<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
<TABLE>
<S> <C>
FOR THE QUARTERLY PERIOD COMMISSION FILE NUMBER:
ENDED MARCH 31, 1999 0-22832
- ------------------------ -----------------------
</TABLE>
ALLIED CAPITAL CORPORATION
------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
MARYLAND 52-1081052
- ------------------------------ -------------------
(STATE OR JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
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 May 3, 1999 there were 58,817,435 shares outstanding of the Registrant's
common stock, $0.0001 par value.
<PAGE> 2
ALLIED CAPITAL CORPORATION
FORM 10-Q INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of March 31, 1999 and
December 31, 1998..................................... 1
Consolidated Statement of Operations -- For the Three
Months Ended March 31, 1999 and 1998.................. 2
Consolidated Statement of Changes in Net Assets -- For
the Three Months Ended March 31, 1999 and 1998........ 3
Consolidated Statement of Cash Flows -- For the Three
Months Ended March 31, 1999 and 1998.................. 4
Consolidated Statement of Investments as of March 31,
1999 and December 31, 1998............................ 5
Notes to Consolidated Financial Statements............. 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 25
Item 3. Quantitative and Qualitative Disclosures
about Market Risk ..................................... 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................. 38
Item 2. Changes in Securities and Use of Proceeds ........ 38
Item 3. Defaults Upon Senior Securities................... 38
Item 4. Submission of Matters to a Vote of Security
Holders................................................ 38
Item 5. Other Information................................. 39
Item 6. Exhibits and Reports on Form 8-K.................. 39
Signatures................................................ 41
</TABLE>
<PAGE> 3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
MARCH 31, 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-$368,776; 1998-$354,870)....................... $351,578 $339,163
Commercial mortgage loans (cost: 1999-$210,553;
1998-$232,745)...................................... 210,865 233,186
Commercial mortgage-backed securities (cost:
1999-$202,283; 1998-$115,174)....................... 200,783 113,674
Small Business Administration 7(a) loans (cost:
1999-$58,985; 1998-$57,651)......................... 58,290 56,285
Equity interests in portfolio companies (cost:
1999-$28,013; 1998-$27,618)......................... 55,911 49,391
Other portfolio assets (cost: 1999-$8,639;
1998-$8,331)........................................ 8,411 8,575
-------- --------
Total portfolio at value.......................... 885,838 800,274
-------- --------
Cash and cash equivalents................................... 35,231 25,075
Other assets................................................ 40,352 30,730
-------- --------
Total assets...................................... $961,421 $856,079
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable.......................... $289,742 $239,350
Revolving lines of credit............................. 121,000 95,000
Accounts payable and other liabilities................ 20,703 27,912
Dividends and distributions payable................... -- 1,700
-------- --------
Total liabilities................................. 431,445 363,962
-------- --------
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; 58,817,435 and 56,729,502 issued and
outstanding at March 31, 1999 and December
31, 1998, respectively.............................. 6 6
Additional paid-in capital............................ 563,853 526,824
Common stock held in deferred compensation trust
(563,537 shares and 810,456 shares at March 31, 1999
and December 31, 1998, respectively)................ (13,622) (19,431)
Notes receivable from sale of common stock............ (23,735) (23,735)
Net unrealized appreciation on portfolio.............. 6,663 2,380
Distributions in excess of earnings................... (10,189) (927)
-------- --------
Total shareholders' equity........................ 522,976 485,117
-------- --------
Total liabilities and shareholders' equity........ $961,421 $856,079
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE> 4
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS
ENDED MARCH 31,
-------------------
1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- --------
(UNAUDITED)
<S> <C> <C>
Interest and related portfolio income:
Interest................................. $24,684 $19,501
Net premiums from loan dispositions...... 1,901 1,336
Net gain on securitization of commercial
mortgage loans......................... -- 14,812
Investment advisory fees and other
income................................. 1,093 1,248
------- -------
Total interest and related portfolio
income............................. 27,678 36,897
------- -------
Expenses:
Interest on indebtedness................. 6,365 4,598
Salaries and employee benefits........... 3,361 2,850
General and administrative............... 2,350 2,757
------- -------
Total operating expenses............. 12,076 10,205
Formula and cut-off awards............... 1,772 1,772
------- -------
Portfolio income before net realized and
unrealized gains............................. 13,830 24,920
------- -------
Net realized and unrealized gains:
Net realized gains....................... 466 6,421
Net unrealized gains..................... 4,284 724
------- -------
Total net realized and unrealized
gains.............................. 4,750 7,145
------- -------
Net increase in net assets resulting from
operations................................... $18,580 $32,065
======= =======
Basic earnings per common share................ $ 0.33 $ 0.62
======= =======
Diluted earnings per common share.............. $ 0.33 $ 0.61
======= =======
Weighted average common shares
outstanding -- basic......................... 56,799 51,814
======= =======
Weighted average common shares
outstanding -- diluted....................... 56,828 52,108
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 5
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
1999 1998
--------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
<S> <C> <C>
Operations:
Portfolio income before realized and
