us with a greater likelihood of continuity of management, which may be necessary for us to realize the full value of our investments. A staggered board of directors also may serve to deter hostile takeovers or proxy contests, as may certain provisions of Maryland law and other measures we have adopted. See “Certain Provisions of Maryland Law and of Our Articles of Incorporation and Bylaws.” | |
| Dividend Reinvestment Plan | We have a dividend reinvestment plan for our stockholders. This is an “opt in” dividend reinvestment plan, meaning that stockholders may elect to have their cash dividends automatically reinvested in additional shares of our common stock. Stockholders who do not so elect will receive their dividends in cash. Stockholders who receive distributions in the form of stock will be subject to the same federal, state and local tax consequences as stockholders who elect to receive their distributions in cash. See “Dividend Reinvestment Plan.” | |
| Management Arrangements | Gladstone Management Corporation serves as our investment adviser, and Gladstone Administration, LLC serves as our administrator. For a description of our Adviser, our Administrator, the Gladstone Companies and our contractual arrangements with these companies, see “Management — Certain Transactions — Investment Advisory and Management Agreement,” “Management — Certain Transactions — Administration Agreement” and “Management — Certain Transactions — Loan Servicing Agreement.” |
FEES AND
EXPENSES
The following table is intended to assist you in understanding
the costs and expenses that an investor in this offering will
bear directly or indirectly. We caution you that some of the
percentages indicated in the table below are estimates and may
vary. Except where the context suggests otherwise, whenever this
prospectus contains a reference to fees or expenses paid by
“us” or “Gladstone Capital,” or that
“we” will pay fees or expenses, stockholders will
indirectly bear such fees or expenses as investors in Gladstone
Capital. The following percentages were calculated based on
actual expenses incurred in the quarter ended March 31,
2011 and average net assets for the quarter ended March 31,
2011.
|
Stockholder Transaction Expenses:
|
||||
|
Sales load (as a percentage of offering price)
|
— | % | ||
|
Dividend reinvestment plan
expenses(1)
|
None | |||
|
Annual expenses (as a percentage of net assets attributable
to common stock):
|
||||
|
Management
fees(2)
|
2.18 | % | ||
|
Incentive fees payable under investment advisory and management
agreement (20% of realized capital gains and 20% of
pre-incentive fee net investment
income)(3)
|
0.44 | % | ||
|
Interest payments on borrowed
funds(4)
|
1.36 | % | ||
|
Other
expenses(5)
|
1.23 | % | ||
|
Total annual
expenses(2)(3)(5)
|
5.21 | % |
| (1) | The expenses of the reinvestment plan are included in stock record expenses, a component of “Other expenses.” We do not have a cash purchase plan. The participants in the dividend reinvestment plan will bear a pro rata |
4
| share of brokerage commissions incurred with respect to open market purchases, if any. See “Dividend Reinvestment Plan” for information on the dividend reinvestment plan. | ||
| (2) | Our annual base management fee is 2.0% (0.5% quarterly) of our average gross assets, which are defined as total assets of Gladstone Capital, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings. For the six months ended March 31, 2011, our Adviser voluntarily agreed to waive the annual base management fee of 2.0% to 0.5% for those senior syndicated loan participations that we purchase using borrowings from our credit facility. Although there can be no guarantee that our Adviser will continue to waive any portion of the fees due under the Advisory Agreement, on an annual basis after giving effect to this waiver, the estimated management fees as a percentage of net assets attributable to common stock were 2.05% and the total estimated annual expenses as a percentage of net assets attributable to common stock were 5.07%. See “Management — Certain Transactions — Investment Advisory and Management Agreement” and footnote 3 below. | |
| (3) | The incentive fee consists of two parts: an income-based fee and a capital gains-based fee. The income-based fee is payable quarterly in arrears, and equals 20% of the excess, if any, of our pre-incentive fee net investment income that exceeds a 1.75% quarterly (7% annualized) hurdle rate of our net assets, subject to a “catch-up” provision measured as of the end of each calendar quarter. The “catch-up” provision requires us to pay 100% of our pre-incentive fee net investment income with respect to that portion of such income, if any, that exceeds the hurdle rate but is less than 125% of the quarterly hurdle rate (or 2.1875%) in any calendar quarter (8.75% annualized). The catch-up provision is meant to provide our Adviser with 20% of our pre-incentive fee net investment income as if a hurdle rate did not apply when our pre-incentive fee net investment income exceeds 125% of the quarterly hurdle rate in any calendar quarter (8.75% annualized). The income-based incentive fee is computed and paid on income that may include interest that is accrued but not yet received in cash. Our pre-incentive fee net investment income used to calculate this part of the income-based incentive fee is also included in the amount of our gross assets used to calculate the 2% base management fee (see footnote 2 above). The capital gains-based incentive fee equals 20% of our net realized capital gains since our inception, if any, computed net of all realized capital losses and unrealized capital depreciation since our inception, less any prior payments, and is payable at the end of each fiscal year. |
Examples of how the incentive fee would be calculated are as
follows:
| • | Assuming pre-incentive fee net investment income of 0.55%, there would be no income-based incentive fee because such income would not exceed the hurdle rate of 1.75%. | |
| • | Assuming pre-incentive fee net investment income of 2.00%, the income-based incentive fee would be as follows: |
= 100% × (2.00% − 1.75%)
= 0.25%
| • | Assuming pre-incentive fee net investment income of 2.30%, the income-based incentive fee would be as follows: |
= (100% ×
(“catch-up”:
2.1875% − 1.75%)) + (20% × (2.30% −
2.1875%))
= (100% × 0.4375%) + (20% × 0.1125%)
= 0.4375% + 0.0225%
= 0.46%
| • | Assuming net realized capital gains of 6% and realized capital losses and unrealized capital depreciation of 1%, the capital gains-based incentive fee would be as follows: |
= 20% × (6% − 1%)
= 20% × 5%
= 1%
5
For a more detailed discussion of the calculation of the
two-part incentive fee, see “Management — Certain
Transactions — Investment Advisory and Management
Agreement.”
| (4) | Includes deferred financing costs. We entered into a revolving credit facility, effective November 22, 2010, under which our borrowing capacity is $127 million. We have drawn down on this credit facility and we expect to borrow additional funds in the future up to an amount so that our asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of our senior securities. Assuming that we borrowed $127 million at an interest rate of 5.25% plus an additional fee related to borrowings of 1.16%, for an aggregate rate of 6.41%, interest payments and amortization of deferred financing costs on borrowed funds would have been 3.28% of our average net assets for the quarter ended March 31, 2011. | |
| (5) | Includes our overhead expenses, including payments under the administration agreement based on our projected allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the administration agreement. See “Management — Certain Transactions — Administration Agreement.” |
Example
The following example demonstrates the projected dollar amount
of total cumulative expenses that would be incurred over various
periods with respect to a hypothetical investment in our
Securities. In calculating the following expense amounts, we
have assumed that our annual operating expenses would remain at
the levels set forth in the table above. In the event that
securities to which this prospectus related are sold to or
through underwriters, a corresponding prospectus supplement will
restate this example to reflect the applicable sales load.
| 1 Year | 3 Years | 5 Years | 10 Years | |||||||||||||
|
You would pay the following expenses on a $1,000 investment,
assuming a 5% annual return
|
$ | 55 | $ | 163 | $ | 271 | $ | 536 | ||||||||
While the example assumes, as required by the SEC, a 5% annual
return, our performance will vary and may result in a return
greater or less than 5%. Additionally, we have assumed that the
entire amount of such 5% annual return would constitute ordinary
income as we have not historically realized positive capital
gains (computed net of all realized capital losses) on our
investments. Because the assumed 5% annual return is
significantly below the hurdle rate of 7% (annualized) that we
must achieve under the investment advisory and management
agreement to trigger the payment of an income-based incentive
fee, we have assumed, for purposes of the above example, that no
income-based incentive fee would be payable if we realized a 5%
annual return on our investments. Additionally, because the
capital gains-based incentive fee is calculated on a cumulative
basis (computed net of all realized capital losses and
unrealized capital depreciation) and because of the significant
capital losses realized to date, we have assumed that we will
not trigger the payment of any capital gains-based incentive fee
in any of the indicated time periods. If we achieve sufficient
returns on our investments, including through the realization of
capital gains, to trigger an incentive fee of a material amount,
our expenses, and returns to our investors after such expenses,
would be higher than reflected in the example. The expenses you
would pay, based on a $1,000 investment and assuming a 5% annual
return resulting entirely from net realized capital gains
(disregarding for purposes of this example all net historical
realized losses and aggregate unrealized depreciation) (and
therefore subject to the capital gains-based incentive fee), and
otherwise making the same assumptions in the example above,
would be: 1 year, $64; 3 years, $190; 5 years,
$312; and 10 years, $603. In addition, while the example
assumes reinvestment of all dividends and distributions at net
asset value, participants in our dividend reinvestment plan will
receive a number of shares of our common stock, determined by
dividing the total dollar amount of the dividend payable to a
participant by the market price per share of our common stock at
the close of trading on the valuation date for the dividend. See
“Dividend Reinvestment Plan” for additional
information regarding our dividend reinvestment plan.
This example and the expenses in the table above should not be
considered a representation of our future expenses, and actual
expenses (including the cost of debt, incentive fees, if any,
and other expenses) may be greater or less than those shown.
6
ADDITIONAL
INFORMATION
We have filed with the SEC a registration statement on
Form N-2
under the Securities Act of 1933, as amended, which we refer to
as the Securities Act, with respect to the Securities offered by
this prospectus. This prospectus, which is a part of the
registration statement, does not contain all of the information
set forth in the registration statement or exhibits and
schedules thereto. For further information with respect to our
business and our Securities, reference is made to the
registration statement, including the amendments, exhibits and
schedules thereto.
We also file reports, proxy statements and other information
with the SEC under the Securities Exchange Act of 1934, as
amended, which we refer to as the Exchange Act. Such reports,
proxy statements and other information, as well as the
registration statement and the amendments, exhibits and
schedules thereto, can be inspected at the public reference
facilities maintained by the SEC at 100 F Street,
N.E., Washington, D.C. 20549. Information about the
operation of the public reference facilities may be obtained by
calling the SEC at
1-800-SEC-0330.
The SEC maintains a website that contains reports, proxy
statements and other information regarding registrants,
including us, that file such information electronically with the
SEC. The address of the SEC’s website is
http://www.sec.gov.
Copies of such material may also be obtained from the Public
Reference Section of the SEC at 100 F Street, N.E.,
Washington, D.C. 20549, at prescribed rates. Our common
stock is listed on The Nasdaq Global Select Market and our
corporate website is located at
http://www.gladstonecapital.com.
The information contained on, or accessible through, our website
is not a part of this prospectus.
We make available free of charge on our website our annual
report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with or
furnished to the SEC.
We also furnish to our stockholders annual reports, which
include annual financial information that has been examined and
reported on, with an opinion expressed, by our independent
registered public accounting firm. See “Experts.”
7
You should carefully consider the risks described below and all
other information provided and incorporated by reference in this
prospectus (or any prospectus supplement) before making a
decision to purchase our Securities. The risks and uncertainties
described below are not the only ones facing us. Additional
risks and uncertainties not presently known to us, or not
presently deemed material by us, may also impair our operations
and performance. If any of the following risks actually occur,
our business, financial condition or results of operations could
be materially adversely affected. If that happens, the trading
price of our Securities could decline, and you may lose all or
part of your investment.
Risks
Related to the Economy
The
current state of the economy and the capital markets increases
the possibility of adverse effects on our financial position and
results of operations. Continued economic adversity could impair
our portfolio companies’ financial positions and operating
results and affect the industries in which we invest, which
could, in turn, harm our operating results. Continued adversity
in the capital markets could impact our ability to raise capital
and reduce our volume of new investments.
The United States is beginning to recover from the recession
that largely began in late 2007. Despite signs of economic
improvement and stabilization in both the equity and debt
markets, however, conditions within the global credit markets
generally continue to experience dislocation and stress. As a
result, we do not know if adverse conditions will again
intensify, and we are unable to gauge the full extent to which
the disruptions will affect us. The longer these uncertain
conditions persist, the greater the probability that these
factors could continue to increase our costs of, and
significantly limit our access to, debt and equity capital and,
thus, have an adverse effect on our operations and financial
results. Many of our portfolio companies, as well as those
companies that we evaluate for investment, are impacted by these
economic conditions, and if these conditions persist, it may
affect their ability to repay our loans or engage in a liquidity
event, such as a sale, recapitalization or initial public
offering.
The uncertain economic conditions have affected the availability
of credit generally. Our current credit facility limits our
distributions to stockholders and as a result we decreased our
monthly cash distribution rate by 50% starting with the April
2009 distributions in an effort to more closely align our
distributions to our net investment income. We do not know when
market conditions will stabilize, if adverse conditions will
intensify or the full extent to which the disruptions will
continue to affect us. Also, it is possible that persistent
instability of the financial markets could have other unforeseen
material effects on our business.
We may
experience fluctuations in our quarterly and annual results
based on the impact of inflation in the United
States.
The majority of our portfolio companies are in industries that
are directly impacted by inflation, such as consumer goods and
services and manufacturing. Our portfolio companies may not be
able to pass on to customers increases in their costs of
operations which could greatly affect their operating results,
impacting their ability to repay our loans. In addition, any
projected future decreases in our portfolio companies’
operating results due to inflation could adversely impact the
fair value of those investments. Any decreases in the fair value
of our investments could result in future unrealized losses and
therefore reduce our net assets resulting from operations.
Risks
Related to Our External Management
We are
dependent upon our key management personnel and the key
management personnel of our Adviser, particularly David
Gladstone, George Stelljes III and Terry Lee Brubaker, and
on the continued operations of our Adviser, for our future
success.
We have no employees. Our chief executive officer, president and
chief investment officer, chief operating officer and chief
financial officer, and the employees of our Adviser, do not
spend all of their time managing our activities and our
investment portfolio. We are particularly dependent upon David
Gladstone, George Stelljes III and Terry Lee Brubaker in
this regard. Our executive officers and the employees of our
Adviser allocate some, and in some cases a material portion, of
their time to businesses and activities that are not related to
our business. We have no separate facilities and are completely
reliant on our Adviser, which has significant discretion as to
the
8
implementation and execution of our business strategies and risk
management practices. We are subject to the risk of
discontinuation of our Adviser’s operations or termination
of the Advisory Agreement and the risk that, upon such event, no
suitable replacement will be found. We believe that our success
depends to a significant extent upon our Adviser and that
discontinuation of its operations could have a material adverse
effect on our ability to achieve our investment objectives.
Our
incentive fee may induce our Adviser to make certain
investments, including speculative investments.
The management compensation structure that has been implemented
under the Advisory Agreement may cause our Adviser to invest in
high-risk investments or take other risks. In addition to its
management fee, our Adviser is entitled under the Advisory
Agreement to receive incentive compensation based in part upon
our achievement of specified levels of income. In evaluating
investments and other management strategies, the opportunity to
earn incentive compensation based on net income may lead our
Adviser to place undue emphasis on the maximization of net
income at the expense of other criteria, such as preservation of
capital, maintaining sufficient liquidity, or management of
credit risk or market risk, in order to achieve higher incentive
compensation. Investments with higher yield potential are
generally riskier or more speculative. This could result in
increased risk to the value of our investment portfolio.
We may
be obligated to pay our Adviser incentive compensation even if
we incur a loss.
The Advisory Agreement entitles our Adviser to incentive
compensation for each fiscal quarter in an amount equal to a
percentage of the excess of our investment income for that
quarter (before deducting incentive compensation, net operating
losses and certain other items) above a threshold return for
that quarter. When calculating our incentive compensation, our
pre-incentive fee net investment income excludes realized and
unrealized capital losses that we may incur in the fiscal
quarter, even if such capital losses result in a net loss on our
statement of operations for that quarter. Thus, we may be
required to pay our Adviser incentive compensation for a fiscal
quarter even if there is a decline in the value of our portfolio
or we incur a net loss for that quarter. For additional
information on incentive compensation under the Advisory
Agreement with our Adviser, see “Business —
Investment Advisory and Management Agreements —
Management services and fees under the Advisory Agreement.”
Our
Adviser’s failure to identify and invest in securities that
meet our investment criteria or perform its responsibilities
under the Advisory Agreement may adversely affect our ability
for future growth.
Our ability to achieve our investment objectives will depend on
our ability to grow, which in turn will depend on our
Adviser’s ability to identify and invest in securities that
meet our investment criteria. Accomplishing this result on a
cost-effective basis will be largely a function of our
Adviser’s structuring of the investment process, its
ability to provide competent and efficient services to us, and
our access to financing on acceptable terms. The senior
management team of our Adviser has substantial responsibilities
under the Advisory Agreement. In order to grow, our Adviser will
need to hire, train, supervise, and manage new employees
successfully. Any failure to manage our future growth
effectively could have a material adverse effect on our
business, financial condition, and results of operations.
There
are significant potential conflicts of interest which could
impact our investment returns.
Our executive officers and directors, and the officers and
directors of our Adviser, serve or may serve as officers,
directors, or principals of entities that operate in the same or
a related line of business as we do or of investment funds
managed by our affiliates. Accordingly, they may have
obligations to investors in those entities, the fulfillment of
which might not be in the best interests of us or our
stockholders. For example, Mr. Gladstone, our chairman and
chief executive officer, is the chairman of the board and chief
executive officer of our Adviser, Gladstone Investment and
Gladstone Commercial and the sole stockholder of Gladstone Land.
In addition, Mr. Brubaker, our vice chairman, chief
operating officer and secretary is the vice chairman, chief
operating officer and secretary of our Adviser, Gladstone
Investment and Gladstone Commercial. Mr. Stelljes, our
president and chief investment officer, is also the president
and chief investment officer of our Adviser and Gladstone
Commercial and vice chairman and chief investment officer of
Gladstone Investment. Moreover, our Adviser may establish or
9
sponsor other investment vehicles which from time to time may
have potentially overlapping investment objectives with those of
ours and accordingly may invest in, whether principally or
secondarily, asset classes similar to those we target. While our
Adviser generally has broad authority to make investments on
behalf of the investment vehicles that it advises, our Adviser
has adopted investment allocation procedures to address these
potential conflicts and intends to direct investment
opportunities to the Gladstone affiliate with the investment
strategy that most closely fits the investment opportunity.
Nevertheless, the management of our Adviser may face conflicts
in the allocation of investment opportunities to other entities
managed by our Adviser. As a result, it is possible that we may
not be given the opportunity to participate in certain
investments made by other members of the Gladstone Companies or
investment funds managed by investment managers affiliated with
our Adviser.
In certain circumstances, we may make investments in a portfolio
company in which one of our affiliates has or will have an
investment, subject to satisfaction of any regulatory
restrictions and, where required, to the prior approval of our
Board of Directors. As of March 31, 2011, our Board of
Directors has approved the following types of co-investment
transactions:
| • | Our affiliate, Gladstone Commercial, may lease property to portfolio companies that we do not control under certain circumstances. We may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria of Gladstone Commercial, and (iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial. We expect that any such negotiations between Gladstone Commercial and our portfolio companies would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours. | |
| • | We may invest simultaneously with our affiliate Gladstone Investment in senior syndicated loans whereby neither we nor any affiliate has the ability to dictate the terms of the loans. | |
| • | Additionally, pursuant to an exemptive order granted by the Securities and Exchange Commission, our Adviser may sponsor a private investment fund to co-invest with us or Gladstone Investment in accordance with the terms and conditions of the order. |
Certain of our officers, who are also officers of our Adviser,
may from time to time serve as directors of certain of our
portfolio companies. If an officer serves in such capacity with
one of our portfolio companies, such officer will owe fiduciary
duties to all stockholders of the portfolio company, which
duties may from time to time conflict with the interests of our
stockholders.
In the course of our investing activities, we will pay
management and incentive fees to our Adviser and will reimburse
our Administrator for certain expenses it incurs. As a result,
investors in our common stock will invest on a “gross”
basis and receive distributions on a “net” basis after
expenses, resulting in, among other things, a lower rate of
return than one might achieve through our investors themselves
making direct investments. As a result of this arrangement,
there may be times when the management team of our Adviser has
interests that differ from those of our stockholders, giving
rise to a conflict. In addition, as a business development
company, we make available significant managerial assistance to
our portfolio companies and provide other services to such
portfolio companies. Although, neither we nor our Adviser
currently receives fees in connection with managerial
assistance, our Adviser provides other services to our portfolio
companies and receives fees for these other services. For
example, certain of our portfolio companies contract directly
with our Adviser for the provision of consulting services. In
addition, Gladstone Securities provides investment banking and
due diligence services to certain of our portfolio companies.
Our
Adviser is not obligated to provide a waiver of the base
management fee, which could negatively impact our earnings and
our ability to maintain our current level of distributions to
our stockholders.
The Advisory Agreement provides for a base management fee based
on our gross assets. Since our 2008 fiscal year, our Board of
Directors has accepted on a quarterly basis voluntary,
unconditional and irrevocable waivers to reduce the annual 2.0%
base management fee on senior syndicated loan participations to
0.5% to the extent that proceeds resulting from borrowings were
used to purchase such syndicated loan participations, and any
waived fees may not be recouped by our Adviser in the future.
However, our Adviser is not required to issue these or other
10
waivers of fees under the Advisory Agreement, and to the extent
our investment portfolio grows in the future, we expect these
fees will increase. If our Adviser does not issue these waivers
in future quarters, it could negatively impact our earnings and
may compromise our ability to maintain our current level of
distributions to our stockholders, which could have a material
adverse impact on our stock price.
Our
business model is dependent upon developing and sustaining
strong referral relationships with investment bankers, business
brokers and other intermediaries.
We are dependent upon informal relationships with investment
bankers, business brokers and traditional lending institutions
to provide us with deal flow. If we fail to maintain our
relationship with such funds or institutions, or if we fail to
establish strong referral relationships with other funds, we
will not be able to grow our portfolio of loans and fully
execute our business plan.
Risks
Related to Our External Financing
Because
of the limited amount of committed funding under our credit
facility, we will have limited ability to fund new investments
if we are unable to expand the facility.
In recent years, creditors have significantly curtailed their
lending to business development companies, including us. In
March 2010, we entered into a fourth amended and restated credit
agreement providing for a revolving line of credit, which we
refer to as the Credit Facility. Committed funding under the
Credit Facility is $127.0 million. The Credit Facility may
be expanded up to $202.0 million through the addition of
other committed lenders to the facility. However, if additional
lenders are unwilling to join the facility on its terms, we will
be unable to expand the facility and thus will continue to have
limited availability to finance new investments under our line
of credit. The Credit Facility matures on March 15, 2012,
and, if the facility is not renewed or extended by this date,
all principal and interest will be due and payable on
March 15, 2013. As of March 31, 2011, we had
$33.2 million drawn and outstanding under the Credit
Facility.
There can be no guarantee that we will be able to renew, extend
or replace the Credit Facility upon its maturity on terms that
are favorable to us, if at all. Our ability to expand the Credit
Facility, and to obtain replacement financing at the time of
maturity, will be constrained by then-current economic
conditions affecting the credit markets. In the event that we
are not able to expand the Credit Facility, or to renew, extend
or refinance the Credit Facility at the time of its maturity,
this could have a material adverse effect on our liquidity and
ability to fund new investments, our ability to make
distributions to our stockholders and our ability to qualify as
a RIC under the Code.
Our
business plan is dependent upon external financing, which is
constrained by the limitations of the 1940 Act.
Our business requires a substantial amount of cash to operate
and grow. We may acquire such additional capital from the
following sources:
| • | Senior Securities. We may issue debt securities, other evidences of indebtedness (including borrowings under our line of credit) and preferred stock, up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us, as a business development company, to issue debt securities and preferred stock, which we refer to collectively as senior securities, in amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of senior securities. As a result of issuing senior securities, we will be exposed to the risks associated with leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we receive on the investments we make with such borrowed funds. In addition, our ability to pay distributions or incur additional indebtedness would be restricted if asset coverage is not at least twice our indebtedness. If the value of our assets declines, we might be unable to satisfy that test. If this happens, we may be required to liquidate a portion of our loan portfolio and repay a portion of our indebtedness at a time when a sale, to the extent possible given the limited market for many of our investments, may be disadvantageous. Furthermore, |
11
| any amounts that we use to service our indebtedness will not be available for distributions to our stockholders. |
| • | Common Stock. Because we are constrained in our ability to issue debt for the reasons given above, we are dependent on the issuance of equity as a financing source. If we raise additional funds by issuing more common stock or senior securities convertible into or exchangeable for our common stock, the percentage ownership of our stockholders at the time of the issuance would decrease and our common stock may experience dilution. In addition, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. In addition, under the 1940 Act, we will generally not be able to issue additional shares of our common stock at a price below net asset value per share to purchasers, other than to our existing stockholders through a rights offering, without first obtaining the approval of our stockholders and our independent directors. At our most recent annual meeting, our stockholders approved such an offering for a period of one year. If we were to sell shares of our common stock below our then current net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. For example, if we issue and sell an additional 10% of our common stock at a 5% discount from net asset value, a stockholder who does not participate in that offering for its proportionate interest will suffer net asset value dilution of up to 0.5% or $5 per $1,000 of net asset value. This imposes constraints on our ability to raise capital when our common stock is trading at below net asset value, as it has for most of the last two years. |
A
change in interest rates may adversely affect our
profitability.
We anticipate using a combination of equity and long-term and
short-term borrowings to finance our investment activities. As a
result, a portion of our income will depend upon the difference
between the rate at which we borrow funds and the rate at which
we loan these funds. Higher interest rates on our borrowings
will decrease the overall return on our portfolio.
Ultimately, we expect approximately 80% of the loans in our
portfolio to be at variable rates determined on the basis of the
LIBOR, and approximately 20% to be at fixed rates. As of
March 31, 2011, our portfolio had approximately 85.4% of
the total loan cost value at variable rates with floors,
approximately 5.2% of the total of the loan cost value at
variable rates without a floor or ceiling and approximately 9.4%
of the total loan portfolio cost basis at fixed rates.
In
addition to regulatory limitations on our ability to raise
capital, our Credit Facility contains various covenants which,
if not complied with, could accelerate our repayment obligations
under the facility, thereby materially and adversely affecting
our liquidity, financial condition, results of operations and
ability to pay distributions.
We will have a continuing need for capital to finance our loans.
In order to maintain RIC status, we are required to distribute
to our stockholders at least 90% of our ordinary income and
short-term capital gains on an annual basis. Accordingly, such
earnings will not be available to fund additional loans.
