<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
------------------
FOR THE QUARTERLY PERIOD
ENDED SEPTEMBER 30, 1999
COMMISSION FILE NUMBER:
0-22832
ALLIED CAPITAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
MARYLAND
(State or Jurisdiction of
Incorporation or Organization)
52-1081052
(IRS Employer
Identification No.)
1919 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, DC 20006
(Address of Principal Executive Offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 331-1112
------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 12 of 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
On November 5, 1999 there were 62,491,777 shares outstanding of the
Registrant's common stock, $0.0001 par value.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
(This page has been left blank intentionally)
<PAGE> 3
ALLIED CAPITAL CORPORATION
FORM 10-Q INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of September 30,
1999 (unaudited) and December 31, 1998............. 1
Consolidated Statement of Operations -- For the
Three and Nine Months Ended September 30, 1999 and
1998 (unaudited)................................... 2
Consolidated Statement of Changes in Net
Assets -- For the Nine Months Ended September 30,
1999 and 1998 (unaudited).......................... 3
Consolidated Statement of Cash Flows -- For the
Nine Months Ended September 30, 1999 and 1998
(unaudited)........................................ 4
Consolidated Statement of Investments as of
September 30, 1999 (unaudited) and December 31,
1998............................................... 5
Notes to Consolidated Financial Statements........ 16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......... 27
Item 3. Quantitative and Qualitative Disclosures about
Market Risk........................................... 43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................. 44
Item 2. Changes in Securities and Use of Proceeds...... 44
Item 3. Defaults Upon Senior Securities................ 44
Item 4. Submission of Matters to a Vote of Security
Holders............................................... 44
Item 5. Other Information.............................. 44
Item 6. Exhibits and Reports on Form 8-K............... 44
Signatures............................................. 47
</TABLE>
<PAGE> 4
(This page has been left blank intentionally)
<PAGE> 5
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) (UNAUDITED)
<S> <C> <C>
ASSETS
Portfolio at value:
Mezzanine loans and debt securities (cost:
1999-$495,169; 1998-$354,870)........................ $ 476,003 $339,163
Commercial mortgage-backed securities (cost:
1999-$297,656; 1998-$115,174)........................ 296,156 113,674
Commercial mortgage loans (cost: 1999-$185,128;
1998-$232,745)....................................... 185,481 233,186
Small Business Administration 7(a) loans (cost:
1999-$69,394; 1998-$57,651).......................... 68,912 56,285
Equity interests in portfolio companies (cost:
1999-$43,192; 1998-$27,618).......................... 70,031 49,391
Other portfolio assets (cost: 1999-$7,572;
1998-$8,331)......................................... 7,070 8,575
---------- --------
Total portfolio at value.......................... 1,103,653 800,274
---------- --------
Cash and cash equivalents................................... 15,376 25,075
Other assets................................................ 50,502 30,730
---------- --------
Total assets...................................... $1,169,531 $856,079
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable.......................... $ 404,850 $239,350
Revolving lines of credit............................. 133,000 95,000
Accounts payable and other liabilities................ 30,848 27,912
Dividends and distributions payable................... -- 1,700
---------- --------
Total liabilities................................. 568,698 363,962
---------- --------
Commitments and Contingencies
Preferred stock issued to Small Business Administration..... 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares
authorized; 62,488,443 and 56,729,502 issued and
outstanding at September 30, 1999 and December 31,
1998, respectively................................... 6 6
Additional paid-in capital............................ 637,096 526,824
Common stock held in deferred compensation trust
(516,779 shares and 810,456 shares at September 30,
1999 and December 31, 1998, respectively)............ (13,128) (19,431)
Notes receivable from sale of common stock............ (27,276) (23,735)
Net unrealized appreciation on portfolio.............. 3,855 2,380
Distributions in excess of earnings................... (6,720) (927)
---------- --------
Total shareholders' equity........................ 593,833 485,117
---------- --------
Total liabilities and shareholders' equity........ $1,169,531 $856,079
========== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE> 6
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Interest and related portfolio income:
Interest................................ $31,577 $20,183 $84,419 $58,428
Net premiums from loan dispositions..... 4,700 865 9,032 2,913
Net gain on securitization of commercial
mortgage loans........................ -- -- -- 14,812
Investment advisory fees and other
income................................ 1,721 1,498 5,411 4,611
------- ------- ------- -------
Total interest and related portfolio
income............................ 37,998 22,546 98,862 80,764
------- ------- ------- -------
Expenses:
Interest on indebtedness................ 9,766 5,709 24,173 14,539
Salaries and employee benefits.......... 4,192 2,737 11,303 8,254
General and administrative.............. 3,200 3,093 8,476 8,970
------- ------- ------- -------
Total operating expenses............ 17,158 11,539 43,952 31,763
Formula and cut-off awards.............. 1,567 1,606 5,188 5,532
------- ------- ------- -------
Portfolio income before net realized and
unrealized gains............................ 19,273 9,401 49,722 43,469
------- ------- ------- -------
Net realized and unrealized gains:
Net realized gains...................... 4,886 6,207 16,448 20,001
Net unrealized gains (losses)........... 2,785 883 1,475 (437)
------- ------- ------- -------
Total net realized and unrealized
gains............................. 7,671 7,090 17,923 19,564
------- ------- ------- -------
Income before minority interests and income
taxes....................................... 26,944 16,491 67,645 63,033
Income tax expense............................ -- 1,585 -- 1,585
------- ------- ------- -------
Net increase in net assets resulting from
operations.................................. $26,944 $14,906 $67,645 $61,448
======= ======= ======= =======
Basic earnings per common share............... $ 0.44 $ 0.29 $ 1.14 $ 1.19
======= ======= ======= =======
Diluted earnings per common share............. $ 0.44 $ 0.29 $ 1.14 $ 1.19
======= ======= ======= =======
Weighted average common shares outstanding --
basic....................................... 61,042 51,373 59,077 51,502
======= ======= ======= =======
Weighted average common shares outstanding --
diluted..................................... 61,458 51,377 59,239 51,712
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 7
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- --------
(UNAUDITED)
<S> <C> <C>
Operations:
Portfolio income before realized and unrealized
gains................................................. $ 49,722 $ 43,469
Net realized gains..................................... 16,448 20,001
Net unrealized gains (losses).......................... 1,475 (437)
Minority interests and income tax expense.............. -- 1,585
-------- --------
Net increase in net assets resulting from
operations....................................... 67,645 61,448
-------- --------
Shareholder distributions:
Portfolio income....................................... (71,800) (54,727)
Preferred stock dividend............................... (165) (165)
-------- --------
Net decrease in net assets resulting from
shareholder distributions........................ (71,965) (54,892)
-------- --------
Capital share transactions:
Sale of common stock................................... 103,022 --
Net decrease (increase) in notes receivable from sale
of common stock....................................... (3,540) 5,711
Issuance of common stock upon the exercise of stock
options............................................... 3,753 222
Issuance of common stock in lieu of cash
distributions......................................... 3,498 4,097
Purchase of common stock by deferred compensation
trust................................................. -- (19,431)
Distribution of common stock by deferred compensation
trust................................................. 6,303 --
Other.................................................. -- 1,500
-------- --------
Net increase (decrease) in net assets resulting
from capital share transactions.................. 113,036 (7,901)
-------- --------
Total increase (decrease) in net assets..................... $108,716 $ (1,345)
-------- --------
Net assets at beginning of period........................... $485,117 $420,060
-------- --------
Net assets at end of period................................. $593,833 $418,715
======== ========
Net asset value per common share............................ $ 9.58 $ 8.13
======== ========
Common shares outstanding at end of period.................. 61,972 51,490
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 8
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1999 1998
(IN THOUSANDS) --------- ---------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net increase in net assets resulting from operations...... $ 67,645 $ 61,448
Adjustments
Net unrealized (gains) losses........................... (1,475) (286)
Net gain on securitization of commercial mortgage
loans.................................................. -- (14,812)
Depreciation and amortization........................... 599 523
Amortization of loan discounts and fees................. (6,195) (3,237)
Changes in other assets and liabilities................. (11,518) 6,206
--------- ---------
Net cash provided by operating activities............. 49,056 49,842
--------- ---------
Cash flows from investing activities:
Investments in small business concerns.................... (534,017) (349,586)
Collections of investment principal....................... 120,563 75,817
Proceeds from loan sales.................................. 120,871 28,957
Proceeds from securitization of commercial mortgage
loans................................................... -- 223,401
Net redemption (purchase) of U.S. government securities... -- 11,091
Collections of notes receivable from sale of common
stock................................................... 212 5,411
Other investing activities................................ (2,738) (1,431)
--------- ---------
Net cash used in investing activities................. (295,109) (6,340)
--------- ---------
Cash flows from financing activities:
Sale of common stock...................................... 103,079 222
Purchase of common stock by deferred compensation trust... -- (19,431)
Common dividends and distributions paid................... (70,003) (51,107)
Special undistributed earnings distribution paid.......... -- (8,261)
Preferred stock dividends................................. (165) (385)
Net borrowings under (payments on) debentures and notes
payable................................................. 165,500 (17,171)
Net borrowings under (payments on) revolving lines of
credit.................................................. 38,000 31,158
Other financing activities................................ (57) (5,342)
--------- ---------
Net cash provided by (used in) financing activities... 236,354 (70,317)
--------- ---------
Net decrease in cash and cash equivalents................... $ (9,699) $ (26,815)
Cash and cash equivalents at beginning of period............ $ 25,075 $ 70,437
--------- ---------
Cash and cash equivalents at end of period.................. $ 15,376 $ 43,622
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 9
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
ACE Products, Inc. Debt Securities $ 13,171 $ 13,171
- -----------------------------------------------------------------------------------------------------
Acme Paging, L.P. Debt Securities 6,525 6,525
Partnership Interest 1,456 2,100
- -----------------------------------------------------------------------------------------------------
Allied Office Products Debt Securities 9,952 9,952
Warrants -- --
- -----------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc. Warrants 125 125
- -----------------------------------------------------------------------------------------------------
AMF Bowling, Inc. (1) High Yield Debt 5,479 5,479
- -----------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -----------------------------------------------------------------------------------------------------
Aurora Communications Inc. Loans 13,365 13,365
Preferred Stock 1,500 1,500
- -----------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 11,934 11,934
Warrants 1,180 1,180
- -----------------------------------------------------------------------------------------------------
CampGroup, LLC Debt Securities 2,450 2,450
Warrants 220 220
- -----------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- -----------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 318 318
Warrants 12 12
- -----------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,610 850
Common Stock (220 shares) 1 --
- -----------------------------------------------------------------------------------------------------
Convenience Corporation of Debt Securities 8,391 2,774
America Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc. Debt Securities 3,458 3,458
Warrants -- 1,138
- -----------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,921 5,921
- -----------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 5,809 5,809
Resources, LLC Options 87 87
- -----------------------------------------------------------------------------------------------------
Coverall North America Loan 9,296 9,296
- -----------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 --
- -----------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 --
- -----------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 49
- -----------------------------------------------------------------------------------------------------
Directory Investment Corporation Common Stock (470 shares) -- --
- -----------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (34 shares) -- --
Series B Common Stock (6 shares) 8 --
Series C Common Stock (10 shares) 22 --
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE> 10
<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Drilltec Patents & Technologies Loan $ 10,908 $ 8,752
Company, Inc. Debt Securities 426 426
Warrants -- --
- -----------------------------------------------------------------------------------------------------
ECM Enterprises Loan 28 4
- -----------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 14 14
Debt Securities 1,875 343
Common Stock (100 shares) 250 --
- -----------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Loans 306 306
- -----------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -----------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 --
- -----------------------------------------------------------------------------------------------------
Everything Yogurt Loan 8 8
- -----------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) 500 500
Common Stock (2,500 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Executive Greetings, Inc. Debt Securities 15,736 15,736
Warrants 360 360
- -----------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,740 5,740
Company Warrants 280 3,628
- -----------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- -----------------------------------------------------------------------------------------------------
FTI Consulting, Inc. (1) Debt Securities 11,874 11,874
Warrants 970 970
- -----------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,731 30,731
Communications, LLC Warrants -- 750
- -----------------------------------------------------------------------------------------------------
Genesis Worldwide, Inc. (1) Loan 1,328 1,328
Common Stock (41,644 shares) 214 151
- -----------------------------------------------------------------------------------------------------
Genoa Mine Acquisition Loan 242 242
Corporation
- -----------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,572 15,572
Warrants 525 1,000
- -----------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- 154
- -----------------------------------------------------------------------------------------------------
Global Communications I, LLC Debt Securities 1,863 1,863
Preferred Stock 5,667 5,667
- -----------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 840
Archery, LLC Convertible Debentures 2,248 2,008
- -----------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 8,500
- -----------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,171 9,171
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Han Hie Loan 504 504
- -----------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- -----------------------------------------------------------------------------------------------------
Jack Henry & Associates, Inc. (1) Common Stock (90,498 shares) 26 3,079
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE> 11
<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Jakel, Inc. Loan $ 17,938 $ 17,938
- -----------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 62 62
- -----------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,130 2,130
Warrants 74 74
- -----------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 3,801 3,801
Warrants 324 4,100
- -----------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Warrants 348 3,495
Equity Interest 4 9
- -----------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,309 6,309
Warrants 96 1,500
- -----------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,648 7,648
Warrants 348 348
- -----------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,430 3,430
Common Stock (64,535 shares) 142 142
- -----------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- -----------------------------------------------------------------------------------------------------
Liqui-Dri Foods, Inc. Loans 10,782 10,782
- -----------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High Yield Debt 15,150 15,150
- -----------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
- -----------------------------------------------------------------------------------------------------
Master Plan, Inc. Common Stock (156 shares) 42 3,042
- -----------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- -----------------------------------------------------------------------------------------------------
MedAssets.com, Inc. Loans 3,803 3,803
Series B Convertible Preferred Stock 2,049 2,049
(227,665 shares)
Warrants 136 136
- -----------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,933 2,933
- -----------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, LLC Loan 10,936 10,936
- -----------------------------------------------------------------------------------------------------
Midview Associates, L.P. Warrants -- --
- -----------------------------------------------------------------------------------------------------
Mihadas Loan 285 285
- -----------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 17 17
Debt Securities 1,823 370
Common Stock (33,333 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Morton Industrial Group (1) Common Stock (5,835 shares) 241 82
- -----------------------------------------------------------------------------------------------------
MVL Group Debt Securities 13,768 13,768
Warrants 849 849
- -----------------------------------------------------------------------------------------------------
NET-Tel Communications, Inc. Debt Securities 9,479 9,479
Series B Convertible Preferred Stock 5,000 5,000
(647 shares)
Warrants 500 500
- -----------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 23 23
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE> 12
<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Nobel Learning Communities, Debt Securities $ 9,473 $ 9,473
Inc. (1) Series D Convertible Preferred Stock 2,000 2,000
(265,957 shares)
Warrants 575 575
- -----------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 391 391
L.P.