unrealized gains................... $ 13,830 $ 24,920
Net realized gains................... 466 6,421
Net unrealized gains................. 4,284 724
-------- --------
Net increase in net assets
resulting from operations..... 18,580 32,065
-------- --------
Shareholder distributions:
Portfolio income..................... (23,505) (18,225)
Preferred stock dividend............. (55) (55)
-------- --------
Net decrease in net assets
resulting from shareholder
distributions................. (23,560) (18,280)
-------- --------
Capital share transactions:
Sale of common stock................. 35,787 --
Net decrease in notes receivable
from sale of common stock.......... -- 3,055
Issuance of common stock in lieu of
cash distributions................. 1,243 1,678
Purchase of common stock by deferred
compensation trust................. -- (15,330)
Distribution of common stock by
deferred compensation trust........ 5,748 --
Other................................ 61 --
-------- --------
Net increase (decrease) in net
assets resulting from capital
share transactions............ 42,839 (10,597)
-------- --------
Total increase in net assets.............. $ 37,859 $ 3,188
-------- --------
Net assets at beginning of year........... $485,117 $420,060
-------- --------
Net assets at end of year................. $522,976 $423,248
======== ========
Net asset value per common share.......... $ 8.98 $ 8.23
======== ========
Common shares outstanding at end of
period.................................. 58,254 51,451
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 6
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------
1999 1998
-------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net increase in net assets resulting from
operations................................. $ 18,580 $ 32,065
Adjustments
Net unrealized gains ...................... (4,284) (724)
Net gain on securitization of commercial
mortgage loans........................... -- (14,812)
Depreciation and amortization.............. 1,450 173
Amortization of loan discounts and fees.... (1,150) (1,349)
Changes in other assets and liabilities.... (10,080) (4,228)
-------- ---------
Net cash provided by operating
activities............................ 4,516 11,125
-------- ---------
Cash flows from investing activities:
Investments in small business concerns....... (159,380) (107,506)
Collections of investment principal.......... 37,321 30,773
Proceeds from loan sales..................... 40,467 9,706
Proceeds from securitization of commercial
mortgage loans............................. -- 223,401
Net purchase of U.S. government securities... -- (13,987)
Collections of notes receivable from sale of
common stock............................... -- 3,055
Other investing activities................... (931) (3,804)
-------- ---------
Net cash (used in) provided by investing
activities............................ (82,523) 141,638
-------- ---------
Cash flows from financing activities:
Sale of common stock......................... 35,787 --
Purchase of common stock by deferred
compensation trust......................... -- (15,330)
Common dividends and distributions paid...... (23,959) (16,547)
Special undistributed earnings distribution
paid....................................... -- (8,848)
Preferred stock dividends.................... (55) (275)
Net (payments on) borrowings under debentures
and notes payable.......................... 50,390 (209,578)
Net borrowings under revolving
lines of credit............................ 26,000 64,158
Other financing activities................... -- (5,767)
-------- ---------
Net cash provided by (used in) financing
activities............................ 88,163 (192,187)
-------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. $ 10,156 $ (39,424)
Cash and cash equivalents at beginning of
period....................................... $ 25,075 $ 70,437
-------- ---------
Cash and cash equivalents at end of period..... $ 35,231 $ 31,013
======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 7
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
<S> <C> <C> <C>
Acme Paging, L.P. Debt Securities $ 6,355 $ 6,355
Partnership Interest 1,456 2,600
- -----------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc. Warrants 125 125
- -----------------------------------------------------------------------------------------------------
AMF Bowling, Inc. (1) High Yield Debt 5,557 5,557
- -----------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -----------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc. (1) Debt Securities 7,441 7,441
Warrants 227 --
- -----------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 11,510 11,510
Warrants 1,000 1,000
- -----------------------------------------------------------------------------------------------------
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 332 332
Warrants 12 12
- -----------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,991 50
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,610 1,406
Common Stock (220 shares) 1 --
- -----------------------------------------------------------------------------------------------------
COHR, Inc. (1) Debt Securities 20,000 20,000
Common Stock (277,778 shares) 1,000 1,000
- -----------------------------------------------------------------------------------------------------
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 3,453 3,453
Warrants -- 1,138
- -----------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,909 5,909
- -----------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 2,950 2,950
Resources, LLC Options -- --
- -----------------------------------------------------------------------------------------------------
Coverall North America Loan 8,917 8,917
- -----------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 350
- -----------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 --
- -----------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 107
- -----------------------------------------------------------------------------------------------------
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 --
- -----------------------------------------------------------------------------------------------------
Drilltec Patents & Technologies Loan 10,139 8,981
Company, Inc.