Therefore, we are party to the Credit Facility, which provides
us with a revolving credit line facility of $127.0 million,
of which $63.9 million was available for borrowings as of
March 31, 2011. The Credit Facility permits us to fund
additional loans and investments as long as we are within the
conditions set out in the credit agreement. Current market
conditions have forced us to write down the value of a portion
of our assets as required by the 1940 Act and fair value
accounting rules. These are not realized losses, but constitute
adjustment in asset values for purposes of financial reporting
and for collateral value for the Credit Facility. As assets are
marked down in value, the amount we can borrow on the Credit
Facility decreases.
As a result of the Credit Facility, we are subject to certain
limitations on the type of loan investments we make, including
restrictions on geographic concentrations, sector
concentrations, loan size, dividend payout, payment frequency
and status, and average life. The credit agreement also requires
us to comply with other financial and
12
operational covenants, which require us to, among other things,
maintain certain financial ratios, including asset and interest
coverage and a minimum net worth. As of March 31, 2011, we
were in compliance with these covenants, however, our continued
compliance with these covenants depends on many factors, some of
which are beyond our control. In particular, depreciation in the
valuation of our assets, which valuation is subject to changing
market conditions that remain very volatile, affects our ability
to comply with these covenants. During the year ended
September 30, 2010, net unrealized appreciation on our
investments was approximately $2.3 million, compared to
$9.5 million unrealized appreciation during the prior
fiscal year. Given the continued deterioration in the capital
markets, the cumulative unrealized depreciation in our portfolio
may increase in future periods and threaten our ability to
comply with the covenants under the Credit Facility.
Accordingly, there are no assurances that we will continue to
comply with these covenants. Under the Credit Facility, we are
also required to maintain our status as a BDC under the 1940 Act
and as a RIC under the Code. Our failure to satisfy these
covenants could result in foreclosure by our lenders, which
would accelerate our repayment obligations under the facility
and thereby have a material adverse effect on our business,
liquidity, financial condition, results of operations and
ability to pay distributions to our stockholders.
Risks
Related to Our Investments
We
operate in a highly competitive market for investment
opportunities.
A large number of entities compete with us and make the types of
investments that we seek to make in small and mid-sized
companies. We compete with public and private buyout funds,
commercial and investment banks, commercial financing companies,
and, to the extent they provide an alternative form of
financing, hedge funds. Many of our competitors are
substantially larger and have considerably greater financial,
technical and marketing resources than we do. For example, some
competitors may have a lower cost of funds and access to funding
sources that are not available to us. In addition, some of our
competitors may have higher risk tolerances or different risk
assessments, which would allow them to consider a wider variety
of investments and establish more relationships than us.
Furthermore, many of our competitors are not subject to the
regulatory restrictions that the 1940 Act imposes on us as a
business development company. The competitive pressures we face
could have a material adverse effect on our business, financial
condition and results of operations. Also, as a result of this
competition, we may not be able to take advantage of attractive
investment opportunities from time to time and we can offer no
assurance that we will be able to identify and make investments
that are consistent with our investment objective. We do not
seek to compete based on the interest rates we offer, and we
believe that some of our competitors may make loans with
interest rates that will be comparable to or lower than the
rates we offer. We may lose investment opportunities if we do
not match our competitors’ pricing, terms, and structure.
However, if we match our competitors’ pricing, terms, and
structure, we may experience decreased net interest income and
increased risk of credit loss.
Our
investments in small and medium-sized portfolio companies are
extremely risky and could cause you to lose all or a part of
your investment.
Investments in small and medium-sized portfolio companies are
subject to a number of significant risks including the following:
| • | Small and medium-sized businesses are likely to have greater exposure to economic downturns than larger businesses. Our portfolio companies may have fewer resources than larger businesses. Therefore, current uncertain economic conditions and any future economic downturns or recessions are more likely to have a material adverse effect on them. If one of our portfolio companies is adversely impacted by a recession, its ability to repay our loan or engage in a liquidity event, such as a sale, recapitalization or initial public offering, would be diminished. | |
| • | Small and medium-sized businesses may have limited financial resources and may not be able to repay the loans we make to them. Our strategy includes providing financing to portfolio companies that typically is not readily available to them. While we believe that this provides an attractive opportunity for us to generate profits, this may make it difficult for the portfolio companies to repay their loans to us upon maturity. A borrower’s ability to repay its loan may be adversely affected by numerous factors, including the failure to meet its business plan, a downturn in its industry, or negative economic conditions. A deterioration in a borrower’s financial condition and prospects usually will be accompanied by a deterioration in the value of |
13
| any collateral and a reduction in the likelihood of us realizing on any guarantees we may have obtained from the borrower’s management. As of March 31, 2011, six investments were on non-accrual. While we are working with the portfolio companies to improve their profitability and cash flows, there can be no assurance that our efforts will prove successful. Although we will sometimes seek to be the senior, secured lender to a borrower, in most of our loans we expect to be subordinated to a senior lender, and our interest in any collateral would, accordingly, likely be subordinate to another lender’s security interest. |
| • | Small and medium-sized businesses typically have narrower product lines and smaller market shares than large businesses. Because our target portfolio companies are smaller businesses, they will tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, our portfolio companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing, and other capabilities and a larger number of qualified managerial, and technical personnel. | |
| • | There is generally little or no publicly available information about these businesses. Because we seek to invest in privately owned businesses, there is generally little or no publicly available operating and financial information about our potential portfolio companies. As a result, we rely on our officers, our Adviser, and its employees and consultants to perform due diligence investigations of these portfolio companies, their operations, and their prospects. We may not learn all of the material information we need to know regarding these businesses through our investigations. | |
| • | Small and medium-sized businesses generally have less predictable operating results. We expect that our portfolio companies may have significant variations in their operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position, or may be adversely affected by changes in the business cycle. Our portfolio companies may not meet net income, cash flow, and other coverage tests typically imposed by their senior lenders. A borrower’s failure to satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially, foreclosure on its senior credit facility, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the borrower’s ability to repay our loan would be jeopardized. | |
| • | Small and medium-sized businesses are more likely to be dependent on one or two persons. Typically, the success of a small or medium-sized business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability, or resignation of one or more of these persons could have a material adverse impact on our borrower and, in turn, on us. | |
| • | Small and medium-sized businesses may have limited operating histories. While we intend to target stable companies with proven track records, we may make loans to new companies that meet our other investment criteria. Portfolio companies with limited operating histories will be exposed to all of the operating risks that new businesses face and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers. |
We may
not be able to replace lost income due to the reduction in the
size of our portfolio and as a result, we may have to reduce our
distributions to stockholders.
Since September 30, 2009, the cost basis of our portfolio
has experienced a net decrease of 13.8%. The decrease in the
size of our portfolio was driven predominantly by repayments and
sales during the year ended September 30, 2010 totaling
approximately $85.6 million. The decrease in our portfolio
has resulted in a reduction of income-producing assets which has
reduced our income and may result in reduced income in future
periods if we are unable to reinvest our cash in comparable
income producing assets. Even though this lost income is
partially offset by a reduction in interest expense due to
reduced borrowings outstanding under our Credit Facility and, to
a lesser extent, reduced operating expenses, we still have
experienced a net decrease in our net investment income as a
result of these sales. While we intend to reinvest our cash as
quickly as possible into income and capital gain-generating
assets, there is no guarantee that that we will be able to do so
or that we will able to do so at yields
14
comparable to the assets that we have recently sold. If we are
unable to reinvest our cash and replace our lost income, we may
need to reduce our distributions to stockholders.
Because
a large percentage of the loans we make and equity securities we
receive when we make loans are not publicly traded, there is
uncertainty regarding the value of our privately held securities
that could adversely affect our determination of our net asset
value.
A large percentage of our portfolio investments are, and we
expect will continue to be, in the form of securities that are
not publicly traded. The fair value of securities and other
investments that are not publicly traded may not be readily
determinable. Our Board of Directors has established an
investment valuation policy and consistently applied valuation
procedures used to determine the fair value of these securities
quarterly. These procedures for the determination of value of
many of our debt securities rely on the opinions of value
submitted to us by Standard & Poor’s Securities
Evaluations, Inc., or SPSE, the use of internally developed
discounted cash flow, or DCF, methodologies, or internal
methodologies based on the total enterprise value, or TEV, of
the issuer used for certain of our equity investments. SPSE will
only evaluate the debt portion of our investments for which we
specifically request evaluation, and SPSE may decline to make
requested evaluations for any reason in its sole discretion.
However, to date, SPSE has accepted each of our requests for
evaluation.
Our use of these fair value methods is inherently subjective and
is based on estimates and assumptions of each security. In the
event that we are required to sell a security, we may ultimately
sell for an amount materially less than the estimated fair value
calculated by SPSE, TEV or the DCF methodology.
Our procedures also include provisions whereby our Adviser will
establish the fair value of any equity securities we may hold
where SPSE or third-party agent banks are unable to provide
evaluations. The types of factors that may be considered in
determining the fair value of our debt and equity securities
include some or all of the following:
| • | the nature and realizable value of any collateral; | |
| • | the portfolio company’s earnings and cash flows and its ability to make payments on its obligations; | |
| • | the markets in which the portfolio company does business; | |
| • | the comparison to publicly traded companies; and | |
| • | discounted cash flow and other relevant factors. |
Because such valuations, particularly valuations of private
securities and private companies, are not susceptible to precise
determination, may fluctuate over short periods of time, and may
be based on estimates, our determinations of fair value may
differ from the values that might have actually resulted had a
readily available market for these securities been available.
A portion of our assets are, and will continue to be, comprised
of equity securities that are valued based on internal
assessment using our own valuation methods approved by our Board
of Directors, without the input of SPSE or any other third-party
evaluator. We believe that our equity valuation methods reflect
those regularly used as standards by other professionals in our
industry who value equity securities. However, determination of
fair value for securities that are not publicly traded, whether
or not we use the recommendations of an independent third-party
evaluator, necessarily involves the exercise of subjective
judgment. Our net asset value could be adversely affected if our
determinations regarding the fair value of our investments were
materially higher than the values that we ultimately realize
upon the disposal of such securities.
The
lack of liquidity of our privately held investments may
adversely affect our business.
We will generally make investments in private companies whose
securities are not traded in any public market. Substantially
all of the investments we presently hold and the investments we
expect to acquire in the future are, and will be, subject to
legal and other restrictions on resale and will otherwise be
less liquid than publicly traded securities. The illiquidity of
our investments may make it difficult for us to quickly obtain
cash equal to the value at which we record our investments if
the need arises. This could cause us to miss important
investment opportunities.
15
In addition, if we are required to liquidate all or a portion of
our portfolio quickly, we may record substantial realized losses
upon liquidation. We may also face other restrictions on our
ability to liquidate an investment in a portfolio company to the
extent that we, our Adviser, or our respective officers,
employees or affiliates have material non-public information
regarding such portfolio company.
Due to the uncertainty inherent in valuing these securities, our
determinations of fair value may differ materially from the
values that could be obtained if a ready market for these
securities existed. Our net asset value could be materially
affected if our determinations regarding the fair value of our
investments are materially different from the values that we
ultimately realize upon our disposal of such securities.
Our
financial results could be negatively affected if a significant
portfolio investment fails to perform
as expected.
Our total investment in companies may be significant
individually or in the aggregate. As a result, if a significant
investment in one or more companies fails to perform as
expected, our financial results could be more negatively
affected and the magnitude of the loss could be more significant
than if we had made smaller investments in more companies.
When
we are a debt or minority equity investor in a portfolio
company, which we expect will generally be the case, we may not
be in a position to control the entity, and its management may
make decisions that could decrease the value of our
investment.
We anticipate that most of our investments will continue to be
either debt or minority equity investments in our portfolio
companies. Therefore, we are and will remain subject to risk
that a portfolio company may make business decisions with which
we disagree, and the shareholders and management of such company
may take risks or otherwise act in ways that do not serve our
best interests. As a result, a portfolio company may make
decisions that could decrease the value of our portfolio
holdings. In addition, we will generally not be in a position to
control any portfolio company by investing in its debt
securities.
Our
portfolio companies may incur debt that ranks equally with, or
senior to, our investments in such companies.
We invest primarily in debt securities issued by our portfolio
companies. In some cases portfolio companies will be permitted
to have other debt that ranks equally with, or senior to, the
debt securities in which we invest. By their terms, such debt
instruments may provide that the holders thereof are entitled to
receive payment of interest and principal on or before the dates
on which we are entitled to receive payments in respect of the
debt securities in which we invest. Also, in the event of
insolvency, liquidation, dissolution, reorganization, or
bankruptcy of a portfolio company, holders of debt instruments
ranking senior to our investment in that portfolio company would
typically be entitled to receive payment in full before we
receive any distribution in respect of our investment. After
repaying such senior creditors, such portfolio company may not
have any remaining assets to use for repaying its obligation to
us. In the case of debt ranking equally with debt securities in
which we invest, we would have to share on an equal basis any
distributions with other creditors holding such debt in the
event of an insolvency, liquidation, dissolution,
reorganization, or bankruptcy of a portfolio company.
Prepayments
of our investments by our portfolio companies could adversely
impact our results of operations and reduce our return on
equity.
In addition to risks associated with delays in investing our
capital, we are also subject to the risk that investments that
we make in our portfolio companies may be repaid prior to
maturity. For the year ended September 30, 2010, we
received principal payments prior to maturity of
$59.7 million. We will first use any proceeds from
prepayments to repay any borrowings outstanding on our credit
facility. In the event that funds remain after repayment of our
outstanding borrowings, then we will generally reinvest these
proceeds in government securities, pending their future
investment in new debt
and/or
equity securities. These government securities will typically
have substantially lower yields than the debt securities being
prepaid and we could experience significant delays in
reinvesting these amounts. As a result, our results of
operations could be materially adversely affected if one or more
of our portfolio companies
16
elects to prepay amounts owed to us. Additionally, prepayments
could negatively impact our return on equity, which could result
in a decline in the market price of our common stock.
Higher
taxation of our portfolio companies may impact our quarterly and
annual operating results.
The recession’s adverse effect on federal, state, and
municipality revenues may induce these government entities to
raise various taxes to make up for lost revenues. Additional
taxation may have an adverse affect on our portfolio
companies’ earnings and reduce their ability to repay our
loans to them, thus affecting our quarterly and annual operating
results.
Our
portfolio is concentrated in a limited number of companies and
industries, which subjects us to an increased risk of
significant loss if any one of these companies does not repay us
or if the industries experience downturns.
As of March 31, 2011 we had loans outstanding to 45
portfolio companies. A consequence of a limited number of
investments is that the aggregate returns we realize may be
substantially adversely affected by the unfavorable performance
of a small number of such loans or a substantial write-down of
any one investment. Beyond our regulatory and income tax
diversification requirements, we do not have fixed guidelines
for industry concentration and our investments could potentially
be concentrated in relatively few industries. In addition, while
we do not intend to invest 25.0% or more of our total
investments in a particular industry or group of industries at
the time of investment, it is possible that as the values of our
portfolio companies change, one industry or a group of
industries may comprise in excess of 25.0% of the value of our
total investments. As of March 31, 2011, 12.8% were
invested in healthcare, education and childcare companies, 12.9%
of our total investments were invested in broadcast companies,
and 9.7% were invested in electronics companies. As a result, a
downturn in an industry in which we have invested a significant
portion of our total assets could have a materially adverse
effect on us.
Our
investments are typically long term and will require several
years to realize liquidation events.
Since we generally make five to seven year term loans and hold
our loans and related warrants or other equity positions until
the loans mature, you should not expect realization events, if
any, to occur over the near term. In addition, we expect that
any warrants or other equity positions that we receive when we
make loans may require several years to appreciate in value and
we cannot give any assurance that such appreciation will occur.
The
disposition of our investments may result in contingent
liabilities.
Currently, all of our investments involve private securities. In
connection with the disposition of an investment in private
securities, we may be required to make representations about the
business and financial affairs of the underlying portfolio
company typical of those made in connection with the sale of a
business. We may also be required to indemnify the purchasers of
such investment to the extent that any such representations turn
out to be inaccurate or with respect to certain potential
liabilities. These arrangements may result in contingent
liabilities that ultimately yield funding obligations that must
be satisfied through our return of certain distributions
previously made to us.
There
may be circumstances where our debt investments could be
subordinated to claims of other creditors or we could be subject
to lender liability claims.
Even though we have structured some of our investments as senior
loans, if one of our portfolio companies were to go bankrupt,
depending on the facts and circumstances, including the extent
to which we actually provided managerial assistance to that
portfolio company, a bankruptcy court might re-characterize our
debt investments and subordinate all, or a portion, of our
claims to that of other creditors. Holders of debt instruments
ranking senior to our investments typically would be entitled to
receive payment in full before we receive any distributions.
After repaying such senior creditors, such portfolio company may
not have any remaining assets to use to repay its obligation to
us. We may also be subject to lender liability claims for
actions taken by us with respect to a borrower’s business
or in instances in which we exercised control over the borrower.
It is possible that we could become subject to a lender’s
liability claim, including as a result of actions taken in
rendering significant managerial assistance.
17
Portfolio
company litigation could result in additional costs and the
diversion of management time and resources.
In the course of providing significant managerial assistance to
certain of our portfolio companies, our executive officers
sometimes serve as directors on the boards of such companies. To
the extent that litigation arises out of our investments in
these companies, such executive officers may be named as
defendants in such litigation, which could result in additional
costs and the diversion of management time and resources.
We may
not realize gains from our equity investments and other yield
enhancements.
When we make a subordinated loan, we may receive warrants to
purchase stock issued by the borrower or other yield
enhancements, such as success fees. Our goal is to ultimately
dispose of these equity interests and realize gains upon our
disposition of such interests. We expect that, over time, the
gains we realize on these warrants and other yield enhancements
will offset any losses we experience on loan defaults. However,
any warrants we receive may not appreciate in value and, in
fact, may decline in value and any other yield enhancements,
such as success fees, may not be realized. Accordingly, we may
not be able to realize gains from our equity interests or other
yield enhancements and any gains we do recognize may not be
sufficient to offset losses we experience on our loan portfolio.
Any
unrealized depreciation we experience on our investment
portfolio may be an indication of future realized losses, which
could reduce our income available for
distribution.
As a business development company we are required to carry our
investments at market value or, if no market value is
ascertainable, at fair value as determined in good faith by or
under the direction of our Board of Directors. Decreases in the
market values or fair values of our investments will be recorded
as unrealized depreciation. Since our inception, we have, at
times, incurred a cumulative net unrealized depreciation of our
portfolio. Any unrealized depreciation in our investment
portfolio could result in realized losses in the future and
ultimately in reductions of our income available for
distribution to stockholders in future periods.
Hedging
strategies can pose risks to us and our
stockholders.
If one of our portfolio companies goes public in the future, we
may undertake hedging strategies with regard to any equity
interests that we may have in that company. We may seek to
mitigate risks associated with the volatility of publicly traded
securities by, for example, selling securities short or writing
or buying call or put options. It is possible, however, that
utilizing short-selling transactions, derivative instruments and
hedging strategies of the type we may use might not perform as
intended or expected, resulting in higher realized losses and
unforeseen cash needs. In addition, these transactions depend on
the performance of various counterparties. Due to the
challenging conditions in the financial markets, these
counterparties may fail to perform, thus rendering our
transactions ineffective, which would likely result in
significant losses. In addition, hedging transactions would
also limit our opportunity to gain from an increase in the value
of our investment in the public company.
Risks
Related to Our Regulation and Structure
We
will be subject to corporate-level tax if we are unable to
satisfy Code requirements for RIC qualification.
To maintain our qualification as a RIC, we must meet income
source, asset diversification, and annual distribution
requirements. The annual distribution requirement is satisfied
if we distribute at least 90% of our ordinary income and
short-term capital gains to our stockholders on an annual basis.
Because we use leverage, we are subject to certain asset
coverage ratio requirements under the 1940 Act and could, under
certain circumstances, be restricted from making distributions
necessary to qualify as a RIC. Warrants we receive with respect
to debt investments will create “original issue
discount,” which we must recognize as ordinary income,
increasing the amounts we are required to distribute to maintain
RIC status. Because such warrants will not produce distributable
cash for us at the same time as we are required to make
distributions in respect of the related original issue discount,
we will need to use cash from other sources to satisfy such
distribution requirements. The asset diversification
requirements must be met at the end of each calendar quarter. If
we fail to meet these tests, we may need to quickly dispose of
certain investments to prevent the loss of RIC status. Since
most of our investments will be illiquid, such dispositions, if
even possible, may not be made at prices advantageous to us and,
in fact, may result in substantial losses. If we fail to qualify
as a RIC for any reason and
18
become fully subject to corporate income tax, the resulting
corporate taxes could substantially reduce our net assets, the
amount of income available for distribution, and the actual
amount distributed. Such a failure would have a material adverse
effect on us and our shares. For additional information
regarding asset coverage ratio and RIC requirements, see
“Business — Competitive Advantages —
Leverage” and “Material U.S. Federal Income Tax
Considerations — Regulated Investment Company
Status.”
Changes
in laws or regulations governing our operations, or changes in
the interpretation thereof, and any failure by us to comply with
laws or regulations governing our operations may adversely
affect our business.
We and our portfolio companies are subject to regulation by laws
at the local, state and federal levels. These laws and
regulations, as well as their interpretation, may be changed
from time to time. Accordingly, any change in these laws or
regulations, or their interpretation, or any failure by us or
our portfolio companies to comply with these laws or regulations
may adversely affect our business. For additional information
regarding the regulations to which we are subject, see
“Material U.S. Federal Income Tax
Considerations — Regulated Investment Company
Status” and “Regulation as a Business Development
Company.”
We are
subject to restrictions that may discourage a change of control.
Certain provisions contained in our articles of incorporation
and Maryland law may prohibit or restrict a change of control
and adversely impact the price of our shares.
Our Board of Directors is divided into three classes, with the
term of the directors in each class expiring every third year.
At each annual meeting of stockholders, the successors to the
class of directors whose term expires at such meeting will be
elected to hold office for a term expiring at the annual meeting
of stockholders held in the third year following the year of
their election. After election, a director may only be removed
by our stockholders for cause. Election of directors for
staggered terms with limited rights to remove directors makes it
more difficult for a hostile bidder to acquire control of us.
The existence of this provision may negatively impact the price
of our securities and may discourage third-party bids to acquire
our securities. This provision may reduce any premiums paid to
stockholders in a change in control transaction.
Certain provisions of Maryland law applicable to us prohibit
business combinations with:
| • | any person who beneficially owns 10% or more of the voting power of our common stock (an “interested stockholder”); | |
| • | an affiliate of ours who at any time within the two-year period prior to the date in question was an interested stockholder; or | |
| • | an affiliate of an interested stockholder. |
These prohibitions last for five years after the most recent
date on which the interested stockholder became an interested
stockholder. Thereafter, any business combination with the
interested stockholder must be recommended by our board of
directors and approved by the affirmative vote of at least 80%
of the votes entitled to be cast by holders of our outstanding
shares of common stock and two-thirds of the votes entitled to
be cast by holders of our common stock other than shares held by
the interested stockholder. These requirements could have the
effect of inhibiting a change in control even if a change in
control were in our stockholders’ interest. These
provisions of Maryland law do not apply, however, to business
combinations that are approved or exempted by our Board of
Directors prior to the time that someone becomes an interested
stockholder.
Our articles of incorporation permit our Board of Directors to
issue up to 50,000,000 shares of capital stock. In
addition, our Board of Directors, without any action by our
stockholders, may amend our articles of incorporation from time
to time to increase or decrease the aggregate number of shares
or the number of shares of any class or series of stock that we
have authority to issue. Our Board of Directors may classify or
reclassify any unissued common stock or preferred stock and
establish the preferences, conversion or other rights, voting
powers, restrictions, limitations as to distributions,
qualifications and terms or conditions of redemption of any such
stock. Thus, our Board of Directors could authorize the issuance
of preferred stock with terms and conditions that could have a
priority as to distributions and amounts payable upon
liquidation over the rights of the holders of our common stock.
Preferred stock could also have the effect of delaying,
deferring or preventing a change in control of us, including an
extraordinary transaction
19
(such as a merger, tender offer or sale of all or substantially
all of our assets) that might provide a premium price for
holders of our common stock.
Risks
Related to an Investment in Our Common Stock
We may
experience fluctuations in our quarterly and annual operating
results.
We may experience fluctuations in our quarterly and annual
operating results due to a number of factors, including, among
others, variations in our investment income, the interest rates
payable on the debt securities we acquire, the default rates on
such securities, the level of our expenses, variations in and
the timing of the recognition of realized and unrealized gains
or losses, the level of our expenses, the degree to which we
encounter competition in our markets, and general economic
conditions, including the impacts of inflation. The majority of
our portfolio companies are in industries that are directly
impacted by inflation, such as manufacturing and consumer goods
and services. Our portfolio companies may not be able to pass on
to customers increases in their costs of production which could
greatly affect their operating results, impacting their ability
to repay our loans. In addition, any projected future decreases
in our portfolio companies’ operating results due to
inflation could adversely impact the fair value of those
investments. Any decreases in the fair value of our investments
could result in future realized and unrealized losses and
therefore reduce our net assets resulting from operations. As a
result of these factors, results for any period should not be
relied upon as being indicative of performance in future periods.
There
is a risk that you may not receive distributions.
Our current intention is to distribute at least 90% of our
ordinary income and short-term capital gains to our stockholders
on a quarterly basis by paying monthly distributions. On an
annual basis, we intend to distribute net long-term capital
gains, after giving effect to any prior year realized losses
that are carried forward, by paying a one-time distribution.
However, our Board of Directors may determine in certain cases
to retain net realized long-term capital gains through a
“deemed distribution” to supplement our equity capital
and support the growth of our portfolio.
Distributions
by us have included and may in the future include a return of
capital.
Our Board of Directors declares monthly distributions based on
estimates of net investment income for each fiscal year, which
may differ, and in the past have differed, from actual results.
Because our distributions are based on estimates of net
investment income that may differ from actual results, future
distributions payable to our stockholders may also include a
return of capital. Moreover, to the extent that we distribute
amounts that exceed our accumulated earnings and profits, these
distributions constitute a return of capital. A return of
capital represents a return of a stockholder’s original
investment in shares of our stock and should not be confused
with a distribution from earnings and profits. Although return
of capital distributions may not be taxable, such distributions
may increase an investor’s tax liability for capital gains
upon the sale of our shares by reducing the investor’s tax
basis for such shares. Such returns of capital reduce our asset
base and also adversely impact our ability to raise debt capital
as a result of the leverage restrictions under the 1940 Act,
which could have a material adverse impact on our ability to
make new investments.
The
market price of our shares may fluctuate
significantly.
The trading price of our common stock may fluctuate
substantially. The extreme volatility and disruption that have
affected the capital and credit markets for over a year have
reached unprecedented levels in recent months We have
experienced greater than usual stock price volatility.