- -----------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,902 10,902
Warrants 900 900
- -----------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 140 --
- -----------------------------------------------------------------------------------------------------
Opinion Research Corporation(1) Debt Securities 13,864 13,864
Warrants 996 996
- -----------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 210 210
- -----------------------------------------------------------------------------------------------------
Panera Bread Company (1) Warrants 227 58
- -----------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Debt Securities 4,591 2,591
Common Stock (208,000 shares) 59 12
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Polaris Pool Systems, Inc. Debt Securities 7,425 7,425
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Powell Plant Farms, Inc. Loan 14,850 14,850
- -----------------------------------------------------------------------------------------------------
Progressive International Debt Securities 3,937 3,937
Corporation Common Stock (197 shares) 13 13
Preferred Stock (500 shares) 500 500
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (14,000 shares) 133 123
Holdings, PLC (1)
- -----------------------------------------------------------------------------------------------------
R.L. Singletary Loan 89 89
- -----------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,884 9,884
Warrants 395 395
- -----------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 271
- -----------------------------------------------------------------------------------------------------
Soff-Cut Holdings, Inc. Debt Securities 8,121 8,121
Common Stock (2,000 shares) 200 200
Preferred Stock (300 shares) 300 300
Warrants 446 446
- -----------------------------------------------------------------------------------------------------
Southwest PCS, LP Debt Securities 7,359 7,359
Options -- --
- -----------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 335 223
Common Stock (6,208 shares) 25 18
- -----------------------------------------------------------------------------------------------------
SunStates Refrigerated Services,
Inc. Loans 6,130 4,641
Debt Securities 2,445 676
- -----------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,666 11,666
Options 266 266
- -----------------------------------------------------------------------------------------------------
Techniplas, Inc. Loan 1,396 1,396
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
8
<PAGE> 13
<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Teknekron Infoswitch Corporation Debt Securities $ 14,714 $ 14,714
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,536 147
Common Stock (910 shares) 57 --
- -----------------------------------------------------------------------------------------------------
Tubbs Snowshoe Company, LLC Debt Securities 3,883 3,883
Warrants 54 54
Common Units (2,325 units) 500 500
- -----------------------------------------------------------------------------------------------------
United Pet Group Debt Securities 4,951 4,951
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,665 3,665
Warrants 360 1,010
- -----------------------------------------------------------------------------------------------------
Vianova Resins GmbH Debt Securities 1,652 1,652
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Vidon, Inc. Loan 257 257
- -----------------------------------------------------------------------------------------------------
William R. Dye Loan 262 262
- -----------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company Warrants 24 322
- -----------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,390 12,390
- -----------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Debt Securities 15,108 15,108
Corporation Common Stock (99 shares) 100 100
Preferred Stock (100 shares) 3,700 3,700
- -----------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and equity
interests in portfolio companies (102 investments) $538,361 $546,034
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
INTEREST NUMBER OF -----------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE-BACKED SECURITIES
Purchased CMBS 6 $ 213,371 $ 213,371
- --------------------------------------------------------------------------------------------------
Residual CMBS 1 75,808 75,808
- --------------------------------------------------------------------------------------------------
Residual securitization spread 1 8,477 6,977
- --------------------------------------------------------------------------------------------------
Total commercial mortgage-backed securities 8 $ 297,656 $ 296,156
- --------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 6 $ 2,033 $ 2,033
7.00%- 8.99% 19 79,535 79,535
9.00%-10.99% 48 41,774 42,127
11.00%-12.99% 23 48,428 48,428
13.00%-14.99% 4 12,365 12,365
15.00% and above 1 993 993
- --------------------------------------------------------------------------------------------------
Total commercial mortgage loans 101 $ 185,128 $ 185,481
- --------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
9
<PAGE> 14
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
INTEREST NUMBER OF -----------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 3 $ 113 $ 113
7.00%- 8.99% 5 54 42
9.00%-10.99% 121 31,677 31,989
11.00%-12.99% 287 37,370 36,605
13.00%-14.99% 3 180 163
15.00% and above -- -- --
- --------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 419 $ 69,394 $ 68,912
- --------------------------------------------------------------------------------------------------
Other portfolio assets 9 $ 7,572 $ 7,070
- --------------------------------------------------------------------------------------------------
Total portfolio at value 639 $1,098,111 $1,103,653
- --------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
10
<PAGE> 15
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
Acme Paging, L.P. Debt Securities $ 6,273 $ 6,273
Partnership Interest 1,456 2,600
- -------------------------------------------------------------------------------------------------------
American Barbecue & Grill,
Inc. Loans 1,475 1,475
Debt Securities 2,084 2,084
Warrants 125 125
- -------------------------------------------------------------------------------------------------------
AMF Bowling, Inc. (1) High Yield Debt 5,086 5,086
- -------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 570 570
- -------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc. (1) Debt Securities 7,427 7,427
Warrants 227 8
- -------------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 12,510 12,510
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc. (1) Common Stock (342,938 shares) 330 --
- -------------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- -------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 339 339
Warrants 12 12
- -------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,991 50
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,557 1,557
Common Stock (220 shares) 1 --
- -------------------------------------------------------------------------------------------------------
Convenience Corporation of Debt Securities 8,391 2,774
America Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cooper Natural Resources,
Inc. Debt Securities 3,450 3,450
Warrants -- 1,138
- -------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,860 5,860
- -------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 2,948 2,948
Resources, LLC Options -- --
- -------------------------------------------------------------------------------------------------------
Coverall North America Loan 8,915 8,915
- -------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 700
- -------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 250
- -------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 133
- -------------------------------------------------------------------------------------------------------
Directory Investment Common Stock (470 shares) -- 148
Corporation
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
11
<PAGE> 16
<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Directory Lending Corporation Series A Common Stock (1,031 shares) $ -- $ --
Series B Common Stock (188 shares) 235 161
Series C Common Stock (292 shares) 656 449
Series A Preferred Stock (214 shares) 307 210
Series B Preferred Stock (175 shares) 931 638
Series C Preferred Stock (58 shares) 58 40
- -------------------------------------------------------------------------------------------------------
Drilltec Patents & Loan 10,020 10,020
Technologies Company, Inc.
- -------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 31 4
- -------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 680
Common Stock (100 shares) 250 --
- -------------------------------------------------------------------------------------------------------
El Dorado Communications, Loans 306 306
Inc.
- -------------------------------------------------------------------------------------------------------
Enterprise Software, Inc. (1) Debt Securities 14,880 14,880
Common Stock (147,975 shares) 1,176 683
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -------------------------------------------------------------------------------------------------------
Esquire Communications Ltd. Warrants 6 --
(1)
- -------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 34 34
- -------------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery,
Inc. Series A Preferred Stock (500 shares) 497 497
Common Stock (2,500 shares) 3 3
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,702 5,702
Company Warrants 280 3,629
- -------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- -------------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,703 30,703
Communications, LLC Warrants -- --
- -------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,080 15,080
Warrants 525 1,000
- -------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 1,390
Archery, LLC Convertible Debentures 2,248 2,242
- -------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- -------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,154 9,154
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Han Hie Loan 510 510
- -------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 233 233
- -------------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- -------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 2
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
12
<PAGE> 17
<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Jack Henry & Associates, Inc. Common Stock (90,438 shares) $ 26 $ 4,193
(1)
- -------------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 93 93
- -------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,111 2,111
Warrants 74 74
- -------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,692 4,692
Warrants 324 2,100
- -------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 3,739 3,739
Debt Securities 2,609 2,609
Warrants 348 3,500
Equity Interest 3 3
- -------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,283 6,283
Warrants 96 2,850
- -------------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,601 7,601
Warrants 348 348
- -------------------------------------------------------------------------------------------------------
KZSF Broadcasting, Inc. Loans 884 884
- -------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems,
Inc. Debt Securities 3,403 3,403
Common Stock (64,535 shares) 142 142
- -------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- -------------------------------------------------------------------------------------------------------
Liqui-Dri Foods, Inc. Loans 10,291 10,291
- -------------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High Yield Debt 15,002 15,002
- -------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
- -------------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- -------------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,918 2,918
- -------------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, Loan 10,434 10,434
LLC
- -------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 197 197
Options -- --
- -------------------------------------------------------------------------------------------------------
Mihadas Loan 287 287
- -------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- -------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 17 17
Debt Securities 1,823 219
Common Stock (33,333 shares) -- --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Morton Industrial Group (1) Common Stock (5,835 shares) 241 82
- -------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 61 61
- -------------------------------------------------------------------------------------------------------
Nobel Learning Communities, Debt Securities 9,419 9,419
Inc. (1) Series D Convertible Preferred Stock (265,957 2,000 2,000
shares)
Warrants 575 575
- -------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 8 8
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
13
<PAGE> 18
<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Northeast Broadcasting Group, Debt Securities $ 415 $ 415
L.P.
- -------------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,841 10,841
Warrants 900 900
- -------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 589 140
Warrants 77 --
- -------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 229 229
- -------------------------------------------------------------------------------------------------------
David Peters Loan 164 55
- -------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loan 31 31
Preferred Stock (276 shares) 160 222
Common Stock (24 shares) -- --
- -------------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Debt Securities 4,091 4,091
Common Stock (208,000 shares) 59 33
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Precision Industries Co. Debt Securities 9,580 9,580
Common Stock (132,507 shares) 1,050 1,616
- -------------------------------------------------------------------------------------------------------
Progressive International Debt Securities 3,680 3,680
Corporation Preferred Stock (500 shares) 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 557
Holdings, PLC (1)
- -------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 2,000 2,000
Debt Securities 9,972 9,972
Common Stock (1,430 shares) -- 3,000
- -------------------------------------------------------------------------------------------------------
Randhawa Brothers Loan 117 117
Enterprises, Inc.
- -------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 98 98
- -------------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,605 9,605
Warrants 395 395
- -------------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 993
- -------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 399 306
Common Stock (6,208 shares) 24 --
- -------------------------------------------------------------------------------------------------------
SunStates Refrigerated
Services, Inc. Loans 1,830 341
Debt Securities 2,445 676
- -------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,881 11,881
Options -- --
- -------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,562 106
Common Stock (910 shares) 57 --
- -------------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,579 3,579
Warrants 360 360
- -------------------------------------------------------------------------------------------------------
Vianova Resins GmbH Debt Securities 1,812 1,812
Warrants -- --
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
14
<PAGE> 19
<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Vidon, Inc. Loan $ 259 $ 259
- -------------------------------------------------------------------------------------------------------
William R. Dye Loan 265 265
- -------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Warrants 24 322
Company
- -------------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,000 12,000
- -------------------------------------------------------------------------------------------------------
WYCB Acquisition Corporation Loan 3,812 3,812
- -------------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Debt Securities 15,094 15,094
Corporation Common Stock (99 shares) 100 100
Preferred Stock (100 shares) 3,700 3,700
- -------------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and equity
interests in portfolio companies (94 investments) $382,488 $388,554
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- -------- --------
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE-BACKED SECURITIES
Purchased CMBS 1 $ 32,221 $ 32,221
- ------------------------------------------------------------------------------------------------
Residual CMBS 1 70,771 70,771
- ------------------------------------------------------------------------------------------------
Residual securitization spread 1 12,182 10,682
- ------------------------------------------------------------------------------------------------
Total commercial mortgage-backed securities 3 $115,174 $113,674
- ------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 3 $ 1,327 $ 1,327
7.00%- 8.99% 43 104,872 104,872
9.00%-10.99% 102 69,635 70,076
11.00%-12.99% 31 44,424 44,424
13.00%-14.99% 4 12,362 12,362
15.00% and above 1 125 125
- ------------------------------------------------------------------------------------------------
Total commercial mortgage loans 184 $232,745 $233,186
- ------------------------------------------------------------------------------------------------
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 12 $ 160 $ 115
7.00%- 8.99% 12 134 57
9.00%-10.99% 364 51,925 51,343
11.00%-12.99% 53 5,148 4,592
13.00%-14.99% 5 284 178
15.00% and above -- -- --
- ------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 446 $ 57,651 $ 56,285
- ------------------------------------------------------------------------------------------------
Other portfolio assets 6 $ 8,331 $ 8,575
- ------------------------------------------------------------------------------------------------
Total portfolio at value 733 $796,389 $800,274
- ------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income
producing and restricted.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
15
<PAGE> 20
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. MERGER
On December 31, 1997, Allied Capital Corporation ("Allied I"), Allied
Capital Corporation II ("Allied II"), Allied Capital Commercial Corporation
("Allied Commercial"), and Allied Capital Advisers ("Advisers"), merged with and
into Allied Capital Lending Corporation ("Allied Lending") (each a "Predecessor
Company" and collectively the "Predecessor Companies") pursuant to an Agreement
and Plan of Merger, dated as of August 14, 1997, as amended and restated as of
September 19, 1997 in a stock-for-stock exchange (the "Merger"). Immediately
following the Merger, Allied Lending changed its name to Allied Capital
Corporation ("ACC" or the "Company").