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE> 8
<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ECM Enterprises Loan $ 29 $ 4
- -----------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 14 14
Debt Securities 1,875 540
Common Stock (100 shares) 250 --
- -----------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Loans 306 306
- -----------------------------------------------------------------------------------------------------
Enterprise Software, Inc. (1) Debt Securities 14,880 14,880
Common Stock (147,975 shares) 1,176 852
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -----------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 --
- -----------------------------------------------------------------------------------------------------
Everything Yogurt Loan 25 25
- -----------------------------------------------------------------------------------------------------
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 5,714 5,714
Company Warrants 280 3,628
- -----------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- -----------------------------------------------------------------------------------------------------
FTI Consulting, Inc. (1) Debt Securities 12,740 12,740
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,712 30,712
Communications, LLC Warrants -- --
- -----------------------------------------------------------------------------------------------------
Genoa Mine Acquisition Loan 242 242
Corporation
- -----------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,243 15,243
Warrants 525 1,000
- -----------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- 154
- -----------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 1,390
Archery, LLC Convertible Debentures 2,248 2,242
- -----------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 7,338
- -----------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,159 9,159
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Han Hie Loan 508 508
- -----------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- -----------------------------------------------------------------------------------------------------
Jack Henry & Associates, Inc. (1) Common Stock (90,438 shares) 26 3,099
- -----------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 83 83
- -----------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,120 2,120
Warrants 74 74
- -----------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,708 4,708
Warrants 324 2,700
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE> 9
<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Kirker Enterprises, Inc. Warrants $ 348 $ 3,500
Equity Interest 5 5
- -----------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,291 6,291
Warrants 96 2,850
- -----------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,616 7,616
Warrants 348 348
- -----------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,411 3,411
Common Stock (64,535 shares) 142 142
- -----------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- -----------------------------------------------------------------------------------------------------
Liqui-Dri Foods, Inc. Loans 10,412 10,412
- -----------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High Yield Debt 15,150 15,150
- -----------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
- -----------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- -----------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,923 2,923
- -----------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, LLC Loan 10,604 10,604
- -----------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 165 165
Options -- --
- -----------------------------------------------------------------------------------------------------
Mihadas Loan 286 286
- -----------------------------------------------------------------------------------------------------
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 49 49
- -----------------------------------------------------------------------------------------------------
Nobel Learning Communities, Debt Securities 9,437 9,437
Inc. (1) Series D Convertible Preferred Stock 2,000 2,000
(265,957 shares)
Warrants 575 575
- -----------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 3 3
- -----------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 406 406
L.P.
- -----------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,853 10,853
Warrants 900 900
- -----------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 589 140
Warrants 77 --
- -----------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 223 223
- -----------------------------------------------------------------------------------------------------
David Peters Loan 162 55
- -----------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loan 31 31
Preferred Stock (276 shares) 160 222
Common Stock (24 shares) -- --
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE> 10
<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Pico Products, Inc. (1) Debt Securities $ 4,091 $ 4,091
Common Stock (208,000 shares) 59 21
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Precision Industries Co. Debt Securities 9,711 9,711
Common Stock (132,507 shares) 1,050 2,561
- -----------------------------------------------------------------------------------------------------
Progressive International Debt Securities 3,933 3,933
Corporation Preferred Stock (500 shares) 500 500
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 806
Holdings, PLC (1)
- -----------------------------------------------------------------------------------------------------
Radio One, Inc. Common Stock (14 shares) -- 5,000
- -----------------------------------------------------------------------------------------------------
R.L. Singletary Loan 96 96
- -----------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,690 9,690
Warrants 395 395
- -----------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 493
- -----------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 315 225
Common Stock (6,208 shares) 24 --
- -----------------------------------------------------------------------------------------------------
SunStates Refrigerated Services, Loans 1,830 341
Inc. Debt Securities 2,445 676
- -----------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,884 11,884
Options -- --
- -----------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,553 106
Common Stock (910 shares) 57 --
- -----------------------------------------------------------------------------------------------------
Tubbs Snowshoe Company, LLC Debt Securities 3,946 3,946
Warrants 54 54
Common Units (2,325 units) 500 500
- -----------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,607 3,607
Warrants 360 360
- -----------------------------------------------------------------------------------------------------
Vianova Resins GmbH Debt Securities 1,632 1,632
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Vidon, Inc. Loan 258 258
- -----------------------------------------------------------------------------------------------------
William R. Dye Loan 264 264
- -----------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company Warrants 24 322
- -----------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,000 12,000
- -----------------------------------------------------------------------------------------------------
WYCB Acquisition Corporation Loan 3,842 3,842
- -----------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Debt Securities 15,099 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 (97 investments) $396,789 $407,489
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
8
<PAGE> 11
<TABLE>
<CAPTION>
MARCH 31, 1999
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 3 $ 1,326 $ 1,326
7.00%- 8.99% 33 86,087 86,087
9.00%-10.99% 88 71,571 71,883
11.00%-12.99% 20 39,066 39,066
13.00%-14.99% 4 12,378 12,378
15.00% and above 1 125 125
- ------------------------------------------------------------------------------------------------
Total commercial mortgage loans 149 $210,553 $210,865
- ------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE-BACKED SECURITIES
Subordinated CMBS 3 $116,344 $116,344
- ------------------------------------------------------------------------------------------------
Residual CMBS 2 75,007 75,007
- ------------------------------------------------------------------------------------------------
Residual securitization spread 1 10,932 9,432
- ------------------------------------------------------------------------------------------------
Total commercial mortgage-backed securities 6 $202,283 $200,783
- ------------------------------------------------------------------------------------------------
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 2 $ 71 $ 71
7.00%- 8.99% 8 135 58
9.00%-10.99% 374 56,624 56,672
11.00%-12.99% 30 1,879 1,298
13.00%-14.99% 4 276 191
15.00% and above -- -- --
- ------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 418 $ 58,985 $ 58,290
- ------------------------------------------------------------------------------------------------
Other portfolio assets 8 $ 8,639 $ 8,411
- ------------------------------------------------------------------------------------------------
Total portfolio 678 $877,249 $885,838
- ------------------------------------------------------------------------------------------------
</TABLE>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
9
<PAGE> 12
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
- ---------------------------------------------------------------------------------------- -------- --------
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
<S> <C> <C> <C>
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>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
10
<PAGE> 13
<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, Inc. Loans 306 306
- -------------------------------------------------------------------------------------------------------
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>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
11
<PAGE> 14
<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, Debt Securities 3,403 3,403
Inc.