The market price and marketability of our shares may from time
to time be significantly affected by numerous factors, including
many over which we have no control and that may not be directly
related to us. These factors include, but are not limited to,
the following:
| • | general economic trends and other external factors; | |
| • | price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies; |
20
| • | significant volatility in the market price and trading volume of shares of RICs, business development companies or other companies in our sector, which is not necessarily related to the operating performance of these companies; | |
| • | changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies; | |
| • | loss of business development company status; | |
| • | loss of RIC status; | |
| • | changes in our earnings or variations in our operating results; | |
| • | changes in the value of our portfolio of investments; | |
| • | any shortfall in our revenue or net income or any increase in losses from levels expected by securities analysts; | |
| • | departure of key personnel; | |
| • | operating performance of companies comparable to us; | |
| • | short-selling pressure with respect to our shares or business development companies generally; | |
| • | the announcement of proposed, or completed, offerings of our securities, including a rights offering; and | |
| • | loss of a major funding source. |
Fluctuations in the trading prices of our shares may adversely
affect the liquidity of the trading market for our shares and,
if we seek to raise capital through future equity financings,
our ability to raise such equity capital.
The
issuance of subscription rights to our existing stockholders may
dilute the ownership and voting powers by existing stockholders
in our common stock, dilute the net asset value of their shares
and have a material adverse effect on the trading price of our
common stock.
There are significant capital raising constraints applicable to
us under the 1940 Act when our stock is trading below its net
asset value per share. In the event that we issue subscription
rights to our existing stockholders, there is a significant
possibility that the rights offering will dilute the ownership
interest and voting power of stockholders who do not fully
exercise their subscription rights. Stockholders who do not
fully exercise their subscription rights should expect that they
will, upon completion of the rights offering, own a smaller
proportional interest in the Company than would otherwise be the
case if they fully exercised their subscription rights. In
addition, because the subscription price of the rights offering
is likely to be less than the Company’s most recently
determined net asset value per share, our stockholders are
likely to experience an immediate dilution of the per share net
asset value of their shares as a result of the offer. As a
result of these factors, any future rights offerings of our
common stock, or our announcement of our intention to conduct a
rights offering, could have a material adverse impact on the
trading price of our common stock.
Shares
of closed-end investment companies frequently trade at a
discount from net asset value.
Shares of closed-end investment companies frequently trade at a
discount from net asset value. Since our inception, our common
stock has at times traded above net asset value, and at times
traded below net asset value. During the past two years, our
common stock has traded consistently, and at times
significantly, below net asset value. Subsequent to
March 31, 2011, our stock has traded at discounts of up to
17% of our net asset value as of March 31, 2011. This
characteristic of shares of closed-end investment companies is
separate and distinct from the risk that our net asset value per
share will decline. As with any stock, the price of our shares
will fluctuate with market conditions and other factors. If
shares are sold, the price received may be more or less than the
original investment. Whether investors will realize gains or
losses upon the sale of our shares will not depend directly upon
our net asset value, but will depend upon the market price of
the shares at the time of sale. Since the market price of our
shares will be affected by such factors as the relative demand
for and supply of the shares in the market, general market and
economic conditions and other factors beyond our control, we
cannot predict whether the shares will trade at, below or above
our net asset value. Under the 1940 Act, we are generally not
able to issue additional shares of our common stock at a price
21
below net asset value per share to purchasers other than our
existing stockholders through a rights offering without first
obtaining the approval of our stockholders and our independent
directors. Additionally, at times when our stock is trading
below its net asset value per share, our dividend yield may
exceed the weighted average returns that we would expect to
realize on new investments that would be made with the proceeds
from the sale of such stock, making it unlikely that we would
determine to issue additional shares in such circumstances.
Thus, for as long as our common stock trades below net asset
value we will be subject to significant constraints on our
ability to raise capital through the issuance of common stock.
Additionally, an extended period of time in which we are unable
to raise capital may restrict our ability to grow and adversely
impact our ability to increase or maintain our distributions.
Stockholders
may incur dilution if we sell shares of our common stock in one
or more offerings at prices below the then current net asset
value per share of our common stock.
At our most recent annual meeting, our stockholders approved a
proposal designed to allow us to access the capital markets in a
way that we were previously unable to as a result of
restrictions that, absent stockholder approval, apply to
business development companies under the 1940 Act. Specifically,
our stockholders approved a proposal that authorizes us to sell
shares of our common stock below the then current net asset
value per share of our common stock in one or more offerings for
a period of one year, provided 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 such sale.
During the past two years, our common stock has traded
consistently, and at times significantly, below net asset value.
Any decision to sell shares of our common stock below the then
current net asset value per share of our common stock would be
subject to the determination by our Board of Directors that such
issuance is in our and our stockholders’ best interests.
If we were to sell shares of our common stock below net asset
value per share, such sales would result in an immediate
dilution to the net asset value per share. This dilution would
occur as a result of the sale of shares at a price below the
then current net asset value per share of our common stock and a
proportionately greater decrease in a stockholder’s
interest in our earnings and assets and voting interest in us
than the increase in our assets resulting from such issuance.
The greater the difference between the sale price and the net
asset value per share at the time of the offering, the more
significant the dilutive impact would be. Because the number of
shares of common stock that could be so issued and the timing of
any issuance is not currently known, the actual dilutive effect,
if any, cannot be currently predicted. However, if for example,
we sold an additional 10% of our common stock at a 5% discount
from net asset value, a stockholder who did not participate in
that offering for its proportionate interest would suffer net
asset value dilution of up to 0.5% or $5 per $1,000 of net asset
value.
Other
Risks
We
could face losses and potential liability if intrusion, viruses
or similar disruptions to our technology jeopardize our
confidential information, whether through breach of our network
security or otherwise.
Maintaining our network security is of critical importance
because our systems store highly confidential financial models
and portfolio company information. Although we have implemented,
and will continue to implement, security measures, our
technology platform is and will continue to be vulnerable to
intrusion, computer viruses or similar disruptive problems
caused by transmission from unauthorized users. The
misappropriation of proprietary information could expose us to a
risk of loss or litigation.
Terrorist
attacks, acts of war, or national disasters may affect any
market for our common stock, impact the businesses in which we
invest, and harm our business, operating results, and financial
conditions.
Terrorist acts, acts of war, or national disasters have created,
and continue to create, economic and political uncertainties and
have contributed to global economic instability. Future
terrorist activities, military or security operations, or
national disasters could further weaken the domestic/global
economies and create additional uncertainties, which may
negatively impact the businesses in which we invest directly or
indirectly and, in turn, could have a material adverse impact on
our business, operating results, and financial condition. Losses
from terrorist attacks and national disasters are generally
uninsurable.
22
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
All statements contained or incorporated by reference in this
prospectus or any accompanying prospectus supplement, other than
historical facts, may constitute “forward-looking
statements.” These statements may relate to, among other
things, future events or our future performance or financial
condition. In some cases, you can identify forward-looking
statements by terminology such as “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: (1) 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 George
Stelljes III; (4) changes in our business 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; and (8) those factors described in the
“Risk Factors” section of this prospectus. We caution
readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made. We undertake
no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future
events or otherwise, after the date of this prospectus.
USE OF
PROCEEDS
Unless otherwise specified in any prospectus supplement
accompanying this prospectus, we intend to use the net proceeds
from the sale of the Securities for general corporate purposes.
We expect the proceeds to be used first to pay down existing
short-term debt, then to make investments in small and mid-sized
businesses in accordance with our investment objective, with any
remaining proceeds to be used for other general corporate
purposes. Indebtedness under our credit facility currently
accrues interest at the rate of approximately 5.25% and matures
on March 15, 2012. We anticipate that substantially all of
the net proceeds of any offering of Securities will be utilized
in the manner described above within three months of the
completion of such offering. Pending such utilization, we intend
to invest the net proceeds of any offering of Securities
primarily in cash, cash equivalents, U.S. government
securities, and other high-quality debt investments that mature
in one year or less from the date of investment, consistent with
the requirements for continued qualification as a RIC for
federal income tax purposes.
PRICE
RANGE OF COMMON STOCK AND DISTRIBUTIONS
We currently intend to distribute in the form of cash dividends,
a minimum of 90% of our ordinary income and short-term capital
gains, if any, on a quarterly basis to our stockholders in the
form of monthly dividends. We intend to retain long-term capital
gains and treat them as deemed distributions for tax purposes.
We report the estimated tax characteristics of each dividend
when declared while the actual tax characteristics of dividends
are reported annually to each stockholder on Form 1099 DIV.
There is no assurance that we will achieve investment results or
maintain a tax status that will permit any specified level of
cash distributions or
year-to-year
increases in cash distributions. At the option of a holder of
record of common stock, all cash distributions can be reinvested
automatically under our dividend reinvestment plan in additional
whole and fractional shares. A stockholder whose shares are held
in the name of a broker or other nominee should contact the
broker or nominee regarding participation in our dividend
reinvestment plan on the stockholder’s behalf. See
“Risk Factors — We will be subject to
corporate-level tax if we are unable to satisfy Code
requirements for RIC qualification;” “Dividend
Reinvestment Plan;” and “Material U.S. Federal
Income Tax Considerations.”
Our common stock is quoted on The Nasdaq Global Select Market
under the symbol “GLAD.” Our common stock has
historically traded at prices both above and below its net asset
value. There can be no assurance, however, that any premium to
net asset value will be attained or maintained. As of
July 11, 2011, we had 66 stockholders of record, meaning
individuals or entities that we carry in our records as the
registered holder (although not necessarily the beneficial
owner) of our common stock.
23
The following table sets forth the range of high and low closing
sales prices of our common stock as reported on The Nasdaq
Global Select Market and the dividends declared by us for the
last two completed fiscal years and the current fiscal year
through July 11, 2011.
SHARE
PRICE DATA
|
Premium |
Discount of |
|||||||||||||||||||||||
| Closing Sales Price |
(Discount) of |
Low Sales |
||||||||||||||||||||||
|
Dividend |
High Sales |
Price to |
||||||||||||||||||||||
| NAV(1) | High | Low | Declared | Price to NAV(2) | NAV(2) | |||||||||||||||||||
|
Fiscal Year ended September 30, 2009
|
||||||||||||||||||||||||
|
First Quarter
|
$ | 12.04 | $ | 15.38 | $ | 5.50 | $ | 0.42 | 28 | % | (54 | )% | ||||||||||||
|
Second Quarter
|
$ | 12.10 | $ | 10.28 | $ | 5.01 | $ | 0.42 | (15 | )% | (59 | )% | ||||||||||||
|
Third Quarter
|
$ | 11.86 | $ | 7.80 | $ | 5.49 | $ | 0.21 | (34 | )% | (54 | )% | ||||||||||||
|
Fourth Quarter
|
$ | 11.81 | $ | 10.40 | $ | 7.17 | $ | 0.21 | (12 | )% | (39 | )% | ||||||||||||
|
Fiscal Year ended September 30, 2010
|
||||||||||||||||||||||||
|
First Quarter
|
$ | 11.92 | $ | 9.49 | $ | 7.50 | $ | 0.21 | (20 | )% | (37 | )% | ||||||||||||
|
Second Quarter
|
$ | 12.10 | $ | 12.19 | $ | 7.19 | $ | 0.21 | 1 | % | (41 | )% | ||||||||||||
|
Third Quarter
|
$ | 11.81 | $ | 13.94 | $ | 10.09 | $ | 0.21 | 18 | % | (15 | )% | ||||||||||||
|
Fourth Quarter
|
$ | 11.85 | $ | 12.34 | $ | 10.30 | $ | 0.21 | 4 | % | (13 | )% | ||||||||||||
|
Fiscal Year ending September 30, 2011
|
||||||||||||||||||||||||
|
First Quarter
|
$ | 11.74 | $ | 12.00 | $ | 10.91 | $ | 0.21 | 2 | % | (7 | )% | ||||||||||||
|
Second Quarter
|
$ | 11.18 | $ | 12.05 | $ | 10.54 | $ | 0.21 | 6 | % | (8 | )% | ||||||||||||
|
Third Quarter
|
$ | * | $ | 11.59 | $ | 9.24 | $ | 0.21 | *% | *% | ||||||||||||||
|
Fourth Quarter (through July 11, 2011)
|
$ | * | $ | 9.69 | $ | 9.30 | $ | 0.21 | *% | *% | ||||||||||||||
| (1) | Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low sale price. The net asset values shown are based on outstanding shares at the end of each period. | |
| (2) | The premiums set forth in these columns represent the high or low, as applicable, closing price per share for the relevant quarter minus the net asset value per share as of the end of such quarter, and therefore may not reflect the premium to net asset value per share on the date of the high and low closing prices. | |
| * | Not yet available, as the net asset value per share as of the end of this quarter has not yet been determined. |
24
CONSOLIDATED
SELECTED FINANCIAL DATA
The following table summarizes our consolidated selected
financial data and other data. The consolidated selected
financial data as of September 30, 2010 and 2009 and for
the fiscal years ended September 30, 2010, 2009 and 2008 is
derived from our audited consolidated financial statements
included in this prospectus. The consolidated selected financial
data as of and for the six months ended March 31, 2011 and 2010
is derived from our unaudited consolidated financial statements
included in this prospectus. The consolidated selected financial
data as of September 30, 2008, 2007 and 2006 and for the
fiscal years ended September 30, 2007 and 2006 is derived
from our audited consolidated financial statements that are not
included in this prospectus. The other data included in the
second table is unaudited. You should read this data together
with our consolidated financial statements and notes thereto
presented elsewhere in this prospectus and the information under
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” for more information.
| Six Months Ended March 31, | Year Ended September 30, | |||||||||||||||||||||||||||
| 2011 | 2010 | 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||||||||
| (unaudited) | (unaudited) | |||||||||||||||||||||||||||
|
Statement of operations data:
|
||||||||||||||||||||||||||||
|
Total investment income
|
$ | 16,405 | $ | 19,618 | $ | 35,539 | $ | 42,618 | $ | 45,725 | $ | 36,687 | $ | 26,900 | ||||||||||||||
|
Total expenses net of credits from Adviser
|
7,339 | 10,716 | 17,780 | 21,587 | 19,172 | 14,426 | 7,447 | |||||||||||||||||||||
|
Net investment income
|
9,066 | 8,902 | 17,759 | 21,031 | 26,553 | 22,261 | 19,351 | |||||||||||||||||||||
|
Net (loss) gain on investments
|
(15,316 | ) | 5,404 | (1,365 | ) | (17,248 | ) | (47,815 | ) | (7,309 | ) | 5,079 | ||||||||||||||||
|
Net (decrease) increase in net assets resulting from operations
|
$ | (6,250 | ) | $ | 14,306 | $ | 16,394 | $ | 3,783 | $ | (21,262 | ) | $ | 14,952 | $ | 24,430 | ||||||||||||
|
Per share
data(1):
|
||||||||||||||||||||||||||||
|
Net (decrease) increase in net assets resulting from operations
per common share —
|
||||||||||||||||||||||||||||
|
Basic
|
$ | (0.30 | ) | $ | 0.68 | $ | (0.78 | ) | $ | (0.18 | ) | $ | (1.08 | ) | $ | 1.13 | $ | 2.15 | ||||||||||
|
Diluted
|
(0.30 | ) | 0.68 | (0.78 | ) | (0.18 | ) | (1.08 | ) | 1.13 | 2.10 | |||||||||||||||||
|
Net investment income before net (loss) gain on investments per
common share —
|
||||||||||||||||||||||||||||
|
Basic
|
0.43 | 0.42 | 0.84 | 1.00 | 1.35 | 1.69 | 1.70 | |||||||||||||||||||||
|
Diluted
|
0.43 | 0.42 | 0.84 | 1.00 | 1.35 | 1.69 | 1.67 | |||||||||||||||||||||
|
Cash distributions declared per share
|
(0.42 | ) | (0.42 | ) | (0.84 | ) | (1.26 | ) | (1.68 | ) | (1.68 | ) | (1.64 | ) | ||||||||||||||
|
Statement of assets and liabilities data:
|
||||||||||||||||||||||||||||
|
Total assets
|
$ | 272,536 | $ | 311,638 | $ | 270,518 | $ | 335,910 | $ | 425,698 | $ | 367,729 | $ | 225,783 | ||||||||||||||
|
Net assets
|
235,215 | 254,549 | 249,246 | 249,076 | 271,748 | 220,959 | 172,570 | |||||||||||||||||||||
|
Net asset value per share
|
11.18 | 12.10 | 11.85 | 11.81 | 12.89 | 14.97 | 14.02 | |||||||||||||||||||||
|
Common shares outstanding
|
21,039,242 | 21,039,242 | 21,039,242 | 21,087,574 | 21,087,574 | 14,762,574 | 12,305,008 | |||||||||||||||||||||
|
Weighted common shares outstanding —
|
||||||||||||||||||||||||||||
|
Basic
|
21,039,242 | 21,081,576 | 21,060,351 | 21,087,574 | 19,699,796 | 13,173,822 | 11,381,378 | |||||||||||||||||||||
|
Diluted
|
21,039,242 | 21,081,576 | 21,060,351 | 21,087,574 | 19,699,796 | 13,173,822 | 11,615,922 | |||||||||||||||||||||
|
Senior securities data:
|
||||||||||||||||||||||||||||
|
Borrowings under line of
credit(2)
|
$ | 33,646 | $ | 53,000 | $ | 17,940 | $ | 83,350 | $ | 151,030 | $ | 144,440 | $ | 49,993 | ||||||||||||||
|
Asset coverage
ratio(3)(4)
|
797 | % | 575 | % | 1,419 | % | 396 | % | 279 | % | 252 | % | 443 | % | ||||||||||||||
|
Asset coverage per
unit(4)
|
$ | 7,966 | $ | 5,754 | $ | 14,187 | $ | 3,963 | $ | 2,792 | $ | 2,294 | $ | 4,435 | ||||||||||||||
| (1) | Per share data for net (decrease) increase in net assets resulting from operations is based on the weighted common stock outstanding for both basic and diluted. | |
| (2) | See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our level of indebtedness. | |
| (3) | As a business development company, we are generally required to maintain an asset coverage ratio of 200% of total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to total borrowings and guaranty commitments. |
25
| (4) | Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per one thousand of indebtedness. |
|
Six Months Ended |
||||||||||||||||||||||||||||
| March 31, | Year Ended September 30, | |||||||||||||||||||||||||||
| 2011 | 2010 | 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||||||||
| (Dollar amounts in thousands, except per unit data) | ||||||||||||||||||||||||||||
|
Other unaudited data:
|
||||||||||||||||||||||||||||
|
Number of portfolio companies
|
45 | 41 | 39 | 48 | 63 | 56 | 32 | |||||||||||||||||||||
|
Average size of portfolio company investment at cost
|
$ | 6,983 | $ | 8,051 | $ | 7,647 | $ | 7,592 | $ | 7,315 | $ | 6,352 | $ | 6,756 | ||||||||||||||
|
Principal amount of new investments
|
(52,424 | ) | (6,880 | ) | (23,245 | ) | (24,911 | ) | (176,550 | ) | (261,700 | ) | (135,955 | ) | ||||||||||||||
|
Proceeds from loan repayments and investments sold
|
36,004 | 41,537 | 85,634 | 96,693 | 70,482 | 121,818 | 124,010 | |||||||||||||||||||||
|
Weighted average yield on
investments(1):
|
11.37 | % | 11.29 | % | 9.88 | % | 9.82 | % | 10.00 | % | 11.22 | % | 12.08 | % | ||||||||||||||
|
Total
return(2)
|
4.12 | 38.77 | 37.46 | (30.94 | ) | (13.90 | ) | (4.40 | ) | 5.21 | ||||||||||||||||||
| (1) | Weighted average yield on investments equals interest income on investments divided by the annualized weighted average investment balance throughout the year. | |
| (2) | Total return equals the increase (decrease) of the ending market value over the beginning market value plus monthly distributions divided by the monthly beginning market value. |
26
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollar amounts in thousands, except per share data or unless otherwise indicated)
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollar amounts in thousands, except per share data or unless otherwise indicated)
The following analysis of our financial condition and results of
operations should be read in conjunction with our consolidated
financial statements and the notes thereto contained elsewhere
herein.
OVERVIEW
General
We were incorporated under the General Corporation Laws of the
State of Maryland on May 30, 2001. Our investment objective
is to achieve a high level of current income by investing in
debt securities, consisting primarily of senior notes, senior
subordinated notes and junior subordinated notes, of established
private businesses that are substantially owned by leveraged
buyout funds, individual investors or are family-owned
businesses, with a particular focus on senior notes. In
addition, we may acquire from other funds existing loans that
meet this profile. We also seek to provide our stockholders with
long-term capital growth through the appreciation in the value
of warrants or other equity instruments that we may receive when
we make loans. We operate as a closed-end, non-diversified
management investment company, and have elected to be treated as
a business development company under the 1940 Act. In addition,
for tax purposes we have elected to be treated as a RIC under
the Code.
We seek to invest in small and medium-sized private
U.S. businesses that meet certain criteria, including some
but not necessarily all of the following: the potential for
growth in cash flow, adequate assets for loan collateral,
experienced management teams with a significant 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.
Business
Environment
While economic conditions generally appear to be improving, we
remain cautious about a long-term economic recovery. The recent
recession in general, and the disruptions in the capital markets
in particular, have decreased liquidity for us and increased our
cost of debt and equity capital. The longer these economic
conditions persist, the greater the probability that these
factors could continue to increase our costs of, and
significantly limit our access to, debt and equity capital and,
thus, have an adverse effect on our operations and financial
results. Many of the companies in which we have made investments
are still susceptible to the economic conditions, which may
affect the ability of one or more of our portfolio companies to
repay our loans or engage in a liquidity event, such as a sale,
recapitalization or initial public offering. The economic
conditions could also disproportionately impact some of the
industries in which we have invested, causing us to be more
vulnerable to losses in our portfolio, which could cause the
number of our non-performing assets to increase and the fair
market value of our portfolio to decrease. We do not know when
market conditions will begin to grow again or if adverse
conditions will intensify, and we do not know the full extent to
which the continued recession will affect us. If market
instability persists or intensifies, we may experience
difficulty in raising capital.
Challenges in the current market are intensified for us by
certain regulatory limitations under the Code and the 1940 Act,
as well as contractual restrictions under the agreement
governing our credit facility that further constrain our ability
to access the capital markets. To maintain our qualification as
a RIC, we must satisfy, among other requirements, an annual
distribution requirement to pay out at least 90% of our ordinary
income and short-term capital gains to our stockholders on an
annual basis. Because we are required to distribute our income
in this manner, and because the illiquidity of many of our
investments makes it difficult for us to finance new investments
through the sale of current investments, our ability to make new
investments is highly dependent upon external financing. Our
external financing sources include the issuance of equity
securities, debt securities or other leverage, such as
borrowings under our line of credit. Our ability to seek
external debt financing, to the extent that it is
27
available under current market conditions, is further subject to
the asset coverage limitations of the 1940 Act, which require us
to have at least a 200% asset coverage ratio, meaning generally
that for every dollar of debt, we must have two dollars of
assets.
Market conditions have also affected the trading price of our
common stock and thus our ability to finance new investments
through the issuance of equity. When our stock trades below net
asset value, or NAV, per share, as it has periodically traded
for more than two years, our ability to issue equity is
constrained by provisions of the 1940 Act which generally
prohibit the issuance and sale of our common stock at an
issuance price below 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 February 17, 2011, stockholders
approved a proposal which authorizes us to sell shares of our
common stock at a price below our then current NAV per share for
a period of one year from the date of approval, provided 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 and that our Board of
Directors makes certain determinations prior to any such sale.
On July 11, 2011, the closing market price of our common
stock was $ 9.54, which price represented a 14.7% discount
to our March 31, 2011 NAV per share.
Unstable economic conditions may also continue to decrease the
value of collateral securing some of our loans, as well as the
value of our equity investments, which has impacted and may
continue to impact our ability to borrow under our credit
facility. Additionally, our credit facility contains covenants
regarding the maintenance of certain minimum net worth
covenants, which are affected by the decrease in value of our
portfolio. Failure to meet these requirements would result in a
default which, if we are unable to obtain a waiver from our
lenders, would result in the acceleration of our repayment
obligations under our credit facility. As of March 31,
2011, we were in compliance with all of our credit
facility’s covenants.
We expect that, given these regulatory and contractual
constraints in combination with current market conditions, debt
and equity capital may be costly or difficult for us to access.
This was demonstrated on January 20, 2011, when we were
informed by the United States Small Business Administration that
our Northern Virginia SBIC, LP application to obtain a license
as a small business investment company, or SBIC, would not be
granted. At this time, we do not intend to pursue a SBIC license
for the foreseeable future. Despite current market constraints,
we believe that our $127.0 million credit facility with a
two-year term increases our ability to make new investments
consistent with our strategy of making conservative investments
in businesses that we believe will weather the current economic
conditions and are likely to produce attractive long-term
returns for our stockholders.
Investment
Highlights
Purchases: During the year ended
September 30, 2010, we extended $10,580 of investments to
three new portfolio companies and $12,665 of investments to
existing portfolio companies through revolver draws or the
additions of new term notes, for total investments of $23,245.
Repayments: During the year ended
September 30, 2010, eight borrowers made unscheduled full
payoffs of $58,731, one borrower made an unscheduled partial
payoff of $950 and we experienced contractual amortization,
revolver repayments and some principal payments received ahead
of schedule for an aggregate of $22,885, for total principal
repayments of $82,566.
Sales: During the year ended
September 30, 2010, we sold three syndicated loans (which
resulted in our exit from three portfolio companies) for an
aggregate of $3,119 in net proceeds. In addition, we wrote off
our investment in Western Directories, which had a cost basis of
$2,865.
Since our initial public offering in August 2001, we have made
300 different loans to, or investments in, 151 companies
for a total of approximately $1,087.0 million, before
giving effect to principal repayments on investments and
divestitures.
Financing
Highlights
On March 15, 2010, through our wholly-owned subsidiary,
Gladstone Business Loan, LLC, or Business Loan, we entered into
a fourth amended and restated credit agreement, which provides
for a $127 million revolving line of credit arranged by Key
Equipment Finance Inc. as administrative agent, which we refer
to as the Credit Facility.
28
Branch Banking and Trust Company and ING Capital LLC also
joined the Credit Facility as committed lenders. Subject to
certain terms and conditions, the Credit Facility may be
expanded up to $202 million through the addition of other
committed lenders to the facility. The Credit Facility matures
on March 15, 2012, and, if the facility is not renewed or
extended by this date, all unpaid principal and interest will be
due and payable one year thereafter on March 15, 2013.