The Merger was treated as a tax-free reorganization under Section 368
(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). For
federal income tax purposes, the Predecessor Companies carried forward the
historical cost basis of their assets and liabilities to the surviving entity
(ACC). For financial reporting purposes, the Predecessor Companies also carried
forward the historical cost basis of their respective assets and liabilities at
the time the Merger was effected. The consolidated financial statements reflect
the operations of ACC with the years ended December 31, 1997 and 1996 restated
as if the Predecessor Companies had merged as of the beginning of the earliest
period presented.
Prior to the Merger, Allied I owned approximately 16 percent of Allied
Lending's total shares outstanding. These shares were distributed to the Allied
I shareholders in a dividend immediately prior to the Merger at a rate of
0.107448 shares of Allied Lending for each share of Allied I held on the record
date. For financial reporting purposes, Allied I's ownership of Allied Lending
has been eliminated for all periods presented.
NOTE 2. ORGANIZATION
Allied Capital Corporation, a Maryland corporation, is a closed-end
management investment company that has elected to be regulated as a business
development company ("BDC") under the Investment Company Act of 1940 ("1940
Act"). The Company has two wholly owned subsidiaries that have also elected to
be regulated as BDCs. Allied Investment Corporation is licensed under the Small
Business Investment Act of 1958 as a Small Business Investment Company ("SBIC").
Allied Investment Corporation is the result of the merger of the Company's two
wholly owned SBIC subsidiaries in July 1998 whereby Allied Investment
Corporation merged with and into Allied Capital Financial Corporation ("Allied
Financial"). Allied Financial then changed its name to Allied Investment
Corporation ("Allied Investment"). Allied Capital SBLC Corporation ("Allied
SBLC") is licensed by the Small Business Administration ("SBA") as a Small
Business Lending Company and is a participant in the SBA Section 7(a) Guaranteed
Loan Program. In addition, the Company has also established a real estate
investment trust subsidiary, Allied Capital REIT, Inc. ("Allied REIT"). The
Company also has several single-member limited liability companies established
primarily to hold real estate properties.
Allied Capital Corporation and its subsidiaries, collectively, are
hereinafter referred to as the "Company" or "ACC."
The investment objective of the Company is to achieve current income and
capital gains. In order to achieve this objective, the Company invests primarily
in private, growing businesses in a variety of industries and in diverse
geographic locations (primarily in the United States).
16
<PAGE> 21
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated
financial statements of the Company contain all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the financial position of
the Company as of September 30, 1999 and the results of operations, changes in
net assets, and cash flows for the periods indicated. Certain information and
footnote disclosures normally included in the consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. The consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's December 31, 1998 Annual Report. The results of operations for the
three and nine months ended September 30, 1999 are not necessarily indicative of
the operating results to be expected for the full year.
The consolidated financial statements include the accounts of the Company
or its wholly owned or majority owned subsidiaries. All intercompany accounts
and transactions have been eliminated in consolidation. Certain
reclassifications have been made to the 1998 balances to conform with the 1999
financial statement presentation.
NOTE 4. PORTFOLIO
The Company's lending operations are conducted in three primary areas:
mezzanine finance, commercial real estate finance, and SBA Section 7(a)
guaranteed lending.
MEZZANINE FINANCE
Mezzanine investments are generally structured as loans that carry a
relatively high fixed rate of interest, which may be combined with equity
features, such as conversion privileges, warrants or options to purchase a
portion of the portfolio company's equity at a nominal price. Such an investment
would typically have a maturity of five to ten years, with interest-only
payments in the early years and payments of both principal and interest in the
later years, although loan maturities and principal amortization schedules vary.
Equity investments consist primarily of securities issued by privately
owned companies and may be subject to restrictions on their resale or otherwise
illiquid. Equity securities generally do not produce a current return, but are
held for investment appreciation and ultimate gain on sale.
At September 30, 1999 and December 31, 1998, approximately 97 percent and
98 percent, respectively, of the Company's mezzanine loan portfolio was composed
of fixed interest rate loans. The weighted average yield (at value) on the
mezzanine portfolio at September 30, 1999 and December 31, 1998 was 14.0 percent
and 14.6 percent, respectively. At September 30, 1999 and December 31, 1998,
mezzanine loans and debt securities with a cost basis of $35,911,000 and
$20,977,000, respectively, were not accruing interest.
17
<PAGE> 22
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
The geographic and industry composition of the mezzanine portfolio at
September 30, 1999 and December 31, 1998 was as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
Mid-Atlantic................................................ 26% 28%
Midwest..................................................... 25 27
Southeast................................................... 20 23
West........................................................ 13 11
Northeast................................................... 11 4
International............................................... 5 7
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Business Services........................................... 26% 11%
Consumer Products........................................... 20 25
Telecommunications.......................................... 14 14
Industrial Products......................................... 14 8
Education................................................... 6 8
Broadcasting................................................ 6 9
Retail...................................................... 4 9
Other....................................................... 10 16
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
COMMERCIAL MORTGAGE-BACKED SECURITIES
In December 1998, the Company purchased $67 million of Purchased Commercial
Mortgage-Backed Securities ("Purchased CMBS") for $32 million. For the nine
months ended September 30, 1999, the Company purchased for a price of $183.4
million, Purchased CMBS with a face value of $373.2 million. The bonds owned by
the Company of non-investment grade and unrated tranches are junior in priority
for payment of principal to the more senior tranches of the related commercial
securitization. Cash flow from the underlying mortgages generally is allocated
first to the senior tranches, with the most senior tranches having a priority
right to the cash flow. Then, any remaining cash flow is allocated, generally,
among the other tranches in order of their relative seniority. To the extent
there are defaults and unrecoverable losses on the underlying mortgages
resulting in reduced cash flows, the subordinate tranche will bear this loss
first.
As of September 30, 1999 and December 31, 1998, the estimated yield to
maturity on the Purchased CMBS was approximately 14.2 percent and 15.0 percent,
respectively. The Company's estimated returns on its Purchased CMBS are based
upon a number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples include the timing and magnitude of
credit losses on the mortgage loans underlying the Purchased CMBS that are a
result of the general condition of the real estate market (including competition
for tenants and their related credit quality) and changes in market rental
rates. As these uncertainties and contingencies are difficult to predict and are
subject to future events which may alter these assumptions, no assurance can be
given that the anticipated yields to maturity, will be achieved.
18
<PAGE> 23
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
On January 30, 1998, the Company in conjunction with Business Mortgage
Investors, Inc. ("BMI"), a private REIT managed by the Company, completed a $310
million asset securitization, whereby bonds totaling $239 million were sold in
three classes rated "AAA", "AA" and "A" by Standard & Poor's Rating Services and
Fitch IBCA, Inc. in a private placement. The three bond classes sold had an
aggregate weighted average interest rate of approximately 6.38 percent.
To effect the securitization, the Company and BMI sold a pool of 97
commercial mortgage loans totaling $310 million to a special purpose, bankruptcy
remote entity which transferred the assets to a trust which issued the bonds.
The Company contributed approximately 95%, or $295 million, of the total assets
securitized, and received cash proceeds, net of costs of approximately $223
million. The Company retained a trust certificate for its residual interest (the
"Residual CMBS") in the loan pool sold, and will receive interest income from
this Residual CMBS as well as the net spread of the interest earned on the loans
sold less the interest paid on the bonds over the life of the bonds (the
"Residual Securitization Spread").
The Company accounted for the securitization in accordance with Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." As a result,
the Company recorded a gain of $14.8 million net of the costs of the
securitization and the cost of settlement of interest rate swaps. The gain
arises from the difference between the carrying amount of the loans and the fair
market value of the assets received (i.e., cash, Residual Securitization Spread,
Residual CMBS and a servicing asset). As of September 30, 1999, the mortgage
loan pool had an approximate weighted average stated interest rate of 9.4
percent. The value of the Residual CMBS was determined using a discount rate
equal to the average interest rate of the underlying mortgage loans. The value
of the Residual Securitization Spread was determined based on a constant
prepayment rate of 7 percent and a discount rate of 14 percent.
The geographic composition and the property types securing the commercial
mortgage-backed securities at September 30, 1999 and December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
West........................................................ 29% 17%
Mid-Atlantic................................................ 23 32
Midwest..................................................... 22 19
Southeast................................................... 21 25
Northeast................................................... 5 7
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Retail...................................................... 33% 32%
Housing..................................................... 30 13
Office...................................................... 20 21
Hospitality................................................. 8 23
Other....................................................... 9 11
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
19
<PAGE> 24
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
COMMERCIAL REAL ESTATE FINANCE
The commercial mortgage loan portfolio contains loans that were originated
by the Company or were purchased from the Resolution Trust Corporation, the
Federal Deposit Insurance Corporation and other third party sellers including
life insurance companies and banks.
At September 30, 1999 and December 31, 1998, approximately 80 percent and
20 percent and 68 percent and 32 percent of the Company's commercial mortgage
loan portfolio was composed of fixed and adjustable interest rate loans,
respectively. The weighted average yield (at value) on the real estate portfolio
as of September 30, 1999 and December 31, 1998 equaled 9.8 percent and 10.4
percent, respectively. As of September 30, 1999 and December 31, 1998, loans
with a cost basis of $5,042,000 and $5,443,000, respectively, were not accruing
interest.
The geographic composition and the property types securing the commercial
mortgage loan portfolio at September 30, 1999 and December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
Mid-Atlantic................................................ 43% 37%
Southeast................................................... 27 26
West........................................................ 19 24
Midwest..................................................... 8 9
Northeast................................................... 3 4
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Hospitality................................................. 35% 47%
Office...................................................... 31 20
Retail...................................................... 13 14
Recreation.................................................. 11 7
Other....................................................... 10 12
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
SBA SECTION 7(a) GUARANTEED LENDING
The Company, through its wholly owned subsidiary, Allied SBLC, participates
in the SBA's Section 7(a) Guaranteed Loan Program ("7(a) loans").
Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA will
guarantee 80 percent of any qualified loan up to $100,000 regardless of
maturity, and 75 percent of any such loan over $100,000 regardless of maturity,
to a maximum guarantee of $750,000 for any one borrower. SBA regulations define
qualified small businesses generally as businesses with no more than $5 million
in annual sales or no more than 500 employees.
The Company charges interest on the 7(a) loans at a variable rate,
typically 1.75 percent to 2.75 percent above the prime rate, as published in The
Wall Street Journal or other financial newspaper, adjusted monthly. All loans
are payable in equal monthly installments of principal and interest from the
date on which the loan was made to its maturity. At September 30, 1999 and
20
<PAGE> 25
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
December 31, 1998, approximately 98 percent and 96 percent, respectively of the
Company's portfolio of 7(a) loans were variable interest rate loans.
As permitted by SBA regulations, the Company sells to investors, without
recourse, the guaranteed portion of its loans while retaining the right to
service 100 percent of such loans.
As of September 30, 1999 and December 31, 1998, 7(a) loans with a cost
basis of $13,133,000 and $11,227,000, respectively, were not accruing interest.