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>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
12
<PAGE> 15
<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 Loans 1,830 341
Services,
Inc. 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>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
13
<PAGE> 16
<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 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
- ------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE-BACKED SECURITIES
Subordinated 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
- ------------------------------------------------------------------------------------------------
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>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
14
<PAGE> 17
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 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).
15
<PAGE> 18
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 March 31, 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 months ended March 31, 1999 are not necessarily indicative of the
operating results to be expected for the full year.
The consolidated financial statements for the periods presented have been
restated to include the accounts of the Predecessor Companies for all periods
presented. Transaction fees and expenses related to the Merger were expensed in
the fourth quarter of 1997. 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, including the purchase of
commercial mortgage-backed securities, 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 March 31, 1999 and December 31, 1998, approximately 98 percent 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 March 31,
1999 and December 31, 1998 was 14.0 percent and 14.6 percent, respectively. At
March 31, 1999 and December 31, 1998, mezzanine loans and debt securities with
a cost basis of $24,922,000 and $20,977,000, respectively, were not accruing
interest.
16
<PAGE> 19
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 March
31, 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................................................... 22 23
West........................................................ 15 11
International............................................... 7 7
Northeast................................................... 5 4
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Consumer Products........................................... 22% 25%
Telecommunications.......................................... 15 14
Business Services........................................... 13 11
Retail...................................................... 8 9
Industrial Products......................................... 8 8
Broadcasting................................................ 6 9
Other....................................................... 28 24
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
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 March 31, 1999 and December 31, 1998, approximately 60 percent and 40
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 March 31, 1999 and December 31, 1998 equaled 10.4 percent and 10.4
percent, respectively. As of March 31, 1999 and December 31, 1998, loans with a
cost basis of $4,804,000 and $5,443,000, respectively, were not accruing
interest.
17
<PAGE> 20
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
The geographic composition and the property types securing the commercial
mortgage loan portfolio at March 31, 1999 and December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
Mid-Atlantic................................................ 37% 36%
Southeast................................................... 29 23
West........................................................ 20 22
Midwest..................................................... 9 13
Northeast................................................... 5 6
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Hospitality................................................. 46% 42%
Office...................................................... 21 29
Retail...................................................... 14 14
Recreation.................................................. 12 5
Other....................................................... 7 10
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
COMMERCIAL MORTGAGE-BACKED SECURITIES
In December 1998, the Company purchased $67 million of Subordinated
Commercial Mortgage Backed Securities ("Subordinated CMBS") for $32 million. In
the first quarter of 1999, the Company purchased for a price of $88.0 million,
Subordinated CMBS with a face value of $177.9 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 March 31, 1999 and December 31, 1998, the estimated yield to maturity
on the Subordinated CMBS was approximately 14.6 percent and 15.0 percent,
respectively. The Company's estimated returns on its Subordinated 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 Subordinated 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.
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
18
<PAGE> 21
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
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 March 31, 1999, the mortgage loan
pool consisted of 67 loans and had an approximate weighted average stated
interest rate of 9.3 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.
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 March 31, 1999 and
December 31, 1998, approximately 97 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 March 31, 1999 and December 31, 1998, 7(a) loans with a cost basis
of $8,729,000 and $11,227,000, respectively, were not accruing interest.
19
<PAGE> 22
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PORTFOLIO, CONTINUED
The geographic and industry composition of the SBA 7(a) portfolio at March
31, 1999 and December 31, 1998 was as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
Midwest..................................................... 38% 34%
Mid-Atlantic................................................ 30 29
Southeast................................................... 15 16
West........................................................ 12 14
Northeast................................................... 5 7
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Retail...................................................... 42% 41%
Hospitality................................................. 29 30
Consumer Products........................................... 6 6
Consumer Services........................................... 5 6
Business Services........................................... 4 4
Broadcasting................................................ 3 4
Other....................................................... 11 9
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>
NOTE 5. DEBT
At March 31, 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 $ 56,392 $250,000 $ 6,000
Unsecured long-term notes
payable................ 180,000 180,000 180,000 180,000
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..... 510,350 289,742 760,350 239,350
======== ======== ======== ========
Revolving lines of credit..... 315,000 121,000 200,000 95,000
-------- -------- -------- --------
Total Debt.......... $825,350 $410,742 $960,350 $334,350
======== ======== ======== ========
</TABLE>
20
<PAGE> 23
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. DEBT, CONTINUED
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 5.9 percent and 6.6 percent, at March 31, 1999 and December 31,
1998, respectively. Average debt outstanding, maximum amount borrowed, and
weighted average interest rate charged on this facility for the three months
ended March 31, 1999 and for the year ended December 31, 1998 were $48,818,000
and $21,932,000; $84,392,000 and $56,000,000; and 6.1 percent and 6.5 percent
respectively. The agreement matures on October 7, 1999.
UNSECURED LONG-TERM NOTES PAYABLE
In June 1998 the Company issued three classes of unsecured long-term notes
held by private institutional investors. The notes have terms of 5 or 7 years
with an aggregate principal balance of $180,000,000. The weighted average
interest rate on the notes is 7.2 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 March 31, 1999 and December 31, 1998, the Company had drawn debentures
totaling $47,650,000, 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-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 and 6.6 percent at March
31, 1999 and December 31,1998, respectively. 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 March 1999, the Company increased its unsecured revolving line of
credit to $315,000,000 from $200,000,000. The facility bears interest at LIBOR
plus 1.25 percent, or 6.2 percent and 6.9 percent at March 31, 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 $71,444,000 and
$51,904,000 for the three months ended March 31, 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 three months ended
March 31, 1999 and for the year ended December 31, 1998 were $121,000,000 and
$105,000,000, and 6.6 percent and 6.8 percent, respectively.
21
<PAGE> 24
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. SHAREHOLDERS' EQUITY
For the three months ended March 31, 1999 and for the year ended December
31, 1998, the Company's compensation committee granted a total of 30,000
options and 5,189,944 options, respectively, to officers of the Company under
the stock option 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 $20.15 per share. At
March 31, 1999, options for 1,468,676 shares were vested. No options were
exercised and 107,222 options were cancelled during the three months ended
March 31, 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 three months ended March 31, 1999, the Company sold 1,455,000
shares of its common stock through an underwriter for net proceeds of
$25,906,000, after costs of $1,375,000 which included a discount of 4.0
percent. In addition, the Company sold 576,326 shares of its common stock to an
institutional investor. The net proceeds from the transaction were $9,881,000,
after costs of $428,000 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 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 three
months ended March 31, 1999 and for the year ended December 31, 1998 the
Company issued 62,979 and 241,482 shares, respectively, at an average price
per share of $18.35 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 MARCH 31, 1999 (UNAUDITED)
Net increase in net assets resulting from operations... $18,580
Less: Preferred stock dividends (55)
-------
Income available to common shareholders................ $18,525
=======
BASIC EARNINGS PER COMMON SHARE........................ 56,799 $0.33
=====
Options outstanding to officers........................ 29
------
DILUTED EARNINGS PER COMMON SHARE...................... 56,828 $0.33
====== =====
FOR THE THREE MONTHS ENDED MARCH 31, 1998 (UNAUDITED)
Net increase in net assets resulting from operations... $32,065
Less: Preferred stock dividends........................ (55)
-------
Income available to common shareholders................ $32,010
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,814 $0.62
=====
Options outstanding to officers........................ 294
------
DILUTED EARNINGS PER COMMON SHARE...................... 52,108 $0.61
====== =====
</TABLE>
22
<PAGE> 25
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. CUT-OFF AWARD AND FORMULA AWARD
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 three months ended March 31, 1999
and for the year ended December 31, 1998, $212,000 and $807,000 of the Cut-off
Award vested.
23
<PAGE> 26
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. CUT-OFF AWARD AND FORMULA AWARD, CONTINUED
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 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 three months ended March 31,
1999 and for the year ended December 31, 1998, $1,560,000 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 three months ended March 31, 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.
NOTE 9. DIVIDENDS AND DISTRIBUTIONS
The Company's Board of Directors declared and the Company paid a $0.40 per
common share dividend, or $23,271,000, for the three months ended March 31,
1999.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company is party to certain lawsuits in connection with its business.
While the outcome of these legal proceedings cannot at this time be predicted
with certainty, management does not expect that these proceedings will have a
material effect upon the financial condition of the Company.
24
<PAGE> 27
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's primary business is investing in and lending to private
small and medium-sized businesses in three areas: mezzanine finance, commercial
real estate finance, including the purchase of commercial mortgage-backed
securities ("CMBS"), and 7(a) lending.
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 $885.8 at March 31, 1999 and $800.3
million at December 31, 1998. During the three months ended March 31, 1999, the
Company originated investments totaling $159.4 million and received repayments
of $37.3 million and sold loans of $40.5 million. As a result, the total
portfolio increased by 10.7% from December 31, 1998 to March 31, 1999. The
portfolio increased approximately 15% for the year ended December 31, 1998.
<TABLE>
<CAPTION>
AT AT
MARCH 31, DECEMBER 31,
ASSET COMPOSITION 1999 1998
----------------- --------- ------------
<S> <C> <C>
Mezzanine Investments................... 42% 46%
Commercial Mortgage Loans............... 22% 27%
Commercial Mortgage-Backed Securities... 21% 13%
SBA 7(a) Loans.......................... 6% 7%
Cash and Other Assets................... 9% 7%
---- ----
100% 100%
==== ====
</TABLE>
25
<PAGE> 28
MEZZANINE
Mezzanine loans, debt securities and equity interests were $407.5 million
and $388.6 million at March 31, 1999 and December 31, 1998, respectively. The
effective yield on the mezzanine loans and debt securities was 14.0% and 14.6%
at March 31, 1999 and December 31, 1998, respectively. Mezzanine loan
originations and purchases were $39.4 million and $37.8 million for the three
months ended March 31, 1999 and 1998, respectively. Mezzanine repayments and
sales were $24.6 million and $13.8 million for the three months ended March 31,
1999 and 1998, respectively.
COMMERCIAL MORTGAGE-BACKED SECURITIES
Commercial Mortgage-Backed Securities (CMBS) were $200.8 million and $113.7
million at March 31, 1999 and December 31, 1998. The portfolio at March 31, 1999
consists of $116.3 million of purchased Subordinated CMBS and $84.5 million of
Residual CMBS retained from a $295 million asset securitization the Company
completed on January 30, 1998. During the first quarter of 1999, the Company
purchased for a price of $88.0 million, Subordinated CMBS with a face value of
$177.9 million. As of March 31, 1999 and December 31, 1998, the estimated yield
to maturity on the Subordinated CMBS and the Residual CMBS was 14.6% and 10.1%
and 15.0% and 9.7%, respectively. As of March 31, 1999 and December 31, 1998,
the weighted average yield on the entire CMBS portfolio was 12.7% and 11.2%,
respectively.
Since the fourth quarter of 1998, few commercial lenders have had the
liquidity to participate in the purchase of these bonds. The Company will
continue to bid on similar CMBS offerings. The purchases of the Subordinated
CMBS have had, and will continue to have, the full scrutiny of the Company's
stringent 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.
COMMERCIAL MORTGAGE LOANS
Commercial mortgage loans were $210.9 million at March 31, 1999 and $233.2
million at December 31, 1998. The weighted average current stated interest rate
on the commercial mortgage loan portfolio at March 31, 1999 was 9.8% and at
December 31, 1998 was 9.7%. The weighted average yield on the commercial
mortgage loan portfolio was 10.4% at March 31, 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.
During the first quarter of 1999, the Company combined its commercial real
estate loan origination for sale operations with its SBA lending operations in
order to increase its competitiveness in the small business lending area, and in
order to increase the premiums earned on loans originated for sale. Small
commercial real estate loans originated for sale in the first quarter of 1999
totaled $13.6 million. Sales of small commercial real estate loans in the first
quarter of 1999 totaled $31.4 million. Sales in the first quarter of 1999
included loans totaling $17 million that were originated or purchased over
several years, and were sold at par.
The commercial mortgage loan portfolio decreased by 48% for the year
ended December 31, 1998. During the first quarter of 1998 the Company
decreased its commercial loan portfolio through the securitization of $295
million in commercial real estate loans. Commercial mortgage loan originations
and purchases were $198.6 million and repayments were $96.7 million for 1998.
26
<PAGE> 29
SBA 7(a) LOANS
The SBA 7(a) loan portfolio was $58.3 million at March 31, 1999 and $56.3
million at December 31, 1998. SBA 7(a) loan originations were $18.4 million and
$15.7 million for the three months ended March 31, 1999 and 1998, respectively.
Sales of the guaranteed portions of SBA 7(a) loans were $13.0 million and $9.7
million for the three months ended March 31, 1999 and 1998, respectively, and
$37.0 million for the year ended December 31, 1998. 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.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Net increase in net assets resulting from operations (NIA) was $18.6
million, or $0.33 per share, and $32.1 million, or $0.61 per share, for the
three months ended March 31, 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 three months ended March 31, 1998 also includes a 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 $27.7 million and $36.9
million for the three months ended March 31, 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 advisory fee and other income. 1998 total
interest and related portfolio income includes a gain on sale of $14.8 million
resulting from a commercial mortgage loan securitization transaction that was
completed in January 1998. Excluding this gain, total interest and related
portfolio income was $22.1 million for the three months ended March 31, 1998.
Thus excluding the 1998 gain on sale, total interest and related portfolio
income increased in the first quarter of 1999 as compared to the first quarter
of 1998 by 25.3%.
Interest income totaled $24.7 million and $19.5 million for the three
months ended March 31, 1999 and 1998, respectively. Interest income increased
$5.2 million or 27% 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 during the periods presented. The
Company's investment portfolio, excluding equity interests in portfolio
companies, increased by 58% to $829.9 million at March 31, 1999 from $524.8
million at March 31, 1998. The weighted average yield on the interest bearing
investments in the portfolio at March 31, 1999 was 12.6% as compared to 12.4% at
March 31, 1998.
Net premiums from loan dispositions were $1.9 million and $1.3 million for
the three months ended March 31, 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 $1.8
million and $0.8 million for the three months ended March 31, 1999 and 1998,
respectively. This premium income results primarily from the premium paid by
purchasers of the guaranteed portion of the
27
<PAGE> 30
Company's SBA 7(a) loans 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 $0.1 million and $0.5 million for the three
months ended March 31, 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 $1.1 million and $1.2
million for the three months ended March 31, 1999 and 1998, respectively.
Investment advisory fees are received from the private funds managed by the
Company, primarily from a fund managed in Germany.
Total operating expenses were $12.1 million and $10.2 million for the three
months ended March 31, 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 $6.4 million and $4.6 million for the three months ended March 31, 1999
and 1998, respectively. Interest expense increased $1.8 million, or 38%,
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 $410.7 million and $202.2
million at March 31, 1999 and 1998, respectively. Average outstanding
indebtedness for the quarters ended March 31, 1999 and 1998 was $353.9 million
and $246.0 million, respectively. The Company's weighted average interest cost
on outstanding borrowings at March 31, 1999 and 1998 was 7.2% and 7.6%,
respectively.
Salaries and employee benefits totaled $3.4 million and $2.9 million for
the three months ended March 31, 1999 and 1998, respectively. Total employees
were 108 and 90 at March 31, 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 was an active recruiter throughout 1998 and in the first quarter of 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 offices in Chicago and San Francisco. In
addition the Company maintains offices focused on small business lending in
Detroit, Atlanta and Philadelphia. 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 $2.4 million and $2.8 million for the three months ended March 31, 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 is the result of
differences that result from the timing of expenses recognized in 1998.
28
<PAGE> 31
Operating expenses excluding interest on indebtedness represented
approximately 0.63% and 0.77% of the Company's average assets for the three
months ended March 31, 1999 and 1998, respectively. For the three months ended
March 31, 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 22% and 14%,
respectively. For the year ended December 31, 1998 this ratio was 22%.
The cut-off award and formula award totaled $1.8 million, or $0.03 per
share, for the three months ended March 31, 1999 and 1998.
The cut-off award expense totaled $0.2 million for the three months ended
March 31, 1999 and 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 $0.8 million.
The formula award expense totaled $1.6 million for the three months ended
March 31, 1999 and 1998. The formula award was designed as an incentive
compensation program that would replace canceled stock options that were
cancelled 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 $6.4 million.
Net realized gains were $0.4 million and $6.4 million for the three months
ended March 31, 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 early
repayment of mezzanine and commercial mortgage loans, offset by losses on
investments.
Realized gains totaled $0.8 million and $6.4 million for the three months
ended March 31, 1999 and 1998, respectively. Realized gains during 1999
primarily resulted from transactions involving three portfolio companies. Gains
resulting from investments in these three companies totaled $0.7 million.
Realized losses totaled $0.3 million for the three months ended March 31, 1999.
There were no realized losses during the quarter ended March 31, 1998. Realized
losses during 1999 resulted primarily from the full or partial liquidation of
several portfolio investments. 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 $0.3 million in
1999 when the related losses were realized.
The Company recorded net unrealized gains of $4.3 million and $0.7 million
for the three months ended March 31, 1999 and 1998, respectively. Net unrealized
gains for 1999 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 March 31, 1999,
net unrealized appreciation in the portfolio totaled $6.7 million, and was
composed of unrealized appreciation of $33.3 million resulting primarily from
appreciated equity interests in portfolio companies, and unrealized
29
<PAGE> 32
depreciation of $26.6 million resulting primarily from underperforming loan and
equity investments in the portfolio. At March 31, 1998, net unrealized
appreciation in the portfolio totaled $2.0 million and was composed of
unrealized appreciation of $25.1 million and unrealized depreciation of $23.1
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.
At March 31, 1999, the Company's portfolio was graded as follows:
<TABLE>
<CAPTION>
PORTFOLIO BY GRADE
------------------ INVESTMENTS PERCENTAGE OF
GRADE AT VALUE TOTAL PORTFOLIO
----- ------------- ---------------
(IN MILLIONS)
<S> <C> <C>
1............................................ $112.7 12.7%
2............................................ 700.6 79.1
3............................................ 39.7 4.5
4............................................ 19.8 2.2
5............................................ 13.0 1.5
------ -----
$885.8 100.0%
====== =====
</TABLE>
Grade 5 mezzanine investments totaled $7.7 million at value at March 31,
1999, or 0.9%, 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 $25.7 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 exposure
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 March 31, 1999, Grade 5 commercial mortgage loans totaled $0.1 million
at value. The value of these Grade 5 loans approximates cost because of the
estimated value of the underlying collateral securing the loans. Grade 5
commercial mortgage loans at December 31, 1998 totaled $0.1 million at value.
Grade 5 SBA 7(a) loans totaled $5.2 million at value at March 31, 1999, and
have been reduced from an aggregate cost basis of $6.7 million. 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 $20.0
million at value at March 31, 1999, or 2.3% of the total portfolio. Included in
this category are loans
30
<PAGE> 33
valued at $8.4 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.
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 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.
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 income annually. The Company intends to take all
steps 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 56.8 million and 51.8 million for the three months ended
March 31, 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 56.8 million and 52.1 million for the three months ended
March 31, 1999 and 1998, respectively.
31
<PAGE> 34
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS
At March 31, 1999, the Company had $35.2 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.
INDEBTEDNESS
The Company had outstanding indebtedness at March 31, 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... $ 56,392 5.94%
Unsecured long-term
notes payable........ 180,000 7.21%
SBA debentures......... 47,650 8.22%
OPIC loan.............. 5,700 6.57%
--------
Total debentures
and notes
payable......... $289,742 7.12%
========
Revolving line of credit.... $121,000 7.35%
========
</TABLE>
- ---------------
(1) The annual interest rate includes the cost of commitment fees and other
facility fees.
MASTER LOAN AND SECURITY AGREEMENT. The Company, in conjunction with
Business Mortgage Investors, Inc. ("BMI"), has a facility to borrow up to $250
million, of which $100 million is committed, using its commercial mortgage loans
as collateral. The agreement generally requires interest-only payments with all
principal due at maturity. The agreement bears interest at one-month London
Inter-Bank Offered Rate ("LIBOR") plus 1.0%. The facility matures on October 7,
1999.
UNSECURED LONG-TERM NOTES PAYABLE. The Company has $180 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
7.2%. The notes require payment of interest only semiannually, and all principal
is due upon maturity.
On May 5, 1999, the Company closed $137 million in additional new long-term
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
7.4%, on substantially the same terms. The notes require payment of interest
only semiannually, and all principal is due upon maturity. Proceeds from the
notes will be used to pay down the Company's short-term borrowings.
32
<PAGE> 35
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, $315 million
unsecured revolving line of credit which expires in March, 2001. This facility
will shortly be increased to $340 million and 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.
EQUITY CAPITAL AND DIVIDENDS
During the first quarter of 1999, the Company raised $35.8 million in new
equity primarily through the sale of shares from its shelf registration
statement. At March 31, 1999, total shareholders' equity had increased to $523.0
million.
The Company expects to distribute four regular quarterly dividends of $0.40
per share during 1999, for total dividends of at least $1.60 per share for 1999.
During the first quarter of 1999, the board of directors declared and the
Company paid a regular quarterly dividend of $0.40 per share.
The Company's dividend policy is to distribute substantially all of its
taxable income, including capital gains, annually. 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
33
<PAGE> 36
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.
YEAR 2000 COMPLIANCE
The Company has a Year 2000 compliance committee which is responsible for
assessing the Company's Year 2000 readiness by focusing on three main areas: the
Company's information technology ("IT") and other operating systems, 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. All testing
of critical software should be completed by May 31, 1999. The Company has tested
most of its critical software applications and the test results have indicated
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 is planned
to be completed by the end of the second quarter 1999. The Company currently has
service and maintenance contracts with all its critical software vendors,
therefore, no additional costs will be incurred by the Company for the upgrades
needed to become compliant.
The second area of focus is the Company's 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.
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 will 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 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.
34
<PAGE> 37
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. The Company is currently assessing its contingency plan, taking into
consideration these worst-case scenarios. This plan will be finalized after the
Year 2000 compliance tests and surveys described above are completed.
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. In addition to the information contained in this prospectus, you
should consider carefully the following information before making investments in
the shares.
LENDING TO SMALL, PRIVATELY OWNED COMPANIES INVOLVES A HIGH DEGREE OF RISK.
Our portfolio consists primarily of loans to small, privately owned
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 businesses 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 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.
35
<PAGE> 38
WE INVEST IN NON-INVESTMENT GRADE CMBS.
The 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 pay a higher interest rate 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. They 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.
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 small 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 our loan 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 net asset 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, magnifies the potential for gain and
loss on amounts invested and, therefore, increases 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 March 31, 1999, the Company's debt as a percentage of total
liabilities and shareholders' equity was 43%. 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 March 31, 1999, the Company had $410.7 million of outstanding
indebtedness, bearing a weighted annual interest rate of 7.2%. In order for us
to cover annual interest payments on indebtedness, we must achieve annual
returns of at least 3.1% 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.
36
<PAGE> 39
BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL.
We will continue to need capital to fund loans. 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 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 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.
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.
37
<PAGE> 40
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to certain lawsuits. While the outcome of these legal
proceedings cannot at this time be predicted with certainty, management does not
expect that these actions will have a material effect upon the consolidated
financial position of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the first three months of 1999 and the years ended December 31, 1998
and 1997, ACC issued a total of 62,979, 241,482 and 550,971 shares,
respectively, pursuant to a dividend reinvestment plan. This plan is not
registered and relies on an exemption from registration in the Securities Act of
1933. The Company also issued 83,333 unregistered shares for the year ended
December 31, 1998.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
38
<PAGE> 41
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.
5 Not applicable.
9 Not applicable.
10.1(11) 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(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(8) Amended and restated Master Loan & Security Agreement dated
October 7, 1998 among the Company, BMI and Morgan Stanley
Mortgage Capital, Inc.
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.
10.11(10) Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
10.12(9) 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 La Salle National Bank Inc.
10.18(3) Dividend Reinvestment Plan.
</TABLE>
39
<PAGE> 42
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
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
PC Acquisition Corporation Maryland
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 the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998.
(9) 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).
(10) 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.
(11) 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).
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 31,
1999.
40
<PAGE> 43
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)
Dated: May 6, 1999 /s/ Penni F. Roll
----------- -----------------------------
Principal and Chief Financial
Officer
41
<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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<INVESTMENTS-AT-COST> 877,249
<INVESTMENTS-AT-VALUE> 885,838
<RECEIVABLES> 0
<ASSETS-OTHER> 40,352
<OTHER-ITEMS-ASSETS> 35,231
<TOTAL-ASSETS> 961,241
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 289,742
<OTHER-ITEMS-LIABILITIES> 141,703
<TOTAL-LIABILITIES> 431,445
<SENIOR-EQUITY> 6
<PAID-IN-CAPITAL-COMMON> 563,858
<SHARES-COMMON-STOCK> 58,221
<SHARES-COMMON-PRIOR> 55,919
<ACCUMULATED-NII-CURRENT> (10,189)
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 6,663
<NET-ASSETS> 522,976
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 24,684
<OTHER-INCOME> 2,994
<EXPENSES-NET> 13,848
<NET-INVESTMENT-INCOME> 13,830
<REALIZED-GAINS-CURRENT> 466
<APPREC-INCREASE-CURRENT> 4,284
<NET-CHANGE-FROM-OPS> 18,580
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 23,505
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 2,021
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 63
<NET-CHANGE-IN-ASSETS> 37,859
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 927
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 387
<INTEREST-EXPENSE> 6,365
<GROSS-EXPENSE> 13,848
<AVERAGE-NET-ASSETS> 504,046
<PER-SHARE-NAV-BEGIN> 8.68
<PER-SHARE-NII> 0.24
<PER-SHARE-GAIN-APPREC> 0.08
<PER-SHARE-DIVIDEND> 0.40
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 8.98
<EXPENSE-RATIO> 0.11
<AVG-DEBT-OUTSTANDING> 372,546
<AVG-DEBT-PER-SHARE> 6.55
</TABLE>