Advances under the Credit Facility initially bore interest at
the 30-day
LIBOR (subject to a minimum rate of 2%), plus 4.5% per annum,
with a commitment fee of 0.5% per annum on undrawn amounts.
However, on November 22, 2010, or the Amendment Date, we
amended our Credit Facility such that advances bear interest at
the 30-day
LIBOR (subject to a minimum rate of 1.5%), plus 3.75% per annum,
with a commitment fee of 0.5% per annum on undrawn amounts when
the facility is drawn more than 50% and 1.0% per annum on
undrawn amounts when the facility is drawn less than 50%.
In addition to the annual interest rate on borrowings
outstanding, under the terms of the Credit Facility prior to the
Amendment Date, we were obligated to pay an annual minimum
earnings shortfall fee to the committed lenders on
March 15, 2011, which was calculated as the difference
between the weighted average of borrowings outstanding under the
Credit Facility and 50% of the commitment amount of the Credit
Facility, multiplied by 4.5% per annum, less commitment fees
paid during the year. However, as a result of the amendment to
the Credit Facility, we are no longer obligated to pay an annual
minimum earnings shortfall fee. As of September 30, 2010,
we had accrued approximately $590 in minimum earnings shortfall
fees. On the Amendment Date, we paid a $665 fee.
During the year ended September 30, 2010, we elected to
apply ASC 825, “Financial Instruments,”
specifically to our Credit Facility, which requires us to apply
a fair value methodology to the Credit Facility as of
September 30, 2010. The Credit Facility was fair valued at
$17,940 as of September 30, 2010.
Investment
Strategy
Our strategy is to make loans at favorable interest rates to
small and medium-sized businesses. Our loans typically range
from $5 million to $20 million, although this
investment size may vary proportionately as the size of our
capital base changes, generally mature in no more than seven
years and accrue interest at fixed or variable rates. Because
the majority of our portfolio loans consist of term debt of
private companies that typically cannot or will not expend the
resources to have their debt securities rated by a credit rating
agency, we expect that most, if not all, of the debt securities
we acquire will be unrated. We cannot accurately predict what
ratings these loans might receive if they were rated, and thus
cannot determine whether or not they could be considered
“investment grade” quality. However, for loans that
lack a rating by a credit rating agency, investors should assume
that these loans will be below what is today considered
“investment grade” quality. Investments rated below
investment grade are often referred to as high yield securities
or junk bonds, and may be considered high risk compared to
investment grade debt instruments.
Some of our loans may contain a provision that calls for some
portion of the interest payments to be deferred and added to the
principal balance so that the interest is paid, together with
the principal, at maturity. This form of deferred interest is
often called “paid in kind,” or PIK, interest and,
when earned, we record PIK interest as interest income and add
the PIK interest to the principal balance of the loans. We seek
to avoid PIK interest with all potential investments under
review. As of March 31, 2011, we had loans in our portfolio
which contained a PIK provision.
To the extent possible, our loans generally are collateralized
by a security interest in the borrower’s assets. Interest
payments are generally made monthly or quarterly (except to the
extent of any PIK interest) with amortization of principal
generally being deferred for several years. The principal amount
of the loans and any accrued but unpaid interest generally
become due at maturity at five to seven years. When we receive a
warrant to purchase stock in a borrower in connection with a
loan, the warrant will typically have an exercise price equal to
the fair value of the portfolio company’s common stock at
the time of the loan and entitle us to purchase a modest
percentage of the borrower’s stock.
Original issue discount, or OID, arises when we extend a loan
and receive an equity interest in the borrower at the same time.
To the extent that the price paid for the equity is not at
market value, we must allocate part of the price paid for the
loan, to the value of the equity. Then the amount allocated to
the equity, the OID, must be amortized over the life of the
loan. As with PIK interest, the amortization of OID also
produces income that must be recognized for purposes of
satisfying the distribution requirements for a RIC under
Subchapter M of the Code, whereas the cash is received, if at
all, when the equity instrument is sold. We seek to avoid OID
with all potential investments under review. As of
March 31, 2011, we had fifteen loans with OID income.
29
In addition, as a BDC under the 1940 Act, we are required to
make available significant managerial assistance to our
portfolio companies. Our Adviser provides these services on our
behalf through its officers who are also our officers.
Currently, neither we nor our Adviser charges a fee for
managerial assistance, however, if our Adviser does receive fees
for managerial assistance, our Adviser will credit the
managerial assistance fees to the base management fee due from
us to our Adviser.
Our Adviser receives fees for the other services it provides to
our portfolio companies. These other fees are typically
non-recurring, are recognized as revenue when earned and are
generally paid directly to our Adviser by the borrower or
potential borrower upon the closing of the investment. The
services our Adviser provides to our portfolio companies vary by
investment, but generally include a broad array of services,
such as investment banking services, arranging bank and equity
financing, structuring financing from multiple lenders and
investors, reviewing existing credit facilities, restructuring
existing investments, raising equity and debt capital from other
investors, turnaround management, merger and acquisition
services and recruiting new management personnel. When our
Adviser receives fees for these services, 50% or 100% of certain
of those fees are credited against the base management fee that
we pay to our Adviser. Any services of this nature subsequent to
closing would typically generate a separate fee at the time of
completion.
Our Adviser also receives fees for monitoring and reviewing
portfolio company investments. These fees are recurring and are
generally paid annually or quarterly in advance to our Adviser
throughout the life of the investment. Fees of this nature are
recorded as revenue by our Adviser when earned and are not
credited against the base management fee. Our Adviser’s
affiliate, Gladstone Securities, also provides our portfolio
companies with investment banking and due diligence services.
These fees are recorded as revenue by Gladstone Securities when
earned and do not impact the fees we pay our Adviser.
We may receive fees for the origination and closing services we
provide to portfolio companies through our Adviser. These fees
are paid directly to us and are recognized as revenue upon
closing of the originated investment and are reported as fee
income in the consolidated statements of operations.
Prior to making an investment, we ordinarily enter into a
non-binding term sheet with the potential borrower. These
non-binding term sheets are generally subject to a number of
conditions, including, but not limited to, the satisfactory
completion of our due diligence investigations of the potential
borrower’s business, reaching agreement on the legal
documentation for the loan, and the receipt of all necessary
consents. Upon execution of the non-binding term sheet, the
potential borrower generally pays the Adviser a non-refundable
fee for services rendered by the Adviser through the date of the
non-binding term sheet. These fees are received by the Adviser
and are offset against the base management fee payable to the
Adviser, which has the effect of reducing our expenses to the
extent of any such fees received by the Adviser.
In the event that we expend significant effort in considering
and negotiating a potential investment that ultimately is not
consummated, we generally will seek reimbursement from the
proposed borrower for our reasonable expenses incurred in
connection with the transaction, including legal fees. Any
amounts collected for expenses incurred by the Adviser in
connection with unconsummated investments will be reimbursed to
the Adviser. Amounts collected for these expenses incurred by us
will be reimbursed to us and will be recognized in the period in
which such reimbursement is received, however, there can be no
guarantee that we will be successful in collecting any such
reimbursements.
Our
Adviser and Administrator
Our Adviser is led by a management team which has extensive
experience in our lines of business. Our Adviser is controlled
by David Gladstone, our chairman and chief executive officer.
Mr. Gladstone is also the chairman and chief executive
officer of our Adviser. Terry Lee Brubaker, our vice chairman,
chief operating officer, secretary and director, is a member of
the board of directors of our Adviser and its vice chairman and
chief operating officer, George Stelljes III, our president,
chief investment officer and director, is a member of the board
of directors of our Adviser and its president and chief
investment officer. Our Administrator, an affiliate of our
Adviser, employs our chief financial officer, chief compliance
officer, internal counsel, treasurer and their respective staffs.
30
Our Adviser and Administrator also provide investment advisory
and administrative services, respectively, to our affiliates,
Gladstone Commercial, a publicly traded real estate investment
trust; Gladstone Investment, a publicly traded BDC and RIC;
Gladstone Lending, a proposed fund that would primarily invest
in first and second lien term loans; Gladstone Partners, a
private partnership fund formed primarily to co-invest with us
and Gladstone Investment; and Gladstone Land, a private
agricultural real estate company. Excluding our chief financial
officer, all of our executive officers serve as either directors
or executive officers, or both, of our Adviser, our
Administrator, Gladstone Commercial and Gladstone Investment.
Our treasurer is also an executive office of Gladstone
Securities, a broker-dealer registered with the Financial
Industry Regulatory Authority. In the future, our Adviser may
provide investment advisory and administrative services to other
funds, both public and private, of which it is the sponsor.
Investment
Advisory and Management Agreement
Under the amended and restated investment advisory agreement, or
the Advisory Agreement, we pay our Adviser an annual base
management fee of 2% of our average gross assets, which is
defined as total assets, including investments made with
proceeds of borrowings, less any uninvested cash or cash
equivalents resulting from borrowings, valued at the end of the
two most recently completed calendar quarters and appropriately
adjusted for any share issuances or repurchases during the
current calendar quarter.
We also pay our Adviser a two-part incentive fee under the
Advisory Agreement. The first part of the incentive fee is an
income-based incentive fee which rewards our Adviser if our
quarterly net investment income (before giving effect to any
incentive fee) exceeds 1.75% of our net assets (the “hurdle
rate”). The second part of the incentive fee is a capital
gains-based incentive fee that is 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 our Adviser, we will calculate the cumulative
aggregate realized capital gains and cumulative aggregate
realized capital losses since our inception, and the aggregate
unrealized capital depreciation as of the date of the
calculation, as applicable, with respect to each of the
investments in our portfolio. The Adviser did not earn the
capital gains-based portion of the incentive fee for the fiscal
year ended September 30, 2010.
We pay our direct expenses including, but not limited to,
directors’ fees, legal and accounting fees, stockholder
related expenses, and directors and officers insurance under the
Advisory Agreement.
Beginning in April 2006, our Board of Directors has accepted
from the Adviser, unconditional and irrevocable voluntarily
waivers on a quarterly basis to reduce the annual 2.0% base
management fee on senior syndicated loans to 0.5% to the extent
that proceeds resulting from borrowings were used to purchase
such syndicated loan participations. In addition to the base
management and incentive fees under the Advisory Agreement, 50%
or 100% of certain fees received by the Adviser from our
portfolio companies are credited against the investment advisory
fee and paid to the Adviser.
The Adviser services our loan portfolio pursuant to a loan
servicing agreement with Business Loan in return for a 1.5%
annual fee, based on the monthly aggregate outstanding loan
balance of the loans pledged under our credit facility. All fees
received by the Adviser from Business Loan are credited toward
the 2% base management fee.
Administration
Agreement
We have entered into an administration agreement with our
Administrator, or the Administration Agreement, 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 our allocable portion of the salaries
and benefits expenses of our chief financial officer, chief
compliance officer, internal counsel, treasurer and their
respective staffs. Our allocable portion of expenses is
primarily derived by multiplying our Administrator’s total
expenses by the percentage of our average assets (the total
assets at the beginning and end of each quarter) in comparison
to the average total assets of all funds that have
administration agreements with our Administrator and are also
managed by our Adviser under similar agreements. On
July 12, 2011, our Board of Directors approved the renewal
of this
31
Administration Agreement through August 31, 2012. We
expect that the Board of Directors will consider a further one
year renewal in July 2012.
Critical
Accounting Policies
The preparation of financial statements and related disclosures
in conformity with generally accepted accounting principles in
the United States requires management to make estimates and
assumptions that affect the reported consolidated amounts of
assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and
revenues and expenses during the years reported. Actual results
could materially differ from those estimates. Actual results
could differ materially from those estimates. We have identified
our investment valuation process, which was modified during the
year ended September 30, 2010, as our most critical
accounting policy.
Investment
Valuation
The most significant estimate inherent in the preparation of our
consolidated financial statements is the valuation of
investments and the related amounts of unrealized appreciation
and depreciation of investments recorded.
General Valuation Policy: We value our
investments in accordance with the requirements of the 1940 Act.
As discussed more fully below, we value securities for which
market quotations are readily available and reliable at their
market value. We value all other securities and assets at fair
value as determined in good faith by our Board of Directors.
We adopted ASC 820 on October 1, 2008. In part,
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 820 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 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 our own assumptions that market participants would use to price the asset or liability based upon the best available information. |
See Note 3, “Investments” in the accompanying
notes to our consolidated financial statements included
elsewhere in this prospectus for additional information
regarding fair value measurements and our adoption of
ASC 820.
We use generally accepted valuation techniques to value our
portfolio unless we have specific information about the value of
an investment to determine otherwise. From time to time we 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 scopes used to value our investments.
When these specific third-party appraisals are engaged or
accepted, we would use estimates of value provided by such
appraisals and our own assumptions including estimated remaining
life, current market yield and interest rate spreads of similar
securities as of the measurement date to value the investment we
have in that business.
In determining the value of our investments, our Adviser has
established an investment valuation policy, or the Policy. The
Policy has been approved by our Board of Directors, and each
quarter our Board of Directors reviews
32
whether our Adviser has applied the Policy consistently and
votes whether or not to accept the recommended valuation of our
investment portfolio.
The Policy, which is summarized below, applies to the following
categories of securities:
| • | Publicly-traded securities; | |
| • | Securities for which a limited market exists; and | |
| • | Securities for which no market exists. |
Valuation
Methods:
Publicly-traded securities: We determine the
value of publicly-traded securities 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 restricted securities that are not freely
tradable, but for which a public market otherwise exists, we
will use the market value of that security adjusted for any
decrease in value resulting from the restrictive feature.
Securities for which a limited market
exists: We value 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. In valuing these assets, we assess trading
activity in an asset class, evaluate variances in prices and
other market insights to determine if any available quote prices
are reliable. If we conclude that quotes based on active markets
or trading activity may be relied upon, firm bid prices are
requested; however, if a firm bid price is unavailable, we base
the value of the security upon the indicative bid price, or IBP,
offered by the respective originating syndication agent’s
trading desk, or secondary desk, on or near the valuation date.
To the extent that we use the indicative bid price as a basis
for valuing the security, our Adviser may take further steps to
consider additional information to validate that price in
accordance with the Policy.
In the event these limited markets become illiquid such that
market prices are no longer readily available, we will value our
syndicated loans using estimated net present values of the
future cash flows or discounted cash flows. The use of a
discounted cash flow, or DCF, methodology follows that
prescribed by ASC 820, 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, the
alternative outlined in ASC 820 is the use of valuing
investments based on DCF. For the purposes of using DCF to
provide fair value estimates, we consider 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, we develop a modified discount rate
approach that incorporates risk premiums including, among
others, increased probability of default, or higher loss given
default, or increased liquidity risk. The DCF valuations applied
to the syndicated loans provide an estimate of what we believe a
market participant would pay to purchase a syndicated loan in an
active market, thereby establishing a fair value. We will
continue to apply the DCF methodology in illiquid markets until
quoted prices are available or are deemed reliable based on
trading activity.
As of March 31, 2011, we assessed trading activity in
syndicated loan assets and determined that there continued to be
market liquidity and a secondary market for these assets. Thus,
firm bid prices or IBPs were used to fair value our remaining
syndicated loans as of March 31, 2011.
Securities for which no market exists: The
valuation methodology for securities for which no market exists
falls into three categories: (1) portfolio investments
comprised solely of debt securities; (2) portfolio
investments in controlled companies comprised of a bundle of
securities, which can include debt and equity securities;
(3) portfolio investments in non-controlled companies
comprised of a bundle of investments, which can include debt and
equity securities; and (4) portfolio investments comprised of
non-publicly-traded non-control equity securities of other funds.
(1) Portfolio investments comprised solely of debt
securities: Debt securities that are not publicly
traded on an established securities market, or for which a
limited market does not exist, which we refer to as Non-Public
Debt Securities, and that are issued by portfolio companies
where we have no equity or equity-like securities, are fair
33
valued in accordance with the terms of the policy, which
utilizes opinions of value submitted to us by SPSE. We may also
submit PIK interest to SPSE for their evaluation when it is
determined that PIK interest is likely to be received.
In the case of Non-Public Debt Securities, we have engaged SPSE
to submit opinions of value for our debt securities that are
issued by portfolio companies in which we own no equity, or
equity-like securities. SPSE’s opinions of value are based
on the valuations prepared by our portfolio management team as
described below. We request that SPSE also evaluate and assign
values to success fees (conditional interest included in some
loan securities) when we determine that there is reasonable
probability of receiving a success fee on a given loan. SPSE
will only evaluate the debt portion of our investments for which
we specifically request evaluation, and may decline to make
requested evaluations for any reason at its sole discretion.
Upon completing our collection of data with respect to the
investments (which may include the information described below
under “— Credit Information,” the risk
ratings of the loans described below under
“— Loan Grading and Risk Rating” and the
factors described hereunder), this valuation data is forwarded
to SPSE for review and analysis. SPSE makes its independent
assessment of the data that we have assembled and assesses its
independent data to form an opinion as to what they consider to
be the market values for the securities. With regard to its
work, SPSE has issued the following paragraph:
SPSE provides evaluated price opinions which are reflective of
what SPSE believes the bid side of the market would be for each
loan after careful review and analysis of descriptive, market
and credit information. Each price reflects SPSE’s best
judgment based upon careful examination of a variety of market
factors. Because of fluctuation in the market and in other
factors beyond its control, SPSE cannot guarantee these
evaluations. The evaluations reflect the market prices, or
estimates thereof, on the date specified. The prices are based
on comparable market prices for similar securities. Market
information has been obtained from reputable secondary market
sources. Although these sources are considered reliable, SPSE
cannot guarantee their accuracy.
SPSE opinions of value of our debt securities that are issued by
portfolio companies where we have no equity or equity-like
securities are submitted to our Board of Directors along with
our Adviser’s supplemental assessment and recommendation
regarding valuation of each of these investments. Our Adviser
generally accepts the opinion of value given by SPSE, however,
in certain limited circumstances, such as when our Adviser may
learn new information regarding an investment between the time
of submission to SPSE and the date of the Board assessment our
Adviser’s conclusions as to value may differ from the
opinion of value delivered by SPSE. Our Board of Directors then
reviews whether our Adviser has followed its established
procedures for determinations of fair value, and votes to accept
or reject the recommended valuation of our investment portfolio.
Our Adviser and our management recommended, and the Board of
Directors voted to accept, the opinions of value delivered by
SPSE on the loans in our portfolio as denoted on the Schedule of
Investments included in our accompanying consolidated financial
statements.
Because there is a delay between when we close an investment and
when the investment can be evaluated by SPSE, new loans are not
valued immediately by SPSE; rather, management makes its own
determination about the value of these investments in accordance
with our valuation policy using the methods described herein.
(2) Portfolio investments in controlled companies
comprised of a bundle of investments, which can include debt and
equity securities: The fair value of these
investments is determined based on the total enterprise value of
the portfolio company, or issuer, utilizing a liquidity
waterfall approach. For Non-Public Debt Securities and equity or
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 have 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. In
accordance with
ASC 820-10,
we apply the in-use premise of value which assumes the debt and
equity securities are sold together. Under this liquidity
waterfall approach, we continue to use the enterprise value
methodology utilizing a liquidity waterfall approach to
determine the fair value of these investments under
ASC 820-10
if we have the ability to initiate a sale of a portfolio company
as of the measurement date. Under this approach, we first
calculate the total enterprise value of the issuer by
incorporating some or all of the following factors:
| • | the issuer’s ability to make payments; | |
| • | the earnings of the issuer; |
34
| • | 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,
we may reference industry statistics and use outside experts.
Once we have estimated the total enterprise value of the issuer,
we 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 total enterprise value over the total debt outstanding for
the issuer. Once the values for all outstanding senior
securities (which include the debt securities) have been
subtracted from the total enterprise value 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 our
Adviser’s judgment, the liquidity waterfall approach does
not accurately reflect the value of the debt component, our
Adviser may recommend that we use a valuation by SPSE or, if
that is unavailable, a DCF valuation technique.
(3) Portfolio investments in non-controlled companies
comprised of a bundle of investments, which can include debt and
equity securities: We value 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 820-10,
we determine the fair value of these debt securities of
non-control investments assuming the sale of an individual debt
security using the in-exchange premise of value. As such, we
estimate the fair value of the debt component using estimates of
value provided by SPSE and our 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.
Subsequent to June 30, 2009, for equity or equity-like
securities of investments for which we do not control or cannot
gain control as of the measurement date, we estimate the fair
value of the equity using the in-exchange premise of value 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 also is given to
capital structure and other contractual obligations that may
impact the fair value of the equity. Further, we may utilize
comparable values of similar companies, recent investments and
indices with similar structures and risk characteristics or our
own assumptions in the absence of other observable market data
and may also employ DCF valuation techniques.
(4) Portfolio investments comprised of non-publicly
traded non-control equity securities of other
funds: We value any uninvested capital of the
non-control fund at par value and value any invested capital at
the value provided by the non-control fund.
Due to the uncertainty inherent in the valuation process, such
estimates of fair value may differ significantly from the values
that would have been obtained had a ready market for the
securities existed, and the differences could be material.
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 we might reasonably
expect to receive upon the current sale of the security in an
arms-length transaction in the security’s principal market.
Valuation Considerations: From time to time,
depending on certain circumstances, the Adviser may use the
following valuation considerations, including but not limited to:
| • | the nature and realizable value of the collateral; | |
| • | the portfolio company’s earnings and cash flows and its ability to make payments on its obligations; | |
| • | the markets in which the portfolio company does business; | |
| • | the comparison to publicly traded companies; and | |
| • | DCF and other relevant factors. |
35
Because such valuations, particularly valuations of private
securities and private companies, are not susceptible to precise
determination, may fluctuate over short periods of time, and may
be based on estimates, our determinations of fair value may
differ from the values that might have actually resulted had a
readily available market for these securities been available.
Credit Information: Our Adviser monitors a
wide variety of key credit statistics that provide information
regarding our portfolio companies to help us assess credit
quality and portfolio performance. We and our Adviser
participate in the periodic board meetings of our portfolio
companies in which we hold Control and Affiliate investments and
also require them to provide annual audited and monthly
unaudited financial statements. Using these statements or
comparable information and board discussions, our Adviser
calculates and evaluates the credit statistics.
Loan Grading and Risk Rating: As part of our
valuation procedures above, we risk rate all of our investments
in debt securities. For syndicated loans that have been rated by
an NRSRO (as defined in
Rule 2a-7
under the 1940 Act), we use the NRSRO’s risk rating for
such security. For all other debt securities, we use a
proprietary risk rating system. Our risk rating system uses a
scale of 0 to 10, with 10 being the lowest probability of
default. This system is used to estimate the probability of
default on debt securities and the probability of loss if there
is a default. These types of systems are referred to as risk
rating systems and are used by banks and rating agencies. The
risk rating system covers both qualitative and quantitative
aspects of the business and the securities we hold. During the
three months ended March 31, 2010, we modified our risk
rating model to incorporate additional factors in our
qualitative and quantitative analysis. While the overall process
did not change, we believe the additional factors enhance the
quality of the risk ratings of our investments. No adjustments
were made to prior periods as a result of this modification.
For the debt securities for which we do not use a third-party
NRSRO risk rating, we seek to have our risk rating system mirror
the risk rating systems of major risk rating organizations, such
as those provided by an NRSRO. While we seek to mirror the NRSRO
systems, we cannot provide any assurance that our risk rating
system will provide the same risk rating as an NRSRO for these
securities. The following chart is an estimate of the
relationship of our risk rating system to the designations used
by two NRSROs as they risk rate debt securities of major
companies. Because our system rates debt securities of companies
that are unrated by any NRSRO, there can be no assurance that
the correlation to the NRSRO set out below is accurate. We
believe our risk rating would be significantly higher than a
typical NRSRO risk rating because the risk rating of the typical
NRSRO is designed for larger businesses. However, our risk
rating has been designed to risk rate the securities of smaller
businesses that are not rated by a typical NRSRO. Therefore,
when we use our risk rating on larger business securities, the
risk rating is higher than a typical NRSRO rating. The primary
difference between our risk rating and the rating of a typical
NRSRO is that our risk rating uses more quantitative
determinants and includes qualitative determinants that we
believe are not used in the NRSRO rating. It is our
understanding that most debt securities of medium-sized
companies do not exceed the grade of BBB on an NRSRO scale, so
there would be no debt securities in the middle market that
would meet the definition of AAA, AA or A. Therefore, our scale
begins with the designation 10 as the best risk rating which may
be equivalent to a BBB− or Baa3 from an NRSRO, however, no
assurance can be given that a 10 on our scale is equal to a
BBB− or Baa3 on an NRSRO scale.
36
|
Company’s |
First |
Second |
||||
|
System
|
NRSRO | NRSRO |
Description(a)
|
|||
|
> 10
|
Baa2 | BBB | Probability of Default (PD) during the next ten years is 4% and the Expected Loss (EL) is 1% or less | |||
|
10
|
Baa3 | BBB− | PD is 5% and the EL is 1% to 2% | |||
|
9
|
Ba1 | BB+ | PD is 10% and the EL is 2% to 3% | |||
|
8
|
Ba2 | BB | PD is 16% and the EL is 3% to 4% | |||
|
7
|
Ba3 | BB− | PD is 17.8% and the EL is 4% to 5% | |||
|
6
|
B1 | B+ | PD is 22% and the EL is 5% to 6.5% | |||
|
5
|
B2 | B | PD is 25% and the EL is 6.5% to 8% | |||
|
4
|
B3 | B− | PD is 27% and the EL is 8% to 10% | |||
|
3
|
Caa1 | CCC+ | PD is 30% and the EL is 10% to 13.3% | |||
|
2
|
Caa2 | CCC | PD is 35% and the EL is 13.3% to 16.7% | |||
|
1
|
Caa3 | CC | PD is 65% and the EL is 16.7% to 20% | |||
|
< 1
|
N/A | D | PD is 85% or there is a payment default and the EL is greater than 20% |
| (a) | The default rates set forth are for a ten year term debt security. If a debt security is less than ten years, then the probability of default is adjusted to a lower percentage for the shorter period, which may move the security higher on our risk rating scale. |
The above scale gives an indication of the probability of
default and the magnitude of the loss if there is a default. Our
policy is to stop accruing interest on an investment if we
determine that interest is no longer collectible. As of
March 31, 2011, and September 30, 2010, two
Non-Control/Non-Affiliate investments and four Control
investments were on non-accrual. As of September 30, 2009,
one Non-Control/Non-Affiliate investment and four Control
investments were on non-accrual. Additionally, we do not risk
rate our equity securities.