The geographic and industry composition of the SBA 7(a) portfolio at
September 30, 1999 and December 31, 1998 was as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
Midwest..................................................... 35% 34%
Mid-Atlantic................................................ 35 29
Southeast................................................... 15 16
West........................................................ 10 14
Northeast................................................... 5 7
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Retail...................................................... 40% 41%
Hospitality................................................. 29 30
Consumer Products........................................... 12 6
Consumer Services........................................... 5 6
Business Services........................................... 4 4
Broadcasting................................................ 3 4
Other....................................................... 7 9
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
21
<PAGE> 26
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. DEBT
At September 30, 1999 and December 31, 1998, the Company had the following
credit facilities:
<TABLE>
<CAPTION>
1999 1998
------------------- -------------------
FACILITY AMOUNT FACILITY AMOUNT
AMOUNT DRAWN AMOUNT DRAWN
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Debentures and notes payable:
Master loan and security agreement............ $250,000 $ 34,500 $250,000 $ 6,000
Unsecured long-term notes payable............. 317,000 317,000 180,000 180,000
SBA debentures................................ 74,650 47,650 74,650 47,650
OPIC loan..................................... 5,700 5,700 5,700 5,700
Master repurchase agreement................... -- -- 250,000 --
-------- -------- -------- --------
Total debentures and notes payable....... 647,350 404,850 760,350 239,350
-------- -------- -------- --------
Revolving lines of credit.......................... 340,000 133,000 200,000 95,000
-------- -------- -------- --------
Total Debt............................... $987,350 $537,850 $960,350 $334,350
======== ======== ======== ========
</TABLE>
MASTER LOAN AND SECURITY AGREEMENT
The Company, and BMI, established a facility to borrow up to $250,000,000,
of which $100,000,000 is committed, using commercial mortgage loans as
collateral under the agreement. The Company pledges commercial mortgage loans as
collateral for the facility such that the amount borrowed is approximately equal
to 80 percent to 90 percent of the value of the collateral pledged. The
agreement generally requires interest only payments with all principal due at
maturity. Principal may be repaid at any time without penalty. The agreement
bears interest at the one-month London Interbank Offer Rate ("LIBOR") plus 1.0
percent, or 6.4 percent and 6.6 percent, at September 30, 1999 and December 31,
1998, respectively. Average debt outstanding, maximum amount borrowed, and
weighted average interest rate charged on this facility for the nine months
ended September 30, 1999 and for the year ended December 31, 1998 were
$40,323,000 and $21,932,000; $84,392,000 and $56,000,000; and 6.1 percent and
6.5 percent; respectively. The agreement matured on October 7, 1999 and the
Company, without BMI, extended the facility through October 30, 2000, with a
total committed facility up to $100,000,000.
UNSECURED LONG-TERM NOTES PAYABLE
In June 1998 and May 1999 the Company issued unsecured long-term notes held
by private institutional investors. The notes have terms of 5 or 7 years with an
aggregate principal balance of $317,000,000. The weighted average interest rate
on the notes is 7.3 percent and interest only is payable semi-annually until
maturity. The notes may be prepaid in whole or in part together with an interest
premium as stipulated in the note agreement.
SBA DEBENTURES
At September 30, 1999 and December 31, 1998, the Company had drawn
debentures totaling $47,650,000 and $47,650,000, respectively, payable to the
SBA at interest rates ranging from 6.9 percent to 9.6 percent. Scheduled
maturity dates are as follows: 1999 -- $0; 2000 -- $17,300,000;
2001 -- $9,350,000; 2002 -- $0; 2003 -- $0; and $21,000,000 thereafter. The
debentures require semi-
22
<PAGE> 27
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. DEBT, CONTINUED
annual interest-only payments with all principal due upon maturity. The SBA
debentures are subject to prepayment penalties if paid prior to maturity.
OVERSEAS PRIVATE INVESTMENT CORPORATION (OPIC) LOAN
The Company has a loan agreement with OPIC to provide financing for
international projects involving qualifying U.S. small businesses. Loans under
this agreement bear interest at the U.S. Treasury rate plus 0.5 percent for the
applicable period of the borrowing, or 6.6 percent at September 30, 1999 and
December 31, 1998. In addition, OPIC is entitled to receive from the Company a
contingent fee at maturity of the loan equal to 5 percent of the return
generated by the OPIC-related investments in excess of 7 percent. There are no
required principal payments until the OPIC loans mature in January 2006.
REVOLVING LINES OF CREDIT
In May 1999, the Company increased its unsecured revolving line of credit
to $340,000,000 from $315,000,000. The facility bears interest at LIBOR plus
1.25 percent, or 6.6 percent and 6.9 percent at September 30, 1999 and December
31, 1998, respectively, and requires a commitment fee equal to 0.25 percent of
the committed amount. The new line expires in March 2001. The line of credit
requires monthly payments of interest and all principal is due upon its
expiration.
The average debt outstanding on the revolving lines were $83,253,000 and
$51,904,000 for the nine months ended September 30, 1999 and for the year ended
December 31, 1998, respectively. The maximum amount borrowed under these
facilities and the weighted average interest rate for the nine months ended
September 30, 1999 and for the year ended December 31, 1998 were $174,000,000
and $105,000,000, and 6.4 percent and 6.8 percent, respectively.
NOTE 6. SHAREHOLDERS' EQUITY
For the nine months ended September 30, 1999 and for the year ended
December 31, 1998, the Company's compensation committee granted a total of
553,921 options and 5,189,944 options, respectively, to officers and non-officer
directors of the Company under the ACC Plan. The options awarded to officers
were generally non-qualified stock options that vest over a five-year period
from the grant date. The stock options have been granted at the market price on
the date of grant with a weighted average exercise price equal to $20.33 per
share. At September 30, 1999, options for 1,460,111 shares were vested. 191,135
options were exercised and 149,611 options were cancelled during the nine months
ended September 30, 1999. Options were exercised for 10,408 shares, and options
were canceled for 65,638 shares during the year ended December 31, 1998.
During the nine months ended September 30, 1999, the Company sold 3,803,000
shares of its common stock through underwriters for net proceeds of $73,321,000,
after costs of $3,608,000 which included a weighted average discount of 3.8
percent. In addition, the Company sold 1,604,119 shares of its common stock to
an institutional investor in three transactions. The net proceeds from the
transactions were $29,758,000, after costs of $1,169,000 which included a
discount of 3.0 percent.
In 1998, the Company sold 3,565,000 shares of its common stock through an
underwriter for net proceeds of $56,776,000, after costs of $3,384,000 which
included a 5.0 percent fee paid to the underwriter. In 1998, the Company also
sold 801,959 shares of its common stock to an institutional
23
<PAGE> 28
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. SHAREHOLDERS' EQUITY, CONTINUED
investor in two transactions. The net proceeds from the transactions were
$12,899,000, after costs of $677,000 which included a weighted average discount
of 4.0 percent.
The Company has a dividend reinvestment plan, whereby the Company may buy
shares of its common stock in the open market or issue new shares in order to
satisfy dividend reinvestment requests. If the Company issues new shares, the
issue price is equal to the average of the closing sales prices reported for the
Company's common stock for the five days on which trading in the shares takes
place immediately prior to the dividend payment date. For the nine months ended
September 30, 1999 and for the year ended December 31, 1998, the Company issued
169,588 and 241,482 shares, respectively, at an average price per share of
$19.80 and $20.35, respectively.
NOTE 7. EARNINGS PER COMMON SHARE
<TABLE>
<CAPTION>
PER COMMON
INCOME SHARES SHARE AMOUNT
-------- ------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
Net increase in net assets resulting from operations... $26,944
Less: Preferred stock dividends (55)
-------
Income available to common shareholders................ $26,889
=======
BASIC EARNINGS PER COMMON SHARE........................ 61,042 $0.44
=====
Options outstanding to officers........................ 416
------
DILUTED EARNINGS PER COMMON SHARE...................... 61,458 $0.44
====== =====
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
Net increase in net assets resulting from operations... $14,906
Less: Preferred stock dividends........................ (55)
-------
Income available to common shareholders................ $14,851
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,373 $0.29
=====
Options outstanding to officers........................ 4
------
DILUTED EARNINGS PER COMMON SHARE...................... 51,377 $0.29
====== =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
Net increase in net assets resulting from operations... $67,645
Less: Preferred stock dividends (165)
-------
Income available to common shareholders................ $67,480
=======
BASIC EARNINGS PER COMMON SHARE........................ 59,077 $1.14
=====
Options outstanding to officers........................ 162
------
DILUTED EARNINGS PER COMMON SHARE...................... 59,239 $1.14
====== =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
Net increase in net assets resulting from operations... $61,448
Less: Preferred stock dividends........................ (165)
-------
Income available to common shareholders................ $61,283
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,502 $1.19
=====
Options outstanding to officers........................ 210
------
DILUTED EARNINGS PER COMMON SHARE...................... 51,712 $1.19
====== =====
</TABLE>
24
<PAGE> 29
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7. EARNINGS PER COMMON SHARE, CONTINUED
Basic earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding each
period.
Diluted earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding plus
common shares issuable upon assumed exercise of stock options outstanding each
period.
NOTE 8. FORMULA AWARD AND CUT-OFF AWARD
The Formula Award was established to compensate employees from the point
when their unvested options would cease to appreciate in value (the Merger
announcement date), up until the time at which they would be able to receive
option awards in ACC post-Merger. In the aggregate, the Formula Award equaled 6
percent of the difference between an amount equal to the combined aggregated
market capitalizations of the Predecessor Companies as of the close of the
market on the day before the Merger date (December 30, 1997), less an amount
equal to the combined aggregate market capitalizations of Allied Lending and the
Predecessor Companies as of the close of the market on the Merger announcement
date. Advisers' compensation committee allocated the Formula Award to individual
officers on December 30, 1997. The amount of the Formula Award as computed at
December 30, 1997 was $18,994,000. This amount was contributed to the Company's
deferred compensation trust under the DC Plan (see Note 10) and was used to
purchase shares of the Company's stock (included in common stock held in
deferred compensation trust). The Formula Award vests equally in three
installments on December 31, 1998, 1999 and 2000; provided, however, that such
Formula Award vests immediately upon a change in control of the Company. The
Formula Award will be expensed in each year in which it vests. For the nine
months ended September 30, 1999 and for the year ended December 31, 1998,
$4,681,000 and $6,242,000, respectively was expensed as a result of the Formula
Award. Vested Formula Awards are distributable to recipients at the Company's
discretion, however, sale of the Company's stock by the recipients is
restricted. Unvested Formula Awards are forfeited upon a recipient's separation
from service and the related Company stock is retired. For the nine months ended
September 30, 1999 and for the year ended December 31, 1998, $61,000 and
$270,000, respectively, of the Formula Award was forfeited.
On January 4, 1999, the Company distributed shares of the Company's common
stock with a value of $4,062,000 representing the portion of the Formula Award
that vested on December 31, 1998.
The Predecessor Companies' existing stock option plans were canceled and
the Company established a cut-off dollar amount for all existing, but unvested
options as of the date of the Merger (the "Cut-off Award"). The Cut-off Award is
computed for each unvested option as of the Merger date. The Cut-off Award is
equal to the difference between the market price on August 14, 1997 (the Merger
announcement date) of the shares of stock underlying the option less the
exercise price of the option. The Cut-off Award is payable for each unvested
option upon the future vesting date of that option. The Cut-off Award was
designed to cap the appreciated value in unvested options at the Merger
announcement date, in order to set the foundation to balance option awards upon
the Merger. The Cut-off Award approximates $2.9 million in the aggregate and is
expensed as the Cut-off Award vests. For the nine months ended September 30,
1999 and for the year ended December 31, 1998, $507,000 and $807,000,
respectively, of the Cut-off Award vested.
25
<PAGE> 30
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9. DIVIDENDS AND DISTRIBUTIONS
The Company's Board of Directors declared and the Company paid a $1.20 per
common share dividend, or $71,800,000, for the nine months ended September 30,
1999.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company is party to certain lawsuits in the normal course of its
business. While the outcome of these legal proceedings cannot at this time be
predicted with certainty, the Company does not expect that these proceedings
will have a material effect upon the Company's financial condition or results of
operations.
26
<PAGE> 31
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto included herein. This Management's
Discussion and Analysis contains certain forward-looking statements. These
statements include the plans and objectives of management for future operations
and financial objectives, loan portfolio growth and availability of funds. These
forward-looking statements are subject to the inherent uncertainties in
predicting future results and conditions. Certain factors that could cause
actual results and conditions to differ materially from those projected in these
forward-looking statements are set forth below in the Investment Considerations
section. Other factors that could cause actual results to differ materially
include the uncertainties of economic, competitive and market conditions, and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
included herein are reasonable, any of the assumptions could be inaccurate and
therefore, there can be no assurance that the forward-looking statements
included herein will prove to be accurate. Therefore, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved.
OVERVIEW
The Company provides capital to small and middle-market companies in a
variety of different industries and in diverse geographic locations. Our lending
and investment activity is focused in three areas:
- Mezzanine finance
- Commercial real estate finance, including the purchase of CMBS, and
- Small business and commercial real estate loans originated for sale
under our Allied Capital Express brand name.
The Company's earnings depend primarily on the level of interest and
related portfolio income and net realized and unrealized gain income earned on
the Company's investment portfolio after deducting interest paid on borrowed
capital and operating expenses. Interest income results from the stated interest
rate earned on a loan, the amortization of loan origination points and original
issue discount, and the amortization of any market discount arising from
purchased loans. The level of interest income is directly related to the balance
of the investment portfolio multiplied by the effective yield on the portfolio.
The Company's ability to generate interest income is dependent on economic,
regulatory and competitive factors that influence interest rates and loan
originations, and the Company's ability to secure financing for its investment
activities.
The total portfolio at value was $1,103.7 million at September 30, 1999 and
$800.3 million at December 31, 1998. During the nine months ended September 30,
1999, the Company invested a total of $534.0 million. After total repayments of
$120.6 million, loan sales of $120.9 million and
27
<PAGE> 32
valuation changes, the Company's investment portfolio increased by 38% since
December 31, 1998. The portfolio increased approximately 15% for the year ended
December 31, 1998.