The following table lists the risk ratings for all
non-syndicated loans in our portfolio at March 31, 2011,
September 30, 2010 and September 30, 2009,
representing approximately 82%, 93% and 96%, respectively, of
all loans in our portfolio at the end of each period:
|
March 31, |
Sept. 30, |
Sept. 30, |
||||||||||
|
Rating
|
2011 | 2010 | 2009 | |||||||||
|
Highest
|
10.0 | 10.0 | 9.0 | |||||||||
|
Average
|
5.9 | 6.1 | 7.1 | |||||||||
|
Weighted Average
|
5.7 | 5.7 | 7.2 | |||||||||
|
Lowest
|
1.0 | 1.0 | 3.0 | |||||||||
The following table lists the risk ratings for all syndicated
loans in our portfolio that were not rated by an NRSRO at
March 31, 2011, September 30, 2010 and
September 30, 2009, representing approximately 2% of all
loans in our portfolio at the end of each period:
|
March 31, |
Sept. 30, |
Sept. 30, |
||||||||||
|
Rating
|
2011 | 2010 | 2009 | |||||||||
|
Highest
|
7.0 | 7.0 | 7.0 | |||||||||
|
Average
|
7.0 | 7.0 | 7.0 | |||||||||
|
Weighted Average
|
7.0 | 7.0 | 7.0 | |||||||||
|
Lowest
|
7.0 | 7.0 | 7.0 | |||||||||
For syndicated loans that are currently rated by an NRSRO, we
risk rate such loans in accordance with the risk rating systems
of major risk rating organizations, such as those provided by an
NRSRO. The following table lists the risk ratings for all
syndicated loans in our portfolio that were rated by an NRSRO at
March 31, 2011, September 30,
37
2010 and September 30, 2009, representing approximately
15%, 4% and 2%, respectively, of all loans in our portfolio at
the end of each period:
|
March 31, |
Sept. 30, |
Sept. 30, |
||||
|
Rating
|
2011 | 2010 | 2009 | |||
|
Highest
|
B+/B2 | B+/B2 | B-/B3 | |||
|
Average
|
B/B2 | B+/B2 | CCC+/Caa1 | |||
|
Weighted Average
|
B/B1 | B+/B2 | CCC+/Caa1 | |||
|
Lowest
|
Caa1/B- | B2 | D/C |
Tax
Status
We intend to continue to qualify for treatment as a RIC under
Subtitle A, Chapter 1 of Subchapter M of the Code. As a
RIC, we are not subject to federal income tax on the portion of
our taxable income and gains distributed to stockholders. To
qualify as a RIC, we must meet certain
source-of-income,
asset diversification, and annual distribution requirements.
Under the annual distribution requirement, we are required to
distribute to stockholders at least 90% of our investment
company taxable income, as defined by the Code. We have a policy
to pay out as distributions up to 100% of that amount.
In an effort to avoid certain excise taxes imposed on RICs, we
currently intend to distribute during each calendar year, an
amount at least equal to the sum of (1) 98% of our ordinary
income for the calendar year, (2) 98% of our capital gains
in excess of capital losses for the one-year period ending on
October 31 of the calendar year and (3) any ordinary income
and net capital gains for preceding years that were not
distributed during such years.
We sought and received a private letter ruling from the Internal
Revenue Service, or IRS, related to our tax treatment for
success fees. In the ruling, executed by our consent on
January 3, 2011, we, in effect, will continue to account
for the recognition of income from the success fees upon
receipt, or when the amount becomes fixed. However, starting
January 1, 2011, the tax characterization of the success
fee amount will be treated as ordinary income. Previously, we
had treated the success fee amount as a realized gain for tax
characterization purposes. The private letter ruling does not
require us to retroactively change the capital gains treatment
of the success fees received prior to January 1, 2011.
Revenue
Recognition
Investment
Income Recognition
Interest income, adjusted for amortization of premiums and
acquisition costs and for the accretion of discounts, is
recorded on an 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 loans may be recognized as income or applied to
principal depending upon management’s judgment. Non-accrual
loans are restored to accrual status when past due principal and
interest is paid and in management’s judgment, are likely
to remain current. As of March 31, 2011, two
Non-Control/Non-Affiliate investments and four Control
investments were on non-accrual with an aggregate cost basis of
approximately $30.4 million, or 9.7% of the cost basis of
all loans in our portfolio. As of September 30, 2010, two
Non-Control/Non-Affiliate investments and four Control
investments were on non-accrual with an aggregate cost basis of
approximately $29.9 million or 10.0% of the cost basis of
all investments in our portfolio. As of September 30, 2009,
one Non-Control/Non-Affiliate investment and four Control
investments were on non-accrual with an aggregate cost basis of
approximately $10 million or 2.8% of the cost basis of all
investments in our portfolio.
As of March 31, 2011, we had loans in our portfolio which
contain a PIK provision. The PIK interest, computed at the
contractual rate specified in each loan agreement, is added to
the principal balance of the loan and recorded as income. To
maintain our status as a RIC, this non-cash source of income
must be paid out to stockholders in the form of distributions,
even though we have not yet collected the cash. We recorded PIK
income
38
of $4 and $8 for the three and six months ended March 31,
2011, respectively, as compared to $4 and $60 for the three and
six months ended March, 31 2010, respectively. We recorded PIK
income of $67, $126 and $0 for the years ended
September 30, 2010, 2009 and 2008, respectively.
We also transfer past due interest to the principal balance as
stipulated in certain loan amendments with portfolio companies.
We transferred past due interest to the principal balance of
$204 for the three and six months ended March 31, 2011, as
compared to $338 and $441 for the three and six months ended
March, 31 2010, respectively. For the years ended
September 30, 2010, 2009 and 2008, we rolled over past due
interest to the principal balance of $1,230, $1,495 and $58,
respectively.
As of March 31, 2011, we had fifteen OID loans. We recorded
OID income of $29 and $53 for the three and six months ended
March 31, 2011, respectively, as compared to $2 for the
three and six months ended March 31, 2010. For the years
ended September 30, 2010, 2009 and 2008, we recorded OID
income of $21, $206 and $29, respectively.
Success fees are recorded upon receipt. Success fees are
contractually due upon a change of control in a portfolio
company and are recorded in Other income in our accompanying
condensed consolidated statements of operations. We recorded
$0.6 million of success fees during the six months ended
March 31, 2011, which resulted from the exits of Pinnacle
Treatment Centers, Inc. and Interfilm Holdings, Inc. During the
six months ended March 31, 2010, we received
$1.4 million in success fees from the exits of ActivStyle
Acquisition Co., Saunders & Associates, Visual Edge
Technology, Inc., Tulsa Welding School, and the prepayment of
success fees from Doe & Ingalls Management LLC.
39
RESULTS
OF OPERATIONS
COMPARISON
OF THE THREE MONTHS ENDED MARCH 31, 2011 TO THE THREE
MONTHS ENDED MARCH 31, 2010
A comparison of our operating results for the three months
ended March 31, 2011 and 2010 is below:
| For the Three Months Ended March 31, | ||||||||||||||||
| 2011 | 2010 | $ Change | % Change | |||||||||||||
|
INVESTMENT INCOME
|
||||||||||||||||
|
Interest income
|
$ | 7,290 | $ | 8,492 | $ | (1,202 | ) | (14.2 | )% | |||||||
|
Other income
|
1,108 | 1,322 | (214 | ) | (16.2 | ) | ||||||||||
|
Total investment income
|
8,398 | 9,814 | (1,416 | ) | (14.4 | ) | ||||||||||
|
EXPENSES
|
||||||||||||||||
|
Loan servicing fee
|
757 | 852 | (95 | ) | (11.2 | ) | ||||||||||
|
Base management fee
|
608 | 739 | (131 | ) | (17.7 | ) | ||||||||||
|
Incentive fee
|
1,102 | 1,072 | 30 | 2.8 | ||||||||||||
|
Administration fee
|
175 | 176 | (1 | ) | (0.6 | ) | ||||||||||
|
Interest expense
|
478 | 1,136 | (658 | ) | (57.9 | ) | ||||||||||
|
Amortization of deferred financing fees
|
368 | 449 | (81 | ) | (18.0 | ) | ||||||||||
|
Professional fees
|
201 | 219 | (18 | ) | (8.2 | ) | ||||||||||
|
Other expenses
|
383 | 703 | (320 | ) | (45.5 | ) | ||||||||||
|
Expenses before credit from Adviser
|
4,072 | 5,346 | (1,274 | ) | (23.8 | ) | ||||||||||
|
Credit to base management and incentive fees from Adviser
|
(102 | ) | (6 | ) | (96 | ) | 1,600.0 | |||||||||
|
Total expenses net of credit to base management and incentive
fees
|
3,970 | 5,340 | (1,370 | ) | (25.7 | ) | ||||||||||
|
NET INVESTMENT INCOME
|
4,428 | 4,474 | (46 | ) | (1.0 | ) | ||||||||||
|
REALIZED AND UNREALIZED (LOSS) GAIN ON:
|
||||||||||||||||
|
Net realized gain on investments
|
5 | 892 | (887 | ) | (99.4 | ) | ||||||||||
|
Net unrealized (depreciation) appreciation on investments
|
(13,069 | ) | 2,483 | (15,552 | ) | NM | ||||||||||
|
Net unrealized appreciation on borrowings
|
255 | 131 | 124 | 94.7 | ||||||||||||
|
Net (loss) gain on investments and borrowings
|
(12,809 | ) | 3,506 | (16,315 | ) | NM | ||||||||||
|
NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | (8,381 | ) | $ | 7,980 | $ | (16,361 | ) | NM | |||||||
NM = Not
Meaningful
Investment
Income
Interest income from our investments in debt securities
decreased for the three months ended March 31, 2011, as
compared to the three months ended March 31, 2010, for
several reasons. The level of interest income from investments
is directly related to the balance, at cost, of the
interest-bearing investment portfolio outstanding during the
period multiplied by the weighted average yield. The weighted
average cost basis of our interest-bearing investment portfolio
during the quarter ended March 31, 2011 was approximately
$256.9 million, compared to approximately
$309.6 million for the prior year quarter, due primarily to
increased principal repayments and limited new investment
activity subsequent to March 31, 2010. The annualized
weighted average yield on our interest-bearing investment
portfolio for the three months ended March 31, 2011 was
11.32%, compared to 10.98% for the prior year period. The
weighted average yield varies from period to period based on the
current stated interest rate on interest-bearing investments and
the amounts of loans for which interest is not accruing. The
increase in the weighted average yield on our portfolio for the
quarter ended March 31, 2011 resulted primarily from the
repayment
40
of loans with lower stated interest rates. During the three
months ended March 31, 2011, six investments were on
non-accrual, for an aggregate of approximately
$30.4 million at cost, or 9.7% of the aggregate cost of our
investment portfolio, and during the prior year period, six
investments were on non-accrual, for an aggregate of
approximately $26.4 million at cost, or 8.0% of the
aggregate cost of our investment portfolio.
Other income decreased for the three months ended March 31,
2011, as compared to the prior year period, primarily due to
success fees earned in aggregate of $0.9 million from exits
in ActivStyle Acquisition Co., or ActivStyle,
Saunders & Associates, or Saunders, and Visual Edge
Technologies, Inc., or Visual Edge, and prepayment fees in
aggregate of $0.3 million from ActiveStyle and ACE
Expediters, Inc., or ACE, during the three months ended
March 31, 2010, partially offset by the receipt of
$0.6 million in a settlement related, in part, to US
Healthcare Communications, Inc., or US Healthcare, and
$0.5 million in success fees earned from our exit in
Pinnacle Treatment Centers, Inc., or Pinnacle, during the
current year period.
The following tables list the interest income from investments
for our five largest portfolio company investments during the
respective periods:
|
Three Months Ended |
||||||||||||||||
| As of March 31, 2011 | March 31, 2011 | |||||||||||||||
|
Company
|
Fair Value | % of Portfolio | Interest Income | % of Total Revenues | ||||||||||||
|
Reliable Biopharmaceutical Holding Inc.
|
$ | 25,699 | 10.0 | % | $ | 755 | 10.4 | % | ||||||||
|
Westlake Hardware, Inc.
|
19,570 | 7.6 | 638 | 8.7 | ||||||||||||
|
Midwest Metal Distribution, Inc. (formerly Clinton Holdings, LLC)
|
16,179 | 6.3 | 548 | 7.5 | ||||||||||||
|
Defiance Integrated Technologies, Inc.
|
13,680 | 5.3 | 225 | 3.1 | ||||||||||||
|
Sunshine Media Holdings
|
13,161 | 5.1 | 704 | 9.7 | ||||||||||||
|
Subtotal — five largest investments
|
88,289 | 34.3 | 2,870 | 39.4 | ||||||||||||
|
Other portfolio companies
|
168,824 | 65.7 | 4,298 | 58.9 | ||||||||||||
|
Other non-portfolio company revenue
|
— | — | 122 | 1.7 | ||||||||||||
|
Total
|
$ | 257,113 | 100.0 | % | $ | 7,290 | 100.0 | % | ||||||||
|
Three Months |
||||||||||||||||
| As of March 31, 2010 | Ended March 31, 2010 | |||||||||||||||
|
Company
|
Fair Value | % of Portfolio | Interest Income | % of Total Revenues | ||||||||||||
|
Reliable Biopharmaceutical Holding Inc.
|
$ | 26,792 | 9.2 | % | $ | 738 | 8.7 | % | ||||||||
|
Sunshine Media Holdings
|
26,580 | 9.1 | 693 | 8.1 | ||||||||||||
|
Westlake Hardware, Inc.
|
24,400 | 8.4 | 672 | 7.9 | ||||||||||||
|
VantaCore
|
13,590 | 4.7 | 408 | 4.8 | ||||||||||||
|
Midwest Metal Distribution, Inc.
|
12,855 | 4.4 | 514 | 6.1 | ||||||||||||
|
Subtotal — five largest investments
|
104,217 | 35.8 | 3,025 | 35.6 | ||||||||||||
|
Other portfolio companies
|
187,534 | 64.2 | 5,359 | 63.1 | ||||||||||||
|
Other non-portfolio company revenue
|
— | — | 108 | 1.3 | ||||||||||||
|
Total
|
$ | 291,751 | 100.0 | % | $ | 8,492 | 100.0 | % | ||||||||
Operating
Expenses
Operating expenses, net of credits from our Adviser for fees
earned and voluntary and irrevocable waivers applied to the base
management and incentive fees, decreased for the three months
ended March 31, 2011, as compared to the prior year period.
This reduction was primarily due to a decrease in interest
expense, other expenses and the base management fee.
Interest expense decreased for the three months ended
March 31, 2011, as compared to the prior year period, due
primarily to decreased borrowings under the Credit Facility
during the three months ended March 31, 2011. The
41
weighted average balance outstanding on the Credit Facility
during the quarter ended March 31, 2011 was approximately
$14.5 million, as compared to $61.0 million in the
prior year period, a decrease of 76.3%. On November 22,
2010, we amended the Credit Facility such that advances bear
interest at LIBOR, subject to a minimum rate of 1.5%, plus 3.75%
per annum. For the three months ended March 31, 2010, under
our prior credit facility and our
pre-amended
Credit Facility, advances generally bore interest at LIBOR,
subject to a minimum rate of 2.0%, plus 4.0% to 4.5% per annum.
In addition to the lower interest rate, the amendment removed
the annual minimum earnings shortfall fee to the committed
lenders.
Amortization of deferred financing fees decreased for the three
months ended March 31, 2011, as compared to the prior year
period, due to significant one-time costs related to the
termination of our prior credit facility and transition to the
Credit Facility, resulting in increased amortization of deferred
financing fees during the quarter ended March 31, 2010 when
compared to the quarter ended March 31, 2011.
Other expenses decreased for the three months ended
March 31, 2011, as compared to the prior year period due
primarily to higher compensation expense, legal fees incurred in
connection with troubled loans and the provision for
uncollectible receivables from portfolio companies during the
three months ended March 31, 2010. The increase in
compensation expense was due to the conversion of stock option
loans of two former employees of the Adviser from recourse to
non-recourse loans. The conversions were non-cash transactions
and were accounted for as repurchases of the shares previously
received by the employees of the Adviser upon exercise of the
stock options in exchange for the non-recourse notes. The
repurchases were accounted for as treasury stock transactions at
the fair value of the shares, totaling $0.4 million. Since
the value of the stock option loans totaled $0.7 million,
we recorded compensation expense of $0.2 million. No
compensation expense was incurred during the three months ended
March 31, 2011.
The base management fee decreased for the three months ended
March 31, 2011, as compared to the prior year period, which
is reflective of holding fewer assets subject to the base
management fee compared to the prior year period. An incentive
fee was earned by the Adviser during the three months ended
March 31, 2011, due primarily to continued other income and
a decrease in operating expenses, partially offset by a decrease
in interest income. The incentive fee earned during the prior
year period was due in part to other income generated from
multiple exits. The base management and incentive fees are
computed quarterly, as described under “Investment
Advisory and Management Agreement” in Note 4 of
the notes to the accompanying Condensed Consolidated
Financial Statements and are summarized in the following
table:
| Three Months Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Average total assets subject to base management
fee(1)
|
$ | 273,000 | $ | 318,200 | ||||
|
Multiplied by pro-rated annual base management fee of 2.0%
|
0.5 | % | 0.5 | % | ||||
|
Unadjusted base management fee
|
$ | 1,365 | $ | 1,591 | ||||
|
Reduction for loan servicing
fees(2)
|
(757 | ) | (852 | ) | ||||
|
Base management
fee(2)
|
608 | 739 | ||||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee
on senior syndicated loans to 0.5% per annum
|
(81 | ) | (6 | ) | ||||
|
Net base management fee
|
$ | 527 | $ | 733 | ||||
|
Incentive
fee(2)
|
$ | 1,102 | $ | 1,072 | ||||
|
Credit from voluntary, irrevocable waiver issued by
Adviser’s board of directors
|
(21 | ) | — | |||||
|
Net incentive fee
|
$ | 1,081 | $ | 1,072 | ||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee
on senior syndicated loans to 0.5% per annum
|
$ | (81 | ) | (6 | ) | |||
|
Incentive fee credit
|
(21 | ) | — | |||||
|
Credit to base management and incentive fees from
Adviser(2)
|
$ | (102 | ) | $ | (6 | ) | ||
42
| (1) | Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash and cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and appropriately adjusted for any share issuances or repurchases during the periods. |
| (2) | Reflected as a line item on the Condensed Consolidated Statement of Operations located elsewhere in this prospectus. |
Net
Realized Gain on Investments
There were $5 in net realized gains for the three months ended
March 31, 2011, primarily due to realized gains from
unamortized discounts on exits during the quarter, partially
offset by realized losses in connection with workout
expenditures related to the Sunshine Media Holdings restructure.
Net realized gains on investments for the three months ended
March 31, 2010 were $0.9 million, which consisted of a
realized gain of $1.4 million from our exit of ACE,
partially offset by an aggregate of $0.5 million of
realized losses from our exits of CCS, LLC and Gold Toe
Investment Corp.
Net
Unrealized (Depreciation) Appreciation on Investments
Net unrealized (depreciation) appreciation on investments is the
net change in the fair value of our investment portfolio during
the reporting period, including the reversal of
previously-recorded unrealized appreciation or depreciation when
gains and losses are actually realized. During the quarter ended
March 31, 2011, we recorded net unrealized depreciation on
investments in the aggregate amount of $13.1 million.
During the prior year period, we recorded net unrealized
appreciation on investments in the aggregate amount of
$2.5 million, which included the reversal of
$2.0 million in unrealized depreciation related to the
payoff of Visual Edge and the sale of CCS, LLC. Excluding
reversals, we had $0.5 million in net unrealized
appreciation for the three months ended March 31, 2010. The
net unrealized (depreciation) appreciation across our
investments for the three months ended March 31, 2011 was
as follows:
| Three Months Ended March 31, 2011 | ||||||
|
Net Unrealized |
||||||
|
Appreciation |
||||||
|
Portfolio Company
|
Investment Classification | (Depreciation) | ||||
|
Defiance Integrated Technologies, Inc.
|
Control | $ | 1,003 | |||
|
Midwest Metal Distribution, Inc.
|
Non-Control / Non-Affiliate | 364 | ||||
|
Sunshine Media Holdings
|
Control | (9,790 | ) | |||
|
Lindmark Acquisition, LLC
|
Control | (1,410 | ) | |||
|
GFRC Holdings LLC
|
Non-Control / Non-Affiliate | (810 | ) | |||
|
Heartland Communications Group
|
Non-Control / Non-Affiliate | (598 | ) | |||
|
Legend Communications of Wyoming, LLC
|
Non-Control / Non-Affiliate | (434 | ) | |||
|
International Junior Golf Training Acquisition Company
|
Non-Control / Non-Affiliate | (408 | ) | |||
|
LocalTel, LLC
|
Control | (361 | ) | |||
|
Reliable Biopharmaceutical Holdings, Inc.
|
Non-Control / Non-Affiliate | (340 | ) | |||
|
SCI Cable, Inc.
|
Non-Control / Non-Affiliate | (316 | ) | |||
|
Other, net (<$250)
|
31 | |||||
| Total: | $ | (13,069 | ) | |||
The primary driver in our net unrealized depreciation for the
quarter ended March 31, 2011 was notable depreciation in
Sunshine Media Holdings, or Sunshine, which was primarily due to
portfolio company performance and the restructure, and certain
comparable multiples. During the quarter ended March 31,
2011, as part of the Sunshine restructure, we acquired a
controlling equity position, restructured certain of the debt
terms, and infused additional equity capital in the form of
preferred equity.
43
The unrealized appreciation (depreciation) across our
investments for the three months ended March 31, 2010 was
as follows:
| Three Months Ended March 31, 2010 | ||||||
|
Net Unrealized |
||||||
|
Appreciation |
||||||
|
Portfolio Company
|
Investment Classification | (Depreciation) | ||||
|
Visual Edge Technology, Inc.
|
Non-Control / Non-Affiliate | $ | 1,662 | (1) | ||
|
Northern Contours, Inc.
|
Non-Control / Non-Affiliate | 429 | ||||
|
CCS, LLC
|
Non-Control / Non-Affiliate | 312 | (2) | |||
|
Puerto Rico Cable Acquisition Company, Inc.
|
Non-Control / Non-Affiliate | 289 | ||||
|
Midwest Metal Distribution, Inc.
|
Control | (857 | ) | |||
|
Sunshine Media Holdings
|
Non-Control / Non-Affiliate | (447 | ) | |||
|
Finn Corporation
|
Non-Control / Non-Affiliate | (354 | ) | |||
|
Other, net (<$250)
|
1,449 | |||||
| Total: | $ | 2,483 | ||||
| (1) | Reflects the reversal of $1.7 million in unrealized depreciation in connection with payoff of the line of credit and senior subordinated term loan of Visual Edge Technology, Inc. |
| (2) | Reflects the reversal of the unrealized depreciation in connection with the $0.3 million realized loss on the sale of CCS, LLC. |
Excluding reversals, the general increase in our net unrealized
appreciation for the quarter ended March 31, 2010 was
experienced throughout the majority of our entire portfolio of
debt holdings based on increases in market comparables and
portfolio company performance.
Over our entire investment portfolio, we recorded an aggregate
of approximately $12.9 million and $0.2 million of net
unrealized depreciation on our debt and equity positions,
respectively, for the quarter ended March 31, 2011. At
March 31, 2011, the fair value of our investment portfolio
was less than its cost basis by approximately
$57.1 million, or $81.8 million as compared to
$44.0 million at December 31, 2010, representing net
unrealized depreciation of $13.1 million for the period. We
believe that our aggregate investment portfolio was valued at a
depreciated value due primarily to reduced performance by
certain portfolio companies and the general instability of the
loan markets and resulting decrease in market multiples relative
to where multiples were when we originated such investments in
our portfolio. Our entire portfolio was fair valued at 81.8% of
cost as of March 31, 2011. The unrealized depreciation of
our investments does not have an impact on our current ability
to pay distributions to stockholders; however, it may be an
indication of future realized losses, which could ultimately
reduce our income available for distribution to stockholders.
Net
Unrealized Appreciation on Borrowings
Net unrealized appreciation on borrowings is the net change in
the fair value of our line of credit borrowings during the
reporting period, including the reversal of previously recorded
unrealized appreciation or depreciation when gains and losses
are realized. We elected to apply ASC 825, “Financial
Instruments,” which requires us to apply a fair value
methodology to the Credit Facility. We estimated the fair value
of the Credit Facility using a combination of estimates of value
provided by an independent third party and our own assumptions
in the absence of observable market data, including estimated
remaining life, credit party risk, current market yield and
interest rate spreads of similar securities as of the
measurement date. The Credit Facility was fair valued at
$33.6 million as of March 31, 2011.
Net
Decrease (Increase) in Net Assets Resulting from
Operations
For the three months ended March 31, 2011, we realized a
net decrease in net assets resulting from operations of
$8.4 million as a result of the factors discussed above.
For the three months ended March 31, 2010, we realized a
net increase in net assets resulting from operations of
$8.0 million. Our net (decrease) increase in net assets
resulting
44
from operations per basic and diluted weighted average common
share for the three months ended March 31, 2011 and
March 31, 2010 were $(0.40) and $0.38, respectively.
COMPARISON
OF THE SIX MONTHS ENDED MARCH 31, 2011 TO THE SIX MONTHS
ENDED MARCH 31, 2010
A comparison of our operating results for the six months
ended March 31, 2011 and 2010 is below:
| For the Six Months Ended March 31, | ||||||||||||||||
| 2011 | 2010 | $ Change | % Change | |||||||||||||
|
INVESTMENT INCOME
|
||||||||||||||||
|
Interest income
|
$ | 15,135 | $ | 17,743 | $ | (2,608 | ) | (14.7 | )% | |||||||
|
Other income
|
1,270 | 1,875 | (605 | ) | (32.3 | ) | ||||||||||
|
Total investment income
|
16,405 | 19,618 | (3,213 | ) | (16.4 | ) | ||||||||||
|
EXPENSES
|
||||||||||||||||
|
Loan servicing fee
|
1,599 | 1,781 | (182 | ) | (10.2 | ) | ||||||||||
|
Base management fee
|
1,113 | 1,459 | (346 | ) | (23.7 | ) | ||||||||||
|
Incentive fee
|
2,261 | 1,447 | 814 | 56.3 | ||||||||||||
|
Administration fee
|
361 | 354 | 7 | 2.0 | ||||||||||||
|
Interest expense
|
358 | 2,671 | (2,313 | ) | (86.6 | ) | ||||||||||
|
Amortization of deferred financing fees
|
664 | 943 | (279 | ) | (29.6 | ) | ||||||||||
|
Professional fees
|
534 | 1,131 | (597 | ) | (52.8 | ) | ||||||||||
|
Other expenses
|
603 | 965 | (362 | ) | (37.5 | ) | ||||||||||
|
Expenses before credit from Adviser
|
7,493 | 10,751 | (3,258 | ) | (30.3 | ) | ||||||||||
|
Credit to base management and incentive fees from Adviser
|
(154 | ) | (35 | ) | (119 | ) | 340.0 | |||||||||
|
Total expenses net of credit to base management and incentive
fees
|
7,339 | 10,716 | (3,377 | ) | (31.5 | ) | ||||||||||
|
NET INVESTMENT INCOME
|
9,066 | 8,902 | 164 | 1.8 | ||||||||||||
|
REALIZED AND UNREALIZED (LOSS) GAIN ON:
|
||||||||||||||||
|
Net realized gain (loss) on investments
|
5 | (28 | ) | 33 | NM | |||||||||||
|
Net unrealized (depreciation) appreciation on investments
|
(16,014 | ) | 5,082 | (21,096 | ) | NM | ||||||||||
|
Net unrealized appreciation on borrowings
|
693 | 350 | 343 | 98.0 | ||||||||||||
|
Net (loss) gain on investments and borrowings
|
(15,316 | ) | 5,404 | (20,720 | ) | NM | ||||||||||
|
NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | (6,250 | ) | $ | 14,306 | $ | (20,556 | ) | NM | |||||||
NM = Not
Meaningful
Investment
Income
Interest income from our investments in debt securities
decreased for the six months ended March 31, 2011, as
compared to the six months ended March 31, 2010, for
several reasons. The level of interest income from investments
is directly related to the balance, at cost, of the
interest-bearing investment portfolio outstanding during the
period multiplied by the weighted average yield. The weighted
average cost basis of our interest-bearing investment portfolio
during the six months ended March 31, 2011 was
approximately $262.7 million, compared to approximately
$311.2 million for the prior year period, due primarily to
increased principal repayments and limited new investment
activity subsequent to March 31, 2010. The annualized
weighted average yield on our interest-bearing investment
portfolio for the six months ended March 31, 2011 was
11.37%, compared to 11.29% for the
45
prior year period. The weighted average yield varies from
period to period based on the current stated interest rate on
interest-bearing investments and the amounts of loans for which
interest is not accruing. The increase in the weighted average
yield on our portfolio for the six months ended March 31,
2011 resulted primarily from the repayment of loans with lower
stated interest rates. During the six months ended
March 31, 2011, six investments were on non-accrual, for an
aggregate of approximately $30.4 million at cost, or 9.7%
of the aggregate cost of our investment portfolio, and during
the prior year period, six investments were on non-accrual, for
an aggregate of approximately $26.4 million at cost, or
8.0% of the aggregate cost of our investment portfolio.
Other income decreased for the six months ended March 31,
2011, as compared to the prior year period, primarily due to
success fees earned in aggregate of $1.4 million from exits
in Doe & Ingalls Management LLC, Tulsa Welding School,
ActivStyle, Saunders and Visual Edge, and prepayment fees in
aggregate of $0.3 million from ActiveStyle and ACE during
the six months ended March 31, 2010, partially offset by
the receipt of $0.6 million in a settlement related, in
part, to US Healthcare and success fees in aggregate of
$0.6 million in success fees earned from our exits in
Pinnacle and Interfilm Holdings, Inc during the current year
period.
The following tables list the interest income from investments
for our five largest portfolio company investments during the
respective periods:
| As of March 31, 2011 | Six Months Ended March 31, 2011 | |||||||||||||||
|
Company
|
Fair Value | % of Portfolio | Interest Income | % of Total Revenues | ||||||||||||
|
Reliable Biopharmaceutical Holdings, Inc.
|
$ | 25,699 | 10.0 | % | $ | 1,508 | 10.0 | % | ||||||||
|
Westlake Hardware, Inc.
|
19,570 | 7.6 | 1,289 | 8.5 | ||||||||||||
|
Midwest Metal Distribution, Inc.
|
16,179 | 6.3 | 1,109 | 7.3 | ||||||||||||
|
Defiance Acquisition Corp.
|
13,680 | 5.3 | 457 | 3.0 | ||||||||||||
|
Sunshine Media Holdings
|
13,161 | 5.1 | 1,568 | 10.4 | ||||||||||||
|
Subtotal — five largest investments
|
88,289 | 34.3 | 5,931 | 39.2 | ||||||||||||
|
Other portfolio companies
|
168,824 | 65.7 | 8,960 | 59.2 | ||||||||||||
|
Other non-portfolio company revenue
|
— | — | 244 | 1.6 | ||||||||||||
|
Total
|
$ | 257,113 | 100.0 | % | $ | 15,135 | 100.0 | % | ||||||||
| As of March 31, 2010 | Six Months Ended March 31, 2010 | |||||||||||||||
|
Company
|
Fair Value | % of Portfolio | Interest Income | % of Total Revenues | ||||||||||||
|
Reliable Biopharmaceutical Holdings, Inc.
|
$ | 26,792 | 9.2 | % | $ | 1,497 | 8.5 | % | ||||||||
|
Sunshine Media Holdings
|
26,580 | 9.1 | 1,539 | 8.7 | ||||||||||||
|
Westlake Hardware, Inc.
|
24,400 | 8.4 | 1,596 | 9.0 | ||||||||||||
|
VantaCore
|
13,590 | 4.7 | 827 | 4.7 | ||||||||||||
|
Midwest Metal Distribution, Inc.
|
12,855 | 4.4 | 1,037 | 5.8 | ||||||||||||
|
Subtotal — five largest investments
|
104,217 | 35.8 | 6,496 | 36.7 | ||||||||||||
|
Other portfolio companies
|
187,534 | 64.2 | 11,026 | 62.1 | ||||||||||||
|
Other non-portfolio company revenue
|
— | — | 221 | 1.2 | ||||||||||||
|
Total
|
$ | 291,751 | 100.0 | % | $ | 17,743 | 100.0 | % | ||||||||
Operating
Expenses
Operating expenses, net of credits from our Adviser for fees
earned and voluntary and irrevocable waivers applied to the base
management and incentive fees, decreased for the six months
ended March 31, 2011, as compared to the prior year period.
This reduction was primarily due to a decrease in interest
expense subsequent to March 31, 2010 and the amortization
of deferred financing fees incurred in connection with the
Credit Facility during the six months ended March 31, 2010,
and a decrease in the base management fee and professional fees,
which were partially offset by an increase in the incentive fee
during the six months ended March 31, 2011.
46
Interest expense decreased for the six months ended
March 31, 2011, as compared to the prior year period, due
primarily to decreased borrowings under the Credit Facility and
the reversal of $0.6 million minimum earnings shortfall fee
during the six months ended March 31, 2011. The weighted
average balance outstanding on the Credit Facility during the
six months ended March 31, 2011 was approximately
$17.2 million, as compared to $70.0 million in the
prior year period, a decrease of 75.4%. On November 22,
2010, we amended the Credit Facility such that advances bear
interest at LIBOR subject to a minimum rate of 1.5%, plus 3.75%
per annum. For the six months ended March 31, 2010, under
our prior credit facility and our
pre-amended
Credit Facility, advances generally bore interest at LIBOR
subject to a minimum rate of 2.0%, plus 4.0% to 4.5% per annum.
In addition to the lower interest rate, the amendment removed
the annual minimum earnings shortfall fee to the committed
lenders. Consequently, we reversed $0.6 million during the
six months ended March 31, 2011 that we had accrued through
September 30, 2010 for a projected minimum earnings
shortfall fee, as it was no longer applicable.
Amortization of deferred financing fees decreased for the six
months ended March 31, 2011, as compared to the prior year
period due to significant one-time costs related to the
termination of our prior credit facility and transition to the
Credit Facility, resulting in increased amortization of deferred
financing fees during the six months ended March 31, 2010
when compared to the six months ended March 31, 2011.
Professional fees decreased for the six months ended
March 31, 2011, as compared to the prior period, primarily
due to legal fees incurred in connection with troubled loans
during the six months ended March 31, 2010.
The base management fee decreased for the six months ended
March 31, 2011, as compared to the prior year period, which
is reflective of holding fewer assets subject to the base
management fee, compared to the prior year period. An incentive
fee was earned by our Adviser during the six months ended
March 31, 2011, due primarily to decreased interest
expense. The incentive fee earned during the prior year period
was due in part to other income generated from multiple exits.
The base management and incentive fees are computed quarterly,
as described under “Investment Advisory and Management
Agreement” in Note 4 of the notes to the
accompanying Condensed Consolidated Financial Statements
and are summarized in the following table:
| Six Months Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Average total assets subject to base management
fee(1)
|
$ | 271,200 | $ | 324,000 | ||||
|
Multiplied by pro-rated annual base management fee of 2.0%
|
1.0 | % | 1.0 | % | ||||
|
Unadjusted base management fee
|
$ | 2,712 | $ | 3,240 | ||||
|
Reduction for loan servicing
fees(2)
|
(1,599 | ) | (1,781 | ) | ||||
|
Base management
fee(2)
|
1,113 | 1,459 | ||||||
|
Credit for fees received by Adviser from the portfolio companies
|
— | — | ||||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee
on senior syndicated loans to 0.5% per annum
|
(133 | ) | (13 | ) | ||||
|
Net base management fee
|
$ | 980 | $ | 1,446 | ||||
|
Incentive
fee(2)
|
$ | 2,261 | $ | 1,447 | ||||
|
Credit from voluntary, irrevocable waiver issued by
Adviser’s board of directors
|
(21 | ) | (22 | ) | ||||
|
Net incentive fee
|
$ | 2,240 | $ | 1,425 | ||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee
on senior syndicated loans to 0.5% per annum
|
$ | (133 | ) | $ | (13 | ) | ||
|
Incentive fee credit
|
(21 | ) | (22 | ) | ||||
|
Credit to base management and incentive fees from
Adviser(2)
|
$ | (154 | ) | $ | (35 | ) | ||
| (1) | Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash and cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and appropriately adjusted for any share issuances or repurchases during the periods. |
47
| (2) | Reflected as a line item on the Condensed Consolidated Statement of Operations located elsewhere in this prospectus. |
Net
Realized Gain (Loss) on Investments
There were $5 in net realized gains for the six months ended
March 31, 2011, primarily due to realized gains from
unamortized discounts on exits during the period, partially
offset by realized losses in connection with workout
expenditures related to the Sunshine Media Holdings restructure.
Net realized losses on investments for the six months ended
March 31, 2010 were $28, which consisted of an aggregate of
$1.4 million of realized losses from our exits in CCS, LLC,
Gold Toe Investment Corp., Kinetek Acquisition Corporation and
Wesco Holdings, Inc., offset by a realized gain of
$1.4 million from our exit of ACE.
Net
Unrealized (Depreciation) Appreciation on Investments
Net unrealized (depreciation) appreciation on investments is the
net change in the fair value of our investment portfolio during
the reporting period, including the reversal of
previously-recorded unrealized appreciation or depreciation when
gains and losses are actually realized. During the six months
ended March 31, 2011, we recorded net unrealized
depreciation on investments in the aggregate amount of
$16.0 million. During the prior year period, we recorded
net unrealized appreciation on investments in the aggregate
amount of $5.1 million, which included the reversal of
$2.0 million in unrealized depreciation related to the
payoff of Visual Edge and the sale of CCS, LLC. Excluding
reversals, we had $3.1 million in net unrealized
appreciation for the six months ended March 31, 2010. The
net unrealized (depreciation) appreciation across our
investments for the six months ended March 31, 2011 was as
follows:
| Six Months Ended March 31, 2011 | ||||||
|
Net Unrealized |
||||||
|
Appreciation |
||||||
|
Portfolio Company
|
Investment Classification | (Depreciation) | ||||
|
Defiance Integrated Technologies, Inc.
|
Control | $ | 3,972 | |||
|
Puerto Rico Cable Acquisition Company, Inc.
|
Non-Control / Non-Affiliate | 732 | ||||
|
Midwest Metal Distribution, Inc.
|
Control | 636 | ||||
|
WP Evenflo Group Holdings, Inc.
|
Non-Control / Non-Affiliate | 333 | ||||
|
Sunshine Media Holdings
|
Non-Control / Non-Affiliate | (15,240 | ) | |||
|
Lindmark Acquisition, LLC
|
Control | (2,461 | ) | |||
|
GFRC Holdings LLC
|
Non-Control / Non-Affiliate | (1,216 | ) | |||
|
Heartland Communications Group
|
Non-Control / Non-Affiliate | (654 | ) | |||
|
Legend Communications of Wyoming LLC
|
Non-Control / Non-Affiliate | (582 | ) | |||
|
SCI Cable, Inc.
|
Non-Control / Non-Affiliate | (533 | ) | |||
|
International Junior Golf Training Acquisition Company
|
Non-Control / Non-Affiliate | (479 | ) | |||
|
LocalTel, LLC
|
Control | (374 | ) | |||
|
Access Television Network, Inc.
|
Non-Control / Non-Affiliate | (305 | ) | |||
|
Other, net (<$250)
|
157 | |||||
| Total: | $ | (16,014 | ) | |||
The primary driver to our net unrealized depreciation for the
six months ended March 31, 2011 was notable depreciation in
Sunshine, which was primarily due to portfolio company
performance and the restructure and certain comparable
multiples, partially offset by appreciation in Defiance
Integrated Technologies, Inc., which was due to an improvement
in portfolio company performance and in certain comparable
multiples.
48
The unrealized appreciation (depreciation) across our
investments for the six months ended March 31, 2010 was as
follows:
| Six Months Ended March 31, 2010 | ||||||
|
Net Unrealized |
||||||
|
Appreciation |
||||||
|
Portfolio Company
|
Investment Classification | (Depreciation) | ||||
|
Visual Edge Technology, Inc.
|
Non-Control / Non-Affiliate | $ | 1,716 | (1) | ||
|
BAS Broadcasting
|
Non-Control / Non-Affiliate | 1,266 | ||||
|
Westlake Hardware, Inc.
|
Non-Control / Non-Affiliate | 731 | ||||
|
Puerto Rico Cable Acquisition Company, Inc.
|
Non-Control / Non-Affiliate | 579 | ||||
|
Northern Contours, Inc.
|
Non-Control / Non-Affiliate | 542 | ||||
|
Kinetek Acquisition Corp.
|
Non-Control / Non-Affiliate | 513 | ||||
|
CCS, LLC
|
Non-Control / Non-Affiliate | 505 | (1) | |||
|
Wesco Holdings, Inc.
|
Non-Control / Non-Affiliate | 408 | ||||
|
Pinnacle Treatment Centers, Inc.
|
Non-Control / Non-Affiliate | 399 | ||||
|
WP Evenflo Group Holdings, Inc.
|
Non-Control / Non-Affiliate | 353 | ||||
|
Allison Publications, LLC
|
Non-Control / Non-Affiliate | 353 | ||||
|
Gold Toe Investment Corp
|
Non-Control / Non-Affiliate | 280 | ||||
|
Defiance Integrated Technologies, Inc.
|
Control | (816 | ) | |||
|
Midwest Metal Distribution, Inc. (formerly Clinton Holdings, LLC)
|
Control | (654 | ) | |||
|
KMBQ Corporation
|
Non-Control / Non-Affiliate | (598 | ) | |||
|
Finn Corporation
|
Non-Control / Non-Affiliate | (573 | ) | |||
|
Heartland Communications Group
|
Non-Control / Non-Affiliate | (447 | ) | |||
|
Legend Communications of Wyoming LLC
|
Non-Control / Non-Affiliate | (395 | ) | |||
|
LocalTel, LLC
|
Control | (357 | ) | |||
|
SCI Cable, Inc.
|
Non-Control / Non-Affiliate | (346 | ) | |||
|
Other, net (<$250)
|
1,623 | |||||
| Total: | $ | 5,082 | ||||
| (1) | Reflects the reversal of $1.7 million in unrealized depreciation in connection with payoff of the line of credit and senior subordinated term loan of Visual Edge Technology, Inc. |
| (2) | Reflects the reversal of the unrealized depreciation in connection with the $0.3 million realized loss on the sale of CCS, LLC. |
Excluding reversals, general increase in our net unrealized
appreciation for the six months ended March 31, 2010 was
experienced throughout the majority of our entire portfolio of
debt holdings, based on increases in market comparables and
portfolio company performance.
Over our entire investment portfolio, we recorded an aggregate
of approximately $18.5 million of net unrealized
depreciation on our debt positions for the six months ended
March 31, 2011, while our equity holdings experienced an
aggregate of approximately $2.5 million of net unrealized
appreciation. At March 31, 2011, the fair value of our
investment portfolio was less than its cost basis by
approximately $57.1 million, or 81.8% of cost, as compared
to $41.1 million at September 30, 2010, representing
net unrealized depreciation of $16.0 million for the
period. We believe that our aggregate investment portfolio was
valued at a depreciated value due primarily to certain reduced
performance by portfolio companies and the general instability
of the loan markets and resulting decrease in market multiples
relative to where multiples were when we originated such
investments in our portfolio. The unrealized depreciation of our
investments does not have an impact on our current ability to
pay distributions to stockholders; however, it may be an
indication of future realized losses, which could ultimately
reduce our income available for distribution to stockholders.
49
Net
Unrealized Appreciation on Borrowings
Net unrealized appreciation on borrowings is the net change in
the fair value of our line of credit borrowings during the
reporting period, including the reversal of previously recorded
unrealized appreciation or depreciation when gains and losses
are realized. We elected to apply ASC 825, “Financial
Instruments,” which requires us to apply a fair value
methodology to the Credit Facility. We estimated the fair value
of the Credit Facility using a combination of estimates of value
provided by an independent third party and our own assumptions
in the absence of observable market data, including estimated
remaining life, credit party risk, current market yield and
interest rate spreads of similar securities as of the
measurement date. The Credit Facility was fair valued at
$33.6 million as of March 31, 2011.
Net
(Decrease) Increase in Net Assets Resulting from
Operations
For the six months ended March 31, 2011, we realized a net
decrease in net assets resulting from operations of
$6.3 million as a result of the factors discussed above.
For the six months ended March 31, 2010, we realized a net
increase in net assets resulting from operations of
$14.3 million. Our net (decrease) increase in net assets
resulting from operations per basic and diluted weighted average
common share for the six months ended March 31, 2011 and
March 31, 2010 were $(0.30) and $0.68, respectively.
50
COMPARISON
OF THE FISCAL YEARS ENDED SEPTEMBER 30, 2010 AND
2009
A comparison of our operating results for the fiscal years
ended September 30, 2010 and 2009 is below:
| Year Ended September 30, | ||||||||||||||||
| 2010 | 2009 | $ Change | % Change | |||||||||||||
|
INVESTMENT INCOME
|
||||||||||||||||
|
Interest income
|
||||||||||||||||
|
Non-Control/Non-Affiliate investments
|
$ | 29,938 | $ | 40,747 | $ | (10,809 | ) | (26.5 | )% | |||||||
|
Control investments
|
2,645 | 933 | 1,712 | 183.5 | % | |||||||||||
|
Cash
|
1 | 11 | (10 | ) | (90.9 | )% | ||||||||||
|
Notes receivable from employees
|
437 | 468 | (31 | ) | (6.6 | )% | ||||||||||
|
Total interest income
|
33,021 | 42,159 | (9,138 | ) | (21.7 | )% | ||||||||||
|
Other income
|
2,518 | 459 | 2,059 | 448.6 | % | |||||||||||
|
Total investment income
|
35,539 | 42,618 | (7,079 | ) | (16.6 | )% | ||||||||||
|
EXPENSES
|
||||||||||||||||
|
Loan servicing fee
|
3,412 | 5,620 | (2,208 | ) | (39.3 | )% | ||||||||||
|
Base management fee
|
2,673 | 2,005 | 668 | 33.3 | % | |||||||||||
|
Incentive fee
|
1,823 | 3,326 | (1,503 | ) | (45.2 | )% | ||||||||||
|
Administration fee
|
807 | 872 | (65 | ) | (7.5 | )% | ||||||||||
|
Interest expense
|
4,390 | 7,949 | (3,559 | ) | (44.8 | )% | ||||||||||
|
Amortization of deferred financing fees
|
1,490 | 2,778 | (1,288 | ) | (46.4 | )% | ||||||||||
|
Professional fees
|
2,101 | 1,586 | 515 | 32.5 | % | |||||||||||
|
Compensation expense
|
245 | — | 245 | NM | ||||||||||||
|
Other expenses
|
1,259 | 1,131 | 128 | 11.3 | % | |||||||||||
|
Expenses before credit from Adviser
|
18,200 | 25,267 | (7,067 | ) | (28.0 | )% | ||||||||||
|
Credit to fees from Adviser
|
(420 | ) | (3,680 | ) | 3,260 | (88.6 | )% | |||||||||
|
Total expenses net of credit to credits to fees
|
17,780 | 21,587 | (3,807 | ) | (17.6 | )% | ||||||||||
|
NET INVESTMENT INCOME
|
17,759 | 21,031 | (3,272 | ) | (15.6 | )% | ||||||||||
|
REALIZED AND UNREALIZED LOSS ON:
|
||||||||||||||||
|
Net realized loss on investments
|
(2,893 | ) | (26,411 | ) | 23,518 | (89.0 | )% | |||||||||
|
Net unrealized appreciation on investments
|
2,317 | 9,513 | (7,196 | ) | (75.6 | )% | ||||||||||
|
Realized loss on settlement of derivative
|
— | (304 | ) | 304 | (100.0 | )% | ||||||||||
|
Net unrealized appreciation on derivative
|
— | 304 | (304 | ) | (100.0 | )% | ||||||||||
|
Net unrealized appreciation on borrowings under line of credit
|
(789 | ) | (350 | ) | (439 | ) | NM | |||||||||
|
Net loss on investments, derivative and borrowings under line of
credit
|
(1,365 | ) | (17,248 | ) | 15,883 | (92.1 | )% | |||||||||
|
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | 16,394 | $ | 3,783 | $ | 12,611 | 333.4 | % | ||||||||
NM = Not
Meaningful
Investment
Income
Investment income for the year ended September 30, 2010 was
$35,539 as compared to $42,618 for the year ended
September 30, 2009. Interest income from our aggregate
investment portfolio decreased for the year ended
51
September 30, 2010 as compared to the prior year. The level
of interest income from investments is directly related to the
balance, at cost, of the interest-bearing investment portfolio
outstanding during the year multiplied by the weighted average
yield. The weighted average yield varies from year to year based
on the current stated interest rate on interest-bearing
investments and the amounts of loans for which interest is not
accruing. Interest income from our investments decreased
primarily due to the overall reduction in the cost basis of our
investments, resulting primarily from the exit of 12 investments
during the year ended September 30, 2010. The annualized
weighted average yield on our portfolio was 9.9% for the year
ended September 30, 2010 as compared to 9.8% for the prior
year. As of September 30, 2010, six investments were on
non-accrual, for an aggregate of approximately $29,926 at cost,
or 10.0% of the aggregate cost of our investment portfolio and
as of September 30, 2009, five investments were on
non-accrual, for an aggregate of approximately $10,022 at cost,
or 2.8% of the aggregate cost of our investment portfolio.
Interest income from Non-Control/Non-Affiliate investments
decreased for the year ended September 30, 2010 as compared
to the prior year, primarily from an overall decrease in the
aggregate cost basis of our Non-Control/Non-Affiliate
investments during the year.
Interest income from Control investments increased for the year
ended September 30, 2010 as compared to the prior year. The
increase was attributable to the Control investments (mainly
Defiance and Midwest Metal) held for the entire year ended
September 30, 2010, where those same investments were held
for only a portion of the year ended September 30, 2009.
Interest income from invested cash was nominal for the years
ended September 30, 2010 and 2009.
Interest income from loans to employees, in connection with the
exercise of employee stock options, decreased slightly for the
year ended September 30, 2010 as compared to the prior year
due to principal payments on the employee loans during the year
ended September 30, 2010. In addition, during the year
ended September 30, 2010, $515 of an employee stock option
loan to a former employee of the Adviser was transferred from
notes receivable — employees to other assets in
connection with the termination of her employment with the
Adviser and the later amendment of the loan. The interest on the
loan from the time the employee stopped working for the Adviser
is included in other income on the accompanying consolidated
statement of operations.
Other income increased for the year ended September 30,
2010 as compared to the prior year. Other income includes
success fees as well as prepayment fees received upon the full
repayment of certain loan investments ahead of contractual
maturity and prepayment fees received upon the early unscheduled
principal repayments, which was based on a percentage of the
outstanding principal amount of the loan at the date of
prepayment. Success fees earned during the year ended
September 30, 2010 totaled $1,866, which we received from
ActivStyle, Anitox, Doe & Ingalls, Saunders, Northern
Contours, Tulsa Welding and Visual Edge. Success fees earned
during the year ended September 30, 2009 totaled $387,
which we received from ActivStyle, Interfilm and It’s Just
Lunch.
The following table lists the investment income for the five
largest portfolio companies during the respective years:
Year
Ended September 30, 2010
|
Investment |
% of |
|||||||
|
Company
|
Income | Total | ||||||
|
Sunshine Media
|
$ | 3,254 | 9.3 | % | ||||
|
Reliable Biopharma
|
3,003 | 8.6 | % | |||||
|
Westlake Hardware
|
2,940 | 8.4 | % | |||||
|
Midwest Metal (Clinton)#
|
2,127 | 6.1 | % | |||||
|
Winchester
|
1,589 | 4.5 | % | |||||
|
Subtotal
|
$ | 12,913 | 36.9 | % | ||||
|
Other companies
|
22,036 | 63.1 | % | |||||
|
Total income from investments*
|
$ | 34,949 | 100.0 | % | ||||
52
Year
Ended September 30, 2009
|
Investment |
% of |
|||||||
|
Company
|
Income | Total | ||||||
|
Sunshine Media
|
$ | 3,352 | 8.0 | % | ||||
|
Reliable Biopharma
|
3,073 | 7.3 | % | |||||
|
Westlake Hardware
|
2,417 | 5.7 | % | |||||
|
Clinton Holdings
|
1,888 | 4.5 | % | |||||
|
VantaCore
|
1,696 | 4.0 | % | |||||
|
Subtotal
|
$ | 12,426 | 29.5 | % | ||||
|
Other companies
|
29,711 | 70.5 | % | |||||
|
Total income from investments*
|
$ | 42,137 | 100.0 | % | ||||
| # | During the year ended September 30, 2010 Clinton Holdings was restructured as Midwest Metal. | |
| * | Includes interest and other income from Non-Control and Control investments. |
Operating
Expenses
Operating expenses, net of credits from the Adviser for fees
earned and voluntary irrevocable and unconditional waivers to
the base management and incentive fees, decreased for the year
ended September 30, 2010 as compared to the prior year.
This reduction was primarily due to a decrease in interest
expense and amortization of deferred financing fees incurred in
connection with the Credit Facility, which were partially offset
by an increase in professional fees.