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, DECEMBER 31,
ASSET COMPOSITION 1999 1998
----------------- ------------- ------------
<S> <C> <C>
Mezzanine Investments................................. 47% 46%
Commercial Mortgage-Backed Securities*................ 25% 13%
Commercial Mortgage Loans............................. 16% 27%
SBA 7(a) Loans........................................ 6% 7%
Cash and Other Assets................................. 6% 7%
---- ----
100% 100%
==== ====
</TABLE>
- -------------------------
* Includes Purchased CMBS totaling 18% and 4% of total assets at September 30,
1999 and December 31, 1998, respectively.
MEZZANINE
Mezzanine loans, debt securities and equity interests were $546.0 million
and $388.6 million at September 30, 1999 and December 31, 1998, respectively.
The effective yield on the mezzanine loans and debt securities was 14.0% and
14.6% at September 30, 1999 and December 31, 1998, respectively. Mezzanine loan
originations and purchases were $110.4 million and $44.3 million for the
quarters ended September 30, 1999 and 1998, respectively, and $237.6 million and
$127.2 million for the nine months ended September 30, 1999 and 1998,
respectively. Mezzanine loan originations and purchases were $236.0 million for
the year ended December 31, 1998. Mezzanine repayments were $38.3 million and
$4.9 million for the quarters ended September 30, 1999 and 1998, respectively,
and $86.5 million and $23.9 million for the nine months ended September 30, 1999
and 1998, respectively. Mezzanine repayments and sales were $41.3 million for
the year ended December 31, 1998.
COMMERCIAL MORTGAGE-BACKED SECURITIES
Commercial mortgage-backed securities (CMBS) were $296.2 million and $113.7
million at September 30, 1999 and December 31, 1998. The portfolio at September
30, 1999 consisted of $213.4 million of purchased CMBS ("Purchased CMBS") and
$82.8 million of CMBS retained primarily from a $295 million asset
securitization the Company completed on January 30, 1998 ("Residual CMBS").
During the third quarter of 1999 we acquired Purchased CMBS with a face value of
$50.4 million for a cost of $27.8 million, and during the first nine months of
1999, the Company acquired Purchased CMBS with a face value of $373.2 million
for a cost of $183.4 million. At September 30, 1999 and December 31, 1998, the
estimated yield to maturity on the Purchased CMBS and the Residual CMBS was
14.2% and 9.9%, and 15.0% and 9.7%, respectively. At September 30, 1999 and
December 31, 1998, the weighted average yield on the entire CMBS portfolio was
13.0% and 11.2%, respectively. The weighted average loan-to-value and debt
service coverage of the loans securing the total CMBS portfolio at September 30,
1999 were 69.9% and 1.4, respectively.
Acquisitions of Purchased CMBS have had, and will continue to have, the
full scrutiny of the Company's underwriting processes. The Company
re-underwrites the majority of the loans securing the bonds, including
determining its own assessment of cash flow available for debt service and
appraisal value, and visits most of the collateral properties. The Company will
continue to bid on similar CMBS offerings as long as we can achieve significant
discounts and attractive yields on the
28
<PAGE> 33
purchase of such offerings. However, we will limit our Purchased CMBS
acquisitions in order to maintain a balanced portfolio.
COMMERCIAL MORTGAGE LOANS
Commercial mortgage loans were $185.5 million at September 30, 1999 and
$233.2 million at December 31, 1998. The weighted average current stated
interest rate on the commercial mortgage loan portfolio at September 30, 1999
was 9.6% and at December 31, 1998 was 9.7%. The weighted average yield on the
commercial mortgage loan portfolio was 9.8% at September 30, 1999 and 10.4% at
December 31, 1998. The effective yield on the commercial mortgage loan portfolio
is higher than the stated interest rate due to the amortization of market
discount on purchased loans and original issue discount.
In the first quarter of 1998, the Company reduced its commercial mortgage
loan portfolio through the securitization of $295 million in commercial real
estate loans. In addition the Company slowed its origination activity in early
1998 due to pricing conditions in the market. The Company has also continued to
sell commercial mortgage loans in order to reduce the portfolio. As a result,
the commercial mortgage loan portfolio decreased by 20% and 48%, respectively,
for the nine months ended September 30, 1999 and the year ended December 31,
1998.
ALLIED CAPITAL EXPRESS
During the second quarter of 1999, the Company combined its commercial real
estate loan origination activity with its SBA 7(a) lending activity in order to
increase its loans originated for sale business under the Allied Capital Express
brand name. Through Allied Capital Express, the Company provides small business
and commercial real estate loans up to $3 million. The majority of the loans
originated in this area are originated for sale, generally at premiums of up to
10% of the loan amount. A summary of Allied Capital Express loan origination and
sale activity for the nine months ended September 30, 1999 and 1998 is as
follows:
<TABLE>
<CAPTION>
FOR THE THREE FOR THE NINE
MONTHS MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
(in thousands)
Loan Originations:
SBA 7(a)............................................. $26,584 $10,200 $64,650 $ 39,600
Other................................................ 26,783 46,300 48,426 182,700
Loan Sales:
SBA 7(a)............................................. 21,467 7,400 45,075 26,800
Other................................................ 31,386 -- 75,796 --
</TABLE>
On a comparative basis, SBA 7(a) loan origination activity has increased
due to the opening of new office locations and due to increased emphasis that is
being placed on the Allied Capital Express product area. Non-SBA 7(a) loan
origination activity has decreased due to the reduction of middle-market
commercial real estate lending activity that occurred in 1998 as discussed under
"Commercial Mortgage Loans." Allied Capital Express targets small commercial
real estate loans that are in many cases originated in conjunction with SBA 7(a)
loans. The 1999 and 1998 non-SBA 7(a) activity is not comparable because of the
shift from larger real estate loans originated for the portfolio to smaller
commercial real estate loans originated primarily for sale. SBA 7(a) loans are
originated with variable interest rates priced at spreads ranging from 1.75% to
2.75% over the prime lending rate.
29
<PAGE> 34
RESULTS OF OPERATIONS
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net increase in net assets resulting from operations (NIA) was $67.6
million, or $1.14 per share, and $61.4 million, or $1.19 per share, for the nine
months ended September 30, 1999 and 1998, respectively. NIA results from total
interest and related portfolio income earned, less total expenses incurred in
the operations of the Company, plus net realized and unrealized gains or losses.
The NIA for the nine months ended September 30, 1998 also includes a one-time
gain of $14.8 million, or $0.28 per share, resulting from a commercial mortgage
loan securitization transaction that was completed in January 1998.
Total interest and related portfolio income was $98.9 million and $80.8
million for the nine months ended September 30, 1999 and 1998, respectively.
Total interest and related portfolio income is primarily a function of the level
of interest income earned and the balance of portfolio assets. In addition,
total interest and related portfolio income includes net premiums from loan
dispositions, prepayment premiums, and investment advisory fees and other
income. 1998 total interest and related portfolio income includes a one-time
gain on sale of $14.8 million resulting from a commercial mortgage loan
securitization transaction that was completed in January 1998. Excluding the
1998 gain on sale, total interest and related portfolio income increased in the
first nine months of 1999 by 50% as compared to the first nine months of 1998.
Interest income totaled $84.4 million and $58.4 million for the nine months
ended September 30, 1999 and 1998, respectively. Interest income increased $26.0
million or 44% compared to the same period in the prior year. The increase in
interest income earned results primarily from continued growth of the Company's
investment portfolio and the Company's focus on increasing its overall portfolio
yield. The Company's investment portfolio, excluding non-interest bearing equity
interests in portfolio companies, increased by 49% to $1,033.6 million at
September 30, 1999 from $692.9 million at September 30, 1998. The weighted
average yield on the interest bearing investments in the portfolio at September
30, 1999 was 12.5% as compared to 11.8% at September 30, 1998.
Net premiums from loan dispositions were $9.0 million and $2.9 million for
the nine months ended September 30, 1999 and 1998, respectively. Included in net
premiums from loan dispositions are premiums from loan sales and premiums
received on the early repayment of loans. Premiums from loan sales were $5.2
million and $2.2 million for the nine months ended September 30, 1999 and 1998,
respectively. This premium income results primarily from the premium paid by
purchasers of the guaranteed portion of the Company's SBA 7(a) loans sold into
the secondary market and the commercial real estate loans sold to third parties,
less the origination commissions associated with the loans sold.
Prepayment premiums were $3.8 million and $0.7 million for the nine months
ended September 30, 1999 and 1998, respectively. While the scheduled maturity of
mezzanine and commercial mortgage loans ranges from five to ten years, it is not
unusual for the Company's borrowers to refinance or pay off their debts to the
Company ahead of schedule. Because the Company seeks to finance primarily
seasoned, performing companies, such companies at times can secure lower cost
financing as their balance sheets strengthen, or as more favorable interest
rates become available. Therefore, the Company generally structures its loans to
require a prepayment premium for the first three to five years of the loan.
Investment advisory fees and other income were $5.4 million and $4.6
million for the nine months ended September 30, 1999 and 1998, respectively.
Investment advisory fees are received from the private funds managed by the
Company.
30
<PAGE> 35
Total operating expenses were $44.0 million and $31.8 million for the nine
months ended September 30, 1999 and 1998, respectively. Operating expenses
include interest on indebtedness, salaries and employee benefits, and general
and administrative expenses.
The Company's single largest expense is interest on indebtedness, which
totaled $24.2 million and $14.5 million for the nine months ended September 30,
1999 and 1998, respectively. Interest expense increased $9.6 million, or 66%,
compared to the same period in the prior year. The increase is attributable to
an increase in borrowings by the Company and its subsidiaries under various
credit facilities. The Company's total borrowings were $537.9 million and $361.7
million at September 30, 1999 and 1998, respectively. Average outstanding
indebtedness for the nine months ended September 30, 1999 and 1998 was $414.1
million and $252.5 million, respectively. The Company's weighted average
interest cost, excluding closing costs, on outstanding borrowings at September
30, 1999 and 1998 was 7.4% and 7.2%, respectively.
Salaries and employee benefits totaled $11.3 million and $8.3 million for
the nine months ended September 30, 1999 and 1998, respectively. Total employees
were 124 and 96 at September 30, 1999 and 1998, respectively. The increase in
salaries and employee benefits reflects the increase in total employees,
combined with wage increases and the experience level of employees hired. The
Company has been an active recruiter throughout 1998 and 1999 for experienced
investment and operational personnel, and the Company will continue to actively
recruit and hire new professionals in 1999 to support anticipated portfolio
growth.
General and administrative expenses include the leases for the Company's
headquarters in Washington, DC, and its regional offices. General and
administrative expenses also include travel costs, stock record expenses,
directors' fees, legal and accounting fees and various other expenses. General
and administrative expenses totaled $8.5 million and $9.0 million for the nine
months ended September 30, 1999 and 1998, respectively. The decrease in general
and administrative expenses was partially due to certain post-Merger integration
expenses incurred in the first quarter of 1998, totaling $0.2 million. The
post-Merger integration expenses included primarily the costs of legal and
accounting advice as well as the use of certain outside consultants. The
remaining decrease results from the timing of incurring expenses in 1999 and
1998.
For the nine months ended September 30, 1999 and 1998, operating expenses
excluding interest on indebtedness as a percent of total interest and related
portfolio income less interest expense plus net realized and unrealized capital
gains was 21% and 20%, respectively. For the years ended December 31, 1998, 1997
and 1996 this ratio was 22%.
The formula award and cut-off award totaled $5.2 million and $5.5 million,
or $0.09 per share and $0.11 per share, for the nine months ended September 30,
1999 and 1998, respectively.
The formula award expense totaled $4.7 million for each of the nine months
ended September 30, 1999 and 1998. The formula award was designed as an
incentive compensation program that would replace canceled stock options that
were canceled as a result of the Company's 1997 Merger and would balance share
ownership among key officers. The formula award vests over a three-year period,
on the anniversary date of the Merger, beginning on December 31, 1998. Assuming
all officers who received a formula award remain with the Company over the
remaining vesting period, the Company will expense the remaining formula award
during 1999 and 2000 in an annual amount of approximately $6.2 million.
The cut-off award expense totaled $0.5 million and $0.8 million for the
nine months ended September 30, 1999 and 1998, respectively. The cut-off award
was designed to cap the appreciated value in unvested options at the Merger
announcement date in order to set the foundation to balance option awards upon
the Merger. The cut-off award will only be payable if the award recipient is
31
<PAGE> 36
employed by the Company on a future vesting date. Total cut-off award that will
vest in 1999 is estimated at $0.5 million.
Net realized gains were $16.4 million and $20.0 million for the nine months
ended September 30, 1999 and 1998, respectively. These gains resulted from the
sale of equity securities associated with certain mezzanine and commercial
mortgage loans and the realization of unamortized discount resulting from the
sale and early repayment of mezzanine and commercial mortgage loans, offset by
losses on investments.
Realized gains totaled $21.6 million and $20.8 million for the nine months
ended September 30, 1999 and 1998, respectively. Realized gains during 1999
primarily resulted from transactions involving three portfolio companies, Radio
One, Inc. ($10.5 million), COHR, Inc. ($5.3 million), and Precision Industries
Co. ($3.3 million). The Company reversed previously recorded unrealized
appreciation of $8.3 million when these gains were realized in 1999. Realized
losses totaled $5.2 million and $0.8 million for the nine months ended September
30, 1999 and 1998, respectively. Realized losses during 1999 resulted primarily
from the liquidation of one portfolio investment, CeraTech Holdings Corporation
($2.5 million). Losses realized in 1999 had been recognized in NIA over time as
unrealized depreciation when the Company determined that the respective
portfolio security's value had become impaired. Thus, the Company reversed
previously recorded unrealized depreciation totaling $4.7 million in 1999 when
the related losses were realized.
The Company recorded net unrealized gains of $1.5 million for the nine
months ended September 30, 1999 and net unrealized losses of $0.4 million for
the nine months ended September 30, 1998. Net unrealized gains for 1999 and net
unrealized losses for 1998 consisted of valuation changes resulting from the
Board of Directors' valuation of the Company's assets and the effect of
reversals of net unrealized appreciation resulting from net realized gains. At
September 30, 1999, net unrealized appreciation in the portfolio totaled $3.9
million, and was composed of unrealized appreciation of $31.8 million resulting
primarily from appreciated equity interests in portfolio companies, and
unrealized depreciation of $27.9 million resulting primarily from
underperforming loan and equity investments in the portfolio. At September 30,
1998, net unrealized appreciation in the portfolio totaled $0.9 million and was
composed of unrealized appreciation of $28.0 million and unrealized depreciation
of $27.1 million.
The Company employs a standard grading system for the entire portfolio.
Grade 1 is used for those investments from which a capital gain is expected.
Grade 2 is used for investments performing in accordance with plan. Grade 3 is
used for investments that require closer monitoring; however, no loss of
interest or principal is expected. Grade 4 is used for investments for which
some loss of contractually due interest is expected, but no loss of principal is
expected. Grade 5 is used for investments for which some loss of principal is
expected and the investment is written down to net realizable value. During
1998, the Company began to grade its commercial mortgage and 7(a) loan
portfolios using the same grading system used for its mezzanine loan portfolio,
so that the Company's entire portfolio would have a uniform grading system.
Prior to this, the commercial real estate portfolio used a different grading
system and the 7(a) loan portfolio was not graded.
32
<PAGE> 37
At September 30, 1999, the Company's portfolio was graded as follows:
<TABLE>
<CAPTION>
INVESTMENTS PERCENTAGE OF
GRADE AT VALUE TOTAL PORTFOLIO
----- ------------- ---------------
(IN MILLIONS)
<S> <C> <C>
1..................................................... $ 114.8 10.4%
2..................................................... 916.0 83.0
3..................................................... 35.4 3.2
4..................................................... 19.4 1.8
5..................................................... 18.1 1.6
-------- -----
$1,103.7 100.0%
======== =====
</TABLE>
Grade 5 mezzanine investments totaled $11.8 million at value at September
30, 1999, or 1.1%, of the Company's total portfolio based on the valuation of
the Board of Directors. The value of these Grade 5 mezzanine investments has
been reduced from an aggregate cost of $31.8 million in order to reflect the
Company's estimate of the net realizable value of these investments upon
disposition. This reduction in value has been recorded previously as unrealized
depreciation over several years in the Company's earnings. The Company continues
to follow its historical practices of working with a troubled portfolio company
in order to recover the maximum amount of the Company's investment, but records
unrealized depreciation for the expected full amount of the potential loss when
such exposure is identified. Grade 5 mezzanine investments at December 31, 1998
totaled $6.4 million at value, or 0.8% of the Company's total portfolio.
At September 30, 1999, there were no Grade 5 commercial mortgage loans.
Grade 5 commercial mortgage loans at December 31, 1998 totaled $0.1 million at
value.
Grade 5 SBA 7(a) loans totaled $6.3 million at value at September 30, 1999.
The value of these loans has been reduced from an aggregate cost basis of $7.3
million, which includes $4.9 million at cost that is guaranteed by the SBA.
Grade 5 SBA 7(a) loans at December 31, 1998 totaled $6.3 million at value.
For the total portfolio, loans greater than 120 days delinquent were $28.6
million at value at September 30, 1999, or 2.6% of the total portfolio. Included
in this category are loans valued at $18.7 million that are fully secured by
real estate. Loans greater than 120 days delinquent generally do not accrue
interest. Loans greater than 120 days delinquent at December 31, 1998 were $13.7
million at value, or 1.7% of the total portfolio, which includes $9.9 million
that are fully secured by real estate.
Because the Company has elected to be taxed as a regulated investment
company ("RIC") under Subchapter M of the Code, the Company is not taxed on its
investment company taxable income and realized capital gains, to the extent that
such income and gains are distributed to shareholders. The Company's dividend
policy currently is to annually distribute substantially all of its net taxable
income, including net capital gains, if any. Annual tax distributions may differ
from NIA for the fiscal year due to timing differences in the recognition of
income and expenses, returns of capital and net unrealized appreciation or
depreciation, which are not included in taxable income. The Company's current
regular quarterly dividend was determined based on estimated 1999 taxable
income.
In order to maintain its RIC status, the Company must, in general, (1)
derive at least 90% of its gross income from dividends, interest and gains from
the sale of securities; (2) meet investment diversification requirements as
defined in the Code; and (3) distribute to shareholders at least 90% of its
investment company taxable ordinary income annually. The Company intends to take
all steps
33
<PAGE> 38
necessary to continue to meet the RIC qualifications. However, there can be no
assurance that the Company will continue to elect or qualify for such treatment
in future years.
Certain of the Company's credit facilities limit the Company's ability to
declare dividends, should the Company default under certain provisions of the
respective credit agreements.
The weighted average common shares outstanding used to compute basic
earnings per share were 59.1 million and 51.5 million for the nine months ended
September 30, 1999 and 1998, respectively. The increases in the weighted average
shares reflect the issuance of new shares and the issuance of shares pursuant to
a dividend reinvestment plan.
All per share amounts included in management's discussion and analysis have
been computed using the weighted average shares used to compute diluted earnings
per share, which were 59.2 million and 51.7 million for the nine months ended
September 30, 1999 and 1998, respectively.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net increase in net assets resulting from operations (NIA) was $26.9
million, or $0.44 per share, and $14.9 million, or $0.29 per share, for the
three months ended September 30, 1999 and 1998, respectively. NIA results from
total interest and related portfolio income earned, less total expenses incurred
in the operations of the Company, plus net realized and unrealized gains or
losses.
Total interest and related portfolio income was $38.0 million and $22.5
million for the three months ended September 30, 1999 and 1998, respectively.
Total interest and related portfolio income is primarily a function of the level
of interest income earned and the balance of portfolio assets. In addition,
total interest and related portfolio income includes net premiums from loan
dispositions, prepayment premiums, and investment advisory fees and other
income. Total interest and related portfolio income increased in the third
quarter of 1999 as compared to the third quarter of 1998 by 69%.
Interest income totaled $31.6 million and $20.2 million for the three
months ended September 30, 1999 and 1998, respectively. Interest income
increased $11.4 million or 56% compared to the same period in the prior year.
The increase in interest income earned results primarily from changes in the
amount of interest bearing investments outstanding, continued growth of the
Company's investment portfolio, and the Company's focus on increasing its
overall portfolio yield. The Company's investment portfolio, excluding
non-interest bearing equity interests in portfolio companies, increased by 49%
to $1,033.6 million at September 30, 1999 from $692.9 million at September 30,
1998. The weighted average yield on the interest bearing investments in the
portfolio at September 30, 1999 was 12.5% as compared to 11.8% at September 30,
1998.
Net premiums from loan dispositions were $4.7 million and $0.9 million for
the three months ended September 30, 1999 and 1998, respectively. Included in
net premiums from loan dispositions are premiums from loan sales and premiums
received on the early repayment of loans. Premiums from loan sales were $1.5
million and $0.8 million for the three months ended September 30, 1999 and 1998,
respectively. This premium income results primarily from the premium paid by
purchasers of the guaranteed portion of the Company's SBA 7(a) loans sold into
the secondary market and commercial real estate loans sold to third parties,
less the origination costs associated with the loans sold.
Prepayment premiums were $3.2 million and $0.1 million for the three months
ended September 30, 1999 and 1998, respectively. While the scheduled maturity of
mezzanine and commercial mortgage loans ranges from five to ten years, it is not
unusual for the Company's borrowers to refinance or pay off their debts to the
Company ahead of schedule. Because the Company seeks to finance primarily
seasoned, performing companies, such companies at times can secure lower cost
financing as their balance sheets strengthen, or as more favorable interest
rates
34
<PAGE> 39
become available. Therefore, the Company generally structures its loans to
require a prepayment premium for the first three to five years of the loan.
Investment advisory fees and other income were $1.7 million and $1.5
million for the three months ended September 30, 1999 and 1998, respectively.
Investment advisory fees are received from the private funds managed by the
Company.
Total operating expenses were $17.2 million and $11.5 million for the three
months ended September 30, 1999 and 1998, respectively. Operating expenses
include interest on indebtedness, salaries and employee benefits, and general
and administrative expenses.
The Company's single largest expense is interest on indebtedness, which
totaled $9.8 million and $5.7 million for the three months ended September 30,
1999 and 1998, respectively. Interest expense increased $4.1 million, or 71%,
compared to the same period in the prior year. The increase is attributable to
an increase in borrowings by the Company and its subsidiaries under various
credit facilities. The Company's total borrowings were $537.9 million and $361.7
million at September 30, 1999 and 1998, respectively. Average outstanding
indebtedness for the quarters ended September 30, 1999 and 1998 was $517.0
million and $313.0 million, respectively. The Company's weighted average
interest cost, excluding closing costs on outstanding borrowings at September
30, 1999 and 1998 was 7.4% and 7.2%, respectively.
Salaries and employee benefits totaled $4.2 million and $2.7 million for
the three months ended September 30, 1999 and 1998, respectively. Total
employees were 124 and 96 at September 30, 1999 and 1998, respectively. The
increase in salaries and employee benefits reflects the increase in total
employees, combined with wage increases and the experience level of employees
hired. The Company has been an active recruiter throughout 1998 and 1999 for
experienced investment and operational personnel, and the Company will continue
to actively recruit and hire new professionals in 1999 to support anticipated
portfolio growth.
General and administrative expenses include the leases for the Company's
headquarters in Washington, DC, and its regional offices. General and
administrative expenses also include travel costs, stock record expenses,
directors' fees, legal and accounting fees and various other expenses. General
and administrative expenses totaled $3.2 million and $3.1 million for the three
months ended September 30, 1999 and 1998, respectively.
For the three months ended September 30, 1999 and 1998, the operating
expenses excluding interest on indebtedness as a percent of total interest and
related portfolio income less interest expense plus net realized and unrealized
capital gains was 21% and 24%, respectively.
The formula award expense totaled $1.6 million for each of the three months
ended September 30, 1999 and 1998. The formula award was designed as an
incentive compensation program that would replace canceled stock options that
were canceled as a result of the Company's 1997 Merger and would balance share
ownership among key officers. The formula award vests over a three-year period,
on the anniversary date of the Merger, beginning on December 31, 1998. Assuming
all officers who received a formula award remain with the Company over the
remaining vesting period, the Company will expense the remaining formula award
during 1999 and 2000 in an annual amount of approximately $6.2 million.
There was no cut-off award expense for the third quarter of 1999 or 1998.
The cut-off award was designed to cap the appreciated value in unvested options
at the Merger announcement date in order to set the foundation to balance option
awards upon the Merger. The cut-off award will only be payable if the award
recipient is employed by the Company on a future vesting date. Total cut-off
award that will vest in 1999 is estimated at $0.5 million.
35
<PAGE> 40
Net realized gains were $4.9 million and $6.2 million for the three months
ended September 30, 1999 and 1998, respectively. These gains resulted from the
sale of equity securities associated with certain mezzanine and commercial
mortgage loans and the realization of unamortized discount resulting from the
sale and early repayment of mezzanine and commercial mortgage loans, offset by
losses on investments.
Realized gains totaled $6.7 million and $6.9 million for the three months
ended September 30, 1999 and 1998, respectively. Realized gains during the third
quarter of 1999 primarily resulted from transactions involving one portfolio
company, COHR, Inc. ($5.3 million). The Company reversed previously recorded
unrealized appreciation of $1.8 million when these gains were realized in the
third quarter of 1999. Realized losses totaled $1.8 million and $0.7 million for
the three months ended September 30, 1999 and 1998, respectively. Realized
losses during the third quarter of 1999 resulted from the liquidation of several
portfolio investments. Losses realized in the third quarter of 1999 had been
recognized in NIA over time as unrealized depreciation when the Company
determined that the respective portfolio security's value had become impaired.
Thus, the Company reversed previously recorded unrealized depreciation totaling
$1.6 million in the third quarter of 1999 when the related losses were realized.
The Company recorded net unrealized gains of $2.8 million and $0.9 million
for the three months ended September 30, 1999 and 1998, respectively. Net
unrealized gains for the third quarter of 1999 and 1998 consisted of valuation
changes resulting from the Board of Directors' valuation of the Company's assets
and the effect of reversals of net unrealized appreciation resulting from net
realized gains.
The weighted average common shares outstanding used to compute basic
earnings per share were 61.0 million and 51.4 million for the three months ended
September 30, 1999 and 1998, respectively. The increases in the weighted average
shares reflect the issuance of new shares and the issuance of shares pursuant to
a dividend reinvestment plan.
All per share amounts included in management's discussion and analysis have
been computed using the weighted average shares used to compute diluted earnings
per share, which were 61.5 million and 51.4 million for the three months ended
September 30, 1999 and 1998, respectively.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS
At September 30, 1999, the Company had $15.4 million in cash and cash
equivalents. The Company invests otherwise uninvested cash in U.S. government or
agency-issued or guaranteed securities that are backed by the full faith and
credit of the United States, or in high quality, short-term repurchase
agreements fully collateralized by such securities. The Company's objective is
to manage to a low cash balance and fund new originations with its lines of
credit.
36
<PAGE> 41
INDEBTEDNESS
The Company had outstanding indebtedness at September 30, 1999 as follows:
<TABLE>
<CAPTION>
AMOUNT ANNUAL
CLASS OUTSTANDING INTEREST RATE(1)
----- -------------- ----------------
(IN THOUSANDS)
<S> <C> <C>
Debentures and notes payable:
Master loan and security agreement............. $ 34,500 6.40%
Unsecured long-term notes payable.............. 317,000 7.30%
SBA debentures................................. 47,650 8.22%
OPIC loan...................................... 5,700 6.57%
--------
Total debentures and notes payable........ $404,850 7.32%
========
Revolving line of credit............................ $133,000 7.69%
========
</TABLE>
- ---------------
(1) The annual interest rate includes the cost of commitment fees and other
facility fees.
MASTER LOAN AND SECURITY AGREEMENT. The Company had a facility to borrow
up to $250 million, of which $100 million was committed, using its commercial
mortgage loans as collateral. The agreement generally required interest-only
payments with all principal due at maturity. The agreement charged interest at
one-month London Inter-Bank Offered Rate ("LIBOR") plus 1.0%. The facility
matured on October 7, 1999, and has been extended through October 28, 2000, with
a total committed facility up to $100 million.
UNSECURED LONG-TERM NOTES PAYABLE. At September 30, 1999, the Company has
$317 million in financing through the issuance of unsecured long-term notes with
private institutional lenders, primarily insurance companies. The terms of the
notes include five- or seven-year maturities, priced at a weighted average rate
of 7.3%. The notes require payment of interest only semiannually, and all
principal is due upon maturity.
The Company is in the process of negotiating terms for additional long term
notes totaling approximately $100 million. The Company plans to complete this
financing during the fourth quarter of 1999.
SBA DEBENTURES. The Company, through its SBIC subsidiary, has debentures
totaling $47.7 million payable to the SBA, at interest rates ranging from 6.9%
to 9.6% with scheduled maturity dates as follows: 1999 -- $0; 2000 -- $17.3
million; 2001 -- $9.4 million; 2002 -- $0; 2003 -- $0; and $21.0 million
thereafter. The debentures require semi-annual interest-only payments with all
principal due upon maturity. During 1997, Congress increased the maximum
leverage available to an SBIC to $101.0 million, and the Company intends to
continue to borrow under the SBIC program as the situation warrants. The Company
currently has a commitment from the SBA for an additional $27.0 million of debt.
REVOLVING LINE OF CREDIT. The Company has a two-year, $340 million
unsecured revolving line of credit which expires in March, 2001. This facility
may be expanded up to $400 million. At the Company's option, the credit facility
bears interest at a rate equal to (i) LIBOR plus 1.25% or (ii) the higher of (a)
the NationsBank, N.A. prime rate and (b) the Federal Funds rate plus 0.50%. The
credit facility requires monthly payments of interest, and all principal is due
upon maturity. The credit facility also requires an annual facility fee equal to
0.25% of the committed amount, regardless of the amount outstanding under the
facility, which is payable quarterly in arrears.
37
<PAGE> 42
EQUITY CAPITAL AND DIVIDENDS
During the first nine months of 1999, the Company raised $106.5 million in
new equity primarily through the sale of shares from its shelf registration
statement. At September 30, 1999, total shareholders' equity had increased to
$593.8 million.
The Company expects to distribute four regular quarterly dividends of $0.40
per share during 1999, for total dividends of $1.60 per share for 1999. During
the first, second and third quarters of 1999, the board of directors declared
and the Company paid regular quarterly dividends of $0.40 per share.
The Company's dividend policy currently is to annually distribute
substantially all of its net taxable income, including net capital gains, if
any. The Company's taxable income can differ from its financial reporting income
due to differences in the timing of revenue and expense recognition. The
Company's current regular dividend was determined based on estimated 1999
taxable income. Dividends for 1998 totaled $1.43 per share.
FUTURE DEBT OR EQUITY OFFERINGS
The Company plans to secure additional debt and equity capital for
continued investment in growing businesses. Because the Company is a RIC, it
distributes substantially all of its income and requires external capital for
growth. Because the Company is a business development company, it is limited in
the amount of debt capital it may use to fund its growth, since it is generally
required to maintain a ratio of 200% of total assets to total borrowings.
The Company plans to maintain a strategy of financing its operations,
dividend requirements and future investments with cash from operations, through
borrowing under short- or long-term credit facilities, through asset sales, or
through obtaining new equity capital. The Company will utilize its short-term
credit facilities only as a means to bridge to long-term financing. The Company
evaluates its interest rate exposure on an ongoing basis and may hedge variable
and short-term interest rate exposure through interest rate swaps, Treasury
locks and other techniques when appropriate. The Company believes that it has
access to capital sufficient to fund its ongoing investment and operating
activities, and from which to pay dividends.
FINANCIAL OBJECTIVES
The Company has set forth certain financial objectives that it intends to
use in allocating its resources and in selecting new investment opportunities.
Management's goal is to increase NIA annually by 15% to 20% and to result in a
ratio of NIA to average shareholders' equity, or return on equity, of 19% to
22%. Management believes that the Company will be able to achieve these goals
over the next three to five years. Factors that may impede the achievement of
these objectives include those described under "Risk Factors" and also include
other factors such as changes in the economy, competitive and market conditions,
and future business decisions.
38
<PAGE> 43
INVESTMENT CONSIDERATIONS
Investing in the Company involves a number of significant risks and other
factors relating to the structure and investment objective of the Company. As a
result, there can be no assurance that the Company will achieve its investment
objective.
LENDING TO PRIVATE SMALL AND MIDDLE-MARKET COMPANIES INVOLVES A HIGH DEGREE OF
RISK.
Our portfolio consists primarily of loans to private small and
middle-market companies. There is generally no publicly available information
about these companies, and we rely on the diligence of our employees and agents
to obtain information in connection with the Company's investment decisions.
Typically, small businesses depend on the management talents and efforts of one
person or a small group of persons for their success. The death, disability or
resignation of these persons could have a material adverse impact on such a
company. In addition, small businesses frequently have smaller product lines and
market shares than their competition. Small companies may be more vulnerable to
customer preferences, market conditions and economic downturns and often need
substantial additional capital to expand or compete. Small companies may also
experience substantial variations in operating results, and frequently have
highly leveraged capital structures. Such factors can severely effect the return
on, or the recovery of, our investment in such businesses. Loans to small
businesses, therefore, involve a high degree of business and financial risk,
which can result in substantial losses and accordingly should be considered
speculative.
OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS.
We invest in and lend to small and middle-market companies that may have
limited financial resources and that may be unable to obtain financing from
traditional sources. Our borrowers may not meet net income, cash flow and other
coverage tests typically imposed by bank lenders. Numerous factors may affect a
borrower's ability to repay its loan, 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 may be
accompanied by deterioration in the collateral for the loan. We also make
unsecured, subordinated loans or invest in equity securities, which may involve
a higher degree of repayment risk.
OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID.
We acquire most of our loans and equity securities directly from small
companies. Our portfolio of loans and equity securities are and will be subject
to restrictions on resale or otherwise have no established trading market. The
illiquidity of most of our portfolio may adversely affect our ability to dispose
of loans and securities at times when it may be advantageous for us to liquidate
such investments.
WE INVEST IN NON-INVESTMENT GRADE CMBS.
The commercial mortgage-backed securities ("CMBS") in which we invest are
non-investment grade, which means that nationally recognized statistical rating
organizations rate them below the top four investment-grade rating categories
(e.g., "AAA" through "BBB"). Non-investment grade securities usually provide a
higher yield than do investment-grade bonds, but with the higher return comes
greater risk. Non-investment grade securities are considered speculative, and
their capacity to pay principal and interest in accordance with the terms of
their issue is not ensured. The CMBS tend to react more to changes in interest
rates than do higher-rated securities, have a higher risk of default, tend to be
less liquid, and may be more difficult to value.
39
<PAGE> 44
OUR PORTFOLIO IS RECORDED AT FAIR VALUE AS DETERMINED BY THE BOARD OF DIRECTORS.
There is typically no public market for the loans and equity securities of
the companies to which we make loans. As a result, our board of directors
estimates the value of these loans and equity securities. Unlike traditional
lenders, we do not establish reserves for anticipated loan losses. Instead, we
adjust quarterly the valuation of our portfolio to reflect the board of
directors' estimate of the current realizable value of each investment in our
portfolio. Without a readily ascertainable market value, the estimated value of
our portfolio of loans and equity securities may differ significantly from the
values that would be placed on the portfolio if there existed a ready market for
the loans and equity securities. Any changes in estimated value are recorded in
the Company's statement of operations as "Net unrealized gains (losses)."
WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY.
We borrow from, and issue senior debt securities to, banks and other
lenders. Lenders of these senior securities have fixed dollar claims on our
consolidated assets which are superior to the claims of our common shareholders.
Borrowings, also known as leverage, magnify the potential for gain and loss
on amounts invested and, therefore, increase the risks associated with investing
in our securities. If the value of our consolidated assets increases, then
leveraging would cause the net asset value attributable to the Company's common
stock to increase more sharply than it would have had we not leveraged.
Conversely, if the value of our consolidated assets decreases, leveraging would
cause net asset value to decline more sharply than it otherwise would have had
we not leveraged. Similarly, any increase in our consolidated income in excess
of consolidated interest payable on the borrowed funds would cause our net
income to increase more than it would without the leverage, while any decrease
in our consolidated income would cause net income to decline more sharply than
it would have had we not borrowed. Such a decline could negatively affect our
ability to make common stock dividend payments, and, if asset coverage for a
class of senior security representing indebtedness declines to less than 200%,
we may be required to sell a portion of our investments when it is
disadvantageous to do so. Leverage is generally considered a speculative
investment technique.
As of September 30, 1999, the Company's debt as a percentage of total
liabilities and shareholders' equity was 46%. Our ability to achieve our
investment objective may depend in part on our continued ability to maintain a
leveraged capital structure by borrowing from banks or other lenders on
favorable terms. There can be no assurance that we will be able to maintain such
leverage.
At September 30, 1999, the Company had $537.9 million of outstanding
indebtedness, bearing a weighted annual interest cost, excluding closing costs,
of 7.4%. In order for us to cover annual interest payments on indebtedness, we
must achieve annual returns of at least 3.4% on our portfolio.
CHANGES IN INTEREST RATES MAY AFFECT OUR PROFITABILITY.
Because we borrow money to make investments, our income is materially
dependent upon the "spread" between the rate at which we borrow funds and the
rate at which we loan these funds. In periods of sharply rising interest rates,
our cost of funds would increase and could reduce or eliminate the spread. We
use a combination of long-term and short-term borrowings to finance our lending
activities. We may use interest rate risk management techniques in an effort 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. There can be no assurance that we can maintain a positive net interest
spread or that a significant change in market interest rates will not have a
material adverse effect on our profitability.
40
<PAGE> 45
BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL.
We will continue to need capital to fund investments. Historically, we have
borrowed from financial institutions and have issued equity securities. A
reduction in the availability of funds from financial institutions could have a
material adverse effect on the Company. We must distribute at least 90% of our
net operating income other than net realized long-term capital gains to our
stockholders to maintain our regulated investment company ("RIC") status. As a
result such earnings will not be available to fund loan originations. We expect
to continue to borrow from financial institutions and sell additional equity
securities. If we fail to obtain funds from such sources or from other sources
to fund our loans, it could have a material adverse effect on the Company's
financial condition and our results. In addition, as a BDC, we are generally
required to maintain a ratio of at least 200% of total assets to total
borrowings, which may restrict our ability to borrow in certain circumstances.
OUR PORTFOLIO MAY NOT PRODUCE CAPITAL GAINS.
Mezzanine loans are typically structured as debt securities with a
relatively high fixed rate of interest and with an equity feature such as
conversion rights, warrants or options. As a result, mezzanine loans will
generate interest income from the time they are made, and may also produce a
realized gain, from an accompanying equity feature. We cannot be sure that our
portfolio will generate a current return or capital gains.
LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS AND
INCOME AVAILABLE FOR DIVIDENDS.
The Company qualifies as a RIC. If we meet certain diversification and
distribution requirements, the Company qualifies for pass-through tax treatment.
The Company would cease to qualify for pass-through tax treatment if it were
unable to comply with these requirements, or if it ceased to qualify as a BDC
under the 1940 Act. We also could be subject to a 4% excise tax (and, in certain
cases, corporate level income tax) if we fail to make certain distributions. If
the Company fails to qualify as a RIC, the Company would become subject to
federal income tax as if it were an ordinary corporation, which would
substantially reduce our net assets and the amount of income available for
distribution to our shareholders.
WE OPERATE IN A COMPETITIVE MARKET.
We compete for investments with many other companies and individuals, some
of whom have greater resources than we do. Increased competition would make it
more difficult for us to purchase or originate loans at attractive prices. As a
result of this competition, sometimes we may be precluded from making otherwise
attractive investments.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT.
We are regulated by the Commission and the SBA. In addition, changes in the
laws or regulations that govern BDCs, RICs, real estate investment trusts
("REITs"), SBICs and SBLCs may significantly affect our business. Laws and
regulations may be changed from time to time, and the interpretations of the
relevant laws and regulations also are subject to change. Any change in the law
or regulations that govern our business could have a material impact on the
Company or its operations.
QUARTERLY RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER.
The Company's quarterly operating results could fluctuate due to a number
of factors. These factors include, among others, the completion of a
securitization transaction in a particular calendar
41
<PAGE> 46
quarter, variations in the loan origination volume, variation in timing of loan
prepayments, variations in and the timing of the recognition of realized and
unrealized gains or losses, the degree to which we encounter competition in our
markets and general economic conditions. As a result of these factors, you
should not rely on quarterly results to be indicative of the Company's
performance in future quarters.
POTENTIAL YEAR 2000 PROBLEMS MAY ADVERSELY AFFECT OUR BUSINESS.
The Company has a Year 2000 compliance committee which is responsible for
assessing the Company's Year 2000 readiness and preparing the Company's Year
2000 contingency plan by focusing on three main areas: the Company's information
technology ("IT") and other operating systems, critical service providers, and
portfolio companies. The committee reports periodically to the board of
directors and to executive management.
The Company's IT systems consist of third-party software and relatively new
hardware systems. All vendors providing critical software and hardware have
indicated that their programs and systems are Year 2000 compliant. The Company
has tested its critical software applications and the test results have
indicated that the software and systems are Year 2000 compliant. In addition to
the testing performed by Company personnel, the Company also contracted with its
loan accounting software vendor to perform independent validation tests, using
the Company's data, to verify that this software will be Year 2000 compliant.
The test results revealed that the Company's loan accounting software is
currently Year 2000 compliant. Implementation of tested software and IT systems
has been completed. The Company currently has service and maintenance contracts
with all its critical software vendors, therefore, no additional costs were
incurred by the Company for the upgrades needed to become compliant.
In addition to our testing prior to Year 2000, all computer software
programs and operating systems will be tested again on January 1, 2000 to
determine that they are operating normally and that the software programs are
accurately processing transactions that are date sensitive. If the computer
hardware or software does not accurately perform its intended functions, the
respective vendors will be contacted immediately and our management information
systems group will work with the vendors to correct any problems. In the event
that our computer systems are not operational due to specific problems
encountered at our headquarters in Washington, DC, we have the option to
transfer our operations to our disaster recovery site. In addition, all critical
company data will be printed from the computer system prior to January 1, 2000
so that it will be available for use after that date as needed.
The second area of focus is the Company's critical service providers. The
Company continues to monitor all of its critical service providers as they work
toward Year 2000 compliance. The Company is not aware of any critical service
provider that will not be Year 2000 compliant. However, the Company cannot give
any assurance that the service providers will be Year 2000 compliant and that no
interruption of business will occur as a result of their noncompliance. We have
communicated with each of our critical service providers to identify contacts
and establish contingency plans in the event that they have a business
disruption resulting from a Year 2000 problem.
The Company has sent Year 2000 questionnaires to its portfolio companies to
assess their awareness and to evaluate their Year 2000 readiness. Based on the
responses to the Year 2000 questionnaires, the portfolio companies have
represented that they expect to be Year 2000 compliant by December 31, 1999. The
Company will continue to monitor the progress of its portfolio companies that
are working toward Year 2000 compliance. During 1998, the Company began to
evaluate each new portfolio company's Year 2000 compliance as part of the due
diligence process. No assurance can be given that certain of the Company's
portfolio companies will not suffer material adverse effects
42
<PAGE> 47
from Year 2000 issues, and if such adverse effects impact such companies'
ability to repay their loans, the Company's operating results and financial
condition could be affected.
We will be closely monitoring the performance of each of our portfolio
companies during the Year 2000 by reviewing their loan payment performance and
financial statements. Borrowers will be contacted immediately in the event of
non-payment or if their operating results indicate that they may not be able to
make required principal and/or interest payments.
The Company estimates its operating costs to reach Year 2000 compliance
will be approximately $100,000, and these costs are included in the Company's
1999 budget. This includes time allocated to this task by Company personnel and
costs incurred in the testing phase.
While the Company believes that it is taking the necessary steps to be Year
2000 compliant, it is difficult to fully predict the impact on the Company of
non-compliance in any of the above-mentioned areas. Significant non-compliance
could result in a material adverse effect on the Company's financial conditions
and results from operations. The Company believes that the worst case Year 2000
scenarios may include 1) incurring additional costs to maintain the Company's
books and records and to service the Company's investment portfolio, 2) the
inability of the Company to access or transfer cash needed to pay its bills or
fund new investments, 3) an increase in delinquencies and/or losses due to Year
2000 problems with the Company's portfolio companies, or 4) disruption in the
capital markets resulting in a lack of liquidity to the Company. The degree of
impact resulting from any of these worst case scenarios cannot be determined at
this time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in the quantitative and qualitative
disclosure about market risk since December 31, 1998.
43
<PAGE> 48
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to certain lawsuits in the normal course of business.
While the outcome of these legal proceedings cannot at this time be predicted
with certainty, the Company does not expect that these proceedings will have a
material effect upon the Company's financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended September 30, 1999 ACC issued a total of
52,190 shares pursuant to a dividend reinvestment plan. This plan is not
registered and relies on an exemption from registration in the Securities Act of
1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3(i)(1) Articles of Amendment and Restatement of the Articles of
Incorporation.
3(ii)(2) Articles of Merger.
3(iii)(3) By-laws.
4.1(6) Specimen certificate of the Company's Common stock, par
value $0.0001 per share. See exhibits 3(i), 3(ii) and 3(iii)
for other instruments defining the rights of security
holders.
4.2(4) Form of debenture between certain subsidiaries of the
Company and the U.S. Small Business Administration.
10.1(10) Credit Agreement dated as of March 9, 1999 between the
Company, as borrower, each of the financial institutions
initially a signatory thereto, as Lenders, and Nationsbank,
N.A., as administrative agent, Nationsbanc Montgomery
Securities LLC, as sole lead arranger and sole book manager,
First Union National Bank, as syndication agent, BankBoston,
N.A., as documentation agent, Riggs Bank, N.A., as managing
agent, and Chevy Chase Bank, F.S.B. and Credit Lyonnais New
York Branch, as co-agents.
10.2.b(12) First Amendment to Credit Agreement dated May 7, 1999.
10.2(7) Note Agreement dated as of April 30, 1998.
10.3(5) Loan Agreement between Allied I and Overseas Private
Investment Corporation, dated April 10, 1995. Letter dated
December 11, 1997 evidencing assignment of Loan Agreement
from Allied I to the Company.
10.5(12) Note Agreement dated as of May 1, 1999.
10.5(11) Second Amended and Restated Master Loan & Security Agreement
dated October 28, 1999 between the Company and Morgan
Stanley Mortgage Capital, Inc.
</TABLE>
44
<PAGE> 49
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10.6(6) Sale and Servicing Agreement dated as of January 1, 1998
among Allied Capital CMT, Inc., Allied Capital Commercial
Mortgage Trust 1998-1 and the Company and LaSalle National
Bank Inc. and ABN AMRO Bank N.V.
10.7(6) Indenture dated as of January 1, 1998 between Allied Capital
Commercial Mortgage Trust 1998-1 and LaSalle National Bank
Inc.
10.8(6) Amended and Restated Trust Agreement dated January 1, 1998
between Allied Capital CMT, Inc., LaSalle National Bank Inc.
and Wilmington Trust Company.
10.9(6) Guaranty dated as of January 1, 1998 by the Company.
10.10(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
10.10a(7) First Amendment to the Company's Employee Stock Ownership
Plan dated April 30, 1998.
10.10b(11) Termination Amendment to the Company's Employee Stock
Ownership Plan dated September 1, 1999.
10.11(9) Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
10.12(8) Stock Option Plan.
10.13a(6) Form of Custody Agreement with Riggs Bank N.A. with respect
to safekeeping.
10.13b(6) Form of Custody Agreement with LaSalle National Bank Inc.
10.18(3) Dividend Reinvestment Plan.
11 Statement regarding computation of per share earnings is
incorporated by reference to Note 7 to the Company's Notes
to the Consolidated Financial Statements filed herein as
Item 1.
21 Direct subsidiaries of the Company and jurisdiction of
incorporation/organization:
Allied Investment Corporation Maryland
Allied Capital SBLC Corporation Maryland
Allied Capital REIT, Inc. Maryland
Allied Capital Holdings LLC Delaware
Allied Capital
Beteiligungsberatung GmbH Germany
27* Financial Data Schedule.
</TABLE>
- ---------------
* Filed herewith.
(1) Incorporated by reference to exhibit 3(i) with Allied Lending's Annual
Report on Form 10-K for the year ended December 31, 1996.
(2) Incorporated by reference from Appendix B to the Company's registration
statement on Form N-14 filed on September 26, 1997 (File No. 333-36459).
(3) Incorporated by reference to the exhibit of the same name filed with the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
(4) Incorporated by reference to the exhibit of the same name filed with Allied
I's Annual Report on Form 10-K for the year ended December 31, 1996.
(5) Incorporated by reference to Exhibit f.7 of Allied I's Pre-Effective
Amendment No. 2 to the registration statement on Form N-2 on January 24,
1996 (File No. 33-64629). Assignment to Company is incorporated by
reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for
the year ended December 31, 1997.
(6) Incorporated by reference to the exhibit of the same name to the Company's
registration statement on Form N-2 filed on the Company's behalf with the
Commission on May 5, 1998 (File No. 333-51899).
(7) Incorporated by reference to the exhibit of the same name filed with the
Company's Quarterly Report on Form 10-Q for the period ended June 30, 1998.
(8) Incorporated by reference to Exhibit 4 of the Allied Capital Corporation
Stock Option Plan registration statement on Form S-8, filed on behalf of
such Plan on February 3, 1998 (File No. 333-45525).
45
<PAGE> 50
(9) Incorporated by reference to the exhibit of the same name filed with the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
(10) Incorporated by reference to exhibit f.2 filed with the Company's
registration statement on Form N-2 on March 26, 1999 (File No. 333-75161).
(11) Incorporated by reference to Exhibit f.6 filed with Post-Effective
Amendment No. 1 of Company's registration statement on Form N-2 on November
10, 1999 (File No. 333-84973).
(12) Incorporated by reference to the exhibit of the same name filed with the
Company's Quarterly Report on Form 10-Q for the period ended June 30, 1999.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended September
30, 1999.
46
<PAGE> 51
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunder duly authorized.
ALLIED CAPITAL CORPORATION
(Registrant)
<TABLE>
<S> <C>
Dated: November 10, 1999 /s/ PENNI F. ROLL
-------------------------------------
Executive Vice President and Chief
Financial Officer
</TABLE>
47
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLIED
CAPITAL CORPORATION AND SUBSIDIARIES' CONSOLIDATED BALANCE SHEET AND
CONSOLIDATED STATEMENTS OF OPERATIONS, CHANGES IN NET ASSETS AND CASH FLOWS AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
INCORPORATED BY REFERENCE IN FORM 10Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<INVESTMENTS-AT-COST> 1,098,111
<INVESTMENTS-AT-VALUE> 1,103,653
<RECEIVABLES> 0
<ASSETS-OTHER> 50,502
<OTHER-ITEMS-ASSETS> 15,376
<TOTAL-ASSETS> 1,169,531
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 404,850
<OTHER-ITEMS-LIABILITIES> 163,848
<TOTAL-LIABILITIES> 0
<SENIOR-EQUITY> 6
<PAID-IN-CAPITAL-COMMON> 637,096
<SHARES-COMMON-STOCK> 61,972
<SHARES-COMMON-PRIOR> 55,919
<ACCUMULATED-NII-CURRENT> (6,720)
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 3,855
<NET-ASSETS> 593,833
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 84,419
<OTHER-INCOME> 14,443
<EXPENSES-NET> 49,140
<NET-INVESTMENT-INCOME> 49,722
<REALIZED-GAINS-CURRENT> 16,448
<APPREC-INCREASE-CURRENT> 1,475
<NET-CHANGE-FROM-OPS> 67,645
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 71,800
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 5,407
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 170
<NET-CHANGE-IN-ASSETS> 108,716
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 927
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 0
<INTEREST-EXPENSE> 24,173
<GROSS-EXPENSE> 49,140
<AVERAGE-NET-ASSETS> 539,475
<PER-SHARE-NAV-BEGIN> 8.68
<PER-SHARE-NII> 0.84
<PER-SHARE-GAIN-APPREC> 0.30
<PER-SHARE-DIVIDEND> 1.20
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 9.58
<EXPENSE-RATIO> 0.09
</TABLE>