Loan servicing fees decreased for the year ended
September 30, 2010 as compared to the prior year. These
fees were incurred in connection with a loan servicing agreement
between Business Loan and our Adviser, which is based on the
size and mix of the portfolio. The decrease was primarily due to
the reduction in the size of our investment portfolio. Due to
voluntary, irrevocable and unconditional waivers in place during
these years, senior syndicated loans incurred a 0.5% annual fee,
whereas proprietary loans incurred a 1.5% annual fee. All of
these fees were reduced against the amount of the base
management fee due to our Adviser.
Base management fee (which is net of loan servicing fees)
increased for the year ended September 30, 2010 as compared
to the prior year. However, the gross management fee (consisting
of the loan servicing fees plus the base management fee)
decreased from the prior year as shown below:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2010 | 2009 | |||||||
|
Loan servicing fee
|
$ | 3,412 | $ | 5,620 | ||||
|
Base management fee
|
2,673 | 2,005 | ||||||
|
Gross management fee
|
$ | 6,085 | $ | 7,625 | ||||
Gross management fee decreased due to fewer total assets held
during the year ended September 30, 2010. The base
management fee is computed quarterly as described under
“Investment Advisory and Management
53
Agreement” in Note 4 of the notes to the accompanying
consolidated financial statements, and is summarized in the
table below:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2010 | 2009 | |||||||
|
Base management
fee(1)
|
$ | 2,673 | $ | 2,005 | ||||
|
Credit for fees received by Adviser from the portfolio companies
|
(213 | ) | (89 | ) | ||||
|
Fee reduction for the voluntary, irrevocable and unconditional
waiver of 2% fee on senior syndicated loans to
0.5%(2)
|
(42 | ) | (265 | ) | ||||
|
Net base management fee
|
$ | 2,418 | $ | 1,651 | ||||
| (1) | Base management fee is net of loan servicing fees per the terms of the Advisory Agreement. | |
| (2) | The board of our Adviser voluntarily, irrevocably and unconditionally waived on a quarterly basis the annual 2% base management fee to 0.5% for senior syndicated loan participations for the years ended September 30, 2010 and 2009. Fees waived cannot be recouped by the Adviser in the future. |
Incentive fee decreased for the year ended September 30,
2010 as compared to the prior year. The board of our Adviser
voluntarily, irrevocably and unconditionally waived a portion of
the incentive fee for the year ended September 30, 2010 and
the entire incentive fee for the year ended September 30,
2009. The incentive fee and associated credits are summarized in
the table below:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2010 | 2009 | |||||||
|
Incentive fee
|
$ | 1,823 | $ | 3,326 | ||||
|
Credit from voluntary, irrevocable and unconditional waiver
issued by Adviser’s board of directors
|
(165 | ) | (3,326 | ) | ||||
|
Net incentive fee
|
$ | 1,658 | $ | — | ||||
Administration fee decreased for the year ended
September 30, 2010 as compared to the prior year, due to a
decrease of administration staff and related expenses, as well
as a decrease in our total assets in comparison to the total
assets of all companies managed by our Adviser under similar
agreements. The calculation of the administration fee is
described in detail under “Investment Advisory and
Management Agreement” in Note 4 of the notes to the
accompanying consolidated financial statements.
Interest expense decreased for the year ended September 30,
2010 as compared to the prior year due primarily to decreased
borrowings under our line of credit during the year ended
September 30, 2010. The balance for the year ended
September 30, 2010 included $590 of the minimum earnings
shortfall fee that was accrued as of September 30, 2010.
Amortization of deferred financing fees decreased for the year
ended September 30, 2010 as compared to the prior year due
to significant one-time costs related to the termination of our
prior credit facility and transition to the Credit Facility,
resulting in increased amortization of deferred financing fees
during the year ended September 30, 2009 as compared to the
year ended September 30, 2010.
Compensation expense increased for the year ended
September 30, 2010 as compared to the prior year due to the
conversion of stock option loans of two former employees from
recourse to non-recourse loans. The conversions were non-cash
transactions and were accounted for as repurchases of the shares
previously received by the employees upon exercise of the stock
options in exchange for the non-recourse notes. The repurchases
were accounted for as treasury stock transactions at the fair
value of the shares, totaling $420. Since the value of the stock
option loans totaled $665, we recorded compensation expense of
$245.
Other operating expenses (including professional fees,
stockholder related costs, director’s fees, insurance and
other direct expenses) increased for the year ended
September 30, 2010 as compared to the prior year, due
primarily
54
to legal fees incurred in connection with certain portfolio
loans during the year ended September 30, 2010 and an
increase in the provision for uncollectible receivables from
portfolio companies.
Realized
Loss and Unrealized Appreciation (Depreciation) on
Investments
Realized
Losses
For the year ended September 30, 2010, we recorded a net
realized loss on investments of $2,893, which consisted of
$4,259 of losses from three syndicated loan sales (Gold Toe,
Kinetek and Wesco), the Western Directories write-off, and the
CCS payoff, offset by a $1,366 gain from the ACE Expediters
payoff. For the year ended September 30, 2009, we recorded
a net realized loss on investments of $26,411, which consisted
of $15,029 of losses from the sale of several syndicated loans
and one non-syndicated loan, a $9,409 write-off of the Badanco
loan, and a $2,000 write-off of a portion of the Greatwide
second lien syndicated loan, partially offset by a $27 gain from
the Country Road payoff.
Unrealized
Appreciation (Depreciation)
Net unrealized appreciation (depreciation) on investments is the
net change in the fair value of our investment portfolio during
the reporting period, including the reversal of previously
recorded unrealized appreciation or depreciation when gains and
losses are actually realized. The net unrealized appreciation
for the years ended September 30, 2010 and 2009 consisted
of the following:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2010 | 2009 | |||||||
|
Reversal of previously recorded unrealized depreciation upon
realization of losses
|
$ | 6,411 | $ | 24,531 | ||||
|
Appreciation from Control investments
|
1,098 | 1,564 | ||||||
|
Depreciation from Non-Control/Non-Affiliate investments
|
(5,192 | ) | (16,582 | ) | ||||
|
Net unrealized appreciation on investments
|
$ | 2,317 | $ | 9,513 | ||||
The primary driver of our net unrealized appreciation for the
years ended September 30, 2010 and 2009 was the reversal of
previously recorded unrealized depreciation on our exited
investments. Our Control investments also experienced unrealized
appreciation due to an increase in certain comparable multiples.
However, our Non-Control investments experienced unrealized
depreciation, which was due primarily to a reduction in certain
comparable multiples and the performance of some of our
portfolio companies used to estimate the fair value of our
investments. Although our investment portfolio appreciated
during the year ended September 30, 2010, our entire
portfolio was fair valued at 86% of cost as of
September 30, 2010. The cumulative unrealized depreciation
of our investments does not have an impact on our current
ability to pay distributions to stockholders; however, it may be
an indication of future realized losses, which could ultimately
reduce our income available for distribution.
Realized
Loss and Unrealized Appreciation on Derivative
For the year ended September 30, 2009, we realized a loss
of $304 due to the expiration of the interest rate cap in
February 2009. In addition, we recorded unrealized appreciation
on derivative of $304, which resulted from the reversal of
previously recorded unrealized depreciation when the loss was
realized during the year.
Net
Unrealized Appreciation on Borrowings under Line of
Credit
Net unrealized appreciation on borrowings under line of credit
is the net change in the fair value of our line of credit
borrowings during the reporting period, including the reversal
of previously recorded unrealized appreciation or depreciation
when gains and losses are realized. The net unrealized
appreciation on borrowings under line of credit for the years
ended September 30, 2010 and 2009 were $789 and $350,
respectively. We elected to apply ASC 825, “Financial
Instruments,” which requires that we apply a fair value
methodology to the Credit Facility. We estimated the fair value
of the Credit Facility using estimates of value provided by an
independent third party and our own assumptions in the absence
of observable market data, including estimated remaining life,
current market
55
yield and interest rate spreads of similar securities as of the
measurement date. The Credit Facility was fair valued at $17,940
and $83,350 as of September 30, 2010 and 2009,
respectively. As a result, we recorded unrealized appreciation
of $789 and $350 for the years ended September 30, 2010 and
2009, respectively.
Net
Increase in Net Assets from Operations
For the year ended September 30, 2010, we realized a net
increase in net assets resulting from operations of $16,394 as a
result of the factors discussed above. For the year ended
September 30, 2009, we realized a net increase in net
assets resulting from operations of $3,783. Our net increase in
net assets resulting from operations per basic and diluted
weighted average common share for the years ended
September 30, 2010 and 2009 were $0.78 and $0.18,
respectively.
56
COMPARISON
OF THE FISCAL YEARS ENDED SEPTEMBER 30, 2009 AND SEPTEMBER 30,
2008
A comparison of our operating results for the fiscal years
ended September 30, 2009 and 2008 is below:
|
Year Ended |
||||||||||||||||
| September 30, | ||||||||||||||||
| 2009 | 2008 | $ Change | % Change | |||||||||||||
|
INVESTMENT INCOME
|
||||||||||||||||
|
Interest income — non control/non affiliate investments
|
$ | 40,747 | $ | 43,734 | $ | (2,987 | ) | (6.8 | )% | |||||||
|
Interest income — control investments
|
933 | 64 | 869 | 1,357.8 | % | |||||||||||
|
Interest income — cash
|
11 | 335 | (324 | ) | (96.7 | )% | ||||||||||
|
Interest income — notes receivable from employees
|
468 | 471 | (3 | ) | (0.6 | )% | ||||||||||
|
Prepayment fees and other income
|
459 | 1,121 | (662 | ) | (59.1 | )% | ||||||||||
|
Total investment income
|
42,618 | 45,725 | (3,107 | ) | (6.8 | )% | ||||||||||
|
EXPENSES
|
||||||||||||||||
|
Interest expense
|
7,949 | 8,284 | (335 | ) | (4.0 | )% | ||||||||||
|
Loan servicing fee
|
5,620 | 6,117 | (497 | ) | (8.1 | )% | ||||||||||
|
Base management fee
|
2,005 | 2,212 | (207 | ) | (9.4 | )% | ||||||||||
|
Incentive fee
|
3,326 | 5,311 | (1,985 | ) | (37.4 | )% | ||||||||||
|
Administration fee
|
872 | 985 | (113 | ) | (11.5 | )% | ||||||||||
|
Professional fees
|
1,586 | 911 | 675 | 74.1 | % | |||||||||||
|
Amortization of deferred financing fees
|
2,778 | 1,534 | 1,244 | 81.1 | % | |||||||||||
|
Stockholder related costs
|
415 | 443 | (28 | ) | (6.3 | )% | ||||||||||
|
Directors’ fees
|
197 | 220 | (23 | ) | (10.5 | )% | ||||||||||
|
Insurance expense
|
241 | 227 | 14 | 6.2 | % | |||||||||||
|
Other expenses
|
278 | 325 | (47 | ) | (14.5 | )% | ||||||||||
|
Expenses before credit from Adviser
|
25,267 | 26,569 | (1,302 | ) | (4.9 | )% | ||||||||||
|
Credit to base management and incentive fees from Adviser
|
(3,680 | ) | (7,397 | ) | 3,717 | (50.3 | )% | |||||||||
|
Total expenses net of credit to base management and incentive
fees
|
21,587 | 19,172 | 2,415 | 12.6 | % | |||||||||||
|
NET INVESTMENT INCOME
|
21,031 | 26,553 | (5,522 | ) | (20.8 | )% | ||||||||||
|
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, DERIVATIVE
AND BORROWINGS UNDER LINE OF CREDIT:
|
||||||||||||||||
|
Net realized loss on investments
|
(26,411 | ) | (787 | ) | (25,624 | ) | 3,255.9 | % | ||||||||
|
Realized (loss) gain on settlement of derivative
|
(304 | ) | 7 | (311 | ) | (4,442.9 | )% | |||||||||
|
Net unrealized appreciation (depreciation) on derivative
|
304 | (12 | ) | 316 | (2,633.3 | )% | ||||||||||
|
Net unrealized appreciation (depreciation) on investments
|
9,513 | (47,023 | ) | 56,536 | (120.2 | )% | ||||||||||
|
Net unrealized appreciation on borrowings under line of credit
|
(350 | ) | — | (350 | ) | — | ||||||||||
|
Net loss on investments, derivative and borrowings under line of
credit
|
(17,248 | ) | (47,815 | ) | 30,567 | (63.9 | )% | |||||||||
|
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | 3,783 | $ | (21,262 | ) | 25,045 | (117.8 | )% | ||||||||
57
Investment
Income
Investment income for the year ended September 30, 2009 was
$42,618 as compared to $45,725 for the year ended
September 30, 2008. Interest income from our aggregate
investment portfolio decreased for the year ended
September 30, 2009 as compared to the prior year. The level
of interest income from investments is directly related to the
balance, at cost, of the interest-bearing investment portfolio
outstanding during the year multiplied by the weighted average
yield. The weighted average yield varies from year to year based
on the current stated interest rate on interest-bearing
investments and the amounts of loans for which interest is not
accruing. Interest income from our investments decreased
primarily due to the overall reduction in the cost basis of our
investments, resulting primarily from the exit of 15 investments
during the year ended September 30, 2009, as well as a
slight decrease in the weighted average yield on our portfolio.
The annualized weighted average yield on our portfolio was 9.8%
for the year ended September 30, 2009 as compared to 10.0%
for the prior year. During the year ended September 30,
2009, five investments were on non-accrual, for an aggregate of
approximately $10,022 at cost, or 2.8% of the aggregate cost of
our investment portfolio and during the prior year, three
investments were on non-accrual for an aggregate of
approximately $13,098 at cost, or 2.8% of the aggregate cost of
our investment portfolio.
Interest income from Non-Control/Non-Affiliate investments
decreased for the year ended September 30, 2009 as compared
to the prior year, primarily from an overall decrease in the
aggregate cost basis of our Non-Control/Non-Affiliate
investments during the year. In addition, the success fees
earned during the year ended September 30, 2009 totaled
$387, compared to $998 earned in the prior year. Success fees
earned during the year ended September 30, 2009 resulted
from refinancings by ActivStyle and It’s Just Lunch and an
amendment by Interfilm. Success fees earned during the year
ended September 30, 2008 resulted from refinancings by
Defiance and Westlake Hardware and a full repayment from Express
Courier.
Interest income from Control investments increased for the year
ended September 30, 2009 as compared to the prior year. The
increase was attributable to four additional Control investments
held during the year ended September 30, 2009, which were
converted from Non-Control/Non-Affiliate investments.
The following table lists the interest income from investments
for the five largest portfolio companies during the respective
years:
Year
ended September 30, 2009
|
Interest |
% of |
|||||||
|
Company
|
Income | Total | ||||||
|
Sunshine Media
|
$ | 3,377 | 8.0 | % | ||||
|
Reliable Biopharma
|
3,076 | 7.3 | % | |||||
|
Westlake Hardware
|
2,451 | 5.8 | % | |||||
|
Clinton Holdings
|
1,899 | 4.5 | % | |||||
|
VantaCore
|
1,705 | 4.0 | % | |||||
|
Subtotal
|
$ | 12,508 | 29.6 | % | ||||
|
Other companies
|
29,629 | 70.4 | % | |||||
|
Total interest income
|
$ | 42,137 | 100.0 | % | ||||
58
Year
ended September 30, 2008
|
Interest |
% of |
|||||||
|
Company
|
Income | Total | ||||||
|
Sunshine Media
|
$ | 2,939 | 6.5 | % | ||||
|
Reliable Biopharma
|
2,871 | 6.4 | % | |||||
|
Westlake Hardware
|
2,860 | 6.4 | % | |||||
|
Clinton Holdings
|
1,903 | 4.2 | % | |||||
|
Winchester Electronics
|
1,401 | 3.1 | % | |||||
|
Subtotal
|
$ | 11,974 | 26.6 | % | ||||
|
Other companies
|
32,945 | 73.4 | % | |||||
|
Total interest income
|
$ | 44,919 | 100.0 | % | ||||
Interest income from invested cash decreased for the year ended
September 30, 2009 as compared to the prior year. Interest
income came from the following sources:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2009 | 2008 | |||||||
|
Interest earned on Gladstone Capital
account(1)
|
$ | — | $ | 50 | ||||
|
Interest earned on Business Loan custodial
account(2)
|
10 | 199 | ||||||
|
Interest earned on Gladstone Financial
account(3)
|
1 | 86 | ||||||
|
Total interest income from invested cash
|
$ | 11 | $ | 335 | ||||
| (1) | Interest earned on our Gladstone Capital account during the year ended September 30, 2008 resulted from proceeds received from the equity offerings completed during the fiscal year that were held in the account prior to being invested or used to pay down the line of credit. | |
| (2) | Interest earned on our Business Loan custodial account during the year ended September 30, 2008 resulted from large cash amounts held in the account prior to disbursement. During this fiscal year, we had $140,817 of originations to new portfolio companies. | |
| (3) | Interest earned on our Gladstone Financial account during the year ended September 30, 2008 resulted from the U.S. Treasury bill that was held with an original maturity of six months. |
Interest income from loans to our employees, in connection with
the exercise of employee stock options, decreased slightly for
the year ended September 30, 2009 as compared to the prior
year due to principal payments on the employee loans during the
current year.
Prepayment fees and other income decreased for the year ended
September 30, 2009 as compared to the prior year. The
income for the prior year consisted of prepayment penalty fees
received upon the full repayment of certain loan investments
ahead of contractual maturity and prepayment fees received upon
the early unscheduled principal repayments, which was based on a
percentage of the outstanding principal amount of the loan at
the date of prepayment.
Operating
Expenses
Operating expenses, net of credits from the Adviser for fees
earned and voluntary irrevocable and unconditional waivers to
the base management and incentive fees, increased for the year
ended September 30, 2009 as compared to the prior year
primarily due to an increase in professional fees and
amortization of deferred financing fees incurred in connection
with our previous credit facility with Deutsche Bank AG, or the
DB Facility, and the new KEF Facility.
Interest expense decreased for the year ended September 30,
2009 as compared to the prior year due primarily to decreased
borrowings under our line of credit during the year ended
September 30, 2009, partially offset by a
59
higher weighted average annual interest cost, which is
determined by using the annual stated interest rate plus
commitment and other fees, plus the amortization of deferred
financing fees divided by the weighted average debt outstanding.
Loan servicing fees decreased for the year ended
September 30, 2009 as compared to the prior year. These
fees were incurred in connection with a loan servicing agreement
between Business Loan and our Adviser, which is based on the
size and mix of the portfolio. The decrease was primarily due to
the reduction in the size of our investment portfolio. Due to
voluntary, irrevocable and unconditional waivers in place during
these years, senior syndicated loans incurred a 0.5% annual fee,
whereas proprietary loans incurred a 1.5% annual fee. All of
these fees were reduced against the amount of the base
management fee due to our Adviser.
The base management fee decreased for the year ended
September 30, 2009 as compared to the prior year, which is
reflective of fewer total assets held during the year ended
September 30, 2009. Furthermore, due to the liquidation of
the majority of our syndicated loans, the credit received
against the gross base management fee for investments in
syndicated loans has also been reduced. The base management fee
is computed quarterly as described under “Investment
Advisory and Management Agreement” in Note 4 to the
accompanying consolidated financial statements, and is
summarized in the table below:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2009 | 2008 | |||||||
|
Base management
fee(1)
|
$ | 2,005 | $ | 2,212 | ||||
|
Credit for fees received by Adviser from the portfolio companies
|
(89 | ) | (1,678 | ) | ||||
|
Fee reduction for the voluntary, irrevocable and unconditional
waiver of 2% fee on senior syndicated loans to
0.5%(2)
|
(265 | ) | (408 | ) | ||||
|
Net base management fee
|
$ | 1,651 | $ | 126 | ||||
| (1) | Base management fee is net of loan servicing fees per the terms of the Advisory Agreement. | |
| (2) | The board of our Adviser voluntarily, irrevocably and unconditionally waived on a quarterly basis the annual 2.0% base management fee to 0.5% for senior syndicated loan participations for the years ended September 30, 2009 and 2008. Fees waived cannot be recouped by the Adviser in the future. |
Incentive fee decreased for the year ended September 30,
2009 as compared to the prior year. The board of our Adviser
voluntarily, irrevocably and unconditionally waived on a
quarterly basis the entire incentive fee for each quarter of the
years ended September 30, 2009 and 2008. The incentive fee
and associated credits are summarized in the table below:
| Year Ended | ||||||||
|
September 30, |
September 30, |
|||||||
| 2009 | 2008 | |||||||
|
Incentive fee
|
$ | 3,326 | $ | 5,311 | ||||
|
Credit from voluntary, irrevocable and unconditional waiver
issued by Adviser’s board of directors
|
(3,326 | ) | (5,311 | ) | ||||
|
Net incentive fee
|
$ | — | $ | — | ||||
Administration fee decreased for the year ended
September 30, 2009 as compared to the prior year, due to a
decrease of administration staff and related expenses, as well
as a decrease in our total assets in comparison to the total
assets of all companies managed by our Adviser under similar
agreements. The calculation of the administrative fee is
described in detail under “Investment Advisory and
Management Agreement” in Note 4 of the notes to the
accompanying consolidated financial statements.
Other operating expenses (including deferred financing fees,
stockholder related costs, directors’ fees, insurance and
other expenses) increased over the prior year driven by
amortization of additional fees incurred with amending the DB
Facility and entering into the new KEF Facility and legal fees
incurred in connection with troubled loans in the current year.
60
Net
Realized Loss on Investments
The realized loss for the year ended September 30, 2009
consisted of a $15,029 loss from the sale of several syndicated
loans and one non-syndicated loan, a $9,409 write-off of the
Badanco loan, and a $2,000 write-off of a portion of the
Greatwide second lien syndicated loan, partially offset by a $27
gain from the Country Road payoff. Net realized loss on
investments during the year ended September 30, 2008
resulted from the partial sale of the senior subordinated term
debt of Greatwide Logistics, as well as the unamortized
investment acquisition costs related to the Anitox and Macfadden
loans, which were repaid in full during the year.
Realized
(Loss) Gain on Settlement of Derivative
The realized loss for the year ended September 30, 2009 was
due to the expiration of our interest rate cap agreement in
February 2009. We did not receive any interest rate cap
agreement payments during the period from October 2008 through
February 2009 as a result of the one-month LIBOR having a
downward trend. During the year ended September 30, 2008,
we received interest rate cap agreement payments of only $7 as a
result of the one-month LIBOR having a downward trend. We
received payments when the one-month LIBOR was over 5%.
Net
Unrealized Appreciation (Depreciation) on Derivative
Net unrealized appreciation (depreciation) on derivative is the
net change in the fair value of our interest rate cap during the
year, including the reversal of previously recorded unrealized
appreciation or depreciation when gains and losses are realized.
The unrealized appreciation on derivative during the year ended
September 30, 2009 resulted from the reversal of previously
recorded unrealized depreciation when the loss was realized
during the three months ended March 31, 2009. For the year
ended September 30, 2008, the unrealized depreciation was
due to a decrease in the fair market value of our interest rate
cap agreement.
Net
Unrealized Appreciation (Depreciation) on Investments
Net unrealized appreciation (depreciation) on investments is the
net change in the fair value of our investment portfolio during
the year, including the reversal of previously recorded
unrealized appreciation or depreciation when gains and losses
are realized. The net unrealized appreciation on investments for
the year ended September 30, 2009 consisted of the
following:
|
• Control investments
|
$ | 1,564 | ||
|
• Non-Control/Non-Affiliate investments
|
(16,582 | ) | ||
|
• Reversal of previously unrealized depreciation upon
realization of losses
|
24,531 | |||
|
Total
|
$ | 9,513 | ||
We believe that our investment portfolio was valued at a
depreciated value due primarily to the general instability of
the loan markets. Although our investment portfolio has
depreciated, our entire portfolio was fair valued at 88% of cost
as of September 30, 2009. The cumulative unrealized
depreciation of our investments does not have an impact on our
current ability to pay distributions to stockholders; however,
it may be an indication of future realized losses, which could
ultimately reduce our income available for distribution.
Net
Unrealized Appreciation on Borrowings under Line of
Credit
Unrealized appreciation on borrowings under line of credit is
the net change in the fair value of our line of credit
borrowings during the year, including the reversal of previously
recorded unrealized appreciation or depreciation when gains and
losses are realized. During the year ended September 30,
2009, we elected to apply ASC 825, “Financial
Instruments,” which requires that we apply a fair value
methodology to the KEF Facility. We estimated the fair value of
the KEF Facility using estimates of value provided by an
independent third party and our own assumptions in the absence
of observable market data, including estimated remaining life,
current market yield and interest rate spreads of similar
securities as of the measurement date. The KEF Facility was fair
valued at $83,350 as of September 30, 2009, and an
unrealized appreciation of $350 was recorded for the year ended
September 30, 2009.
61
Net
Increase (Decrease) in Net Assets from Operations
For the year ended September 30, 2009, we realized a net
increase in net assets resulting from operations of $3,783 as a
result of the factors discussed above. For the year ended
September 30, 2008, we realized a net decrease in net
assets resulting from operations of $21,262. Our net increase
(decrease) in net assets resulting from operations per basic and
diluted weighted average common share for the years ended
September 30, 2009 and 2008 were $0.18 and ($1.08),
respectively.
LIQUIDITY
AND CAPITAL RESOURCES
Operating
Activities
Net cash used in operating activities for the six months ended
March 31, 2011 was $6.7 million and consisted
primarily of disbursements of $44.2 million in new
investments, partially offset by principal repayments of
$35.2 million and net unrealized depreciation of
$16.0 million. Net cash provided by operating activities
for the six months ended March 31, 2010 was
$39.2 million and consisted primarily of principal
repayments of $38.4 million.
At March 31, 2011, we had investments in equity of, loans
to, or syndicated participations in, 45 private companies with
an aggregate cost basis of approximately $314.2 million. At
March 31, 2010, we had investments in equity of, loans to,
or syndicated participations in, 41 private companies with an
aggregate cost basis of approximately $330.1 million. The
following table summarizes our total portfolio investment
activity during the six months ended March 31, 2011 and
2010:
| Six Months Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Beginning investment portfolio at fair value
|
$ | 257,109 | $ | 320,969 | ||||
|
New investments
|
44,203 | 180 | ||||||
|
Disbursements to existing portfolio companies
|
8,220 | 6,700 | ||||||
|
Principal repayments
|
(35,227 | ) | (38,471 | ) | ||||
|
Proceeds from sales
|
(777 | ) | (3,119 | ) | ||||
|
Increase in investment balance due to PIK
|
8 | 60 | ||||||
|
Increase in investment balance due to transferred interest
|
204 | 441 | ||||||
|
Unrealized (depreciation) appreciation
|
(16,014 | ) | 1,645 | |||||
|
Reversal of prior period depreciation on realization
|
— | 3,437 | ||||||
|
Net realized gain (loss)
|
163 | (28 | ) | |||||
|
Net change in premiums, discounts and amortization
|
(776 | ) | (63 | ) | ||||
|
Ending investment portfolio at fair value
|
$ | 257,113 | $ | 291,751 | ||||
62
The following table summarizes the contractual principal
repayments and maturity of our investment portfolio by fiscal
year, assuming no voluntary prepayments, at March 31, 2011.
| Amount | ||||
|
For the remaining six months ending September 30:
|
||||
|
2011
|
$ | 18,295 | ||
|
For the fiscal year ending September 30:
|
||||
|
2012
|
76,646 | |||
|
2013
|
122,981 | |||
|
2014
|
28,863 | |||
|
2015
|
32,088 | |||
|
2016 and thereafter
|
30,926 | |||
|
Total contractual repayments
|
$ | 309,799 | ||
|
Investments in equity securities
|
5,984 | |||
|
Adjustments to cost basis on debt securities
|
(1,548 | ) | ||
|
Total cost basis of investments held at March 31, 2011:
|
$ | 314,235 | ||
Net cash provided by operating activities for the years ended
September 30, 2010 and 2009 were $86,501 and $95,521,
respectively, and consisted primarily of proceeds received from
the principal payments received from existing investments,
partially offset by the purchase of new investments. In
contrast, net cash used in operating activities for the year
ended September 30, 2008 was $80,218, and consisted of the
purchase of new investments, partially offset by principal loan
repayments.
As of September 30, 2010, we had investments in debt
securities, or loans to or syndicated participations in 39
private companies with a cost basis totaling $298,216. As of
September 30, 2009, we had investments in debt securities,
or loans to or syndicated participations in 48 private companies
with a cost basis totaling $364,393. The following table
summarizes our total portfolio investment activity during the
years ended September 30, 2010 and 2009:
| Year Ended September 30, | ||||||||
| 2010 | 2009 | |||||||
|
Beginning investment portfolio at fair value
|
$ | 320,969 | $ | 407,933 | ||||
|
New investments
|
23,245 | 24,911 | ||||||
|
Principal repayments (including repayment of PIK)
|
(82,566 | ) | (47,490 | ) | ||||
|
Proceeds from sales
|
(3,119 | ) | (49,203 | ) | ||||
|
Increase in investment balance due to PIK
|
53 | 166 | ||||||
|
Increase in investment balance due to rolled-over interest
|
529 | 1,455 | ||||||
|
Loan impairment / contra-investment
|
(715 | ) | — | |||||
|
Net unrealized appreciation
(depreciation)(1)
|
2,317 | 9,513 | ||||||
|
Net realized loss
|
(2,893 | ) | (26,411 | ) | ||||
|
Amortization of premiums and discounts
|
(711 | ) | 95 | |||||
|
Ending investment portfolio at fair value
|
$ | 257,109 | $ | 320,969 | ||||
| (1) | Includes the reversal of unrealized depreciation due to investment exits for the years ended September 30, 2010 and 2009 of $6,411 and $24,835, respectively. |
63
During the fiscal years ended September 30, 2010, 2009 and
2008, the following investment activity occurred during each
quarter of the respective fiscal year:
|
New |
Principal |
Proceeds from |
Net Gain (Loss) |
|||||||||||||
|
Quarter Ended
|
Investments(1) | Repayments(2) | Sales/Exits(3) | on Disposal | ||||||||||||
|
September 30, 2010
|
$ | 14,193 | $ | 25,615 | $ | — | $ | — | ||||||||
|
June 30, 2010
|
2,171 | 18,482 | — | (2,865 | ) | |||||||||||
|
March 31, 2010
|
4,817 | 23,065 | 337 | 892 | ||||||||||||
|
December 31, 2009
|
2,064 | 15,404 | 2,782 | (920 | ) | |||||||||||
|
Total fiscal year 2010
|
$ | 23,245 | $ | 82,566 | $ | 3,119 | $ | (2,893 | ) | |||||||
|
September 30, 2009
|
$ | 1,221 | $ | 4,071 | $ | 7,241 | $ | (12,086 | ) | |||||||
|
June 30, 2009
|
6,975 | 15,439 | 39,750 | (10,594 | ) | |||||||||||
|
March 31, 2009
|
8,013 | 13,053 | — | (2,000 | ) | |||||||||||
|
December 31, 2008
|
8,702 | 14,927 | 2,212 | (1,731 | ) | |||||||||||
|
Total fiscal year 2009
|
$ | 24,911 | $ | 47,490 | $ | 49,203 | $ | (26,411 | ) | |||||||
|
September 30, 2008
|
$ | 39,048 | $ | 21,381 | $ | 1,299 | $ | (701 | ) | |||||||
|
June 30, 2008
|
43,678 | 40,755 | — | (86 | ) | |||||||||||
|
March 31, 2008
|
20,483 | 3,000 | — | — | ||||||||||||
|
December 31, 2007
|
73,341 | 4,047 | — | — | ||||||||||||
|
Total fiscal year 2008
|
$ | 176,550 | $ | 69,183 | $ | 1,299 | $ | (787 | ) | |||||||
| (1) | New Investments: |
|
Disbursements to |
||||||||||||||||
| New Investments |
Existing Portfolio |
Total |
||||||||||||||
|
Quarter Ended
|
Companies | Investments | Companies | Disbursements | ||||||||||||
|
September 30, 2010
|
1 | (a) | $ | 10,000 | $ | 4,193 | $ | 14,193 | ||||||||
|
June 30, 2010
|
1 | (b) | 400 | 1,771 | 2,171 | |||||||||||
|
March 31, 2010
|
— | — | 4,817 | 4,817 | ||||||||||||
|
December 31, 2009
|
1 | (c) | 180 | 1,884 | 2,064 | |||||||||||
|
Total fiscal year 2010
|
3 | $ | 10,580 | $ | 12,665 | $ | 23,245 | |||||||||
|
September 30, 2009
|
— | $ | — | $ | 1,221 | $ | 1,221 | |||||||||
|
June 30, 2009
|
— | — | 6,975 | 6,975 | ||||||||||||
|
March 31, 2009
|
— | — | 8,013 | 8,013 | ||||||||||||
|
December 31, 2008
|
— | — | 8,702 | 8,702 | ||||||||||||
|
Total fiscal year 2009
|
— | $ | — | $ | 24,911 | $ | 24,911 | |||||||||
|
September 30, 2008
|
3 | (d) | $ | 33,375 | $ | 5,673 | $ | 39,048 | ||||||||
|
June 30, 2008
|
3 | (e) | 35,750 | 7,928 | 43,678 | |||||||||||
|
March 31, 2008
|
1 | (f) | 13,700 | 6,783 | 20,483 | |||||||||||
|
December 31, 2007
|
5 | (g) | 57,992 | 15,349 | 73,341 | |||||||||||
|
Total fiscal year 2008
|
12 | $ | 140,817 | $ | 35,733 | $ | 176,550 | |||||||||
| (a) | Airvana Network Solutions | |
| (b) | FedCap Partners | |
| (c) | Northstar Broadband | |
| (d) | AKQA, VantaCore and Tulsa Welding School |
64
| (e) | Saunders, Legend and BAS Broadcasting | |
| (f) | ACE Expediters | |
| (g) | Interfilm, Reliable, Lindmark, GS Maritime and GFRC |
(2) Principal
Repayments (including repayment of PIK previously applied to
principal balance):
|
Number of |
Unscheduled |
Scheduled |
Total |
|||||||||||||||||
|
Companies |
Principal |
Principal |
Principal |
Net Gain on |
||||||||||||||||
|
Quarter Ended
|
Fully Exited | Repayments(*) | Repayments | Repayments | Sale/Exit(#) | |||||||||||||||
|
September 30, 2010
|
2 | (a) | $ | 14,135 | $ | 11,480 | $ | 25,615 | $ | — | ||||||||||
|
June 30, 2010
|
1 | (b) | 13,590 | 4,892 | 18,482 | — | ||||||||||||||
|
March 31, 2010
|
4 | (c) | 18,902 | 4,163 | 23,065 | 1,055 | ||||||||||||||
|
December 31, 2009
|
1 | (d) | 13,054 | 2,350 | 15,404 | — | ||||||||||||||
|
Total fiscal year 2010
|
8 | $ | 59,681 | $ | 22,885 | $ | 82,566 | $ | 1,055 | |||||||||||
|
September 30, 2009
|
— | $ | — | $ | 4,071 | $ | 4,071 | $ | — | |||||||||||
|
June 30, 2009
|
1 | (e) | 10,449 | 4,990 | 15,439 | — | ||||||||||||||
|
March 31, 2009
|
— | (f) | 7,813 | 5,240 | 13,053 | — | ||||||||||||||
|
December 31, 2008
|
2 | (g) | 6,966 | 7,961 | 14,927 | — | ||||||||||||||
|
Total fiscal year 2009
|
3 | $ | 25,228 | $ | 22,262 | $ | 47,490 | $ | — | |||||||||||
|
September 30, 2008
|
2 | (h) | $ | 12,797 | $ | 8,584 | $ | 21,381 | $ | — | ||||||||||
|
June 30, 2008
|
3 | (i) | 28,134 | 12,621 | 40,755 | — | ||||||||||||||
|
March 31, 2008
|
— | (j) | 500 | 2,500 | 3,000 | — | ||||||||||||||
|
December 31, 2007
|
— | — | 4,047 | 4,047 | — | |||||||||||||||
|
Total fiscal year 2008
|
5 | $ | 41,431 | $ | 27,752 | $ | 69,183 | $ | — | |||||||||||
| (*) | Includes principal payments due to excess cash flows, covenant violations, exits, refinancing, etc. | |
| (#) | Net gain on principal repayments of $1,055 plus the net loss on sales/exits of $3,948 (per footnote 3 below) equals net loss of $2,893, which is included on the consolidated statement of operations for the year ended September 30, 2010. | |
| (a) | Full payoff from Anitox and Doe and Ingalls. | |
| (b) | Full payoff from VantaCore. | |
| (c) | Full payoff from ACE Expediters (which resulted in a gain on the warrants), ActivStyle, CCS and Visual Edge. | |
| (d) | Full payoff from Tulsa Welding and partial payoff from BAS Broadcasting senior term debt (last out tranche). | |
| (e) | Full payoff from Multi-Ag Media ($1,687), partial payoff from Saunders line of credit ($2,500) and refinancing from ActivStyle ($6,262). | |
| (f) | Refinancing from ACE Expediters and Sunburst media. | |
| (g) | Full payoff from Community Media and Country Road. | |
| (h) | Full payoff from Express Courier International and Meteor Holding. | |
| (i) | Full payoff from Macfadden Performing Arts, Reading Broadcasting and SCS ($25,074) and partial payoff from Anitox Senior Real Estate Term Debt ($3,060). | |
| (j) | Partial payoff from Risk Metrics Senior Subordinated Term Debt. |
65
| (3) | Loan Sales/Exits: |
|
Number of |
Position |
Unamortized |
Net (Loss) |
|||||||||||||||||
|
Companies |
Proceeds |
(Principal) |
Loan |
Gain on |
||||||||||||||||
|
Quarter Ended
|
Fully Exited | Received | Exited | Costs(*) | Exit(#) | |||||||||||||||
|
September 30, 2010
|
— | $ | — | $ | — | $ | — | $ | — | |||||||||||
|
June 30, 2010
|
1 | (a) | — | (2,865 | ) | — | (2,865 | ) | ||||||||||||
|
March 31, 2010
|
1 | (b) | 337 | (500 | ) | — | (163 | ) | ||||||||||||
|
December 31, 2009
|
2 | (c) | 2,782 | (3,685 | ) | (17 | ) | (920 | ) | |||||||||||
|
Total fiscal year 2010
|
4 | $ | 3,119 | $ | (7,050 | ) | $ | (17 | ) | $ | (3,948 | ) | ||||||||
|
September 30, 2009
|
3 | (d) | $ | 7,241 | $ | (19,321 | ) | $ | (6 | ) | $ | (12,086 | ) | |||||||
|
June 30, 2009
|
8 | (e) | 39,750 | (52,295 | ) | 1,951 | (10,594 | ) | ||||||||||||
|
March 31, 2009
|
1 | (f) | — | (2,000 | ) | — | (2,000 | ) | ||||||||||||
|
December 31, 2008
|
— | (g) | 2,212 | (3,950 | ) | 7 | (1,731 | ) | ||||||||||||
|
Total fiscal year 2009
|
12 | $ | 49,203 | $ | (77,566 | ) | $ | 1,952 | $ | (26,411 | ) | |||||||||
|
September 30, 2008
|
— | (h) | $ | 1,299 | $ | (2,000 | ) | $ | — | $ | (701 | ) | ||||||||
|
June 30, 2008
|
— | — | — | (86 | ) | (86 | ) | |||||||||||||
|
March 31, 2008
|
— | — | — | — | — | |||||||||||||||
|
December 31, 2007
|
— | — | — | — | — | |||||||||||||||
|
Total fiscal year 2008
|
— | $ | 1,299 | $ | (2,000 | ) | $ | (86 | ) | $ | (787 | ) | ||||||||
| (*) | Includes balance of premiums, discounts and acquisition cost at time of exit. | |
| (#) | Net gain on principal repayments of $1,055 (per footnote 2 above) plus the net loss on sales/exits of $3,948 equals net loss of $2,893, which is included on the consolidated statement of operations for the year ended September 30, 2010. | |
| (a) | Write-off of Western Directories line of credit, preferred stock and common stock. | |
| (b) | Complete sale of Gold Toe senior subordinated syndicated loan. | |
| (c) | Complete sale of Kinetek senior term syndicated loan and Wesco Holdings senior subordinated syndicated loan. | |
| (d) | Full sale of CHG and John Henry syndicated loans, write-off of Badanco loan, and partial sale of Kinetek syndicated loan (senior subordinated debt). | |
| (e) | Full sale of 8 loans (7 syndicated and 1 non-syndicated) and partial sale of CHG, GTM and Wesco syndicated loans (senior term debt). | |
| (f) | Write-off of Greatwide syndicated loan (senior subordinated term debt). | |
| (g) | Partial sale of Greatwide Logistics syndicated loan (senior term debt). | |
| (h) | Partial sale of Greatwide Logistics syndicated loan (senior subordinated term debt). |
66
The following table summarizes the contractual principal
repayment and maturity of our investment portfolio by fiscal
year, assuming no voluntary prepayments.
|
Fiscal Year Ending September 30,
|
Amount | |||
|
2011
|
$ | 59,575 | ||
|
2012
|
72,201 | |||
|
2013
|
124,496 | |||
|
2014
|
31,840 | |||
|
2015
|
6,850 | |||
|
Total Contractual Repayments
|
$ | 294,962 | ||
|
Investments in equity securities
|
4,189 | |||
|
Unamortized premiums, discounts and investment acquisition costs
on debt securities
|
(935 | ) | ||
|
Total
|
$ | 298,216 | ||
Investing
Activities
Net cash provided by investing activities for the fiscal year
ended September 30, 2008 was $2,484 for the redemption of a
U.S. Treasury Bill with an original maturity of six months.
The U.S. Treasury Bill was purchased in 2007 with proceeds
from our initial stock purchase in our wholly-owned subsidiary,
Gladstone Financial Corporation (previously known as Gladstone
SSBIC Corporation).
Financing
Activities
Net cash provided by financing activities for the six months
ended March 31, 2011 was $7.9 million and consisted
primarily of net borrowings from the Credit Facility of
$16.4 million, partially offset by distributions to
stockholders of $8.8 million. Net cash used in financing
activities for the six months ended March 31, 2010 was
$40.3 million and primarily consisted of net payments on
the Credit Facility of $30.0 million and distributions to
stockholders of $8.9 million.
Net cash used in financing activities for the fiscal year ended
September 30, 2010 was $84,043 and mainly consisted of net
payments on the Credit Facility of $91,100, distribution
payments of $17,690 and financing fees of $1,525 associated with
the Credit Facility, which was entered into on March 15,
2010.
Net cash used in financing activities for the fiscal year ended
September 30, 2009 was $96,738 and mainly consisted of net
payments on our line of credit of $68,030, distribution payments
of $26,570 and financing fees of $2,103 associated with the
Credit Facility which was entered into on May 15, 2009.
Net cash provided by financing activities for the fiscal year
ended September 30, 2008 was $75,388 and mainly consisted
of net borrowings on our line of credit of $6,590, proceeds of
$105,374, net of offering costs, from the issuance of common
stock and distribution payments of $33,379.
Distributions
To qualify as a RIC and, therefore, avoid corporate level tax on
the income we distribute to our stockholders, we are required,
under Subchapter M of the Code, to distribute at least 90% of
our ordinary income and short-term capital gains to our
stockholders on an annual basis. In accordance with these
requirements, we declared and paid monthly cash distributions of
$0.14 per common share for each month from October 2008 through
March 2009 and $0.07 per common share for each month from April
2009 through March 2011. We declared and paid monthly cash
distributions of $0.14 per common share during each month of the
fiscal year ended September 30, 2008.
For the year ended September 30, 2010, our distribution
payments were approximately $17.7 million. We declared
these distributions based on our estimates of net investment
income for the fiscal year. Our investment pace was slower than
expected and, consequently, our net investment income was lower
than our original estimates. A portion of the distributions
declared during fiscal 2010 is expected to be treated as a
return of capital to our stockholders.
67
Issuance
of Equity
We have filed a registration statement with the SEC, which we
refer to as the Registration Statement, of which this prospectus
is a part, that permits us to issue, through one or more
transactions, up to an aggregate of $300 million in
securities, consisting of common stock, preferred stock,
subscription rights, debt securities and warrants to purchase
common stock, or a combined offering of these securities.
We anticipate issuing equity securities to obtain additional
capital in the future. However, we cannot determine the terms of
any future equity issuances or whether we will be able to issue
equity on terms favorable to us, or at all. Additionally, when
our common stock is trading below NAV, as it has consistently
traded for most of the last 2 years, we will have
regulatory constraints under the 1940 Act on our ability to
obtain additional capital in this manner. Generally, the 1940
Act provides that we may not issue and sell our common stock at
a price below our NAV per share, other than to our then existing
stockholders pursuant to a rights offering, without first
obtaining approval from our stockholders and our independent
directors. As of March 31, 2011, our NAV per share was
$11.18 per share and as of July 11, 2011 our closing market
price was $9.54 per share. To the extent that our common
stock trades at a market price below our NAV per share, we will
generally be precluded from raising equity capital through
public offerings of our common stock, other than pursuant to
stockholder approval or a rights offering. The asset coverage
requirement of a BDC under the 1940 Act effectively limits our
ratio of debt to equity to 1:1. To the extent that we are unable
to raise capital through the issuance of equity, our ability to
raise capital through the issuance of debt may also be inhibited
to the extent of our regulatory debt to equity ratio limits.
At our annual meeting of stockholders held on February 17,
2011, stockholders approved a proposal which authorizes us to
sell shares of our common stock at a price below our then
current NAV per share for a period of one year from the date of
approval, provided 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 and
that our Board of Directors makes certain determinations prior
to any such sale. We have not issued any common stock since
February 2008.
On May 17, 2010, we and our Adviser entered into an equity
distribution agreement, which we refer to as the Equity
Agreement, with BB&T Capital Markets, a division of
Scott & Stringfellow, LLC, who we refer to as the
Agent, under which we may, from time to time, issue and sell
through the Agent up to 2,000,000 shares of our common
stock, or the Shares, based upon instructions from us
(including, at a minimum, the number of Shares to be offered,
the time period during which sales are requested to be made, any
limitation on the number of Shares that may be sold in any one
day and any minimum price below which sales may not be made).
Sales of Shares through the Agent, if any, will be executed by
means of either ordinary brokers’ transactions on the
NASDAQ Global Select Market in accordance with Rule 153
under the Securities Act or such other sales of the Shares as
shall be agreed by us and the Agent. The compensation payable to
the Agent for sales of Shares with respect to which the Agent
acts as sales agent shall be equal to 2.0% of the gross sales
price of the Shares for amounts of Shares sold pursuant to the
Agreement. To date, we have not issued any shares pursuant to
the Equity Agreement and the agreement may be terminated by us
or the Agent at any time.
Revolving
Credit Facility
On March 15, 2010, we entered into the Credit Facility,
which currently provides for a $127 million revolving line
of credit. Advances under the Credit Facility initially bore
interest at the
30-day LIBOR
(subject to a minimum rate of 2.0%), plus 4.5% per annum, with a
commitment fee of 0.5% per annum on undrawn amounts. However, on
November 22, 2010 (the Amendment Date), we amended our
Credit Facility such that advances bear interest at the
30-day LIBOR
(subject to a minimum rate of 1.5%), plus 3.75% per annum, with
a commitment fee of 0.5% per annum on undrawn amounts when the
facility is drawn more than 50% and 1.0% per annum on undrawn
amounts when the facility is drawn less than 50%. Subject to
certain terms and conditions, the Credit Facility may be
expanded up to $202,000 through the addition of other committed
lenders to the facility. As of March 31, 2011, there was a
cost basis of approximately $33.2 million of borrowings
outstanding under the Credit Facility at an average interest
rate of 5.25%. As of July 11, 2011, there was a cost basis
of approximately $92.20 million of borrowings outstanding.
We expect that the Credit Facility will allow us to increase the
rate of our investment activity and grow the size of our
investment portfolio. Available borrowings are subject to
various constraints
68
imposed under the Credit Facility, based on the aggregate loan
balance pledged by us. Interest is payable monthly during the
term of the Credit Facility. The Credit Facility matures on
March 15, 2012, and, if the facility is not renewed or
extended by this date, all unpaid principal and interest will be
due and payable on March 15, 2013. In addition, if the
Credit Facility is not renewed on or before March 15, 2012,
we will be required to use all principal collections from our
loans to pay outstanding principal on the Credit Facility.
In addition to the annual interest rate on borrowings
outstanding, under the terms of the Credit Facility prior to the
Amendment Date, we were obligated to pay an annual minimum
earnings shortfall fee to the committed lenders on
March 15, 2011, which was calculated as the difference
between the weighted average of borrowings outstanding under the
Credit Facility and 50% of the commitment amount of the Credit
Facility, multiplied by 4.5% per annum, less commitment fees
paid during the year. As of the Amendment Date, we paid a
$0.7 million fee.
The Credit Facility contains covenants that require Business
Loan to maintain its status as a separate entity, prohibit
certain significant corporate transactions (such as mergers,
consolidations, liquidations or dissolutions) and restrict
material changes to our credit and collection policies. The
facility requires a minimum of 20 obligors in the borrowing base
and also limits payments of distributions. As of March 31,
2011, Business Loan had 30 obligors and we were in compliance
with all of the Credit Facility covenants.
Contractual
Obligations and Off-Balance Sheet Arrangements
As of September 30, 2010, we had a commitment to purchase a
$3,000 syndicated loan, which closed subsequent to
September 30, 2010 and as of March 31, 2011, we were
not party to any signed term sheets for potential investments.
However, we have certain line of credit and capital commitments
with our portfolio companies that have not been fully drawn or
called, respectively. Since these commitments have expiration
dates, and we expect many will never be fully drawn or called,
the total commitment amounts do not necessarily represent future
cash requirements. In addition, we have certain lines of credit
with 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. We estimate the fair value of these unused lines
of credit commitments as of March 31, 2011 and
September 30, 2010 to be nominal.
In July 2009, we executed a guaranty of a line of credit
agreement between Comerica Bank and Defiance Integrated
Technologies, Inc., or Defiance, one of our Control investments,
which we refer to as the Guaranty. Pursuant to the Guaranty, if
Defiance had a payment default, the guaranty was callable once
the bank had reduced its claim by using commercially reasonable
efforts to collect through disposition of the Defiance
collateral. The guaranty was limited to $0.3 million plus
interest on that amount accrued from the date demand payment was
made under the Guaranty, and all costs incurred by the bank in
its collection efforts. On March 1, 2011, the Guaranty was
terminated.
In accordance with GAAP, the unused portions of the lines of
credit commitments are not recorded on the accompanying
consolidated statements of assets and liabilities. The following
table summarizes the nominal dollar balance of unused line of
credit commitments, uncalled capital commitments and guarantees
as of March 31, 2011 and September 30, 2010:
| As of | ||||||||
|
March 31, |
September 30, |
|||||||
| 2011 | 2010 | |||||||
|
Unused lines of credit
|
$ | 7,361 | $ | 9,304 | ||||
|
Uncalled capital commitment
|
1,200 | 1,600 | ||||||
|
Guarantees
|
— | 250 | ||||||
The following table shows our contractual obligations as of
September 30, 2010:
| Payments Due by Period | ||||||||||||||||||||
|
Less than |
||||||||||||||||||||
|
Contractual
Obligations(1)
|
1 Year | 1-3 Years | 4-5 Years | After 5 Years | Total | |||||||||||||||
|
Line of
credit(2)
|
— | $ | 17,940 | — | — | $ | 17,940 | |||||||||||||
69
| (1) | Excludes the unused commitments to extend credit to our portfolio companies of $9,304, as discussed above. | |
| (2) | Borrowings under the Credit Facility are listed, at fair value, based on the contractual maturity due to the revolving nature of the facility. |
Quantitative
and Qualitative Disclosures About Market Risk
Market risk includes risks that arise from changes in interest
rates, foreign currency exchange rates, commodity prices, equity
prices and other market changes that affect market sensitive
instruments. The prices of securities held by the us may decline
in response to certain events, including those directly
involving the companies whose securities are owned by us;
conditions affecting the general economy; overall market
changes; local, regional or global political, social or economic
instability; and interest rate fluctuations.
The primary risk we believe we are exposed to is interest rate
risk. Because we borrow money to make investments, our net
investment is dependent upon the difference between the rate at
which we borrow funds and the rate at which we invest those
funds. As a result, there can be no assurance that a significant
change in market interest rates will not have a material adverse
effect on our net investment income. We use a combination of
debt and equity capital to finance our investing activities. We
may use interest rate risk management techniques to limit our
exposure to interest rate fluctuations. Such techniques may
include various interest rate hedging activities to the extent
permitted by the 1940 Act. We have analyzed the potential impact
of changes in interest rates on interest income net of interest
expense.
While we expect that ultimately approximately 20% of the loans
in our portfolio will be made at fixed rates, with approximately
80% made at variable rates or variables rates with a floor
mechanism, all of our variable-rate loans have rates associated
with either the current LIBOR or Prime Rate. At March 31,
2011, our portfolio, at cost, consisted of the following
breakdown in relation to all outstanding debt investments: