================================================================================
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON , 1999
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
1933 Act
File No. 333-____
FORM N-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. _____ |_|
Post-Effective Amendment No. _____ |_|
AMERICAN CAPITAL STRATEGIES, LTD.
-------------------------------------------------
(Exact name of Registrant as specified in charter)
3 Bethesda Metro Center
Suite 860
Bethesda, MD 20814
---------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (301) 951-6122
Malon Wilkus
3 Bethesda Metro Center
Suite 860
Bethesda, MD 20814
---------------------------------------
(Name and address of agent for service)
-----------------
COPIES TO:
Robert B. Ott
Samuel A. Flax
Arnold & Porter
555 Twelfth Street, N.W.
Washington, DC 20004-1206
(202) 942-5000
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: From time to time
after the effective date of this Registration Statement.
-----------------
If any securities being registered on this form will be offered on a delayed or
continuous basis in reliance on Rule 415 under the Securities Act of 1933, other
than securities offered in connection with a dividend reinvestment plan, check
the following box. /x/
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8 (A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8 (A), MAY DETERMINE.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
<TABLE>
<CAPTION>
==========================================================================================================
Proposed
Maximum Amount of
Title of Securities Amount Being Aggregate Registration
Being Registered Registered Offering Price Fee
---------------- ---------- -------------- ------------
<S> <C> <C> <C>
Common Stock, $0.01 par value per share;
Preferred Stock, $0.01 par value per share;
and Debt Securities... $250,000,000 $250,000,000 $69,500
==========================================================================================================
</TABLE>
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
Cross Reference Sheet Showing Location in Prospectus of Information
Required by Parts A and B of Form N-2 Registration Statement
<TABLE>
<CAPTION>
Item Number Registration Statement Item and Heading Caption or Location in Prospectus
----------- --------------------------------------- ---------------------------------
<S> <C> <C>
1 Outside Front Cover............................. Outside Front Cover Page
2 Inside Front and Outside Back Cover Page........ Inside Front and Outside Back Cover Page
3 Fee Table and Synopsis.......................... Prospectus Summary; Fees and Expenses;
Additional Information
4 Financial Highlights............................ Selected Consolidated Financial Data;
Management's Discussion and Analysis of Financial
Condition and Results of Operations
5 Plan of Distribution............................ Outside Front Cover; Plan of Distribution
6 Selling Shareholders............................ Not Applicable
7 Use of Proceeds................................. Use of Proceeds
8 General Description of Registrant............... Outside Front Cover;
Prospectus Summary; Risk Factors;
Business; Investment Policies; Portfolio Companies
9 Management...................................... Management; Safekeeping, Transfer and Dividend
Paying Agent and Registrar; Principal Stockholders
10 Capital Stock, Long-Term Debt and Other
Securities...................................... Description of the Securities; Price Range of
Common Stock and Distributions;
Dividend Reinvestment Plan; Investment
Policies; Regulation; Principal Stockholders
11 Defaults and Arrears on Senior Securities....... Not Applicable
12 Legal Proceedings............................... Legal Proceedings
13 Table of Contents of the Statement of
Additional Information.......................... Inside Front Cover Page; Outside Back Cover Page
14 Cover Page...................................... Outside Front Cover Page of Statement of
Additional Information
15 Table of Contents............................... Outside Front Cover Page of Statement of
Additional Information
16 General Information and History................. General Information and History
17 Investment Objectives and Policies.............. Investment Policies
18 Management...................................... Management
19 Control Persons and Principal Holders of
Securities...................................... Principal Stockholders
20 Investment Advisory and Other Services.......... Safekeeping Transfer and Dividend Paying Agent and Registrar
21 Brokerage Allocation and Other Practices........ Brokerage Allocation and Other Practices
22 Tax Status...................................... Business - The Company's Operatons as a BDC and RIC
23 Financial Statements............................ Financial Statements in Prospectus
</TABLE>
* Pursuant to General Instruction on Form N-2, all items required to be set
forth in Part C are set forth in Part C.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the Registration Statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and is not soliciting an offer to buy these securities
in any state where the offer or sale is not permitted.
<PAGE>
PROSPECTUS (SUBJECT TO COMPLETION)
ISSUED ______________, 1999
[LOGO]
COMMON STOCK
PREFERRED STOCK
DEBT SECURITIES
We may offer, from time to time, up to $250 million aggregate initial
offering price of our common stock, $0.01 par value per share (the "Common
Stock"), preferred stock, or debt securities (collectively, the "Securities") in
one or more offerings. The Securities may be offered at prices and on terms to
be set forth in one or more supplements to this Prospectus (each a "Prospectus
Supplement"). In the case of our Common Stock, the offering price per share less
any underwriting commissions or discounts will not be less than the net asset
value per share of our Common Stock at the time we make the offering. You should
read this Prospectus and the applicable Prospectus Supplement carefully before
you invest in our Securities.
Our Securities may be offered directly to one or more purchasers,
through agents designated from time to time by us, or to or through underwriters
or dealers. The Prospectus Supplement relating to the offering will identify any
agents or underwriters involved in the sale of our Securities, and will set
forth any applicable purchase price, fee, commission or discount arrangement
between us and our agents or underwriters or among our underwriters or the basis
upon which such amount may be calculated. See "Plan of Distribution." We may not
sell any of our Securities through agents, underwriters or dealers without
delivery of a Prospectus Supplement describing the method and terms of the
offering of our Securities. Our Common Stock is traded on the Nasdaq National
Market under the symbol "ACAS." As of , 1999, the last reported sales
price for our Common Stock was $ .
We are a buyout and specialty finance company. We are principally
engaged in buying senior and subordinated debt from, and making equity
investments in, middle market companies. These companies are in a variety of
industries and in diverse geographic locations, primarily in the United States.
We also provide financial advisory services to businesses through ACS Capital
Investments Corporation ("CIC"), our wholly-owned subsidiary. We are a
non-diversified, closed end investment company that has elected to be treated as
a business development company ("BDC") under the Investment Company Act of 1940,
as amended ("1940 Act"). We also qualify to be taxed as a regulated investment
company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). During the period from
August 1997 through March 31, 1999, we invested $176 million in debt and equity
securities of middle market companies. Prior to August 1997, we advised
companies in connection with their obtaining financing from third parties and
arranged 29 financing transactions aggregating over $400 million and invested in
the equity securities of eight of those companies.
Additional information about us, including information contained in our
Statement of Additional Information ("SAI") dated as of the same date as this
Prospectus, has been filed with the U.S. Securities and Exchange Commission (the
"Commission"). You may obtain a copy of our SAI by writing us at our principal
office, which is located at 3 Bethesda Metro Center, Suite 860, Bethesda, MD
20814, Attention: Shareholder Relations. You may also obtain a copy of our SAI
by calling 1-800-543-1976. You will not be charged by us for this document. The
Commission maintains a web site (http://www.sec.gov) that contains the SAI and
other information regarding us. The SAI is incorporated in its entirety in this
Prospectus by reference and its table of contents appears on page 39 of the
Prospectus. See "Additional Information."
----------------
AN INVESTMENT IN OUR SECURITIES INVOLVES CERTAIN RISKS, INCLUDING,
AMONG OTHER THINGS, RISKS RELATING TO INVESTMENTS IN SECURITIES OF SMALL,
PRIVATE AND DEVELOPING BUSINESSES. WE DESCRIBE SOME OF THESE RISKS IN THE
SECTION ENTITLED "RISK FACTORS" WHICH BEGINS ON PAGE 29. YOU SHOULD CAREFULLY
CONSIDER THESE RISKS TOGETHER WITH ALL OF THE OTHER INFORMATION CONTAINED IN
THIS PROSPECTUS AND ANY PROSPECTUS SUPPLEMENT BEFORE MAKING A DECISION TO
PURCHASE OUR SECURITIES.
THE SECURITIES WE ARE OFFERING HAVE NOT BEEN APPROVED OR DISAPPROVED BY
THE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES
UNLESS ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.
----------------
The date of this Prospectus is __________, 1999.
<PAGE>
INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS
MAY CONTAIN "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995, WHICH CAN BE IDENTIFIED BY THE USE OF
FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL," "EXPECT," "INTEND," "PLANS,"
"ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE THEREOF OR OTHER
VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. THE MATTERS DESCRIBED IN "RISK
FACTORS" AND CERTAIN OTHER FACTORS NOTED THROUGHOUT THIS PROSPECTUS AND IN ANY
EXHIBITS TO THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS IS A PART,
CONSTITUTE CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS WITH RESPECT TO
ANY SUCH FORWARD-LOOKING STATEMENTS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES,
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH
FORWARD-LOOKING STATEMENTS.
PROSPECTUS SUMMARY
The following summary contains basic information about this offering.
It likely does not contain all the information that is important to an investor.
For a more complete understanding of this offering, we encourage you to read
this entire document and the documents to which we have referred.
The Company
We are a buyout and specialty finance company principally engaged in
buying senior and subordinated debt from, and making equity investments in,
middle market companies in need of capital for management buyouts including
employee stock ownership plan ("ESOP") buyouts, leveraged buyouts, growth,
acquisitions, liquidity and restructuring, or recapitalization of corporations,
subsidiaries, divisions and product lines. Our ability to fund the entire
capital structure is an advantage in completing middle market transactions. The
companies in which we invest are in a variety of industries and in diverse
geographic locations, primarily in the United States. We also provide financial
advisory services to businesses through ACS Capital Investments Corporation
("CIC"), our wholly-owned subsidiary. We are a non-diversified, closed end
investment company that has elected to be treated as a business development
company ("BDC") under the Investment Company Act of 1940, as amended ("1940
Act"). We operate so as to qualify to be taxed as a regulated investment company
("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). Operating as a RIC allows us to
avoid paying a corporate level tax on income we distribute to our shareholders.
See "Business."
We typically invest between $3 million and $20 million in each
transaction and through our subsidiary, CIC, we will arrange and secure capital
for larger transactions. We do not concentrate our investments in any particular
industry or group of industries. Our primary business objectives are to increase
our net operating income and net asset value by investing our assets in senior
debt, subordinated debt with detachable warrants and capital stock of middle
market companies with attractive current yields and potential for equity
appreciation. Our loans typically mature in five to ten years and require
monthly or quarterly interest payments at fixed rates or variable rates based on
the prime rate, plus a margin. We price our debt and equity investments based on
our analysis of each transaction. As of March 31, 1999, the weighted average
effective yield on our investments was 13.1%. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
We generally acquire equity interests in the companies from which we
have purchased debt securities with the goal of enhancing our overall return. As
of March 31, 1999 we had a weighted average ownership interest of 26.7% in our
portfolio companies. We are prepared to be a long-term partner to our portfolio
companies thereby positioning us to participate in their future financing needs.
The opportunity to liquidate our investment and realize a gain may occur if the
business recapitalizes its equity, either through a sale to new owners or a
public offering of its equity or if we exercise our rights to require the
business to purchase the warrants and stock held by us ("Put Rights"). We
generally do not have the right to require that a business undergo an initial
public offering by registering securities under the Securities Act of 1933, but
we generally do have the right to sell our equity interests in a public offering
by the business to the extent permitted by the underwriters. See "Portfolio
Companies."
We make available significant managerial assistance to our portfolio
companies. We assist management in developing the business plan of the company,
hiring additional senior management when necessary, managing the capital
structure of the company and participating on its board of directors.
Prior to August 1997, when we restructured our business activities, we
had established ourselves as a leading firm in structuring and obtaining third
party funding for management and employee buyouts of subsidiaries, divisions and
product lines being divested by larger corporations through the use of an ESOP.
The companies for whom we helped raise financing included companies who
purchased businesses from Sunbeam Corporation, the U.S. Office of Personnel
Management, American Premier Underwriters, Inc. (formerly Penn Central
Corporation), Campbell Soup Company, Union Carbide Corporation, National Forge
Company, Inc., Air Products Company, Ampco-Pittsburgh Corporation and British
Petroleum Company. In most of the ESOP transactions structured by
1
<PAGE>
us, the employees agreed to restructure their wages and benefits so that overall
cash compensation is reduced while contributions of stock are made to an ESOP.
The resulting company was structured so that the fair market value of stock
contributed to the ESOP could be deducted from corporate income before paying
taxes. Restructuring employee compensation together with the ESOP tax advantages
has the effect of improving the cash flow of the ESOP company. We are a leading
firm in structuring and implementing ESOP employee buyouts. We believe that our
ESOP knowledge and experience and our ability to fund transactions positions us
favorably in the market place. See "Business."
The Offering
We may offer, from time to time, up to $250 million of our Securities,
on terms to be determined at the time of the offering. Our Securities may be
offered at prices and on terms to be set forth in one or more Prospectus
Supplements. In the case of the offering of our Common Stock, the offering price
per share less any underwriting commissions or discounts will not be less than
the net asset value per share of our Common Stock.
Our Securities may be offered directly to one or more purchasers,
through agents designated from time to time by us, or to or through underwriters
or dealers. The Prospectus Supplement relating to the offering will identify any
agents or underwriters involved in the sale of our Securities, and will set
forth any applicable purchase price, fee, commission or discount arrangement
between us and our agents or underwriters or among our underwriters or the basis
upon which such amount may be calculated. See "Plan of Distribution." We may not
sell any of our Securities through agents, underwriters or dealers without
delivery of a Prospectus Supplement describing the method and terms of the
offering of our Securities.
Set forth below is additional information regarding the offering of our
Securities:
<TABLE>
<S> <C>
Nasdaq National Market Symbol........................... ACAS
Use of Proceeds......................................... Unless otherwise specified in a Prospectus Supplement, we
intend to use the net proceeds from the sale of our
Securities for general corporate purposes, which may
include investment in middle market companies in
accordance with our investment objectives, repayment of
indebtedness, acquisitions and other general corporate
purposes. See "Use of Proceeds."
Distributions........................................... We have paid quarterly dividends to the holders of our
Common Stock and generally intend to continue to do so.
The amount of the quarterly dividends is determined by the
Board of Directors and is based on our estimate of taxable
ordinary income and short-term capital gains. See "Price
Range of Common Stock and Distributions." Other types of
Securities will likely pay distributions in accordance
with their terms.
Principal Risk Factors.................................. Investment in our Securities involves certain risks
relating to our structure and investment objectives that
should be considered by the prospective purchasers of the
Securities. As a BDC, our portfolio includes securities
primarily issued by privately held companies. These
investments may involve a high degree of business and
financial risk, and are generally less liquid than public
securities. A large number of entities compete for the
same kind of investment opportunities as we do. We borrow
funds to make investments in and loans to middle market
businesses. As a result, we are exposed to the risks of
leverage, which may be considered a speculative investment
technique. In addition, the loss of pass-through tax
treatment under Subchapter M of the Code could have a
materially adverse effect on the total return, if any,
obtainable from an investment in our Securities. See "Risk
Factors" for a discussion of these risks.
Certain Anti-Takeover Provisions........................ Our certificate of incorporation and bylaws, as well as
certain statutory and regulatory requirements, contain
certain provisions that may have the effect of
discouraging a third party from making an acquisition
proposal for us and thereby inhibit a change in control of
us in circumstances that could give the holders of our
Common Stock the opportunity to realize a premium over the
then prevailing market price for our Common Stock. See
"Risk Factors -- Provisions Of Our Certificate of
Incorporation and Bylaws Could
</TABLE>
2
<PAGE>
<TABLE>
<S> <C>
Deter Takeover Attempts" and "Certain Provisions of the
Second Amended and Restated Certificate of Incorporation
and the Second Amended and Restated Bylaws."
Dividend Reinvestment Plan.............................. Cash distributions to holders of our Common Stock may be
reinvested under our Dividend Reinvestment Plan (the
"Reinvestment Plan") in additional whole and fractional
shares of Common Stock if you or your representative
elects to enroll in the Reinvestment Plan. See "Dividend
Reinvestment Plan" and "Business - The Company's
Operations as a BDC and RIC."
</TABLE>
Fees and Expenses
The following table will assist you in understanding the various costs
and expenses that an investor in our Securities will bear directly or
indirectly.
<TABLE>
<S> <C>
Stockholder Transaction Expenses
Sales Load (as a percentage of offering price)(1)............................................................
Dividend Reinvestment Plan Fees(2)........................................................................... None
Annual Expenses (as a percentage of net assets attributable to common shares)(3)
Management Fees.............................................................................................. None
Interest Payments on Borrowed Funds(4)....................................................................... 0.04%
Other Expenses(5)............................................................................................ 1.08%
Total Annual Expenses (estimated)(6)............................................................ 1.12%
</TABLE>
- ---------------
(1) In the event that the Securities to which this Prospectus relates are sold
to or through underwriters, a corresponding Prospectus Supplement will
disclose the applicable sales load.
(2) The expenses of the Reinvestment Plan are included in stock record
expenses, a component of Total Operating Expenses. We have no cash purchase
plan. The participants in the Reinvestment Plan will bear a pro rata share
of brokerage commissions incurred with respect to open market purchases, if
any. See "Dividend Reinvestment Plan."
(3) "Net assets attributable to common shares" equal net assets (i.e., total
assets less total liabilities) at December 31, 1998.
(4) The "Interest payments on borrowed funds" percentage is based on interest
payments for the year ended December 31, 1998 divided by assets
attributable to our common shares. We had outstanding borrowings of $105.9
million at December 31, 1998. See "Risk Factors - We May Incur Debt Which
Could Increase Our Investment Risks."
(5) "Other expenses" are based on amounts for the year ended December 31, 1998
and represent all expenses of the Company (except fees and expenses
reported in other items of this table) that are deducted from the Company's
assets and will be reflected as expenses in the Company's statement of
operations.
(6) "Total annual expenses" as a percentage is based on amounts for the year
ended December 31, 1998. "Total annual expenses" as a percentage of net
assets attributable to common shares are higher than the total annual
expenses percentage would be for a company that is not leveraged. The
Company borrows money to leverage its net assets and increase its total
assets. The "Total annual expenses" percentage is required by the
Commission to be calculated as a percentage of net assets, rather than the
total assets, including assets that have been funded with borrowed monies.
If the "Total annual expenses" percentage were calculated instead as a
percentage of total assets, "Total annual expenses" for the Company would
be 0.63% of total assets.
Example
The following example demonstrates the projected dollar amount of total
cumulative expenses that would be incurred over various periods with respect to
a hypothetical investment in our Securities. These amounts are based upon
payment by an investor of an assumed 7% sales load and payment by us of
operating expenses at the levels set forth in the table above which, as
indicated above, does not include leverage or related expenses.
3
<PAGE>
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000 investment, assuming a 5%
annual return............................................................... $81 $104 $130 $207
</TABLE>
This example should not be considered a representation of our future
expenses, and actual expenses may be greater or less than those shown. Moreover,
while the example assumes (as required by the Commission) a 5% annual return,
our performance will vary and may result in a return greater or less than 5%. In
addition, while the example assumes reinvestment of all dividends and
distributions at net asset value, participants in the Reinvestment Plan may
receive shares purchased by the Reinvestment Plan Administrator at the market
price in effect at the time, which may be at, above or below net asset value.
See "Dividend Reinvestment Plan."
Summary Financial Data
The following summary of our financial information should be read in
conjunction with our Financial Statements and Notes thereto presented elsewhere
in this Prospectus. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" ON PAGE 11 FOR MORE INFORMATION.
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months Three Months | | Nine Months
Ended Ended Year Ended Ended | | Ended
March 31, March 31, December 31, December 31, | | September 30,
1999 1998 1998 1997 | | 1997
----------- --------- ---------- ------------ | | -------------
<S> <C> <C> <C> <C> | | <C>
Total operating income $ 6,520 $ 3,298 $ 16,979 $ 2,797 | | $ 2,901
Total operating expenses 1,398 444 1,709 551 | | 2,651
-------- -------- -------- -------- | | --------
| |
Operating income (loss) before | |
equity in (loss) earnings of | |
consolidated operating 5,122 2,848 15,270 2,246 | | 250
subsidiary | |
Equity in (loss) earnings of | |
unconsolidated operating | |
subsidiary (395) 101 (482) 24 | | --
-------- -------- -------- -------- | | --------
| |
Net operating income (loss) 4,727 2,949 14,788 2,270 | | 250
Increase in unrealized | |
appreciation on investments 1,981 28 2,127 167 | | 5,321
Realized gain (loss) on | |
investments 316 -- -- -- | | --
-------- -------- -------- -------- | | --------
| |
Income before income taxes 7,024 2,977 16,915 2,437 | | 5,571
Provision for income taxes -- -- -- -- | | 2,128
-------- -------- -------- -------- | | --------
| |
Net increase in shareholders' | |
equity resulting from | |
operations $ 7,024 $ 2,977 $ 16,915 $ 2,437 | | $ 3,443
======== ======== ======== ======== | | ========
| |
| |
Per share data: | |
Net operating income: | |
Basic $ 0.43 $ 0.27 $ 1.34 $ 0.21 | |
Diluted $ 0.42 $ 0.26 $ 1.29 $ 0.20 | |
Net increase in shareholders' | |
equity resulting from | |
operations: | |
Basic $ 0.63 $ 0.27 $ 1.53 $ 0.22 | |
Diluted $ 0.62 $ 0.26 $ 1.48 $ 0.21 | |
Cash dividends $ 0.41 $ 0.25 $ 1.34 $ 0.21 | |
| |
Balance Sheet Data: | |
Total assets $263,551 $151,031 $270,019 $150,705 | | $154,322
Total shareholders' equity 155,546 150,862 152,723 150,652 | | 150,539
| |
Other Data: | |
Number of portfolio | |
companies at period end 17 6 15 3 | |
Principal amount of loan | |
originations $ 24,328 $ 20,215 $118,390 $ 16,817 | |
Investments in equity | |
securities $ 3,684 $ 9,456 $ 24,475 $ 3,805 | |
Principal amount of loan | |
repayments $ 6,860 303 $ 1,719 $ 93 | |
Return on equity (1) (2) 18.2% 7.9% 11.2% 6.5% | |
Weighted average yield on | |
investments to date 13.1% 12.3% 13.0% 12.2% | |
</TABLE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Total operating income $2,746 $2,706 $2,498
Total operating expenses 2,862 2,928 2,606
------- ------ ------
Operating income (loss) before
equity in (loss) earnings of
consolidated operating (116) (222) (108)
subsidiary
Equity in (loss) earnings of
unconsolidated operating
subsidiary -- -- --
------- ------ ------
Net operating income (loss) (116) (222) (108)
Increase in unrealized
appreciation on investments 484 371 956
Realized gain (loss) on
investments -- 66 (23)
------- ------ ------
Income before income taxes 368 215 825
Provision for income taxes 159 57 422
------- ------ ------
Net increase in shareholders'
equity resulting from
operations $ 209 $ 158 $ 403
======= ====== ======
Per share data:
Net operating income:
Basic
Diluted
Net increase in shareholders'
equity resulting from
operations:
Basic
Diluted
Cash dividends
Balance Sheet Data:
Total assets $ 5,432 $ 4,382 $ 3,930
Total shareholders' equity 3,372 2,946 2,571
Other Data:
Number of portfolio
companies at period end
Principal amount of loan
originations
Investments in equity
securities
Principal amount of loan
repayments
Return on equity (1) (2)
Weighted average yield on
investments to date
</TABLE>
(1) Amounts are annualized.
(2) Return represents net increase in shareholders' equity resulting from
operations.
4
<PAGE>
Additional Information
We have filed with the Commission a Registration Statement on Form N-2
(together with all amendments and exhibits, the "Registration Statement") under
the Securities Act of 1933, as amended (the "Securities Act"), with respect to
the Securities offered by this Prospectus. The Prospectus, which is a part of
the Registration Statement, does not contain all of the information set forth in
the Registration Statement or the exhibits and schedules thereto. For further
information with respect to the our business and our Securities, reference is
made to the Registration Statement, including the exhibits and schedules thereto
and the SAI, contained in the Registration Statement.
We also file reports, proxy statements and other information with the
Commission under the Securities Exchange Act of 1934, as amended. Such reports,
proxy statements and other information, as well as the Registration Statement
and the exhibits and schedules thereto, can be inspected at the public reference
facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the Commission's Regional Offices, located at
Seven World Trade Center, New York, New York 10048, and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661. The Commission maintains a web site that
contains reports, proxy statements and other information regarding registrants,
including the Company, that file such information electronically with the
Commission. The address of the Commission's web site is (http://www.sec.gov).
Copies of such material may also be obtained from the Public Reference Section
of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. Our Common Stock is listed on the Nasdaq National Market, and
such reports, proxy statements and other information can also be inspected at
the offices of the Nasdaq Stock Market, 1735 K Street, N.W., Washington, D.C.
20006.
We also furnish to our stockholders annual and quarterly reports, which
will include annual financial information that has been examined and reported
on, with an opinion expressed, by independent public accountants, and quarterly
unaudited financial information. See "Experts."
RISK FACTORS
You should carefully consider the risks described below together with
all of the other information provided and incorporated by reference in this
Prospectus (or any Prospectus Supplement) before making a decision to purchase
our Securities. The risks and uncertainties described below are not the only
ones facing our Company. Additional risks and uncertainties not presently known
to, or deemed material by us, may also impair our operations and performance.
If any of the following risks actually occur, our business, financial
condition or results of operations could be materially adversely affected. If
that happens, the trading price of our Common Stock could decline, and you may
lose all or part of your investment.
This Prospectus also contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks faced by us described below and elsewhere in or incorporated
by reference in this Prospectus (or any Prospectus Supplement).
We Make Loans To And Investments In Middle Market Borrowers Who May Default On
Their Loans Or Provide No Return On Our Investments
We invest in and lend to middle market privately-owned businesses.
There is generally no publicly available information about these businesses.
Therefore we rely on our principals and consultants to investigate these
businesses. Our portfolio companies may not meet net income, cash flow and other
coverage tests typically imposed by senior lenders. Numerous factors may affect
a portfolio company'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 portfolio company's financial condition and prospects may be
accompanied by deterioration in the collateral for the loan. We also make
unsecured, subordinated loans and invest in equity securities, which involve a
higher degree of risk than senior loans.
Middle market businesses typically have narrower product lines and
smaller market shares than large businesses. They tend to be more vulnerable to
competitors' actions and market conditions, as well as general economic
downturns. These businesses may also experience substantial variations in
operating results. Typically, the success of a middle market business also
depends on the management talents and efforts of one or two persons or a small
group of persons. The death, disability or resignation of one or more of these
persons could have a material adverse impact on the Company. In addition, middle
market businesses often need substantial additional capital to expand or compete
and will have borrowed money from other lenders.
5
<PAGE>
Our senior loans generally are secured by the assets of our borrowers.
Our subordinated loans are often secured by the assets of the borrower but our
rights to payment and our security interest are usually subordinated to the
payment rights and security interests of the senior lender. Therefore, we may be
limited in our ability to enforce our rights to collect our loans and to recover
any of the loan balance through a foreclosure of collateral. Often, a
deterioration in a borrower's financial condition and prospects is accompanied
by a deterioration in the value of the collateral securing its loan. These
conditions may make it difficult for us to obtain repayment of our loans.
We May Not Realize Gains From Our Equity Investments
When we make a loan, we generally receive warrants to acquire stock
issued by the borrower, and we may make direct equity investments. Our goal is
to ultimately dispose of these equity interests and realize gains. These equity
interests may not appreciate in value and, in fact, may depreciate in value.
Accordingly, we may not be able to realize gains from our equity interests.
We May Lose Our Pass-Through Tax Treatment
We operate so as to qualify to be taxed as a RIC under Subchapter M of
the Code and, provided we meet certain requirements under the Code, we can avoid
corporate level taxes. We would cease to qualify for this favorable pass-through
tax treatment if we are unable to comply with the diversification or
distribution requirements contained in Subchapter M of the Code, or if we cease
to operate so as to qualify to be taxed as a BDC under the 1940 Act. If we fail
to qualify to be taxed as a RIC, we would be subject to corporate level taxes
thereby significantly reducing our net asset value and the amount of income
available for distribution to stockholders. The loss of our current tax
treatment could have a material adverse effect on the total return, if any,
obtainable from your investment in the Securities. See "Business - The Company's
Operations as a BDC and RIC."
There Is Uncertainty Regarding the Value Of Our Privately Held
Securities
A majority of our portfolio securities are not publicly traded. We
value these securities based on a determination of their fair value made in good
faith by our Board of Directors. Due to the uncertainty inherent in estimating
the value of securities that are not publicly traded, our estimates of fair
value may differ materially from the values that would exist if a ready market
for these securities existed. Our net asset value could be materially effected
if the estimated fair value of our investments is materially different from the
values that would exist if a ready market existed for these securities.
The Lack Of Liquidity Of Our Privately Held Securities May Adversely
Affect Our Business
Most of our investments consist of securities acquired directly from
their issuers in private transactions. Some of these securities are subject to
restrictions on resale (including in some instances legal restrictions) or
otherwise are less liquid than public securities. The illiquidity of our
investments may make it difficult for us to obtain cash equal to the value at
which we record our investments if the need arises.
We May Incur Debt Which Could Increase Our Investment Risks
We borrow money or issue senior debt securities to provide us with
additional funds to invest. Our lenders have fixed dollar claims on our assets
that are senior to the claims of our stockholders. Although borrowing money for
investment increases the potential for gain, it also increases the risk of a
loss. A decrease in the value of our investments will have a sharper impact on
the value of our Common Stock if we borrow money to make investments. Our
ability to pay dividends could also be adversely impacted. In addition, we are
required by regulation to have asset coverage equal to at least twice our
indebtedness. If the value of our assets decline, we might be unable to satisfy
that test. If this happens, we may be required to sell some of our investments
and repay a portion of our indebtedness at a time when a sale may be
disadvantageous.
A Change In Interest Rates May Adversely Affect Our Profitability
A portion of our income will depend upon the difference between the
rate at which we borrow funds and the rate at which we loan these funds. We
anticipate using a combination of equity and long-term and short-term borrowings
to finance our lending activities. Certain of our borrowings may be at fixed
rates and others at variable rates. We may use interest rate hedging techniques
to reduce such risks but there can be no assurance that a significant change in
market interest rates may not have a material adverse effect on our
profitability. See "Business - The Company's Operations as a BDC and RIC."
6
<PAGE>
We Have Limited Information Regarding The Companies In Which We Invest
Consistent with our operation as a business development company, our
portfolio consists primarily of securities issued by privately held companies.
There is generally little or no publicly available information about such
companies, and we must rely on the diligence of our employees and the
consultants we hire to obtain the information necessary for our decision to
invest in them. There can be no assurance that our diligence efforts will
uncover all material information about the privately held business necessary to
make a fully informed investment decision.
We May Experience Fluctuations In Our Quarterly Results
We could experience fluctuations in our quarterly operating results due
to a number of factors including, among others, 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, results for any period should not be relied upon as
being indicative of performance in future periods. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
There Is A Risk That You May Not Receive Dividends
Since our initial public offering, we have distributed more than 90% of
our net operating income and net realized short-term capital gains on a
quarterly basis to our stockholders. Our current intention is to continue these
distributions to our stockholders. Net realized long-term capital gains may be
retained to supplement our equity capital and support growth in our portfolio,
unless our Board of Directors determines in certain cases to make a
distribution. We cannot assure you that we will achieve investment results or
maintain a tax status that will allow any specified level of cash distributions
or year-to-year increases in cash distributions.
We Operate In A Highly Competitive Market For Investment Opportunities
A large number of entities compete with us and make the types of
investments that we make in middle market privately-owned businesses. Some of
our competitors have greater financial resources. As a result of this
competition, we may not be able to take advantage of attractive investment
opportunities from time to time. There can be no assurance, therefore, that we
will be able to identify and make investments that satisfy our investment
objectives or that we will be able to fully invest our available capital.
Loss Of Key Personnel Or The Failure To Hire Additional Personnel Could
Adversely Affect Our Business
We are dependent for the final selection, structuring, closing and
monitoring of our investments on the diligence and skill of our senior
management and other management members. If we lose the services of one or more
of these individuals, it could materially and adversely affect our business and
our future prospects. Our future success will also depend on our ability to
attract and retain additional key management and technical personnel. If we are
unable to do so, there could be a material adverse impact on our business. We do
not maintain key man life insurance on any of our officers or employees.
Provisions Of Our Certificate Of Incorporation And Bylaws Could Deter
Takeover Attempts
Our certificate of incorporation and bylaws and the Delaware General
Corporation Law contain provisions that may have the effect of discouraging,
delaying or making more difficult a change in control and preventing the removal
of incumbent directors. The existence of these provisions may negatively impact
on the price of our Common Stock and may discourage third-party bids. These
provisions may reduce any premiums paid to you for shares of your Common Stock.
Furthermore, we are subject to Section 203 of the Delaware General Corporation
Law. Section 203 governs business combinations with interested stockholders, and
also could have the effect of delaying or preventing a change in control.
Risks Related To Potential Year 2000 Problems May Adversely Affect Our
Business
We depend on our computer software programs and operating systems in
operating our business. We also depend on the proper functioning of computer
systems of third parties, such as portfolio companies, vendors and suppliers.
The failure of any of these systems to appropriately interpret the upcoming
calendar year 2000 could have a material adverse effect on our business and
financial condition. We are currently identifying our own systems that are not
Year 2000 compliant and taking steps to determine whether third parties are
doing the same. In addition, we are implementing a plan to prepare our most
critical computer systems to be Year 2000 compliant in 1999.
7
<PAGE>
Throughout 1999, we will continue to address any issues of Year 2000
non-compliance and further develop our contingency plan to ensure business
operations in the event of systems failure in the Year 2000. We are utilizing
both internal and external resources to reprogram or replace, test, and
implement the software and other systems for Year 2000 modifications. We
estimate that the cost of our Year 2000 project will be less than $125,000. This
amount includes the cost of additional software, reviewing the portfolio
companies' readiness, and outside systems professionals working on our Year 2000
compliance. We cannot assure you that our Year 2000 compliance program will be
effective or that our estimates about the cost of completing our program will be
accurate.
Changes In Laws Or Regulations Governing Our Operations May Adversely
Affect Our Business
We are subject to regulation by laws at the local, state and federal
level. These laws and regulations, as well as their interpretation, may be
changed from time to time. Accordingly, any change in these laws or regulations
could have a material adverse impact on our business. See "Regulation."
CAPITALIZATION
The following table sets forth (i) the actual capitalization of the
Company at March 31, 1999, and (ii) the capitalization of the Company at March
31, 1999, as adjusted to reflect the effects of the sale of the Securities
offered hereby by the Company, and the application of the net proceeds as set
forth under "Use of Proceeds."
<TABLE>
<CAPTION>
March 31, 1999
(in thousands)
Actual As Adjusted (1)
------ ---------------
<S> <C> <C>
Revolving credit facility $ 30,000
Notes Payable 77,091
Shareholders' equity: Common Stock, $0.01 par
value, 70,000 shares authorized; 11,122 issued
and outstanding (_______________ issued and
outstanding as adjusted)(2)(3); preferred stock, $0.01 par value, 5,000 111
shares authorized and no shares issued and outstanding
Capital in excess of par value 145,879
Notes receivable from sale of Common Stock (580)
Undistributed net realized earnings 372
Unrealized appreciation of investments 9,764
--------
Total shareholders' equity $155,546
--------
Total Capitalization $262,637
========
</TABLE>
(1) Assumes a public offering price of $___________ (the last reported sale
price of the Common Stock on the Nasdaq National Market on ___________,
1999).
(2) Excludes an aggregate of _______ shares issuable pursuant to stock
options outstanding at _____________, 1999 that vest over varying
periods of time.
(3) Reflects the increase in the authorized shares of Common Stock approved
by the stockholders on May 6, 1999.
USE OF PROCEEDS
Unless otherwise specified in the Prospectus Supplement accompanying
this Prospectus, the Company intends to use the net proceeds from the sale of
the Securities for general corporate purposes, which may include investment in
middle market privately-owned companies in accordance with the Company's
investment objectives, repayment of the Company's indebtedness outstanding from
time to time, acquisitions and other general corporate purposes.
The Company anticipates that substantially all of the net proceeds of
any offering of Securities will be utilized in the manner described above within
six months, and in any event within two years. Pending such utilization, the
Company intends to invest the net proceeds of any offering of Securities in time
deposits, income-producing securities with maturities of three months or less
that are issued or guaranteed by the federal government or an agency thereof and
high quality debt securities maturing in one year or less from the time of
investment.
8
<PAGE>
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS
Since the Company became a RIC, it has distributed, and currently
intends to continue to distribute in the form of dividends, a minimum of 90% of
its net operating income and 98% of its net realized short-term capital gains,
if any, on a quarterly basis to its stockholders. Net realized long-term capital
gains may be retained to supplement the Company's equity capital and support
growth in its portfolio, unless the Board of Directors determines in certain
cases to make a distribution. There is no assurance that the Company will
achieve investment results or maintain a tax status that will permit any
specified level of cash distributions or year-to-year increases in cash
distributions. At the option of a holder of Common Stock, all cash distributions
can be reinvested automatically under the Company's Reinvestment Plan in
additional whole and fractional shares. A stockholder whose shares are held in
the name of a broker or other nominee should contact the broker or nominee
regarding participation in the Reinvestment Plan on the stockholder's behalf.
See "Risk factors--We May Lose Our Pass-Through Tax Treatment;" "Reinvestment
Plan;" and "Business - The Company's Operations as a BDC and RIC." The Common
Stock of the Company historically trades at prices both above and below its net
asset value. There can be no assurance, however, that such premium or discount,
as applicable, to net asset value will be maintained.
The Company's Common Stock is quoted on the Nasdaq Stock Market under
the symbol ACAS. As of May 17, 1999, the Company had 208 stockholders of record
and approximately 4,500 beneficial owners. The following table sets forth the
range of high and low sales prices of the Company's Common Stock as reported on
the Nasdaq Stock Market and the dividends declared by the Company for the period
from August 29, 1997, when public trading of the Common Stock commenced pursuant
to the IPO, through May 17, 1999.
Bid Price
<TABLE>
<CAPTION>
Premium Premium
(Discount) of (Discount) of
Low Sales High Sales
Net Asset Dividend Price to Price to
Value Per Share(1) High Low Declared Net Asset Value Net Asset Value
---------------- ---- --- -------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
1997
Third Quarter (beginning $13.60 $20.25 $18.50 $0.00 36.03% 48.90%
August 29, 1997)
Fourth Quarter $13.61 $20.75 $16.50 $0.21 21.23% 52.46%
1998
First Quarter $13.63 $22.50 $17.25 $0.25 26.56% 65.08%
Second Quarter $13.65 $24.63 $21.25 $0.29 55.68% 80.44%
Third Quarter $13.77 $24.25 $10.13 $0.32 (26.43)% 76.11%
Fourth Quarter $13.80 $18.44 $ 9.19 $0.48 (33.42)% 33.62%
1999
First Quarter $14.02 $18.56 $14.75 $0.41 5.21% 32.38%
Second Quarter (through $14.02 $19.88 $16.50 $0.43 N/A N/A
May 17, 1999)
</TABLE>
- -------------------
(1) Net Asset Value per share is determined as of the last day in the
relevant quarter and therefore may not reflect the net asset value per
share on the date of the high and low sale price. Historically, the
Company's net assets have been highest at the end of the quarter. The
net asset values shown are based on outstanding shares at the end of
each period.
ASSUMED RETURN ON THE COMPANY'S PORTFOLIO
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Assumed Return on Portfolio -15% -10% -5% 0 5% 10% 15%
(Net of Expenses)
- ---------------------------------------------------------------------------------------------------------------------------------
Corresponding Return to Common Stockholder -30.05% -21.58% -13.11% -4.64% 3.83% 12.31% 20.78%
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data should be read in conjunction with the
Company's financial statements and notes thereto. As discussed in Notes 1 and 2,
the Company completed an initial public offering of its Common Stock on August
29, 1997, and on October 1, 1997, began to operate as a BDC so as to qualify to
be taxed as a RIC. As a result of the changes, the financial results of the
Company for periods prior to October 1, 1997 are not comparable to periods
commencing October 1, 1997 and are not expected to be representative of the
financial results of the Company in the future.
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months Three Months | | Nine Months
Ended Ended Year Ended Ended | | Ended
March 31, March 31, December 31, December 31, | | September 30,
1999 1998 1998 1997 | | 1997
---------- ----------- ---------- ---------- | | -------------
<S> <C> <C> <C> <C> | | <C>
Total operating income $ 6,520 $ 3,298 $ 16,979 $ 2,797 | | $ 2,901
Total operating expenses 1,398 444 1,709 551 | | 2,651
-------- -------- -------- -------- | | --------
| |
Operating income (loss) before | |
equity in (loss) earnings of | |
unconsolidated operating | |
subsidiary 5,122 2,848 15,270 2,246 | | 250
Equity in (loss) earnings of | |
unconsolidated operating | |
subsidiary (395) 101 (482) 24 | | --
-------- -------- -------- -------- | | --------
| |
| |
Net operating income (loss) 4,727 2,949 14,788 2,270 | | 250
Increase in unrealized | |
appreciation on investments 1,981 28 2,127 167 | | 5,321
Realized gain (loss) on | |
investments 316 -- -- -- | | --
-------- -------- -------- -------- | | --------
| |
| |
Income before income taxes 7,024 2,977 16,915 2,437 | | 5,571
Provision for income taxes -- -- -- -- | | 2,128
-------- -------- -------- -------- | | --------
| |
Net increase in shareholders' | |
equity resulting from | |
operations $ 7,024 $ 2,977 $ 16,915 $ 2,437 | | $ 3,443
======== ======== ======== ======== | | ========
| |
| |
Per share data: | |
Net operating income: | |
Basic $ 0.43 $ 0.27 $ 1.34 $ 0.21 | |
Diluted $ 0.42 $ 0.26 $ 1.29 $ 0.20 | |
Net increase in | |
shareholders' equity | |
resulting from | |
operations: | |
Basic $ 0.63 $ 0.27 $ 1.53 $ 0.22 | |
Diluted $ 0.62 $ 0.26 $ 1.48 $ 0.21 | |
Cash dividends $ 0.41 $ 0.25 $ 1.34 $ 0.21 | |
| |
Balance Sheet Data: | |
Total assets $263,551 $151,031 $270,019 $150,705 | | $154,322
Total shareholders' equity 155,546 150,862 152,723 150,652 | | 150,539
| |
Other Data: | |
Number of portfolio | |
companies at period end 17 6 15 3 | |
Principal amount of loan | |
originations $ 28,012 $ 20,215 $118,390 $ 16,817 | |
Investments in equity | |
securities $ 3,684 $ 9,456 $ 24,475 $ 3,805 | |
Principal amount of loan | |
repayments $ 6,860 303 $ 1,719 $ 93 | |
Return on equity (1) (2) 18.2% 7.9% 11.2% 6.5% | |
Weighted average yield on | |
investments to date 13.1% 12.3% 13.0% 12.2% | |
</TABLE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Total operating income $2,746 $2,706 $2,498
Total operating expenses 2,862 2,928 2,606
------ ------ ------
Operating income (loss) before
equity in (loss) earnings of
unconsolidated operating
subsidiary (116) (222) (108)
Equity in (loss) earnings of
unconsolidated operating
subsidiary -- -- --
------ ------ ------
Net operating income (loss) (116) (222) (108)
Increase in unrealized
appreciation on investments 484 371 956
Realized gain (loss) on
investments -- 66 (23)
------ ------ ------
Income before income taxes 368 215 825
Provision for income taxes 159 57 422
------ ------ ------
Net increase in shareholders'
equity resulting from
operations $ 209 $ 158 $ 403
====== ====== ======
Per share data:
Net operating income:
Basic
Diluted
Net increase in
shareholders' equity
resulting from
operations:
Basic
Diluted
Cash dividends
Balance Sheet Data:
Total assets $5,432 $4,382 $3,930
Total shareholders' equity 3,372 2,946 2,571
Other Data:
Number of portfolio
companies at period end
Principal amount of loan
originations
Investments in equity
securities
Principal amount of loan
repayments
Return on equity (1) (2)
Weighted average yield on
investments to date
</TABLE>
(1) Amounts are annualized for the three months ended December 31, 1997.
(2) Return represents net increase in shareholders' equity resulting from
operations.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(In thousands except per share data)
All statements contained herein that are not historical facts
including, but not limited to, statements regarding anticipated activity are
forward looking in nature and involve a number of risks and uncertainties.
Actual results may differ materially. Among the factors that could cause actual
results to differ materially are the following: changes in the economic
conditions in which the Company operates negatively impacting the financial
resources of the Company; certain of the Company's competitors with
substantially greater financial resources than the Company reducing the number
of suitable investment opportunities offered to the Company or reducing the
yield necessary to consummate an investment; increased costs related to
compliance with laws, including environmental laws; general business and
economic conditions and other risk factors described in the Company's reports
filed from time to time with the Commission. The Company cautions readers not to
place undue reliance on any such forward looking statements, which statements
are made pursuant to the Private Securities Litigation Reform Act of 1995 and,
as such, speak only as of the date made.
The following analysis of the financial condition and results of
operations of the Company should be read in conjunction with the Company's
financial statements and the notes thereto. As discussed in Notes 1 and 2, the
Company completed an initial public offering ("IPO") of its Common Stock on
August 29, 1997 and on October 1, 1997 began to operate so as to qualify to be
taxed as a RIC. After the IPO, the Company changed its primary business plan and
format from structuring and arranging financing for buyout transactions on a fee
for services basis to being a lender to and investor in middle market companies.
As a result of the changes, the Company's predominant source of operating income
has changed from financial performance and advisory fees to interest and
dividends earned from investing the Company's assets in debt and equity of
businesses. Additionally, pursuant to RIC accounting requirements, effective
October 1, 1997, the Company's accounting for its operating subsidiary, CIC,
changed from a consolidated basis to the equity method. The financial results of
the Company for the periods through September 30, 1997 are not comparable to
periods commencing October 1, 1997 and are not expected to be representative of
the financial results of the Company in the future. Accordingly, those periods
are discussed separately.
Portfolio Composition
The Company's primary business is investing in and lending to
privately-owned businesses through investments in senior debt, subordinated debt
with detachable common stock warrants, preferred stock and common stock. The
total portfolio value of investments in non-publicly traded securities was
$182,498, $165,035 and $20,645 at March 31, 1999, December 31, 1998, and
December 31, 1997, respectively. During the three months ended March 31, 1999
(the "First Quarter 1999"), the year ended December 31, 1998, and the three
months ended December 31, 1997, the Company made investments totaling $26,212
and advanced $1,800 previously committed under working capital facilities,
$150,249, including $7,384 in funds committed but undrawn under credit
facilities, and $20,622 respectively. The weighted average effective interest
rate on the investment portfolio was 13.1%, 13.0% and 12.2%, respectively, at
March 31, 1999, December 31, 1998, and December 31, 1997. A summary of the
composition of the Company's portfolio of non-publicly traded securities at
March 31, 1999, December 31, 1998, and December 31, 1997 is shown in the
following table:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998 December 31, 1997
-------------- ----------------- -----------------
<S> <C> <C> <C>
Senior debt 15.4% 15.0% 27.7%
Subordinated debt 66.1% 65.5% 53.5%
Convertible preferred stock 1.6% 3.3% 11.2%
Common Stock warrants 15.1% 13.5% 7.6%
Common Stock 1.8% 2.7% --
</TABLE>
The Company expects its portfolio composition for the remainder of 1999
to be similar to its portfolio composition at March 31, 1999 and at December 31,
1998. The Company will continue to weight its portfolio composition heavily
toward investments in subordinated debt with detachable warrants.
11
<PAGE>
The following table shows the portfolio composition by industry
grouping:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998 December 31, 1997
-------------- ----------------- -----------------
<S> <C> <C> <C>
Manufacturing 63.2% 66.1% 52.8%
Health Care 9.6% -- --
Media 8.5% 9.1% --
Construction 9.1% 10.0% --
Wholesale & Retail 2.7% 7.4% 30.0%
Transportation 4.9% 5.4% --
Service 2.0% 2.0% 17.2%
</TABLE>
Management expects that the largest percentage of its investments will
continue to be in manufacturing companies; however, the Company intends to
continue to diversify its portfolio and will explore new investment
opportunities in a variety of industries.
Results of Operations
The Company's financial performance, as reflected in its Statements of
Operations, is composed of four primary elements. The first element is "Net
operating income (loss)," which for periods prior to October 1, 1997
("Pre-RIC"), is the difference between the Company's revenue earned from
arranging financing for middle market companies and other financial advisory
work and its total operating expenses including ESOP contributions, depreciation
and interest expense. For periods prior to October 1, 1997, ESOP contributions
represented a significant component of total operating expenses. All required
contributions to the Company's ESOP have been made by the Company, and further
contributions will be made at the discretion of the Company's Board of
Directors. Net operating income (loss) for periods commencing October 1, 1997
("Post-RIC"), is primarily the interest and dividends earned from investing in
debt and equity securities and the equity in earnings of its unconsolidated
operating subsidiary less the operating expenses of the Company. The second
element is "Change in unrealized appreciation of investments," which is the net
change in the estimated fair value of the Company's portfolio assets at the end
of the period compared with their estimated fair values at the beginning of the
period or their stated costs, as appropriate. The third element is "Realized
gain on investments," which reflects the difference between the proceeds from a
sale or maturity of a portfolio investment and the cost at which the investment
was carried on the Company's balance sheet. The fourth element is "Provision for
income taxes," which reflects a statutory tax rate applied to the Company's
pretax income, under generally accepted accounting principles in the United
States consistently applied ("GAAP"), for pre-RIC periods. Actual taxes paid
have historically been lower than the provision primarily due to the temporary
difference of the unrealized appreciation of investments which has resulted in a
deferred tax liability on the pre-RIC balance sheet of CIC. For post-RIC
periods, the Company intends to operate so as to qualify to be taxed as a RIC.
As long as the Company qualifies as a RIC, it will be able to take a deduction
against its otherwise taxable income for certain dividends it pays, allowing it
to substantially reduce or eliminate its corporate-level tax liability. As a
result, the provisions for income taxes for post-RIC periods are expected to be
minimal.
As discussed above, as a RIC, the Company is required to account for
investments in operating subsidiaries under the equity method, regardless of
ownership interest. Accordingly, the Company's investment in CIC, which prior to
RIC status was consolidated, is presented on the equity method effective October
1, 1997. Therefore, commencing on October 1, 1997, and consistent with the
equity method of accounting, the portfolio companies owned by CIC are not
reported separately by the Company.
Three Months Ended March 31, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Operating income $6,520 $3,292
Operating expenses 1,398 444
Equity in (loss) earnings of unconsolidated operating subsidiary (395) 101
------ ------
Net operating income 4,727 2,949
Realized gain on investments 316 --
Increase in unrealized appreciation of investments 1,981 28
------ ------
Net increase in shareholders' equity resulting from operations $7,024 $2,977
====== ======
</TABLE>
12
<PAGE>
Total operating income for the First Quarter 1999 increased $3,228, or
98%, compared to the three months ended March 31, 1998 (the "First Quarter
1998"). The increase in operating income is a result of the Company closing 15
investments in private companies totaling $141 million between March 31, 1998
and March 31, 1999. For the First Quarter 1999, operating income consisted of
$666 in loan fees, $5,813 in interest and dividends on non-publicly traded
securities and $41 in interest on government agency securities, bank deposits
and repurchase agreements; for the First Quarter 1998, operating income
consisted of $612 in loan fees, $1,207 in interest and dividends on non-publicly
traded securities and $1,473 in interest on government agency securities, bank
deposits and repurchase agreements. The First Quarter 1999 loan fees include
$288 in prepayment fees collected as a result of the repayment of $5,000 in
subordinated debt and the sale of senior and subordinated debt of $2,667. As the
Company increases its investment portfolio of non-publicly traded securities,
the interest and dividends the Company realizes on these securities will also
increase.
Operating expenses for the First Quarter 1999 increased $954, or 215%,
over the same period in 1998. The increase is primarily due to interest expense
of $794 in the First Quarter 1999, which resulted from the Company's $41,070
weighted average borrowings under credit facilities and notes payable. The
weighted average interest rates on borrowings at March 31, 1999 was 7.7%.
Operating expenses also increased due to the increase in salaries and benefits
from $170 the three months ended March 31, 1998 to $310 for the same period in
1999. The Company had 32 and 21 employees at March 31, 1999 and 1998,
respectively. The increase in salary and benefit expense is directly
attributable to the increase in the number of employees. The Company intends to
continue to hire new professionals in 1999 to support anticipated portfolio
growth.
Equity in (loss) earnings of unconsolidated operating subsidiary, which
represents CIC's results, decreased from a gain of $101 for First Quarter 1998
to a loss of $(395) for First Quarter 1999. For the three months ended March 31,
1999, CIC's results included $1,435 of operating income, $2,044 of operating
expenses, $925 of realized gains on investments, $954 of unrealized depreciation
of investments, and $243 in other income. The realized gain was a result of the
sale of CIC's common stock investment in Four S Baking Company and the
unrealized depreciation was due to the reversal of previously recorded
unrealized appreciation of CIC's Four S Baking Company investment. For the three
months ended March 31, 1998, CIC's results included $1,779 of operating income,
$1,546 of operating expenses, $96 of unrealized depreciation of investments, and
$36 of other expenses. The decrease in CIC's earnings was primarily attributable
to the $556 increase in salary and benefits expense caused by the increase in
the number of employees noted above.
During the First Quarter 1999, the Company recorded a net realized gain
of $316 on the sale of its investment of Four S Baking Company. Total proceeds
from the sale of securities, which included senior debt, subordinated debt,
preferred stock, common stock warrants, and common stock, were $7,163. The net
realized gain is comprised of the realization of the unamortized loan discounts.
The increase in unrealized appreciation of investments is based on
portfolio asset valuations determined by the Company's Board of Directors. The
unrealized appreciation of investments for the First Quarter 1999 increased
$1,953 over the First Quarter 1998. The increase for the First Quarter 1999 was
comprised of valuation increases of $2,468 at four portfolio companies and
valuation decreases of $487 at six portfolio companies.
Year Ended December 31, 1998.
The operating results for the year ended December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
Year Ended
December 31, 1998
-----------------
<S> <C>
Operating income $16,979
Operating expenses 1,709
Equity in loss of unconsolidated operating subsidiary (482)
--------
Net operating income 14,788
Increase in unrealized appreciation of investments 2,127
Net increase in shareholders' equity resulting from operations $16,915
=======
</TABLE>
Total operating income consisted of $2,549 in loan processing fees and
$11,020 in interest and dividends on non-publicly traded securities and $3,410
in interest on government agency securities, bank deposits and repurchase
agreements. The loan fees were earned as result of closing fourteen investments
in private companies totaling $150 million during the year.
13
<PAGE>
Operating expenses for the year consisted of $843 in salaries and
benefits, $809 in general and administrative expenses and $57 in interest
expense.
Equity in loss of unconsolidated operating subsidiary represents CIC's
results. For the year ended December 31, 1998, CIC's results included $5,227 of
operating income, $6,451 of operating expenses, $481 of unrealized appreciation
of investments, and $202 in other income.
The increase in unrealized appreciation of investments as discussed in
Note 2 to the financial statements is based on portfolio asset valuations
determined by the Company's Board of Directors. The increase in unrealized
appreciation of investments for the year ended December 31, 1998 is $2,127,
which consists of valuation increases of $2,324 at nine portfolio companies and
valuation decreases of $197 at three portfolio companies.
Three Months Ended December 31, 1997.
The Post-RIC operating results for the three months ended December 31,
1997 are summarized as follows:
<TABLE>
<CAPTION>
Three Months Ended
December 31, 1997
-----------------
<S> <C>
Operating income $2,797
Operating expenses 551
Equity in earnings of unconsolidated operating subsidiary 24
------
Net operating income 2,270
Increase in unrealized appreciation of investments 167
------
Net increase in shareholders' equity resulting from operations $2,437
======
</TABLE>
Total operating income consisted of approximately $700 in loan
processing fees and $200 in interest on non-publicly traded securities and
$1,900 in interest on government agency securities and overnight repurchase
agreements. The loan fees were earned as a result of closing three investments
in private companies totaling $21 million during the period.
Operating expenses for the period consisted of $243 in salaries and
benefits and $308 in general and administrative expenses.
Equity in earnings of unconsolidated operating subsidiary represents
CIC's results including the portfolio companies. For the three months ended
December 31, 1997, CIC's results included $414 of operating income, $987 of
operating expenses, $605 of unrealized appreciation of investment and $8 in tax
provisions.
The increase in unrealized appreciation of investments as discussed in
Note 2 to the financial statements is determined by the Company's Board of
Directors. The change in unrealized appreciation of investments for the three
month period is $167 which consists of an increase of $52 in the valuation of
the government agency securities and an increase of $115 in the valuation of the
investments in private companies.
Nine Months Ended September 30, 1997 and 1996.
The operating results for the nine months ended September 30, 1997
compared to nine months ended September 30, 1996.
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
---- ----
<S> <C> <C>
Operating income $2,901 $1,758
Operating expenses 2,651 1,921
------ ------
Net operating income 250 (163)
Increase in unrealized appreciation of investments 5,321 441
Provision for income taxes 2,128 109
------ ------
Net increase in shareholders' equity resulting from
operations $3,443 $ 169
====== ======
</TABLE>
14
<PAGE>
Total operating income was $2,901 for the nine months ended September
30, 1997, compared to $1,758 for the nine months ended September 30, 1996, a
65.0% increase. Financial advisory fees were $1,122 and $1,300 for the nine
months ended September 30, 1997 and 1996, respectively. The decline in financial
advisory fees was attributable to a relative increase in management attention to
engagements producing financial performance fees, and to the IPO. Financial
performance fees were $798 and $241 for the nine months ended September 30, 1997
and 1996, respectively. The increase in financial performance fees was
associated with the Company's successful completion of an engagement to advise
the Allied Pilots Association on the structuring of an employee option plan at
American Airlines. Other operating income was $428 and $265 for the nine months
ended September 30, 1997 and 1996, respectively. The increase in other operating
income was attributable to a higher level of expense reimbursement for the
Company. Included in total operating revenue for the nine months ended September
30, 1997, was interest income earned on investment securities and overnight
repurchase agreements of $553.
Total operating expenses for the nine months ended September 30, 1997
and 1996, were $2,651 and $1,921, respectively, an increase of 38.0%. Salaries
and benefits for the nine months ended September 30, 1997 and 1996, were $1,221
and $935, respectively, a 30.6% increase which was predominantly associated with
increased levels of staffing. General and administrative expenses for the nine
months ended September 30, 1997 and 1996, were $1,514 and $772, respectively, a
96.1% increase primarily associated with the increased use of consultants by the
Company. The increase in other expenses is attributable to a variety of expenses
associated with potential transactions. For the nine months ended September 30,
1997 and 1996, interest expense was $60 and $21, respectively. The increase in
interest expense relates to the Company's increased levels of working capital
for the period in 1997 prior to the initial public offering.
During the nine months ended September 30, 1997, the Company changed
its evaluation of collectibility of a receivable from Martino's Bakery, Inc.,
due to Martino's improved financial condition, restructuring of repayment terms,
and subsequent payment history. Therefore, the Company recorded a reversal in
its provision for doubtful accounts totaling $177. During the nine months ended
September 30, 1996, the Company had accrued $164 as a provision for doubtful
accounts related to two companies, one of which was Martino's Bakery, Inc.
For the nine months ended September 30, 1997 and 1996, the Company
recorded net increases in unrealized appreciation of investments in its
portfolio companies of $5,321 and $441, respectively. Included in unrealized
appreciation of investments during the first nine months of 1997 was $4,400
associated with the acquisition of Biddeford Textile Company, formerly the
blanket operation of the electric blanket manufacturing division of Sunbeam
Products, Inc. Also included in unrealized appreciation of investments during
the first nine months of 1997 was appreciation of $731 associated with the
Company's investment in Mobile Tool International, Inc., appreciation of $356
associated with Four S Baking Company, Inc., and depreciation of $138 associated
with Martino's Bakery, Inc.
The following table sets forth the components of the increase in
unrealized appreciation of investments for the nine months ended September 30,
1997 and 1996:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
---- ----
<S> <C> <C>
Government Securities $ (27) $ --
Erie Forge and Steel, Inc. -- 153
Four S Baking Company 355 (54)
Indiana Steel & Wire Corporation -- 7
Martino's Bakery, Inc. (138) 143
Mobile Tool International, Inc. 731 192
Biddeford Textile Corporation 4,400 --
------ ----
Increase in unrealized appreciation of investments $5,321 $441
====== ====
</TABLE>
The Company recorded provisions for income taxes for the nine months
ended September 30, 1997 and 1996, of $2,129 and $109, respectively. Unrealized
appreciation (depreciation) of investments does not affect the actual tax paid
by the Company. However, under GAAP, the Company provides for income taxes based
on its GAAP pretax income, which includes unrealized appreciation (depreciation)
of investments. Actual income taxes paid may differ substantially from the
provision for income taxes. The Company accounted for this difference by
recognition of a deferred tax liability in the Pre-RIC balance sheet of CIC.
15
<PAGE>
Year Ended December 31, 1996.
Year Ended
December 31, 1996
-----------------
Operating income $ 2,746
Operating expenses excluding ESOP contribution 2,645
ESOP contribution 216
-------
Total operating expenses 2,861
-------
Net operating loss before investment activity (115)
Increase in unrealized appreciation of investments 483
Provision for income taxes 159
-------
Net increase in shareholders' equity resulting from operations $ 209
=======
Operating income consists predominantly of financial advisory fees and
financial performance fees. During 1996, financial advisory fees and financial
performance fees constituted 86.9% of total revenue.
Total operating expenses at the Company were $2,861 in 1996. Salaries
and benefits, excluding ESOP contributions, were $1,067 in 1996. General and
administrative and other expenses were $1,282 in 1996.
The Company's interest expense was $33 in 1996. Interest expense is
primarily associated with credit facilities used by the Company to support its
working capital requirements and to finance a portion of its investments in
middle market companies. The Company's total borrowings under these facilities
were approximately $430 at December 31, 1996. In addition, the Company had a
note payable to its President in the amount of $74 at December 31, 1996. During
1996, the Company has paid interest on its debt obligations to unrelated parties
at rates ranging from 1.5% above the lender's base rate of interest to 3% above
such rate. The rate of interest on the Company's note payable to its President
was 4% above the prime rate of interest.
The Company made ESOP contributions of $216 in 1996. These
contributions represent an allocation of the preferred stock held by the ESOP to
the Company's employees, which preferred stock was converted into Common Stock
on a one for one basis on July 28, 1997. As a result, these contributions did
not result in a cash outflow from the Company. These contributions were
deductible for tax purposes and served to reduce the Company's tax obligations.
At December 31, 1996, unearned ESOP shares totaled $117 and the Company's
obligation to make further contributions to the ESOP was limited to that amount.
For the year ended December 31, 1996, the Company recorded net
increases in unrealized appreciation of investments of $483 as follows:
Year Ended
December 31,
1996
----
Erie Forge and Steel $204
Four S Baking Company (81)
Indiana Steel & Wire Corporation 9
Martino's Bakery, Inc. 156
Mobile Tool International, Inc. 195
----
Increase in unrealized appreciation of investments $483
====
During 1996, the Company was taxed as a C Corporation. Unrealized
appreciation (depreciation) of investments does not affect the actual tax paid
by the Company. However, under GAAP, the Company provides for income taxes based
on its GAAP pretax income, which includes unrealized appreciation (depreciation)
of investments. The Company accounted for this difference by recognition of a
deferred tax provision of $159 in 1996.
16
<PAGE>
Financial Condition, Liquidity, and Capital Resources
At March 31, 1999, the Company had $1,231 in cash and cash equivalents
and $68,991 in investments in Federal agency securities. In addition, the
Company had outstanding debt secured by assets of the Company of $30,000 in
borrowings under credit facilities and $77,091 in short term notes payable.
During 1998, the Company's primary source of funding was the proceeds received
in connection with its IPO. The Company completed investing the proceeds of its
IPO during 1998 and began funding its investments with proceeds from a line of
credit and short term borrowings.
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility. In connection with the closing, the Company established ACS
Funding Trust I (the "Trust"), an affiliated business trust and contributed or
sold to the Trust approximately $157,000 in loans. Subject to certain
conditions, the Company will remain servicer of the loans. Simultaneously with
the initial contribution, the Trust entered into a loan agreement with First
Union Capital Markets Corp., as deal agent, and certain other parties providing
for loans in an amount up to 50% of the eligible loan balance subject to certain
concentration limits. The term of the facility is two years and interest on
borrowings will be charged at LIBOR plus 2.50%. The full amount of principal is
payable over two years beginning at the end of the term and interest is payable
monthly. The Company will use borrowings under this facility to repay existing
debt and to continue making investments in the debt and equity securities of
middle market companies. In order to manage interest rate risk associated with
the floating rate borrowings, the Company or ACAS Funding will enter into
hedging agreements. The Company intends to use derivative instruments for
non-trading and non-speculative purposes only.
In order to maintain its RIC status, the Company is required to
distribute annually 90% or more of its net operating income and net realized
short-term capital gains to shareholders. The Company anticipates having to
issue debt or equity securities in addition to the above borrowings to expand
its investments in middle market companies. The terms of the future debt and
equity issuances can not be determined and there can be no assurances that the
debt or equity markets will be available to the Company on terms it deems
favorable.
Portfolio Credit Quality
The Company has implemented a system under which it grades all loans on
a scale of 1 to 4. This system is intended to reflect the performance of the
borrower's business, the collateral coverage of the loans and other factors
considered relevant. Under this system, management believes that loans with a
grade of 4 involve the least amount of risk in the Company's portfolio. The
borrower is performing above expectations and the trends and risk factors are
generally favorable. Management believes that loans graded 3 involve an
acceptable level of risk that is similar to the risk at the time of origination.
The borrower is performing as expected and the risk factors are neutral to
favorable. All new loans are initially graded 3.
Loans graded 2 involve a borrower performing below expectations and the
loan risk has increased since origination. The borrower may be out of compliance
with debt covenants, however, loan payments are not more than 120 days past due.
For loans graded 2, the Company's management will increase procedures to monitor
the borrower and will write down the fair value of the loan if it is deemed to
be impaired. A loan grade of 1 indicates that the borrower is performing
materially below expectations and the loan risk has substantially increased
since origination. Some or all of the debt covenants are out of compliance and
payments are delinquent. Loans graded 1 are not anticipated to be repaid in full
and the Company will reduce the fair market value of the loan to the amount it
anticipates will be recovered.
To monitor and manage the investment portfolio risk, management tracks
the weighted average portfolio grade. The weighted average portfolio grade was
3.0 and 3.2 at March 31, 1999 and December 31, 1998, respectively. In addition,
all of the Company's outstanding loans are performing and paying as agreed as of
March 31, 1999. At March 31, 1999, the Company's portfolio was graded as
follows:
Percentage of Total
Grade Investments at Value Portfolio
----- -------------------- ---------
4 $ 30,709 16.8%
3 142,938 78.3%
2 8,851 4.9%
1 -- --
-------- -----
$182,498 100.0%
17
<PAGE>
Impact of the Year 2000
The "Year 2000 Issue" is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruption of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities. The Company created a Year 2000 Compliance Committee to address the
Year 2000 compliance of the Company's information technology and non-information
technology systems, the systems of third parties, and the systems of the
portfolio companies. The Company has also engaged outside technology consultants
to assist with its Year 2000 project.
All of the software used by the Company in its information technology
systems is provided by outside vendors. The Company has taken an inventory of
all of its information technology systems and is in the process of obtaining
Year 2000 compliance designations from its vendors and internally conducting
compliance testing. Based on its assessment of its information technology
systems, management has identified the general ledger software package as the
significant system that is Year 2000 non-compliant. As such, the Company will
replace its accounting software with a new, Year 2000 compliant software
package. The new accounting software and all necessary modifications to other
information technology systems will be completed by August, 1999.
The Company is also evaluating the Year 2000 compliance of its
non-information technology systems, which includes the Company's office
equipment other than its computers and communications equipment. The Company has
contacted its office equipment vendors to obtain Year 2000 compliance
designations. The Company believes it will complete the remediation, testing and
implementation of these non-information technology systems by July, 1999.
The Company has contacted third parties that do not share information
systems with the Company ("external agents"). These third parties include the
Company's banks, landlords, utility companies, telecommunication providers and
other vendors. To date, the Company is not aware of any external agent Year 2000
issue that would have a material adverse effect on the Company's results of
operations, liquidity, or capital resources. However, the Company has no means
of ensuring that external agents will be Year 2000 compliant by the end of this
year. The inability of external agents to complete their Year 2000 compliance
process in a timely fashion could have a material adverse effect on the Company.
The effect of non-compliance by external agents is not determinable.
The Company is also evaluating the Year 2000 readiness of its portfolio
companies. Beginning in the summer of 1998, the Company has required that each
portfolio company expressly warrant in its loan agreement that it is or will be
Year 2000 compliant prior to December 31, 1999. The Company has also submitted
questionnaires to all of its portfolio companies to determine their exposure to
the Year 2000 problem and the adequacy of their plans to address the issues.
Over 90% of the portfolio companies have responded to the questionnaire. Based
on the correspondence received from the portfolio companies, management believes
that over 80% of its portfolio companies have either no material exposure to the
Year 2000 issue or are adequately carrying out their plans to address their
exposure. The Company has either not received complete questionnaires from the
remaining 20% of the portfolio companies or has requested that the portfolio
companies improve the scope and detail of their responses. The Company intends
to follow up with the portfolio companies to ensure that they have executed
their compliance plan by June 30, 1999.
Throughout 1999, the Company will continue to address any issues of
Year 2000 non-compliance and further develop its contingency plan to ensure
business operations in the event of systems failure in the Year 2000. The
Company is utilizing both internal and external resources to reprogram or
replace, test, and implement the software and other systems for Year 2000
modifications. The Company estimates that the cost of its Year 2000 project will
be less than $125. This amount includes the cost of additional software,
reviewing the portfolio companies' readiness, and outside systems professionals
working on the Company's Year 2000 compliance.
The Company's plans to complete the Year 2000 modifications are based
on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability of certain
resources, estimates on the status of completion and the total expected costs.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Specific issues that
might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties. Significant
systems failures at the Company, a third party, or the portfolio companies could
have a materially adverse effect on the Company's business. While the Company
believes that its portfolio companies are adequately addressing the Year 2000
issue, no assurance can be given that some of its portfolio companies will not
suffer material adverse effects from Year 2000 issues. Management believes that
the most likely worst case Year 2000 scenario is a material decrease in interest
income and an impairment in the valuation of the Company's investment portfolio.
The magnitude of these material adverse effects on the portfolio companies and
the operating results and financials of the Company cannot be determined at this
time.
18
<PAGE>
Impact of Inflation
Management believes that inflation can influence the value of the
Company's investments through the impact it may have on the capital markets, the
valuations of business enterprises and the relationship of the valuations to
underlying earnings.
BUSINESS
The Company was incorporated in 1986 to provide financial advisory
services to and invest in middle market companies. On August 29, 1997, the
Company completed an IPO of 10,382,437 shares of its Common Stock and became a
non-diversified, closed end investment company that has elected to be treated as
a BDC under the 1940 Act. On October 1, 1997, the Company began operations so as
to qualify to be taxed as a RIC as defined in Subtitle A, Chapter 1, under
Subchapter M of the Internal Revenue Code of 1986 as amended (the "Code"). As
contemplated by these transactions, the Company materially changed its business
plan and format from structuring and arranging financing for buyout transactions
on a fee for services basis to primarily being a lender to and investor in
middle market companies. The Company continues to provide financial advisory
services to businesses through CIC, a wholly-owned subsidiary. The Company had
established itself as a leading firm in structuring and obtaining funding for
management and employee buyouts of subsidiaries, divisions and product lines
being divested by larger corporations through the use of ESOPs. From its
formation in 1986 through the IPO, the Company arranged 29 financing
transactions aggregating over $400 million and invested in the equity securities
of eight of those transactions. From the IPO through March 31, 1999, the Company
invested $197 million in debt and equity securities of middle market companies
including over $5 million in funds committed but undrawn under credit
facilities.
The Company is a buyout and specialty finance company that is
principally engaged in providing senior debt, subordinated debt and equity to
middle market companies in need of capital for management buyouts including ESOP
buyouts, growth, acquisitions, liquidity and restructuring. The Company's
ability to fund the entire capital structure is an advantage in completing
middle market transactions. The Company generally invests up to $20 million in
each transaction and through its subsidiary, CIC, will arrange and secure
capital for larger transactions. The Company's primary business objectives are
to increase its net operating income and net asset value by investing its assets
in senior debt, subordinated debt with detachable warrants and equity of middle
market companies with attractive current yields and potential for equity
appreciation. The Company's loans typically range from $3 million to $20
million, mature in five to ten years, and require monthly or quarterly interest
payments at fixed rates or variable rates based on the prime rate, plus a
margin. The Company prices its debt and equity investments based on its analysis
of each transaction. As of March 31, 1999, the weighted average effective yield
on the Company's investments was 13.1%.
In most cases, the Company receives Put Rights under various
circumstances including, typically, the repayment of the Company's loans or debt
securities. The Company may use its Put Rights to dispose of its equity interest
in a business, although the Company's ability to exercise Put Rights may be
limited or nonexistent if a business is illiquid. In most cases, the Company
also receives the right to representation on the businesses' board of directors.
At March 31, 1999, the Company had board seats on 13 out of 17 businesses and
had board observation rights on 2 of the remaining businesses in which it has
made investments.
The Company generally acquires equity interests in the companies from
which it has purchased debt securities with the goal of enhancing its overall
return. As of March 31, 1999, the Company had a weighted average ownership
interest of 26.7% in our portfolio companies. The Company is prepared to be a
long-term partner to its portfolio companies thereby positioning the Company to
participate in their future financing needs. The opportunity to liquidate its
investments and realize a gain may occur if the business recapitalizes its
equity, either through a sale to new owners or a public offering of its equity
or if the Company exercises its Put Rights. The Company generally does not have
the right to require that a business undergo an initial public offering by
registering securities under the Securities Act of 1933, but the Company
generally does have the right to sell its equity interests in a public offering
by the business to the extent permitted by the underwriters.
The Company makes available significant managerial assistance to its
portfolio companies. Such assistance typically involves closely monitoring the
operations of the company, hiring additional senior management, if needed, being
available for consultation with its officers, developing the business plan and
providing financial guidance and participating on its board of directors.
Providing assistance to its borrowers serves as a means of influence for the
Company as well as an opportunity for the Company to assist in maximizing the
value of the portfolio company.
Prior to the IPO, the Company established itself as a leading firm in
structuring and obtaining funding for management and employee buyouts of
subsidiaries, divisions and product lines being divested by larger corporations
through the use of an ESOP. The selling entities have included Sunbeam
Corporation, the U.S. Office of Personnel Management, American Premier
Underwriters, Inc. (formerly Penn Central Corporation), Campbell Soup Company,
Union Carbide Corporation, National Forge Company, Inc., Air Products Company,
Ampco-Pittsburgh Corporation and British Petroleum Company. In most of the ESOP
transactions structured by the Company, the employees agree to restructure their
wages and benefits so that overall cash compensation is reduced while
19
<PAGE>
contributions of stock are made to an ESOP. The resulting company is structured
so that the fair market value of stock contributed to the ESOP can be deducted
from corporate income before paying taxes. Restructuring employee compensation
together with the ESOP tax advantages has the effect of improving the cash flow
of the ESOP company. The Company is a leading firm in structuring and
implementing ESOP employee buyouts. The Company believes that its ESOP knowledge
and experience and its ability to fund transactions positions the Company
favorably in the market place.
The Company provides financial advisory services and structuring of
transactions through its wholly-owned subsidiary CIC. The typical advisory
engagement includes a monthly retainer and a performance fee contingent upon
closing of the transaction or event which is the subject of the engagement.
Management believes that future growth of CIC is attainable through adding
additional professionals, by gaining additional market share and by realizing
the benefits of what is expected to be an increasing client base, which should
expand as a result of its relationship with the Company.
The Company believes that, through the structuring and advisory
business, it has established an extensive referral network comprised of venture
capitalists, investment bankers, attorneys, accountants, commercial bankers,
unions, business and financial brokers, and existing ESOP companies. The Company
has also developed an extensive internet site that generates financing requests
and provides businesses an efficient tool for learning about the Company and its
capabilities. During 1998, a $15.5 million investment by the Company was
originated as a result of the internet site. The Company has invested, and
continues to invest, in developing internet sites that service the financing
needs of middle market companies and may result in incremental business to the
Company. The Company has a marketing department headed by a vice president of
marketing dedicated to maintaining contact with members of the referral network
and receiving opportunities for the Company to consider. During 1998, the vice
president of marketing received in excess of 1,500 transactions for
consideration. Many of those transactions did not meet the Company's criteria
for initial consideration, but the opportunities that met those criteria were
sent to the Company's principals for further review and consideration. The vice
president of marketing and CIC are continuing the relationships with the
referral network and the Company utilizes the referral network and CIC's client
base as its primary sources of investment opportunities.
The Company's executive offices are located at 3 Bethesda Metro Center,
Suite 860, Bethesda, MD 20814 and its telephone number is (301) 951-6122. In
addition to its executive offices, the Company maintains offices in New York,
Boston, Pittsburgh, San Francisco, Chicago and Dallas.
Lending and Investment Decision Criteria
The Company reviews certain criteria in order to make investment
decisions. The criteria listed below provide a general guide for the Company's
lending and investment decisions, although not all criteria are required to be
favorable in order for the Company to make an investment.
Operating History. The Company focuses on target companies that have
stable operating histories and are profitable or near profitable at existing
operating levels. The Company reviews the target company's ability to service
and repay debt based on its historical results of operations. The Company
considers factors such as market shares, customer concentration, recession
history, competitive environment and ability to sustain margins. The Company
does not expect to lend or invest in start-up or other early stage companies.
Growth. The Company considers a target company's ability to increase
its cash flow. Anticipated growth is a key factor in determining the value
ascribed to any warrants and equity interests acquired by the Company.
Liquidation Value of Assets. Although the Company does not operate as
an asset-based lender, liquidation value of the assets collateralizing the
Company's loans is an important factor in many credit decisions. Emphasis is
placed both on tangible assets (accounts receivable, inventory, plant, property
and equipment) as well as intangible assets such as customer lists, networks,
databases and recurring revenue streams.
Experienced Management Team. The Company requires that each portfolio
company have a management team that is experienced and properly incentivized
through a significant ownership interest in the portfolio company. The Company
requires that a potential recipient of the Company's financing have a management
team who have demonstrated the ability to execute the portfolio company's
objectives and implement its business plan.
Exit Strategy. Prior to making an investment, the Company analyzes the
potential for the target company to experience a liquidity event that will allow
the Company to realize value for its equity position. Liquidity events include,
among other things, a private sale of the Company's financial interest, a sale
of the portfolio company, an initial public offering or a purchase by the
portfolio company or one of its stockholders of the Company's equity position.
20
<PAGE>
Operations
Marketing and Origination Process. The Company and CIC have 22
professionals responsible for originating loans and investments and providing
financial assistance to middle market companies and intends to hire an
additional three to six professionals during the next twelve months. To service
financing opportunities, the Company has a dedicated marketing department headed
by a vice president who manages an extensive referral network comprised of
venture capitalists, investment bankers, unions, attorneys, accountants,
commercial bankers, business and financial brokers and prospective or existing
ESOP companies. The Company also has an extensive set of internet sites that it
uses to attract financing opportunities.
Approval Process. The Company's financial professionals review
informational packages in search of potential financing opportunities and
conduct a due diligence investigation of each applicant that passes an initial
screening process. This due diligence investigation generally includes one or
more on-site visits, a review of the target company's historical and prospective
financial information, interviews with management, employees, customers and
vendors of the applicant, and background checks and research on the applicant's
product, service or particular industry. The Company engages professionals such
as environmental consultants, accountants, lawyers, risk managers and management
consultants to perform elements of the due diligence review as it deems
appropriate. Upon completion of a due diligence investigation, one of the
Company's principals prepares an investment committee report summarizing the
target company's historical and projected financial statements, industry and
management team and analyzing its conformity to the Company's general investment
criteria. The principal then presents this profile to the Company's Investment
Committee. The Company's Investment Committee and the Company's Board of
Directors must approve each financing.
Portfolio Management. In addition to the review at the time of original
underwriting, the Company attempts to preserve and enhance the earnings quality
of its portfolio companies through proactive management of its relationships
with its clients. This process includes attendance at portfolio company board
meetings, management consultation and review and management of covenant
compliance. The Company's investment and finance personnel regularly review
portfolio company monthly financial statements to assess cash flow performance
and trends, periodically evaluate the operations of the client, seek to identify
industry or other economic issues that may adversely affect the client, and
prepare quarterly summaries of the aggregate portfolio quality for management
review.
Support Services. A commercial bank provides certain administrative
services for the Company's investments and also acts as the custodian of the
Company's portfolio assets pursuant to and in accordance with the 1940 Act.
Loan Grading
The Company has implemented a system to evaluate and classify all loans
based on their current risk profile. The system requires the Director of
Reporting and Compliance to grade a loan on a scale of one to four. Loans graded
four involve the least amount of risk of loss, while loans graded one have an
unacceptable level of risk and a high probability of loss. The loan grade is
then reviewed and approved by the Investment Committee and the Board of
Directors. This system is intended to reflect the performance of the portfolio
company's business, the collateral coverage of the loans and other factors
considered relevant. For more information regarding the Company's loan grading
practices, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Portfolio Credit Quality."
Competition
The Company's primary competitors include financial institutions,
buyout and venture capital firms and other nontraditional lenders. Some of these
entities have greater financial and managerial resources than the Company.
Nevertheless, the Company believes that it competes effectively with these
entities through, among other means, its responsiveness to the needs of its
potential portfolio companies and its flexibility in structuring transactions.
Legal Proceedings
While the Company may, from time to time, be a party to certain
lawsuits in connection with its business it currently has no pending lawsuits.
Employees
As of March 31, 1999, the Company had thirty-two employees, twenty-two
of whom are professionals working on financings for middle market companies. The
Company believes that the relations with its employees are excellent.
21
<PAGE>
The Company's Operations as a BDC and RIC
As a BDC, the Company may not acquire any asset other than Qualifying
Assets unless, at the time the acquisition is made, Qualifying Assets represent
at least 70% of the value of the Company's total assets. The principal
categories of Qualifying Assets relevant to the business of the Company are the
following:
o securities purchased in transactions not involving any public
offering from the issuer of such securities, which issuer is an
eligible portfolio company. An eligible portfolio company is
defined as any issuer that (a) is organized and has its principal
place of business in the United States, (b) is not an investment
company other than a small business investment company
wholly-owned by the BDC, and (c) does not have any class of
publicly-traded securities with respect to which a broker may
extend credit;
o securities received in exchange for or distributed with respect to
securities described above, or pursuant to the exercise of
options, warrants or rights relating to such securities; and
o cash, cash items, Government securities, or high quality debt
securities maturing in one year or less from the time of
investment.
The Company may not change the nature of its business so as to cease to
be, or withdraw its election as, a BDC unless authorized by vote of a majority,
as defined in the 1940 Act, of the Company's shares. Since the Company made its
BDC election, it has not made any substantial change in its structure or in the
nature of its business.
The Company operates so as to qualify as a RIC under the Code.
Generally, in order to qualify as a RIC, the Company must continue to qualify as
a BDC and distribute to shareholders in a timely manner, at least 90% of its
"investment company taxable income" as defined by the Code. Also, the Company
must derive at least 90% of its gross income from dividends, interest, payments
with respect to securities loans, gains from the sale of stock or other
securities or other income derived with respect to its business of investing in
such stock or securities as defined by the Code. Additionally, the Company must
diversify its holdings so that (i) at least 50% of the value of the Company's
assets consists of cash, cash items, government securities, securities of other
RICs and other securities if such other securities of any one issuer do not
represent more than 5% of the Company's assets and 10% of the outstanding voting
securities of the issuer and (ii) no more than 25% of the value of the Company's
assets are invested in the securities of one issuer (other than U.S. government
securities and securities of other RICs), or of two or more issuers that are
controlled by the Company and are engaged in the same or similar or related
trades or businesses. If the Company qualifies as a RIC, it will not be subject
to federal income tax on the portion of its taxable income and net capital gains
it distributes to stockholders. In addition, each calendar year the Company must
be treated as having distributed at least 98% of its "ordinary income" and
"capital gain net income" as defined under the Code to avoid a 4% federal excise
tax on undistributed income. The Company generally will endeavor to distribute
to stockholders all of its investment company taxable income and its net capital
gain, if any, for each taxable year so that it will not incur income and excise
taxes on its earnings.
If the Company fails to satisfy the 90% distribution requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in such year on all of its taxable income, regardless of whether the Company
makes any distribution to its stockholders. In addition, in that case, all of
the Company's distributions to its stockholders will be characterized as
ordinary income (to the extent of the Company's current and accumulated earnings
and profits).
Temporary Investments
Pending investment in other types of Qualifying Assets, the Company has
invested its otherwise uninvested cash primarily in cash, cash items, government
securities, agency paper or high quality debt securities maturing in one year or
less from the time of investment in such high quality debt investments
("Temporary Investments") so that at least seventy percent (70%) of its assets
are Qualifying Assets. Typically, the Company invests in U.S. Treasury bills.
Additionally, the Company may invest in repurchase obligations of a "primary
dealer" in government securities (as designated by the Federal Reserve Bank of
New York) or of any other dealer whose credit has been established to the
satisfaction of the Board of Directors. There is no percentage restriction on
the proportion of the Company's assets that may be invested in such repurchase
agreements. A repurchase agreement involves the purchase by an investor, such as
the Company, of a specified security and the simultaneous agreement by the
seller to repurchase it at an agreed upon future date and at a price which is
greater than the purchase price by an amount that reflects an agreed-upon
interest rate. Such interest rate is effective for the period of time during
which the investor's money is invested in the arrangement and is related to
current market interest rates rather than the coupon rate on the purchased
security. The Company requires the continual maintenance by its custodian or the
correspondent in its account with the Federal Reserve/Treasury Book Entry System
of underlying securities in an amount at least equal to the repurchase price. If
the seller were to default on its repurchase obligation, the Company might
suffer a loss to the extent that the proceeds from the sale of the underlying
securities were less than the repurchase price. A seller's bankruptcy could
delay or prevent a sale of the underlying securities.
22
<PAGE>
Leverage
For the purpose of making investments and to take advantage of
favorable interest rates, the Company has issued, and intends to continue to
issue, senior debt securities and other evidences of indebtedness, up to the
maximum amount permitted by the 1940 Act, which currently permits the Company,
as a BDC, to issue senior debt securities and preferred stock (collectively,
"Senior Securities") in amounts such that the Company's asset coverage, as
defined in the 1940 Act, is at least 200% after each issuance of Senior
Securities. Such indebtedness may also be incurred for the purpose of effecting
share repurchases. As a result, the Company is exposed to the risks of leverage.
Although the Company has no current intention to do so, it has retained the
right to issue preferred stock. As permitted by the 1940 Act, the Company may,
in addition, borrow amounts up to five percent (5%) of its total assets for
temporary or emergency purposes.
Investment Objectives and Policies
The Company's investment objectives are to achieve a high level of
current income from the collection of interest and advisory fees, as well as
long-term growth in its stockholders' equity through the appreciation in value
of the Company's equity interests in the portfolio companies in which it
invests. The following restrictions, along with these investment objectives, are
the Company's only fundamental policies - that is, policies which may not be
changed without the approval of the holders of the majority, as defined in the
1940 Act, of the Company's outstanding voting securities. The percentage
restrictions set forth below other than the restriction pertaining to the
issuance of Senior Securities, as well as those contained elsewhere in this
Prospectus, apply at the time a transaction is effected, and a subsequent change
in a percentage resulting from market fluctuations or any cause other than an
action by the Company will not require the Company to dispose of portfolio
securities or to take other action to satisfy the percentage restriction.
The Company will at all times conduct its business so as to retain its
status as a BDC. In order to retain that status, the Company may not acquire any
assets (other than non-investment assets necessary and appropriate to its
operations as a BDC) if after giving effect to such acquisition the value of its
"Qualifying Assets" amounts to less than 70% of the value of its total assets.
For a summary definition of "Qualifying Assets," see "Regulation." The Company
believes that the securities it proposes to acquire (provided that the Company
controls, or through its officers or other participants in the financing
transaction, makes significant managerial assistance available to the issuers of
these securities), as well as Temporary Investments, will generally be
Qualifying Assets. Securities of public companies, on the other hand, are
generally not Qualifying Assets unless they were acquired in a distribution, in
exchange for or upon the exercise of a right relating to securities that were
Qualifying Assets.
The Company may invest up to 100% of its assets in securities acquired
directly from issuers in privately-negotiated transactions. With respect to such
securities, the Company may, for the purpose of public resale, be deemed an
"underwriter" as that term is defined in the 1933 Act. The Company may invest up
to 50% of its assets to acquire securities of issuers for the purpose of
acquiring control (up to 100% of the voting securities) of such issuers. The
Company will not concentrate its investments in any particular industry or group
of industries. Therefore, the Company will not acquire any securities (except
upon the exercise of a right related to previously acquired securities) if, as a
result, 25% or more of the value of its total assets consists of securities of
companies in the same industry.
The Company may issue Senior Securities to the extent permitted by the
1940 Act for the purpose of making investments, to fund share repurchases, or
for temporary or emergency purposes. A business development company may issue
Senior Securities up to an amount so that the asset coverage, as defined in the
1940 Act, is at least 200% immediately after each issuance of Senior Securities.
For the risks associated with the resulting leverage, see "Risk
Factors--Leverage."
The Company will not (i) act as an underwriter of securities of other
issuers (except to the extent that it may be deemed an "underwriter" of
securities purchased by it that must be registered under the 1933 Act before
they may be offered or sold to the public); (ii) purchase or sell real estate or
interests in real estate or real estate investment trusts (except that the
Company may purchase and sell real estate or interests in real estate in
connection with the orderly liquidation of investments and may own the
securities of companies or participate in a partnership or partnerships that are
in the business of buying, selling or developing real estate); (iii) sell
securities short; (iv) purchase securities on margin (except to the extent that
it may purchase securities with borrowed money); (v) write or buy put or call
options (except to the extent of warrants or conversion privileges in connection
with its acquisition financing or other investments, and rights to require the
issuers of such investments or their affiliates to repurchase them under certain
circumstances); (vi) engage in the purchase or sale of commodities or commodity
contracts, including futures contracts (except where necessary in working out
distressed loan or investment situations); or (vii) acquire more than 3% of the
voting stock of, or invest more than 5% of its total assets in any securities
issued by, any other investment company, except as they may be acquired as part
of a merger, consolidation or acquisition of assets. With regard to that portion
of the Company's investments in securities issued by other investment companies
it should be noted that such investments may subject the Company's stockholders
to additional expenses.
23
<PAGE>
Investment Advisor
The Company has no investment advisor and is internally managed by its
executive officers under the supervision of the Board of Directors.
PORTFOLIO COMPANIES
The following table sets forth certain information as of March 31,
1999, regarding each portfolio company in which the Company currently has an
equity investment. Unless otherwise noted in the table or the descriptions that
follow the table, the only relationship between each portfolio company and the
Company is the Company's investment. Any such loans and investments will be made
in accordance with the Company's investment policies and procedures.
<TABLE>
<CAPTION>
% OF CLASS VALUE OF
OWNED ON A COST OR INITIAL INVESTMENT
NAME AND ADDRESS OF NATURE OF TYPE OF FULLY VALUE OF AS OF
PORTFOLIO COMPANY BUSINESS SECURITY DILUTED BASIS(1) INVESTMENT March 31, 1999(2)
------------------- --------- -------- ---------------- --------------- -----------------
<S> <C> <C> <C> <C> <C>
AUXI Health, Inc. Home Health Care Subordinated Debt -- $ 9,532 $ 9,532
810 Crescent
Center Drive Common Stock
Franklin, TN 37067 Warrants 20.0% 2,599 2,599
BIW Connector Systems, Inc. Specialty Senior Debt -- 3,404 3,404
500 Tesconi Circle Connectors
Santa Rosa, CA 95401 Subordinated Debt -- 6,740 6,740
Common Stock
Warrants 20.0% 652 513
Centennial Broadcasting, LLC Radio Stations Subordinated Debt -- 15,495 15,495
3825 Forrestgate Drive
Winston-Salem, NC 27103
Chance Coach, Inc. Bus Manufacturer Senior Debt -- 1,232 1,232
2811 North Ohio Street
Wichita, KS 67219 Subordinated Debt -- 7,171 7,171
Convertible
Preferred Stock 20.0% 2,000 2,214
Common Stock
Warrants 43.7% 4,041 4,839
Common Stock 18.3% 1,896 2,269
Confluence Holdings Corp. Kayak and Canoe Senior Debt -- 11,475 11,475
3761 Old Glenola Road Manufacturing
Trinity, NC 27370 Subordinated Debt -- 5,226 5,226
Common Stock
Warrants 18.0% 1,319 1,319
ConStar International, Inc. Electrical Subordinated Debt -- 12,877 12,877
661 Pleasant Street
Norwood, MA 02062 Common Stock
Warrants 17.5% 3,171 3,171
Common Stock 2.8% 500 500
Cycle Gear, Inc. Motorcycle Parts Senior Debt -- 750 750
303 43rd Street and
Richmond, CA 94805 Accessories
Subordinated Debt -- 639 639
Common Stock
Warrants 16.5% 374 374
Decorative Surfaces International, Inc. Decorative Paper Subordinated Debt -- 5,516 5,516
1280 N. Grant Avenue and Vinyl
Columbus, OH 43201 Manufacturing Convertible
Preferred Stock 2.9% 665 665
Common Stock
Warrants 42.3% 4,571 6,805
24
<PAGE>
% OF CLASS VALUE OF
OWNED ON A COST OR INITIAL INVESTMENT
NAME AND ADDRESS OF NATURE OF TYPE OF FULLY VALUE OF AS OF
PORTFOLIO COMPANY BUSINESS SECURITY DILUTED BASIS INVESTMENT(1) March 31, 1999(2)
------------------- --------- -------- ---------------- --------------- -----------------
<S> <C> <C> <C> <C> <C>
Electrolux, LLC Consumer Subordinated Debt -- 7,563 7,563
5956 Sherry Lane Appliances
Dallas, TX 75225 Common Stock
Warrants 2.5% 246 642
Euro-Caribe Packing Meat Processing Senior Debt -- 7,062 7,062
Company, Inc.
PO Box 3146 Subordinated Debt -- 8,921 8,921
Zona Industrial Sabana Abajo
Carolina (San Juan), Common Stock
PR 00984 Warrants 37.0% 1,110 1,110
JAG Industries, Inc. Diversified Senior Debt -- 1,200 1,200
2201 Aisquith Street Manufacturing
Baltimore, MD 21218 Subordinated Debt -- 2,346 2,346
Common Stock
Warrants 75.0% 505 454
The LA Studios, Inc. Audio Production Subordinated Debt -- 2,411 2,411
3453 Cahuenga Blvd., West
Hollywood, CA 90068 Common Stock
Warrants 17.0% 902 839
Lion Brewery, Inc. Malt Beverages Subordinated Debt -- 5,958 5,958
700 N. Pennsylvania Ave.
Wilkes-Barre, PA 18705 Common Stock
Warrants 54.0% 675 675
Patriot Medical Repair Services Senior Debt -- 3,000 3,000
Technologies, Inc.
210 Twenty-Fifth Avenue Subordinated Debt -- 2,090 2,090
Nashville, TN 37203
Common Stock
Warrants 17.0% 410 410
The New Piper Aircraft, Inc. Aircraft Subordinated Debt -- 17,897 17,897
2926 Piper Drive
Vero Beach, FL 32960 Common Stock
Warrants 4.0% 2,231 2,528
Specialty Transportation Services, Inc. Municipal Waste Subordinated Debt -- 7,386 7,386
5979 McCasland Avenue Transportation
Portage, IN 46368 Common Stock
Warrants up to 40.0% 694 1,007
Common Stock 9.1% 500 458
Westwind Holdings, Inc. Restaurant Subordinated Debt -- 2,945 2,945
12555 High Bluff Drive
San Diego, CA 92130 Common Stock
Warrants 5.0% 350 271
</TABLE>
(1) Percentages shown for warrants and preferred stock held represent the
percentage of class of security we may own, on a fully diluted basis,
assuming we exercise our warrants or convert our preferred stock to common
stock.
(2) These valuations were determined by the Company's Board of Directors.
The following is a summary of additional information concerning certain
portfolio companies in which the Company's investment in each such company
represents more than 5% of the Company's assets. This information was provided
to the Company by its respective portfolio companies. The Company has relied
exclusively on the information provided by its portfolio companies in preparing
this summary. For additional information relating to the value of the Company's
investments in its portfolio companies, see the Company's consolidated financial
statements as of March 31, 1999 appearing elsewhere in this Prospectus.
25
<PAGE>
Chance Coach, Inc.
Chance Coach, Inc. ("Chance") is a leading manufacturer of transit
buses under thirty feet in length and of buses that are vintage streetcar
replicas. Its primary customer base consists of municipal transit authorities.
Many of these customers are repeat buyers who desire to maintain continuity in
their fleets once a purchase decision is made. Growth opportunities for Chance
are expected to come from municipalities re-sizing their bus fleets by adding
smaller and more cost effective buses and those instituting a "trunk line"
system with smaller buses on feeder routes and in downtown areas. The vintage
streetcar replicas are typically used in downtown redevelopment projects.
The company's primary competitors in the under thirty feet transit bus
market are Gillig Corporation, El Dorado National, a division of Thor
Industries, and New Flyer Corporation of Winnipeg, Canada. Chance makes the
leading streetcar replica purchased by municipal transit authorities, and has no
significant competition in that market segment. Chance operates in a niche
market and makes the leading heavy duty transit vehicle seating under thirty
passengers, as opposed to light duty minivan-type vehicles competing in this
market. However, its niche market position is not protected by patents or other
significant barriers to entry. The federal government is a major supplier of
capital to the customers of the bus manufacturing industry in the form of
subsidies for the purchase of equipment. A cutback in federal funding for mass
transit, or a change in the funding mix, could have a material adverse effect on
Chance's business.
The president of the company, Scott Culbertson, has been with Chance
for 10 years. John Freal, a principal of the Company, is a member of the Board
of Directors of Chance and performs financial advisory services for Chance.
The New Piper Aircraft, Inc.
The New Piper Aircraft, Inc. ("Piper") is a manufacturer of
piston-powered light general aviation aircraft, offering eight different models
of planes. Piper sells these planes through a network of 30 domestic and
international distributors. The company's planes are small, generally from 2 to
6 seats, marketed to military flight schools, commercial flight training centers
and individual owner/operators. The light aircraft industry is considered
dependent upon new product development for future profits. The introduction of
new aircraft has historically been the single most important factor in
maintaining and increasing the company's revenues. Piper is currently developing
a new turbo-prop plane, called the "Malibu Meridian," that is scheduled to be
delivered to customers during the second quarter in the year 2000 and will be
the next step up in its product line. As of May 1999, the company received
approximately one hundred non-refundable deposits from customers awaiting
delivery of the Malibu Meridian.
The company is one of the three principal U.S. manufacturers of
piston-powered general aviation aircraft. Piper's principal competitors are
Cessna and Raytheon/Beechcraft, both of whom make piston as well as jet powered
aircraft. Of the three, only Piper is not part of a larger conglomerate. Piper
has the largest share of the piston market revenues, although Cessna has a
larger share of the actual deliveries. Piper's lead in piston market revenue is
partially attributable to a broader product line than both of its principal
competitors. Piper must also compete for sales of new aircraft against used
aircraft in the resale market. Piper holds various patents and other rights with
regard to its products and processes.
In the 1980's, product liability lawsuits created a crisis in the
general aviation sector and led to a sharp decline in sales across the industry.
An oversupply of high quality, used aircraft and escalating product liability
awards led to structural changes in the aircraft industry. In the mid-1990's,
Piper's predecessor declared bankruptcy as a result of these conditions. Tort
reform and the fact that the average age of used aircraft is 28 years has led to
a mild resurgence in this industry, but it is not expected that overall
deliveries for the industry will reach the historical highs prior to those of
the 1980's. In 1994, Congress passed the General Aviation Revitalization Act of
1994 that limited general aviation aircraft manufacturers' liability.
Consequently, this legislation reduced the Piper's pool of potential liability
with respect to Piper manufactured aircraft.
Piper has an experienced management team, led by Chuck Suma, president
and chief executive officer of the company, who has been with Piper and its
predecessor since 1976. The Company has observation rights to attend and
participate in Piper's board meetings.
Decorative Surfaces International, Inc.
Decorative Surfaces International, Inc. ("DSI") manufactures and sells
coated papers and vinyls used in wall coverings and in laminates such as
Formica(R), Wilsonart(R), and Congoleum(R). DSI has manufacturing plants in St.
Louis, Missouri and Columbus, Ohio. The company manufactures products that are
sold to industrial customers for laminates in furniture, cabinetry, floor tiles
and wallboards. In addition, the company makes vinyl wall coverings sold
directly or through representatives to decorators, contractors and hotel chains
for use in offices, hotels and restaurants.
26
<PAGE>
No single customer represents more than 15% percent of the revenues of
the company's sales of industrial products for laminates. DSI has a variety of
competitors that manufacture such industrial products, none of whom is believed
to have a significantly larger market share in any one sector. In vinyl wall
covering, the company has a 8% market share. No single customer represents more
than 10% percent of the revenues for vinyl wall covering. The company's main
competitors in the wall covering market are Gencorp, with a 40% market share,
and RFG, with a 16% market share. Various of the company's designs are protected
by domestic and foreign copyrights.
Malon Wilkus, Stephen Hester and John Ireland, the Chief Executive
Officer, a Vice President, and a principal of the Company, respectively, are
members of the DSI Board of Directors and CIC performs financial advisory
services for DSI. Additionally, Stephen P. Walko, the president and chief
executive officer of DSI, is a Director of the Company.
Confluence Holdings Corp.
Confluence Holdings Corp., ("Confluence") is a paddle sports
manufacturing business whose brands include Wilderness Systems ("Wilderness"),
the third largest U.S. brand of kayaks, and Mad River Canoe ("Mad River"), the
second largest U.S. brand of canoes. Confluence operates these two businesses
such that their established brand names are retained. Paddle sports are one of
the fastest growing segments of the outdoor sporting industry.
Competition in the paddle sports industry historically was highly
fragmented and the industry is currently undergoing a rapid consolidation.
Wilderness' competitors in the kayak market include the Perception, Dagger, Old
Town, Ocean Kayaks and Current Designs brands. While principal competitors are
heavily focused in the lower to middle market segments as defined by retail
price points, Wilderness has focused on the upper middle to high end segments of
its markets in the touring, recreational and sit-on-top categories. Wilderness
has recently acquired the Wave Sport whitewater brand. Mad River's competitors
in the canoe market include the Old Town, Dagger, Wenonah, Coleman and Mohawk
brands. Mad River is the market leader in the specialty segment, where more than
half of canoes are sold. Mad River competes mainly on design, durability and
quality and is generally the most expensive brand in the market. While
Confluence has various trademarks, its products and processes are generally not
protected by patents.
A recessionary period could have a material adverse effect on
Confluence's business due to the possible reduction in the discretionary demand
for kayaks and canoes. In addition, there is also the potential for a decrease
in demand if consumers shift away from kayaks and canoes to other product
categories for outdoor recreation. Andrew Zimmerman, founder of Wilderness is
the chief executive officer of Confluence. John Freal, a principal of the
Company, is a member of the Board of Directors of Confluence.
Euro-Caribe Packing Company, Inc.
Euro-Caribe Packing Company, Inc., ("Euro-Caribe"), is the largest
independent producer of processed pork products in Puerto Rico. Euro-Caribe
claims more than 60% of the local sausage market and over 90% of the local ham
market. Euro-Caribe sells its "Congusto" brand name sausage products to all
seven of Puerto Rico's major supermarket chains, the five minor supermarket
chains, and the three associations of independently owned smaller stores that
buy on a cooperative basis, as well as restaurants throughout Puerto Rico. The
company also exports 5% of its sales to several U.S. mainland distributors that
sell in Latin American markets in New York and Miami. The ham products are sold
under the "El Serranito" brand name to major retail chains and many smaller
supermarkets. Euro-Caribe also manufactures a small amount of cooked sausages,
such as pepperoni, mortadella and salami. In partnership with another company,
Euro-Caribe has provided the Puerto Rican school system with lunchmeat for four
of the last five years.
Euro-Caribe's local competition includes approximately 16 companies
that fulfill USDA requirements and currently make meat products. Two of these
companies, Piku and Aguadillana, make competing sausages but both of them have
significantly less market share then Euro-Caribe. Sausage from foreign
competitors are generally more expensive and not tailored specifically to the
Puerto Rican taste. In the ham market, competing products are primarily from
Denmark and the United States.
Demand for pork products is relatively stable, but prices for pork vary
cyclically and seasonally. Cyclical variation is caused by the time lags
inherent in the biological production of pigs that affects supply and demand.
Seasonal price variations are caused by the annual increase in the demand for
pork during the Christmas holiday season and differing demand levels, such as
increased demand during summer months due to more people grilling outside. The
variations in the price for pork could have a material adverse effect on
Euro-Caribe's business.
Jose M. Casanova, the president and chief executive officer of the
company, has 24 years of experience in the pork industry. Virginia Rollins, a
principal of the Company, is a member of the Board of Directors of Euro-Caribe.
27
<PAGE>
ConStar Holdings, Inc.
ConStar Holdings, Inc. ("Holdings"), through its wholly-owned
subsidiary, ConStar International, Inc. ("ConStar"), is a provider of design,
integration and installation services of commercial electrical,
telecommunications, and computer networking systems. ConStar offers services
through two operating divisions: Consolidated Electrical Services (the
"Electrical Services Group") and Consolidated Services Group (the "Networking
Group"). The Electrical Services Group is one of the leading providers of
customer premise electrical systems in the northeast United States and offers
services primarily on a negotiated and "design and build" basis whereby the
company is responsible for the design, engineering, project management and
installation of a customized electrical system for its customers. ConStar's
Networking Group provides network design and consulting services related to
telecommunication, local and wide area networks and other connectivity systems.
The Electrical Services Group has limited competition in its primary
geographic market, the northeast United States, and is believed to rank second
in market revenue behind Mass. Electric Construction. The Networking Group's
competitors for network design and consulting services include the following:
Williams Communications Group, IPC Information Systems, Amerilink Corporation,
ICG Fiber Optic Technologies, Inc., and Henkels and McCoy, Inc. The Networking
Group ranks fourth in market revenue in this sector with respect to companies
that that make this information available to the public. The Networking Group
also competes to a lesser degree with certain companies in different, discreet
aspects of ConStar's business such as firms which may install only one part of a
network system such as cables.
ConStar's design and build capability gives it a competitive advantage
over many firms in the industry. However, the company may not be able to hire
enough field services and technical personnel to support its projected growth in
tight labor markets. In addition, in a recession, commercial building activity
is expected to decline. This may have a material adverse effect on ConStar's
business.
ConStar's chief executive officer, Stephen Bisson, has over 30 years of
experience in the electrical services business. John Freal, a principal of the
Company, is a member of the Board of Directors of Holdings.
Centennial Broadcasting, LLC
Centennial Broadcasting, LLC ("Centennial"), is the owner and operator
of seven radio stations, three in Las Vegas, three in New Orleans and one in
Vero Beach, Florida. New Orleans and Las Vegas are among the top 50 largest
radio advertising markets in the United States. The primary assets of Centennial
are the seven broadcast licenses owned by a wholly-owned subsidiary. The
company's programming decisions are aimed at narrowly defined niches of the
listening audience, with a strong preference towards targeting listeners between
the ages of 25-54, considered to be desirable listener group for advertisers. In
attempt to capture a larger share of these listeners, Centennial has instituted
format changes that include adding a younger listening base and increasing its
sales efforts with advertisers among its various stations.
The radio broadcasting industry is competitive. Centennial competes
with other local radio broadcasters including, but not limited to, KMZQ, KSNE,
KOMP, KXPT, KMXB and KXTE in the Las Vegas market, and WYLD and WQUE in the New
Orleans market. Centennial's stations compete with numerous other stations in
each of its markets as well as with operators of radio stations that are
significantly larger than Centennial. It is possible that better capitalized
market entrants will decrease the market base of one or more of Centennial's
stations. In addition, the format changes instituted by the company may not be
successful. This could have a material adverse effect on Centennial's business.
The president and chief executive officer of Centennial is Allen Shaw,
who has 30 years of experience in the broadcasting industry. The Company has the
right to designate an observer on Centennial's board of managers.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of the Company's outstanding shares is
determined quarterly, as soon as practicable after and as of the end of each
calendar quarter, by dividing the value of total assets minus liabilities by the
total number of shares outstanding at the date as of which the determination is
made.
In calculating the value of the Company's total assets, securities that
are traded in the over-the-counter market or on a stock exchange are valued at
the prevailing bid price on the valuation date, unless the investment is subject
to a restriction that requires a discount from such price, which is determined
by the Board of Directors. All other investments are valued at fair market value
as determined in good faith by the Board of Directors. In making such
determination, the Board of Directors will value loans and non-convertible debt
securities for which there exists no public trading market at cost plus
amortized original issue discount, if any, unless adverse factors lead to a
determination of a lesser value. In valuing convertible debt securities, equity
or other types of securities for
28
<PAGE>
which there exists no public trading market, the Board of Directors will
determine fair market value on the basis of collateral, the issuer's ability to
make payments, its earnings and other pertinent factors.
A substantial portion of the Company's assets consist of securities
carried at fair market values determined by its Board of Directors.
Determination of fair market values involves subjective judgment not susceptible
to substantiation by auditing procedures. Accordingly, under current auditing
standards, the notes to the consolidated financial statements refer to the
uncertainty with respect to the possible effect of such valuations on the
financial statements.
MANAGEMENT
The business and affairs of the Company are managed under the direction
of its Board of Directors. The Board of Directors has ten members, five of whom
are not "interested persons" of the Company as defined in Section 2(a)(19) of
the 1940 Act (the "Independent Directors"). The Board of Directors elects the
Company's officers who serve at the pleasure of the Board of Directors.
Pursuant to the terms of the Company's Second Amended and Restated
Certificate of Incorporation, the directors are divided into three classes. One
class holds office initially for a term expiring at the annual meeting of
stockholders to be held in 2000, a second class holds office initially for a
term expiring at the annual meeting of stockholders to be held in 2001 and a
third class holds office initially for a term expiring at the annual meeting of
stockholders to be held in 2002. Each director holds office for the term to
which he or she is elected and until his or her successor is duly elected and
qualified. Messrs. Wilkus, Harper and Walko have terms expiring in 2000, Messrs.
Gladstone, Allbritton and Puryear have terms expiring in 2001 and Messrs.
Blumenthal, Hahl and Lundine have terms expiring in 2002. At each annual meeting
of the stockholders of the Company, the successors to the class of directors
whose terms expire at such meeting will be elected to hold office for a term
expiring at the annual meeting of stockholders held in the third year following
the year of their election.
Executive Officers and Directors
The persons that are executive officers and directors of the Company
and their positions are set forth below:
<TABLE>
<CAPTION>
NAME AND YEAR FIRST ELECTED DIRECTOR AGE POSITIONS
- ------------------------------------ --- ---------
<S> <C> <C>
Malon Wilkus................................47 President, Chief Executive Officer and Chairman of the Board of Directors(1)
David Gladstone.............................56 Vice Chairman of the Board of Directors (1)
Adam Blumenthal (1993)......................37 Executive Vice President, Secretary and Director (1)
Robert L. Allbritton (1992).................30 Director
Landon Butler (1997)........................55 Director (2)
Neil M. Hahl (1997).........................50 Director
Philip R. Harper (1997).....................55 Director
Stan Lundine (1997).........................60 Director
Alvin N. Puryear (1998).....................55 Director (3)
Stephen P. Walko (1997).....................48 Director (1)
</TABLE>
- --------------
(1) Interested Person as defined in Section 2(a)(19) of the 1940 Act. Messrs.
Blumenthal, Gladstone and Wilkus are Interested Persons because they are
employees and officers of the Company. Mr. Walko is an Interested Person because
he is an officer and employee of Decorative Surfaces International, Inc., a
company under "control," as defined in Section 2(a)(9) of the 1940 Act, of the
Company.
(2) Resigned from the Board of Directors effective August 14, 1998.
(3) Joined the Board of Directors effective September 15, 1998.
The following is a summary of certain biographical information
concerning the Company's executive officers and directors:
Malon Wilkus. Mr. Wilkus founded the Company in 1985 and has served as
the Company's Chief Executive Officer and President since that time. Mr. Wilkus
served as Vice Chairman of the Board of Directors of the Company from 1997 to
1998 and has served as Chairman of the Board of Directors since 1998. Mr. Wilkus
is the past Chairman and a current Director of the National Center for Employee
Ownership. Mr. Wilkus is a member of the Board of Governors of the ESOP
Association. Mr. Wilkus is a Director of Decorative Surfaces International, Inc.
David Gladstone. Mr. Gladstone served as Vice Chairman of the Board of
the Company since 1998. From 1974 to February 1997, Mr. Gladstone held various
positions, including Chairman and Chief Executive officer, with Allied Capital
Corporation and all of its predecessor companies. From 1992 to 1997, Mr.
Gladstone served as a Director and President and Chief Executive Officer of
Business Mortgage Investors, a Real Estate Investment Trust. Mr. Gladstone
served as a Director of The Riggs National Corporation
29
<PAGE>
(the parent of Riggs Bank) from 1993 to May 1997 and of Riggs Bank from 1991 to
1993. He currently serves as a Trustee of The George Washington University. Mr.
Gladstone is the managing member of Capital Investor, a private fund backed by
Information Technology professionals to make investments in start-up companies
and is chairman of Coastal Berry Company, a large farming business. He is also
an advisor to the Women's Growth Fund, a venture capital fund which invests in
women-owned businesses.
Adam Blumenthal. Mr. Blumenthal has served as the Company's Executive
Vice President since 1995. From 1990 to 1995, Mr. Blumenthal served as a Vice
President of the Company. Mr. Blumenthal currently serves as a Director of
Mobile Tool International, Inc.
Robert L. Allbritton. Mr. Allbritton has served as Director since 1992,
as Executive Vice President from 1994 to 1998, and as President since 1998 of
Allbritton Communications Company, an owner of eight television stations. Mr.
Allbritton currently serves as Director of Riggs National Corporation (owner of
Riggs Bank, N.A.), Riggs Bank Europe Limited, Perpetual Corporation (owner of
Allbritton Communications Company and a cable news programming company), and
Allbritton Jacksonville, Inc. (owner of a television station). Mr. Allbritton
also serves as a trustee of The Allbritton Foundation and Allbritton Art
Institute.
Neil M. Hahl. Mr. Hahl has been President of The Weitling Group, a
business consulting firm, since 1996. From 1995 to 1996, Mr. Hahl served as
Senior Vice President of the American Financial Group. From 1982 to 1996, Mr.
Hahl served as Senior Vice President and CFO of Penn Central Corporation. Mr.
Hahl is currently a Director of Buckeye Management Company and American
Financial Enterprises.
Philip R. Harper. Mr. Harper has served as Chairman, Chief Executive
Officer, and President, of US Investigations Services, Inc. since 1996. From
1991 to 1995, Mr. Harper served a President of Wells Fargo Alarm Services. From
1988 to 1991, Mr. Harper served as President of Burns International Security
Services - Western Business Unite. Mr. Harper served in the U.S. Army from 1961
to 1982, where he commanded airborne infantry and intelligence units.
Stan Lundine. Mr. Lundine has served as Of Counsel for the law firm of
Sotir and Goldman since 1995. From 1987 to 1994, he was the Lieutenant Governor
of the State of New York. Mr. Lundine is a Director of US Investigations
Services, Inc. and National Forge Holdings. From 1976 to 1986, Mr. Lundine
served as a member of the U.S. House of Representatives.
Alvin N. Puryear. Dr. Puryear is a Professor of Management at Baruch
College of the City University of New York and has been on the faculty there
since 1970. He is Director of the Bank of Tokyo-Mitsubishi Trust Company, the
GreenPoint Bank and GreenPoint Financial Corporation.
Stephen P. Walko. Mr. Walko has been President, Chief Executive Officer
and a Director of Decorative Surfaces International, Inc. since 1998. From 1990
to 1998, he was President and a Director of Textileather Corporation. Mr. Walko
is a Director of Bliss Salem Steel Corp and Mobile Tool International, Inc.
Executive Officers Who Are Not Directors
John Erickson. Mr. Erickson has served as Vice President and Chief
Financial Officer of the Company since 1998. From 1990 to 1996, he served as the
Chief Financial Officer of Storage USA, Inc. From 1996 to 1998, Mr. Erickson
served as President of Storage USA Franchise Corp.
Roland H. Cline. Roland H. Cline has served as Vice President of the
Company since 1988. From 1988 to 1993, he was a Director of Roland Cline &
Associates, a consulting firm that specialized in financial services. From 1983
to 1986, Mr. Cline structured employee buyouts and performed feasibility studies
at the Industrial Cooperative Association. From 1979 to 1983, he served as
Director of Technical Assistance and Senior Business Analyst at the Institute of
Public Administration's Trade Adjustment Assistance Center.
Stephen L. Hester. Stephen L. Hester has served as Vice President and
General Counsel of the Company since 1994. From 1973 to 1994, he was a senior
partner in the Washington, D.C. law firm of Arnold & Porter.
30
<PAGE>
John S. Hoffmire, III. John S. Hoffmire, III has served as Vice
President of sales and marketing of the Company since 1997. From 1989 to 1997,
Mr. Hoffmire was the founder and president of Hoffmire & Associates, a
consulting and investment banking firm. From 1986 to 1989, Mr. Hoffmire was a
consultant with Bain & Company.
Employment Agreements
The Company has employment agreements with each of the named executive
officers. Each of the agreements provides for a five-year term. However, two
years before expiration of each agreement, its term will be automatically
renewed for an additional year, unless either party has given six months advance
written notice that the automatic extensions are to cease.
The base salary under the employment agreements of Messrs. Gladstone,
Wilkus and Hester is $150,000 per year. The base salary under the employment
agreements of Messrs. Blumenthal and Cline is $135,000 and $132,500 per year,
respectively, subject to certain geographic cost of living adjustments, Mr.
Erickson's employment agreement provides for an annual base salary of $125,000.
Mr. Hester's base salary is subject to adjustment for part-time status. The
Board of Directors has the right to increase the base salary during the term and
also, generally, to decrease it, but not below the original base salary. The
employment agreements provide that the executive officers are entitled to
participate in a performance based bonus program under which each will receive
up to 200% of his base salary depending on the Company's performance against
certain criteria to be established annually by the Compensation Committee of the
Board of Directors. Each executive officer will be entitled to receive 5% of
this bonus regardless of the Company's performance.
Under the agreement, the executive officers are contractually entitled
to participate in the Company's Employee Option Plan. If the Company should
terminate an executive officer's employment by reason of the executive officer's
disability, the executive officer would be entitled for two years to receive
from the Company the difference between his base salary plus annual bonus and
any long-term disability benefits. Additionally, the executive officer's
unvested options that would have vested within one year of the disability
termination would vest. Vested options would expire unless exercised (and all
outstanding loans resulting from the prior exercise of any options would have to
be repaid) within 18 months of the termination date. If the Company should
terminate an executive officer's employment for any reason other than a
disability or misconduct, the executive officer would be entitled to receive his
base salary and bonus for two years, although the executive officer could choose
to forgo the payments and thus obtain a release from non-compete provisions
applicable during this period. These payments would also be made if the
executive officer resigned with good reason, which generally includes conduct by
the Company materially and adversely changing the executive's responsibilities
and duties, a material breach by the Company of the employment agreement or a
change in control of the Company. Mr. Gladstone's contract also defines good
reason as determination by him of a material difference with the Board of
Directors. Additionally, an executive officer's unvested stock options would
generally vest if his employment were terminated for any reason other than a
disability or misconduct or if he resigned with good reason.
If the executive officer dies, his estate will be entitled to receive
the annual bonus in the year of death. Additionally, he will be considered to
have vested on the date of death in those options that would vest within one
year of the date of death, and would forfeit any unvested options. All such
vested options would expire unless exercised (and all outstanding loans
resulting from the prior exercise of any options would have to be repaid) within
18 months of the date of death.
In the event that the Company should terminate an executive officer's
employment as a result of the executive officer's misconduct or in the event
that the executive officer voluntary terminates his employment for other than
good reason, all unvested stock options would be forfeited (except that in the
case of a voluntary termination by Mr. Gladstone, 30% of such options would be
considered to have vested six months after the date of grant, 30% more would be
considered to have vested one year after the date of grant, and 20% more would
be considered to have vested on the second anniversary of the date of grant) and
the executive officer would have no more than 90 days to exercise any
unexercised options (and to repay any outstanding loans resulting from the prior
exercise of any options).
Upon termination of employment, an executive officer would be subject
to certain non-compete covenants. These covenants would generally apply for two
years, although should the executive officer resign without good reason, the
covenants would apply for only one year following resignation. The covenants
applicable to Mr. Gladstone are generally shorter although in essentially all
cases, Mr. Gladstone would be prohibited from competing with the Company for at
least one year following the public offering completed in August, 1997. As of
July 31, 1998, Mr. Gladstone's contract was amended. As noted above, during
periods when executive officers are receiving severance payments from the
Company, they may terminate covenants prohibiting competition by foregoing such
payments.
31
<PAGE>
Committees of the Board of Directors
The Board of Directors holds regular quarterly meetings and meets on
other occasions when required by special circumstances. Certain directors also
serve on the Board's principal standing committees. The committees, their
primary functions, and memberships are as follows:
Executive Committee -- This Committee has the authority to exercise all
powers of the Board of Directors except for actions that must be taken by the
full Board of Directors under the Delaware General Corporation Law. Members of
the Executive Committee are Messrs. Wilkus, Gladstone and Blumenthal. All three
members of the Executive Committee are "interested persons" under the 1940 Act.
Audit Committee -- This committee makes recommendations to the Board of
Directors with respect to the engagement of independent auditors, reviews with
the independent auditors the plans and results of the audit engagement, approves
professional services provided by the independent auditors, reviews the
independence of the independent auditors and reviews the adequacy of the
Company's internal accounting controls. Members of the Audit Committee are
Messrs. Allbritton, Hahl, Walko and Lundine.
Compensation Committee -- This committee has the responsibility for
reviewing and approving the salaries, bonuses, and other compensation and
benefits of executive officers, reviewing and advising management regarding
benefits and other terms and conditions of compensation of management, and
administering the Company's 1997 Stock Option Plan (the "Employee Option Plan").
Members of the Compensation Committee are Messrs. Puryear, Hahl and Harper.
The Board of Directors does not have a standing nominating committee.
Nominations for election to the Board of Directors may be made by the Board of
Directors, a nominating committee appointed by the Board of Directors or by any
stockholder entitled to vote for the election of directors. Nominations made by
stockholders must be made by written notice (setting forth the information
required by the Company's Bylaws) received by the Secretary of the Company at
least 120 days in advance of an annual meeting or within 10 days of the date on
which notice of a special meeting for the election of directors is first given
to stockholders.
The Board of Directors held thirteen formal meetings during 1998. The
Executive Committee held no formal meetings during 1998. The Compensation
Committee held four formal meetings during fiscal 1998 and the Audit Committee
held one meeting during fiscal 1998. Each of the directors attended at least 75%
of the meetings of the Board of Directors and the committees on which he served.
Long Term Incentive Plans
The Company maintains two long term incentive plans in which executive
officers of the Company participate: (i) the ESOP in which all employees of the
Company are eligible to participate after meeting minimum service requirements
and (ii) the 1997 Stock Option Plan (the "Employee Option Plan"). The Company
maintains no stock appreciation rights plan or defined benefit or actuarial
plan.
ESOP. The Company maintains the ESOP for the benefit of its employees
and enables them to share in the growth of the Company. The ESOP is a
combination money purchase and stock bonus plan, designed to be invested
primarily in Common Stock of the Company and qualified under section 401(a) of
the Internal Revenue Code of 1986, as amended (the "Code"). The ESOP provides
that ESOP participants will receive allocations of Company stock at least equal
to 3% of their annual compensation, up to certain statutory maximums. The
Company has the ability to make additional contributions also subject to certain
statutory maximums. Each ESOP participant vests in his or her ESOP account over
a five-year period beginning on the date of first employment.
Option Plan. The Employee Option Plan was established for the purpose
of attracting and retaining executive officers and other key employees.
Non-employee Directors may not participate. Options for a maximum of 1,828,252
shares of Common Stock were subject to issuance under the Employee Option Plan.
Of such amount, options for 1,617,778 shares of Common Stock are outstanding and
options for 48,000 shares of Common Stock have been exercised. The Compensation
Committee administers the Option Plan and may grant options for a maximum of
608,782 shares to any single participant. The Compensation Committee uses such
criteria as it deems important to determine who will receive awards and the
number of awarded options. The Compensation Committee has the authority to set
the exercise price for options and to adjust the exercise price following the
occurrence of events such as stock splits, dividends, distribution and
recapitalizations. Options may be exercised during a period of no more than ten
years following the date of grant. The Compensation Committee has the discretion
to set the vesting period for options and to permit the acceleration of vesting
under certain circumstances. Vesting is automatically accelerated upon the
occurrence of specified change of control transactions.
32
<PAGE>
1997 Disinterested Director Stock Option Plan
The Company established the 1997 Disinterested Director Stock Option
Plan (the "Director Option Plan") for directors who are not employees of the
Company. The Director Option Plan provides for the issuance of options to
purchase an aggregate of 150,000 shares of Common Stock to participants. Of such
amount, options for 15,000 shares of Common Stock have been granted to each of
the six directors who are not employees of the Company.
The Director Option Plan is currently administered by the Company's
Executive Committee (which is currently composed of directors who are not
eligible to participate in the Director Option Plan). Options may be exercised
during a period of no more than ten years following the date of grant. Vesting
of options will be automatically accelerated upon the occurrence of specified
change of control transactions and certain other events including the death or
disability of the director. Options to purchase a maximum of 25,000 shares may
be issued to any single participant under the Director Option Plan.
33
<PAGE>
DIVIDEND REINVESTMENT PLAN
Pursuant to the Company's Dividend Reinvestment Plan (the "Reinvestment
Plan"), a stockholder whose shares are registered in his own name may have all
distributions reinvested automatically in additional shares by EquiServe, L.P.,
the Reinvestment Plan administrator (the "Reinvestment Plan Administrator"), by
providing the required enrollment notice to the Reinvestment Plan Administrator.
Stockholders whose shares are held in the name of a broker or other nominee may
have distributions reinvested automatically only if such a service is provided
by the broker or the nominee or if the broker or the nominee permits
participation in the Reinvestment Plan. Stockholders whose shares are held in
the name of a broker or other nominee should contact the broker or nominee for
details. A stockholder may terminate participation in the Reinvestment Plan at
any time by delivering written notice to the Reinvestment Plan Administrator
before the record date of the next dividend or distribution. All distributions
to stockholders who do not participate in the Reinvestment Plan will be paid by
check mailed directly to the record holder by or under the direction of the
Reinvestment Plan Administrator.
When the Company declares a dividend or distribution, stockholders who
are participants in the Reinvestment Plan receive the equivalent of the amount
of the dividend or distribution in shares of the Common Stock. The Reinvestment
Plan Administrator buys shares in the open market, on the Nasdaq National Market
or elsewhere. Alternatively, the Board of Directors may choose to contribute
newly issued shares of Common Stock to the Reinvestment Plan, in lieu of the
payment of cash dividends on shares held in the Reinvestment Plan. The
Reinvestment Plan Administrator applies all cash received on account of a
dividend or distribution as soon as practicable, but in no event later than 30
days, after the payment date of the dividend or distribution except to the
extent necessary to comply with applicable provisions of the federal securities
laws. The number of shares to be received by the Reinvestment Plan participants
on account of the dividend or distribution is calculated on the basis of the
average price of all shares purchased for that 30 day period, including
brokerage commissions, and is credited to their accounts as of the payment date
of the dividend or distribution.
The Reinvestment Plan Administrator maintains all stockholder accounts
in the Reinvestment Plan and furnishes written confirmations of all transactions
in the account, including information needed by stockholders for personal and
tax records. Common Stock in the account of each Plan participant is held by the
Reinvestment Plan Administrator in non-certificated form in the name of the
participant, and each stockholder's proxy includes shares purchased pursuant to
the Reinvestment Plan.
There is no charge to participants for reinvesting dividends and
capital gains distributions. The fees of the Reinvestment Plan Administrator for
handling the reinvestment of dividends and capital gains distributions are
included in the fee to be paid by the Company to its transfer agent. There are
no brokerage charges with respect to shares issued directly by the Company as a
result of dividends or capital gains distributions payable either in shares or
in cash. However, each participant bears a pro rata share of brokerage
commissions incurred with respect to the Reinvestment Plan Administrator's open
market purchases in connection with the reinvestment of distributions.
The automatic reinvestment of distributions does not relieve
participants of any income tax that may be payable on distributions. See
"Business - The Company's Operations as a BDC and RIC."
DESCRIPTION OF THE SECURITIES
The authorized capital stock of the Company consists of 70,000,000
shares of Common Stock, $0.01 par value per share and 5,000,000 shares of
preferred stock, par value $0.01 per share (the "Preferred Stock," the Preferred
Stock and the Common Stock are collectively referred to as the "Capital Stock").
The following summary of the Company's Capital Stock and other securities does
not purport to be complete and is subject to, and qualified in its entirety by,
the Company's Second Amended and Restated Certificate of Incorporation, as
amended. Reference is made to the Company's Second Amended and Restated
Certificate of Incorporation, as amended, for a detailed description of the
provisions summarized below.
Common Stock. All shares of Common Stock, have equal rights as to
earnings, assets, dividends and voting privileges and, when issued, will be duly
authorized, validly issued, fully paid and nonassessable. Distributions may be
paid to the holders of Common Stock if and when declared by the Board of
Directors of the Company out of funds legally available therefor. The holders of
Common Stock have no preemptive, conversion or redemption rights and their
interests therein are freely transferable. In the event of liquidation
dissolution or winding up of the Company, each share of Common Stock is entitled
to share ratably in all assets of the Company that are legally available for
distribution after payment of all debts and other liabilities and subject to any
prior rights of holders of Preferred Stock, if any, then outstanding. Each share
of Common Stock is entitled to one vote and does not have cumulative voting
rights, which means that holders of a majority of such shares, if they so
choose, could elect all of the directors, and holders of less than a majority of
such shares would, in that case, be unable to elect any director.
34
<PAGE>
Preferred Stock. In addition to shares of Common Stock, the Company's
Second Amended and Restated Certificate of Incorporation, as amended, authorizes
the issuance of shares of Preferred Stock. The Board of Directors is authorized
to provide for the issuance of Preferred Stock with such preferences, powers,
rights and privileges as the Board deems appropriate; except that, such an
issuance must adhere to the requirements of the 1940 Act. The 1940 Act requires,
among other things, that (i) immediately after issuance and before any
distribution is made with respect to Common Stock, the Preferred Stock, together
with all other Senior Securities, must not exceed an amount equal to 50% of the
Company's total assets and (ii) the holders of shares of Preferred Stock, if any
are issued, must be entitled as a class to elect two directors at all times and
to elect a majority of the directors if dividends on the Preferred Stock are in
arrears by two years or more. The Company has no present plans to issue any
shares of Preferred Stock, but believes the availability of such stock will
provide the Company with increased flexibility in structuring future financings
and acquisitions. If we offer preferred stock under this Prospectus, we will
issue an appropriate Prospectus Supplement. You should read that Prospectus
Supplement for a description of the preferred stock, including, but not limited
to, whether there will be an arrearage in the payment of dividends or sinking
fund installments, if any, restrictions with respect to the declaration of
dividends, requirements in connection with the maintenance of any ratio or
assets, or creation or maintenance of reserves, or provisions for permitting or
restricting the issuance of additional securities.
Warrants. In connection with the ipo, the Company sold to certain
underwriters named in the underwriting agreement (the "Underwriters") warrants
(the "Underwriters' Warrants") to purchase up to 392,351 shares of Common Stock,
representing 4% of the shares of Common Stock outstanding after completion of
the IPO, at a purchase price equal to the initial offering price per share. The
Underwriters' Warrants were immediately exercisable and have a term of five
years from the date of the IPO (the "Warrant Exercise Term"). The Company has
also registered the shares of Common Stock underlying the Underwriters'
Warrants. During the Warrant Exercise Term, the holders are given the
opportunity to profit from a rise in market price of the shares of Common Stock.
To the extent that the Underwriters' Warrants are exercised, dilution to the
interests of the holders of the Common Stock will occur. In addition, the terms
upon which the Company will be able to obtain additional equity capital may be
adversely affected because the holders of the Underwriters' Warrants can be
expected to exercise them at a time when the Company likely would be able to
obtain any needed capital on terms more favorable to the Company than those
provided in the Underwriters' Warrants.
Debt Securities. The Company may issue debt securities that may be
senior or subordinated in priority of payment. The Company will provide a
Prospectus Supplement that describes the ranking, whether senior or
subordinated, the specific designation, the aggregate principal amount, the
purchase price, the maturity, the redemption terms, the interest rate or manner
of calculating the interest rate, the time of payment of interest, if any, the
terms for any conversion or exchange, including the terms relating to the
adjustment of any conversion or exchange mechanism, the listing, if any, on a
securities exchange, the name and address of the trustee and any other specific
terms of the debt securities.
CERTAIN PROVISIONS OF THE SECOND AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION, AS AMENDED, AND THE SECOND AMENDED AND RESTATED BYLAWS
Limitation on Liability of Directors
The Company has adopted provisions in its Second Amended and Restated
Certificate of Incorporation, as amended, limiting the liability of directors
and officers of the Company for monetary damages. The effect of this provision
in the Second Amended and Restated Certificate of Incorporation, as amended, is
to eliminate the rights of the Company and its stockholders (through
stockholders' derivative suits on behalf of the Company) to recover monetary
damages against a director or officers for breach of the fiduciary duty of care
as a director or officer (including breaches resulting from negligent or grossly
negligent behavior) except in certain limited situations. This provision does
not limit or eliminate the rights of the Company or any stockholder to seek
nonmonetary relief such as an injunction or rescission in the event of a breach
of a director's or officer's duty of care. These provisions will not alter the
liability of directors or officers under federal securities laws.
Certain Anti-Takeover Provisions
The Second Amended and Restated Certificate of Incorporation, as
amended, and the Second Amended and Restated By-Laws of the Company contain
certain provisions that could make more difficult the acquisition of the Company
by means of a tender offer, a proxy contest or otherwise. These provisions are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company to negotiate first with the Board of Directors. The Company believes
that the benefits of these provisions outweigh the potential disadvantages of
discouraging such proposals because, among other things, negotiation of such
proposals might result in an improvement of their terms. The description set
forth below is intended as a summary only and is qualified in its entirety by
reference to the Second Amended and Restated Certificate of Incorporation, as
amended, and the Second Amended and Restated By-Laws.
35
<PAGE>
Classified Board of Directors
The Second Amended and Restated Certificate of Incorporation, as
amended, provides for the Board of Directors to be divided into three classes of
directors serving staggered three-year terms, with each class to consist as
nearly as possible of one-third of the directors then elected to the Board. A
classified board may render more difficult a change in control of the Company or
removal of incumbent management. The Company believes, however, that the longer
time required to elect a majority of a classified Board of Directors will help
to ensure continuity and stability of the Company's management and policies.
Number of Directors; Removal; Filing Vacancies
The Second Amended and Restated Certificate of Incorporation, as
amended, provides that the number of directors will be determined pursuant to
the By-Laws. In addition, the Second Amended and Restated By-Laws provide that
the number of directors shall not be increased by 50% or more in any 12-month
period without the approval of at least 66 2/3% of the members of the Board of
Directors then in office. The Second Amended and Restated Certificate of
Incorporation, as amended, provides that any vacancies will be filled by the
vote of a majority of the remaining directors, even if less than a quorum, and
the directors so appointed shall hold office until the next election of the
class for which such directors have been chosen and until their successors are
elected and qualified. Accordingly, the Board of Directors could temporarily
prevent any stockholder from enlarging the Board of Directors and filling the
new directorships with such stockholder's own nominees.
The Second Amended and Restated Certificate of Incorporation, as
amended, also provides that, except as may be provided in a resolution or
resolution designating any class or series of Preferred Stock, the directors may
only be removed for cause by the affirmative vote of 75% of the voting power of
all of the shares of capital stock of the Company then entitled to vote
generally in the election of directors, voting together as a single class.
No Stockholder Action By Written Consent
The Second Amended and Restated Certificate of Incorporation, as
amended, and the Second Amended and Restated By-Laws provide that stockholder
action can be taken only at an annual or special meeting of Stockholders. They
also prohibit stockholder action by written consent in lieu of a meeting. These
provisions may have the effect of delaying consideration of a stockholder
proposal until the next annual meeting.
Advance Notice Provisions For Stockholder Nominations And Stockholder
Proposals
The Second Amended and Restated By-Laws establish an advance notice
procedure for stockholders to make nominations of candidates for election as
directors or to bring other business before an annual meeting of stockholders of
the Company (the "Stockholder Notice Procedure").
The Stockholder Notice Procedure provides that (i) only persons who are
nominated by, or at the direction of, the Board of Directors, or by a
stockholder who has given timely written notice containing specified information
to the Secretary of the Company prior to the meeting at which directors are to
be elected, will be eligible for election as directors of the Company and (ii)
at an annual meeting, only such business may be conducted as has been brought
before the meeting by, or at the direction of, the Board of Directors or by a
stockholder who has given timely written notice to the Secretary of the Company
of such stockholder's intention to bring such business before the meeting.
Except for stockholder proposals submitted in accordance with the Federal proxy
rules as to which the requirements specified therein shall control, notice of
stockholder nominations or business to be conducted at a meeting must be
received by the Company not less than 60 days or more than 90 days prior to the
first anniversary of the previous year's annual meeting if the notice is to be
submitted at an annual stockholders meeting or no later than 10 days following
the day on which notice of the date of a special meeting of stockholders was
given if the notice is to be submitted at a special stockholders meeting.
The purpose of requiring stockholders to give the Company advance
notice of nominations and other business is to afford the Board of Directors a
meaningful opportunity to consider the qualifications of the proposed nominees
and the advisability of the other proposed business and, to the extent deemed
necessary or desirable by the Board of Directors, to inform stockholders and
make recommendations about such qualifications or business, as well as to
provide a more orderly procedure for conducting meetings of stockholders.
Although the Second Amended and Restated By-Laws do not give the Board of
Directors any power to disapprove stockholder nominations for the election of
directors or proposals for action, they may have the effect of precluding a
contest for the election of directors or the consideration of stockholder
proposals if proper procedures are not followed and of discouraging or deterring
a third party from conducting a solicitation of proxies to elect its own slate
of directors or to approve its own proposal without regard to whether
consideration of such nominees or proposals might be harmful or beneficial to
the Company and its stockholders.
36
<PAGE>
Amendment of Certificate of Incorporation and Bylaws
The Company's Second Amended and Restated Certificate of Incorporation,
as amended, provides that the provisions therein relating to the classified
Board of Directors, the number of directors, vacancies on the Board of Directors
and removal of directors may be amended, altered, changed or repealed only by
the affirmative vote of the holders of at least 75% of the voting power of all
of the shares of capital stock of the Company then entitled to vote generally in
the election of directors voting together as a single class.
The Company's Second Amended and Restated Certificate of Incorporation,
as amended, also provides that the other provisions of such Certificate may be
amended, altered, changed or repealed, subject to the resolutions providing for
any class or series of Preferred Stock, only by the affirmative vote of both a
majority of the members of the Board of Directors then in office and a majority
of the voting power of all of the shares of capital stock of the Company
entitled to vote generally in the election of directors, voting together as a
single class.
The Company's Second Amended and Restated Certificate of Incorporation,
as amended, also provides that the Second Amended and Restated By-Laws may be
adopted, amended, altered, changed or repealed by the affirmative vote of the
majority of the Board of Directors then in office. Any action taken by the
stockholders with respect to adopting, amending, altering, changing or repealing
the Second Amended and Restated By-Laws may be taken only by the affirmative
vote of the holders of at least 75% of the voting power of all of the shares of
capital stock of the Company then entitled to vote generally in the election of
directors, voting together as a single class.
These provisions are intended to make it more difficult for
stockholders to circumvent certain other provisions contained in the Company's
Second Amended and Restated Certificate of Incorporation and Second Amended and
Restated By-Laws, such as those that provide for the classification of the Board
of Directors. These provisions, however, also will make it more difficult for
stockholders to amend the Second Amended and Restated Certificate of
Incorporation or Second Amended and Restated By-Laws without the approval of the
Board of Directors, even if a majority of the stockholders deems such amendment
to be in the best interests of all stockholders.
REGULATION
The Company is a closed-end, non-diversified, management investment
company that has elected to be regulated as a business development company under
Section 54 of the 1940 Act and, as such, is subject to regulation under that
Act. The 1940 Act contains prohibitions and restrictions relating to
transactions between business development companies and their affiliates,
principal underwriters and affiliates of those affiliates or underwriters and
requires that a majority of the directors be persons other than "interested
persons," as defined in the 1940 Act. In addition, the 1940 Act provides that
the Company may not change the nature of its business so as to cease to be, or
to withdraw its election as, a business development company unless so authorized
by the vote of a majority, as defined in the 1940 Act, of its outstanding voting
securities.
The Company is permitted, under specified conditions, to issue multiple classes
of indebtedness and one class of stock senior to the shares offered hereby if
its asset coverage, as defined in the 1940 Act, is at least 200% immediately
after each such issuance. In addition, while Senior Securities are outstanding,
provision must be made to prohibit any distribution to stockholders or the
repurchase of such securities or shares unless the Company meets the applicable
asset coverage ratios at the time of the distribution or repurchase. The Company
may also borrow amounts up to 5% of the value of its total assets for temporary
or emergency purposes.
Under the 1940 Act, a business development company may not acquire any asset
other than assets of the type listed in Section 5(a) of the 1940 Act
("Qualifying Assets") unless, at the time the acquisition is made, Qualifying
Assets represent at least 70% of the company's total assets. The principal
categories of Qualifying Assets relevant to the proposed business of the Company
are the following:
(1) Securities purchased in transactions not involving any public offering
from the issuer of such securities, which issuer is an eligible
portfolio company. An eligible portfolio company is defined in the 1940
Act as any issuer which:
(a) is organized under the laws of, and has its principal place of
business in, the United States;
(b) is not an investment company other than a small business
investment company wholly-owned by the business development
company; and
(c) does not have any class of securities with respect to which a
broker or dealer may extend margin credit.
(2) Securities of any eligible portfolio company which is controlled by the
business development company.
37
<PAGE>
(3) Securities received in exchange for or distributed on or with respect
to securities described in (1) or (2) above, or pursuant to the
exercise of options, warrants or rights relating to such securities.
(4) Cash, cash items, government securities, or high quality debt
securities maturing in one year or less from the time of investment.
In addition, a BDC must have been organized (and have its principal place of
business) in the United States and must be operated for the purpose of making
investments in the types of securities described in (1) or (2) above. However,
in order to count portfolio securities as Qualifying Assets for the purpose of
the 70% test, the BDC must either control the issuer of the securities or must
offer to make available to the issuer of the securities significant managerial
assistance; except that, where the BDC purchases such securities in conjunction
with one or more other persons acting together, one of the other persons in the
group may make available such managerial assistance. Making available
significant managerial assistance means, among other things, any arrangement
whereby the BDC, through its directors, officers or employees, offers to
provide, and, if accepted, does so provide, significant guidance and counsel
concerning the management, operations or business objectives and policies of a
portfolio company.
SHARE REPURCHASES
Common Stock of closed-end investment companies frequently trade at
discounts from net asset value. The Company cannot predict whether its shares
will trade above, at or below net asset value. The market price of the Company's
shares is determined by, among other things, the supply and demand for the
Company's shares, the Company's investment performance and investor perception
of the Company's overall attractiveness as an investment as compared with
alternative investments. The Board of Directors has authorized officers of the
Company in their discretion, subject to compliance with the 1940 Act and other
applicable law, to purchase on the open market or in privately negotiated
transactions, outstanding shares of the Company in the event that the shares
trade at a discount to net asset value. There is no assurance that any such open
market purchases will be made and such authorization may be terminated at any
time. In addition, if at any time after the September, 1999 the Company's shares
publicly trade for a substantial period of time at a substantial discount from
the Company's then current net asset value per share, the Company's Board of
Directors will consider authorizing periodic repurchases of the Company's shares
or other actions designed to eliminate the discount. The Board of Directors
would consider all relevant factors in determining whether to take any such
actions, including the effect of such actions on the Company's status as a RIC
under the Code and the availability of cash to finance these repurchases in view
of the restrictions on the Company's ability to borrow. No assurance can be
given that any share repurchases will be made or that if made, they will reduce
or eliminate market discount. Should any such repurchases be made in the future,
it is expected that they would be made at prices at or below the current net
asset value per share. Any such repurchase would cause the Company's total
assets to decrease, which may have the effect of increasing the Company's
expense ratio. The Company may borrow money to finance the repurchase of shares
subject to the limitations described in this Prospectus. Any interest on such
borrowing for this purpose will reduce the Company's net income.
PLAN OF DISTRIBUTION
The Company may sell the Securities through underwriters or dealers,
directly to one or more purchasers, through agents or through a combination of
any such methods of sale. Any underwriter or agent involved in the offer and
sale of the Securities will be named in the applicable Prospectus Supplement.
The distribution of the Securities may be effected from time to time in
one or more transactions at a fixed price or prices, which may be changed, at
prevailing market prices at the time of sale, at prices related to such
prevailing market prices, or at negotiated prices, provided, however, that in
the case of Common Stock, the offering price per share less any underwriting
commissions or discounts must equal or exceed the net asset value per share of
the Company's Common Stock.
In connection with the sale of the Securities, underwriters or agents
may receive compensation from the Company or from purchasers of the Securities,
for whom they may act as agents, in the form of discounts, concessions or
commissions. Underwriters may sell the Securities to or through dealers and such
dealers may receive compensation in the form of discounts, concessions or
commissions from the underwriters and/or commissions from the purchasers for
whom they may act as agents. Underwriters, dealers and agents that participate
in the distribution of the Securities may be deemed to be underwriters under the
Securities Act, and any discounts and commissions they receive from the Company
and any profit realized by them on the resale of the Securities may be deemed to
be underwriting discounts and commissions under the Securities Act. Any such
underwriter or agent will be identified and any such compensation received from
the Company will be described in the applicable Prospectus Supplement.
Any Common Stock sold pursuant to a Prospectus Supplement will be
quoted on the Nasdaq National Market, or another exchange on which the Common
Stock are traded.
38
<PAGE>
Under agreements into which the Company may enter, underwriters,
dealers and agents who participate in the distribution of the Securities may be
entitled to indemnification by the Company against certain liabilities,
including liabilities under the Securities Act. Underwriters, dealers and agents
may engage in transactions with, or perform services for, the Company in the
ordinary course of business.
If so indicated in the applicable Prospectus Supplement, the Company
will authorize underwriters or other persons acting as the Company's agents to
solicit offers by certain institutions to purchase the Securities from the
Company pursuant to contracts providing for payment and delivery on a future
date. Institutions with which such contracts may be made include commercial and
savings banks, insurance companies, pension funds, investment companies,
educational and charitable institutions and others, but in all cases such
institutions must be approved by the Company. The obligations of any purchaser
under any such contract will be subject to the condition that the purchase of
the Securities shall not at the time of delivery be prohibited under the laws of
the jurisdiction to which such purchaser is subject. The underwriters and such
other agents will not have any responsibility in respect of the validity or
performance of such contracts. Such contracts will be subject only to those
conditions set forth in the Prospectus Supplement, and the Prospectus Supplement
will set forth the commission payable for solicitation of such contracts.
In order to comply with the securities laws of certain states, if
applicable, the Securities offered hereby will be sold in such jurisdictions
only through registered or licensed brokers or dealers. In addition, in certain
states, the Securities may not be sold unless they have been registered or
qualified for sale in the applicable state or an exemption from the registration
or qualification requirement is available and is complied with.
SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR
The Company's securities are held under a custodian agreement by
LaSalle Bank, N.A. The address of the custodian is 135 South LaSalle Street,
Chicago, IL 60603. The Company's assets are held under bank custodianship in
compliance with the 1940 Act. State Street Bank and Trust Company acts as the
Company's transfer and dividend paying agent and registrar. The principal
business address of State Street Bank and Trust is c/o. EquiServe, L.P., 150
Royall Street, mail stop 45-02-62, Canton, MA 02021.
LEGAL MATTERS
The legality of the Securities offered hereby will be passed upon for
the Company by Arnold & Porter, Washington, D.C. Certain legal matters will be
passed upon for the underwriters, if any, by the counsel named in the Prospectus
Supplement.
EXPERTS
Ernst & Young LLP, independent auditors, have audited the Company's
financial statements and financial highlights at December 31, 1998 and 1997, and
for the year ended December 31, 1998, the three months ended December 31, 1997,
the nine months ended September 30, 1997 and the year ended December 31, 1996,
as set forth in their report. The Company has included its financial statements
and financial highlights in this Prospectus and elsewhere in the Registration
Statement in reliance upon Ernst & Young LLP's report on their authority as
experts in accounting and auditing.
TABLE OF CONTENTS OF STATEMENT OF
ADDITIONAL INFORMATION
<TABLE>
<CAPTION>
Page in the Location
Statement of Related
of Additional Disclosure in
Information The Prospectus
------------- --------------
<S> <C> <C>
General Information and History................................. SAI-1
Investment Objective and Policies............................... SAI-1
Management...................................................... SAI-2
Compensation of Executive Officers and Directors................ SAI-2
Compensation of Directors....................................... SAI-2
Stock Option Awards............................................. SAI-3
Control Persons and Principal Holders of Securities............. SAI-4
Investment Advisory Services.................................... SAI-5
Safekeeping, Transfer and Dividend Paying Agent and Registrar... SAI-5
39
<PAGE>
Accounting Services............................................. SAI-5
Brokerage Allocation and Other Practices........................ SAI-5
Tax Status...................................................... SAI-5
</TABLE>
40
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
AUDITED FINANCIAL STATEMENTS
Report of Independent Auditors................................................................................... F-2
Balance Sheets as of December 31, 1998 and 1997.................................................................. F-3
Schedules of Investments as of December 31, 1998 and 1997........................................................ F-4
Statements of Operations for the year ended December 31, 1998, the three months ended December 31, 1997, the
nine months ended September 30, 1997 and the year end December 31, 1996...................................... F-6
Statements of Shareholders' Equity for the year ended December 31, 1998, the three months ended December 31,
1997, the nine months ended September 30, 1997 and the year ended December 31, 1996.......................... F-7
Statements of Cash Flows for the year ended December 31, 1998, the three months ended December 31, 1997, the
nine months ended September 30, 1997 and the year ended December 31, 1996.................................... F-8
Financial Highlights for the year ended December 31, 1998 and the three months ended December 31, 1997........... F-9
Notes to Financial Statements.................................................................................... F-10
UNAUDITED FINANCIAL STATEMENTS
Balance Sheets as of March 31, 1999 and 1998..................................................................... F-19
Schedules of Investments as of March 31, 1999 and 1998........................................................... F-20
Statements of Operations for the three months ended March 31, 1999 and 1998...................................... F-21
Statements of Shareholders' Equity for the three months ended March 31, 1999 and 1998............................ F-22
Statements of Cash Flows for the three months ended March 31, 1999 and 1998...................................... F-23
Financial Highlights for the three months ended March 31, 1999 and 1998.......................................... F-24
Notes to Financial Statements.................................................................................... F-25
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American Capital Strategies, Ltd.
We have audited the accompanying balance sheets of American Capital
Strategies, Ltd., including the schedules of investments, as of December 31,
1998 and 1997, the related statements of operations, shareholders' equity and
cash flows for the year ended December 31, 1998, the three months ended December
31, 1997, the nine months ended September 30, 1997, and the year ended December
31, 1996, and the financial highlights for the year ended December 31, 1998 and
the three months ended December 31, 1997. These financial statements and the
financial highlights are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of American Capital
Strategies, Ltd. at December 31, 1998 and 1997, and the results of its
operations and its cash flows for the year ended December 31, 1998, the three
months ended December 31, 1997, the nine months ended September 30, 1997, and
the year ended December 31, 1996, and the financial highlights for the year
ended December 31, 1998 and the three months ended December 31, 1997 in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Washington, D.C.
February 2, 1999
F-2
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
BALANCE SHEETS
(In thousands except per share data)
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Assets
Investments at fair value (cost of $252,718 and $133,274, respectively) $254,983 $133,415
Cash and cash equivalents 6,149 8,862
Investment in unconsolidated operating subsidiary 6,386 6,869
Due from unconsolidated operating subsidiary 778 861
Interest receivable 1,561 644
Other 162 54
-------- --------
Total assets $270,019 $150,705
======== ========
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 126 $ 53
Accrued dividends payable 1,222 --
Notes payable 85,948 --
Revolving credit facility 30,000 --
-------- --------
Total liabilities 117,296 53
Shareholders' equity:
Undesignated preferred stock, $0.01 par value, 5,000 shares authorized,
0 issued and outstanding -- --
Common stock, $.01 par value, 20,000 shares authorized, and 11,081 and
11,069 issued and outstanding, respectively 111 111
Capital in excess of par value 145,245 144,940
Note receivable from sale of common stock (300) --
Distributions in excess of net realized earnings (116) (55)
Unrealized appreciation of investments 7,783 5,656
-------- --------
Total shareholders' equity 152,723 150,652
-------- --------
Total liabilities and shareholders' equity $270,019 $150,705
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
DECEMBER 31, 1998
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
<S> <C> <C> <C>
Senior Debt--9.47%
- ------------------
Four S Baking Company Baking $ 1,266 $ 1,266
BIW Connector Systems, LLC Manufacturing 3,404 3,404
Chance Coach, Inc. Bus Manufacturer 1,286 1,286
JAG Industries, Inc. Manufacturing 1,200 1,200
Confluence Holdings Corp. Canoes & Kayaks 9,675 9,675
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Eurocaribe, Inc. Meat Processing 7,181 7,181
-------- --------
Subtotal 24,762 24,762
Subordinated Debt--41.37%
- -------------------------
Four S Baking Company Baking 1,588 1,588
BIW Connector Systems, LLC. Manufacturing 6,710 6,710
Westwinds Holdings, Inc. Restaurant 2,932 2,932
JAG Industries, Inc. Manufacturing 2,335 2,335
Specialty Transportation Services, Inc. Waste Hauler 7,368 7,368
Chance Coach, Inc. Bus Manufacturer 7,060 7,060
The L.A. Studios, Inc. Audio Production 2,393 2,393
Decorative Surfaces International, Inc. Decorative Paper & Vinyl Mfg. 10,490 10,490
New Piper Aircraft, Inc. Aircraft Manufacturing 17,858 17,858
Electrolux, LLC Vacuum Cleaner 7,264 7,264
Cycle Gear, Inc. Motor Cycle Accessories 633 633
Confluence Holdings Corp. Canoes & Kayaks 4,701 4,701
Eurocaribe, Inc. Meat Processing 8,905 8,905
ConStar International, Inc. Electrical 12,839 12,839
Centennial Broadcasting, Inc. Radio Stations 15,040 15,040
-------- --------
Subtotal 108,116 108,116
Convertible Preferred Stock(2)--2.10%
- -------------------------------------
Four S Baking Company 15% dividend convertible into 51,390 shares of
common stock or 10.89% of Co. Baking 2,756 2,756
Chance Coach, Inc. 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,079
Decorative Surfaces International, Inc. prime rate plus 4% dividend
convertible into 2.9% of Co. Decorative Paper & Vinyl Mfg. 646 646
-------- --------
Subtotal 5,402 5,481
Common Stock Warrants(1)--8.52%
- -------------------------------
Four S Baking Company (2) 15,390 shares 3.26% of Co. Baking 462 600
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 540
Westwinds Holdings, Inc. 5% of Co. Restaurant 350 421
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 465
Specialty Transportation Services, Inc. 9.1% of Co. Waste Hauler 694 784
Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 4,543
The L.A. Studios, Inc. 17% of Co. Audio Production 902 857
Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 5,596
New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,231
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 246
Cycle Gear, Inc. 16.5% of Co. Motor Cycle Accessories 374 374
Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,319
Eurocaribe, Inc. 37% of Co. Meat Processing 1,110 1,110
ConStar International, Inc. 17.5% of Co. Electrical 3,171 3,171
-------- --------
Subtotal 20,628 22,257
Common Stock (1)--1.69%
- -----------------------
Four-S Baking Company (2) 5.5% of Co. Baking 966 1,004
Specialty Transportation Services, Inc. 9.1% of Co. Waste Hauler 500 784
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,131
ConStar International, Inc. 2.8% Electrical 500 500
-------- --------
Subtotal 3,862 4,419
-------- --------
Subtotal--non-publicly traded securities--63.15% 162,770 165,035
Government Securities--34.41%
- -----------------------------
FHLB Discount Note due 1/4/98 89,948 89,948
-------- --------
Total Investments 252,718 254,983
Investment in Unconsolidated Operating Subsidiary--2.44%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. Investment Banking 403 6,386
-------- --------
Totals $253,121 $261,369
======== ========
</TABLE>
(1) Non-income producing
(2) Affiliate
See accompanying notes.
F-4
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
DECEMBER 31, 1997
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
<S> <C> <C> <C>
Senior Debt--4.07%
- ------------------
Four S Baking Company Baking $ 1,825 $ 1,825
BIW Connector Systems, LLC Manufacturing 3,890 3,890
-------- --------
Subtotal 5,715 5,715
Subordinated Debt--7.88%
- ------------------------
Four S Baking Company Baking 1,492 1,492
BIW Connector Systems, LLC Manufacturing 6,350 6,350
Westwinds Holdings, Inc. Restaurant 3,206 3,206
-------- --------
Subtotal 11,048 11,048
Convertible Preferred Stock(2)--1.64%
- -------------------------------------
Four S Baking Company 15% dividend convertible into 4% dividend
common stock or 10.89% of Co. Baking 2,303 2,303
Common Stock Warrants(1)(2)--1.13%
- ----------------------------------
Four S Baking Company 15,390 shares 3.26% of Co. Baking 461 577
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 652
Westwinds Holdings, Inc. 5% of Co. Restaurant 350 350
-------- --------
Subtotal 1,463 1,579
-------- --------
Subtotal--non-publicly traded securities--14.72% 20,529 20,645
Government Securities--80.38%
- -----------------------------
FHLB Discount Note due 2/4/98 20,969 20,981
FHLB Discount Note due 3/6/98 10,893 10,898
FHLB Discount Note due 4/1/98 9,865 9,868
FNMA Discount Note due 4/24/98 6,877 6,883
FFCB 5.90% due 6/2/98 20,017 20,016
FHLB Discount Note due 6/8/98 14,646 14,644
FHLB Discount Note due 8/20/98 14,483 14,480
FNMA 5.71% due 9/9/98 14,995 15,000
-------- --------
Subtotal 112,745 112,770
-------- --------
Total Investments 133,274 133,415
Investment in Unconsolidated Operating Subsidiary--4.90%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. Investment Banking 403 6,869
-------- --------
Totals $133,677 $140,284
======== ========
</TABLE>
(1) Non-income producing
(2) Affiliate
See accompanying notes.
F-5
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF OPERATIONS
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months
Year Ended Ended Nine Months Ended Year Ended
December 31, 1998 December 31, 1997 September 30, 1997 December 31, 1996
----------------- ----------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Operating income:
Financial advisory fees $ -- $ -- $1,122 $1,738
Financial performance fees -- -- 798 649
Interest and dividend income 14,430 2,123 553 --
Loan processing fees 2,549 654 -- --
Other -- 20 428 359
------- ------- ------ ------
Total operating income 16,979 2,797 2,901 2,746
Operating expenses:
Salaries and benefits 843 243 1,221 1,283
General, administrative and other 809 308 1,514 1,282
Provision for (reversal of) doubtful accounts -- -- (177) 224
Interest 57 -- 60 33
Depreciation and amortization -- -- 33 39
------- ------- ------ ------
Total operating expenses 1,709 551 2,651 2,861
Operating income (loss) before equity in earnings
of unconsolidated operating subsidiary 15,270 2,246 250 (115)
Equity in (loss) earnings of unconsolidated
operating subsidiary (482) 24 -- --
------- ------ ------ ------
Net operating income (loss) 14,788 2,270 250 (115)
Increase in unrealized appreciation of investments 2,127 167 5,321 483
------- ------- ------ ------
Income before income taxes 16,915 2,437 5,571 368
Provision for income taxes -- -- 2,128 159
------- ------- ------ ------
Net increase in shareholders' equity resulting from
operations $16,915 $ 2,437 $3,443 $ 209
======= ======= ====== ======
Net operating income per share Basic $ 1.34 $ 0.21
Diluted $ 1.29 $ 0.20
Net increase in shareholders' equity Basic $ 1.53 $ 0.22
resulting from operations per share Diluted $ 1.48 $ 0.21
Weighted average shares of Basic 11,068 11,069
common stock outstanding Diluted 11,424 11,405
</TABLE>
See accompanying notes.
F-6
<PAGE>
AMERICAN CAPITAL STRATEGIES, INC.
STATEMENTS OF SHAREHOLDERS" EQUITY
(In thousands except per share data)
<TABLE>
<CAPTION>
Note
Unearned Capital in Receivable
Preferred ESOP Common Stock Excess of Retained From Sale of
Stock Shares Shares Amount Par Value Earnings Common Stock
----- ------ ------ ------ --------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $ 1,419 $ (333) 480 $ 5 $ 10 $ 1,845 --
Net increase in shareholders' equity
resulting from operations -- -- -- -- -- 209 --
Options exercised -- -- 1 -- 1 -- --
ESOP shares earned -- 216 -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1996 $ 1,419 $ (117) 481 $ 5 $ 11 $ 2,054 --
-------- -------- -------- -------- -------- -------- --------
Net increase in shareholders' equity
resulting from operations -- -- -- -- -- 3,443 --
Contribution of common stock to
ESOP -- -- 1 -- 8 (8) --
Conversion of preferred stock to
common stock (1,419) -- 205 2 1,417 -- --
Issuance of common stock -- -- 10,382 104 143,504 -- --
ESOP shares earned -- 117 -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Balance at September 30, 1997 $ -- $ -- 11,069 $ 111 $144,940 $ 5,489 $ --
======== ======== ======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Effect of reorganization as a RIC -- -- -- -- -- (5,489) --
Net increase in shareholders'
equity resulting from operations -- -- -- -- -- -- --
Distributions -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997 $ -- $ -- 11,069 $ 111 $144,940 $ -- $ --
======== ======== ======== ======== ======== ======== ========
Issuance of common stock under
the 1997 Stock Option Plan -- -- 28 -- 396 -- --
Issue of common stock under the
Dividend Reinvestment Plan -- -- 7 -- 128 -- --
Repurchase of outstanding shares -- -- (23) -- (219) -- --
Issuance of note receivable from
sale of common stock -- -- -- -- -- -- (300)
Net increase in shareholders'
equity resulting from
operations -- -- -- -- -- -- --
Distributions -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1998 $ -- $ -- 11,081 $ 111 $145,245 $ -- $ (300)
======== ======== ======== ======== ======== ======== ========
<CAPTION>
Undistributed Unrealized Total
Net Realized Appreciation Shareholders
Earnings of Investments Equity
-------- -------------- ------
<S> <C> <C> <C>
Balance at December 31, 1995 -- -- $ 2,946
Net increase in shareholders' equity
resulting from operations -- -- 209
Options exercised -- -- 1
ESOP shares earned -- -- 216
-------- -------- --------
Balance at December 31, 1996 -- -- $ 3,372
-------- -------- --------
Net increase in shareholders' equity
resulting from operations -- -- 3,443
Contribution of common stock to
ESOP -- -- --
Conversion of preferred stock to
common stock -- -- --
Issuance of common stock -- -- 143,608
ESOP shares earned -- -- 117
-------- -------- --------
Balance at September 30, 1997 $ -- $ -- $150,540
======== ======== ========
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Effect of reorganization as a RIC -- 5,489 --
Net increase in shareholders'
equity resulting from 2,269 167 2,436
operations
Distributions (2,324) -- (2,324)
-------- -------- --------
Balance at December 31, 1997 $ (55) $ 5,656 $150,652
======== ======== ========
Issuance of common stock under
the 1997 Stock Option Plan -- -- 396
Issue of common stock under the
Dividend Reinvestment Plan -- -- 128
Repurchase of outstanding shares -- -- (219)
Issuance of note receivable from
sale of common stock -- -- (300)
Net increase in shareholders'
equity resulting from operations 14,788 2,127 16,915
Distributions (14,849) -- (14,849)
-------- -------- --------
Balance at December 31, 1998 $ (116) $ 7,783 $152,723
======== ======== ========
</TABLE>
See accompanying notes.
F-7
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF CASH FLOWS
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months| | Nine Months
Year Ended Ended | | Ended Year Ended
December 31, December 31,| |September 30, December 31,
1998 1997 | | 1997 1996
---- ---- | | ---- ----
<S> <C> <C> | | <C> <C>
Operating activities | |
Net increase in shareholders' equity resulting from operations $ 16,915 $ 2,437 | | $ 3,443 $ 209
Adjustments to reconcile net increase in shareholders' equity | |
resulting from operations to net cash provided by (used in) | |
operating activities: | |
Depreciation and amortization -- -- | | 33 38
Unrealized appreciation of investments (2,127) (167) | | (5,321) (483)
Net amortization of securities (1,336) (1,234) | | (337) --
Amortization of loan discounts (913) -- | | -- --
Amortization of deferred finance costs -- -- | | 3 11
Provision for deferred income taxes -- -- | | 2,102 121
Contribution of stock to ESOP -- -- | | 117 216
Increase in interest receivable (917) (207) | | (122) --
Provision for doubtful accounts -- -- | | (177) 224
Increase in accrued payment-in-kind dividend and interest (478) -- | | -- --
Decrease (increase) in due from unconsolidated subsidiary 83 (526) | | -- --
Decrease (increase) in accounts receivable -- -- | | 486 (865)
Decrease in income taxes receivable -- -- | | 24 101
(Increase) decrease in other assets (71) 62 | | (113) 6
Increase (decrease) in accounts payable and accrued | |
liabilities 73 (328) | | 128 228
Loss (earnings) of unconsolidated operating subsidiary 482 (24) | | -- --
--------- --------- | | --------- ---------
| |
Net cash provided by (used in) operating activities 11,711 13 | | 266 (194)
Investing activities | |
Proceeds from sale or maturity of investments 231,580 35,000 | | 60 --
Principal repayments 1,719 93 | | -- --
Purchase of investments (142,865) (20,622) | | (483) (75)
Purchase of securities (207,146) (16,593) | | (129,896) --
Purchases of property and equipment, net of disposals -- -- | | (29) (39)
--------- --------- | | --------- ---------
| |
Net cash used in investing activities (116,712) (2,122) | | (130,348) (114)
Financing activities | |
Proceeds from short term notes payable, net 85,948 -- | | (430) 269
Drawings on revolving credit facilities, net 30,000 -- | | -- --
Increase in deferred financing costs (37) -- | | -- (4)
(Decrease) increase in due to related parties, net -- -- | | (78) 6
Repurchase of common stock (219) -- | | -- --
Issuance of common stock 224 -- | | 143,608 --
Options exercised -- -- | | -- 1
Distributions paid (13,628) (2,325) | | -- --
--------- --------- | | --------- ---------
| |
Net cash provided by (used in) financing activities 102,288 (2,325) | | 143,100 272
--------- --------- | | --------- ---------
| |
Net (decrease) increase in cash and cash equivalents (2,713) (4,434) | | 13,018 (36)
Cash and cash equivalents at beginning of period 8,862 13,296 | | 323 359
--------- --------- | | --------- ---------
| |
Cash and cash equivalents at end of period $ 6,149 $ 8,862 | | $ 13,341 $ 323
========= ========= | | ========= =========
| |
Non-cash financing activities: | |
Note receivable issued in sale of common stock $ 300 $ -- | | $ -- $ --
| |
</TABLE>
See accompanying notes.
F-8
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
FINANCIAL HIGHLIGHTS
(In thousands except per share data)
<TABLE>
<CAPTION>
Year Ended Three Months Ended
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Per Share Data(1)
Net asset value at beginning of the period $ 13.61 $ 13.60
Net operating income 1.34 0.21
Increase in unrealized appreciation on investments 0.19 0.01
-------- --------
Net increase in shareholders' equity from operations $ 1.53 $ 0.22
Distribution of net investment income 1.34 0.21
-------- --------
Net asset value at end of period $ 13.80 $ 13.61
Per share market value at end of period $ 17.25 $ 18.125
Total return (2) 2.57% 22.23%
Common Stock outstanding at end of period 11,081 11,069
Ratio/Supplemental Data
Net assets at end of period $152,723 $150,652
Ratio of operating expenses to average net assets (3) 1.13% 1.46%
Ratio of net operating income to average net assets (3) 9.75% 6.03%
</TABLE>
- ------------------
(1) Basic per share data.
(2) Amounts were not annualized for the results of the three month period ended
December 31, 1998.
(3) Amounts were annualized for the results of the three month period ended
December 31, 1997.
See accompanying notes.
F-9
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(In thousands except per share data)
Note 1. Organization
American Capital Strategies, Ltd., a Delaware corporation (the
"Company"), was incorporated in 1986 to provide financial advisory services to
and invest in middle market companies. On August 29, 1997, the Company completed
an initial public offering ("IPO") of 10,382 shares of common stock ("Common
Stock"), and became a non-diversified close end investment company that has
elected to be treated as a business development company ("BDC") under the
Investment Company Act of 1940, as amended ("1940 Act"). On October 1, 1997, the
Company began operations so as to qualify to be taxed as a regulated investment
company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the
Internal Revenue Code of 1986 as amended (the "Code"). As contemplated by these
transactions, the Company materially changed its business plan and format from
structuring and arranging financing for buyout transactions on a fee for
services basis to primarily being a lender to and investor in middle market
companies. As a result of the changes, the Company is operating as a holding
company whose predominant source of operating income has changed from financial
performance and advisory fees to interest and dividends earned from investing
the Company's assets in debt and equity of businesses. The Company's investment
objectives are to achieve current income from the collection of interest and
dividends, as well as long-term growth in its shareholders' equity through
appreciation in value of the Company's equity interests. The Company continues
to provide financial advisory services to businesses through ACS Capital
Investments Corporation ("CIC"), a wholly-owned subsidiary. The Company is
headquartered in Bethesda, Maryland, and has offices in New York, Boston,
Pittsburgh, San Francisco, Chicago, and Dallas.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying financial statements have been prepared in accordance
with generally accepted accounting principles and for periods commencing with
the Company's election to be treated as a RIC, in accordance with Article 6 of
Regulation S-X of the Code of Federal Regulations. For the nine months ended
September 30, 1997 and the year ended December 31, 1996 the financial statements
are prepared on a consolidated basis with the accounts of CIC, the Company's
wholly owned subsidiary. All intercompany transactions and balances were
eliminated. Effective October 1, 1997, pursuant to RIC accounting requirements,
CIC was deconsolidated, and, as a result, for the year ended December 31, 1998
and the three months ended December 31, 1997 the Company accounted for its
investment in CIC under the equity method. In connection with this change, the
Company contributed the following assets and liabilities to CIC:
Investment in Erie Forge and Steel $2,736
Other assets 791
Other liabilities 69
Deferred tax liability 3,333
As a result of these changes, the Company's financial statements for
periods through September 30, 1997 ("pre-RIC") are not comparable with the
financial statements for periods commencing after October 1, 1997 ("post-RIC").
Valuation of Investments
Investments are carried at fair value, as determined by the Board of
Directors.
Securities which are publicly traded are valued at the closing bid
price on the valuation date.
Debt and equity securities which are not publicly traded are valued at
fair value as determined in good faith by the Board of Directors. In making such
determination, the Board of Directors will value non-convertible debt securities
at cost plus amortized original issue discount, if any, unless adverse factors
lead to a determination of a lesser valuation. In valuing convertible debt,
equity or other securities, the Board of Directors determines the fair value
based on the collateral, the issuer's ability to make payments, the earnings of
the issuer, sales to third parties of similar securities, the comparison to
publicly traded securities and other pertinent factors. Due to the uncertainty
inherent in the valuation process, such estimates of fair value may differ
significantly from the values that would have been used had a ready market for
the securities existed, and the differences could be material.
F-10
<PAGE>
Cash and Cash Equivalents
Cash and cash equivalents consist of demand, deposits and highly liquid
investments with original maturities of three months or less. Cash and cash
equivalents are carried at cost which approximates fair value.
Interest and Dividend Income Recognition
Interest income is recorded on the accrual basis to the extent that
such amounts are expected to be collected. Original issue discount is amortized
into interest income using the effective interest method.
Dividend income is recognized on the ex-dividend date.
Financial Advisory and Performance Fee Recognition
Financial advisory fees represent amounts received for providing advice
and analysis to middle market companies and are recognized as earned based on
hours incurred. Financial performance fees represent amounts received for
structuring, financing, and executing transactions and are generally payable
only if the transaction closes and are recognized as earned when the transaction
is completed. Financial advisory and performance fees are for services provided
by CIC.
Loan Fee and Loan Processing Fee Recognition
The Company records loan fees as income on the closing date of the
related loan. Loan processing fees are recorded by the Company's wholly owned
subsidiary, CIC, as income on the closing date of the related loan.
Realized Gain or Loss and Unrealized Appreciation or Depreciation on Investments
Realized gain or loss is recorded at the disposition of an investment
and is the difference between the net proceeds from the sale and the cost basis
of the investment using the specific identification method. Unrealized
appreciation or depreciation reflects the difference between the Board of
Directors' valuation of the investments and the cost basis of the investments.
Distributions to Shareholders
Distributions to shareholders are recorded on the ex-dividend date.
Federal Income Taxes
The Company operates so as to qualify to be taxed as a RIC under the
Internal Revenue Code. Generally, a RIC is entitled to deduct dividends it pays
to its shareholders from its income to determine "taxable income." The Company
has distributed and currently intends to distribute sufficient dividends to
eliminate taxable income. Therefore, the statement of operations contains no
provision for income taxes for the year ended December 31, 1998 and the three
months ended December 31, 1997.
During the pre-RIC periods, the Company operated under Subchapter C of
the Internal Revenue Code and calculated its tax provision pursuant to Statement
of Financial Accounting Standards No. 109. Deferred income taxes were determined
based on the differences between financial reporting and tax basis of assets and
liabilities.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses and disclosure of contingent assets and liabilities. Actual results
could differ from those estimates.
Property and Equipment
Property and equipment are carried at cost and are depreciated using
the straight-line method over the estimated useful lives of the related assets
ranging from five to seven years.
Management Fees
The Company is self-managed and therefore does not incur management
fees payable to third parties.
F-11
<PAGE>
Reclassifications
Certain previously reported amounts have been reclassified to conform
with the current financial statement presentation.
Recent Accounting Pronouncements
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 established new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this statement
had no impact on the Company's net increase in shareholders' equity resulting
from operations or shareholders' equity.
As of January 1, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
established standards for determining an entity's operating segments and the
type and level of financial information to be disclosed in both annual and
interim financial statements. It also established standards for related
disclosures about products and services, geographic areas and major customers.
Accordingly, the Company's reportable segments are its investing operations as a
business development company and the financial advisory operations of its
wholly-owned subsidiary, CIC (see Note 4).
As of January 1, 1998, the Company adopted SFAS No. 132, "Employers"
Disclosures about Pensions and Other Postretirement Benefits - an amendment of
FASB Statements No. 87, 88, and 106" ("SFAS 132"). SFAS 132 revises employers'
disclosures about pension and other postretirement benefit plans. Adoption of
SFAS 132 does not have a material impact on the financial statements of the
Company.
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments. The statement requires an entity to recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Adoption of SFAS 133 is not expected to have a material impact on the Company's
financial statements or disclosures.
Note 3. Investments
Investments consists of securities issued by various agencies of the
Federal government valued at $89,948 with maturities of less than one year from
the date of purchase and securities issued by privately-held companies valued at
$165,035. The securities issued by privately-held companies consist of senior
debt, subordinated debt with equity warrants, convertible preferred stock and
Common Stock. The debt securities have effective interest rates ranging from
8.8% to 22.4% and are payable in installments with final maturities from 5 to 10
years and are generally collateralized by assets of the borrower. The Company's
investments in equity warrants and Common Stock are non-income producing. The
net unrealized appreciation in investments for Federal income tax purposes is
the same as for book purposes and none of the Company's investments are on
non-accrual status.
Note 4. Investment in Unconsolidated Operating Subsidiary
As discussed in Note 2, CIC is an operating subsidiary of the Company
and is accounted for under the equity method effective October 1, 1997. The
investment in CIC is carried at fair value as determined by the Board of
Directors.
F-12
<PAGE>
Condensed financial information for CIC is as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Assets
Investments in portfolio companies, at fair value $10,837 $10,361
Other assets, net 1,359 991
------- -------
Total assets $12,196 $11,352
======= =======
Liabilities and Shareholder's Equity
Deferred income taxes $ 2,921 $ 3,323
Due to parent 778 861
Other liabilities 2,111 299
Shareholder's equity 6,386 6,869
------- -------
Total liabilities and shareholder's equity $12,196 $11,352
======= =======
<CAPTION>
Year Ended Three Months Ended
December 31, 1998 December 31, 1997
----------------- --------------------
<S> <C> <C>
Operating income $ 5,227 $ 532
Operating expense 6,451 1,084
-------- -------
Net operating loss (1,224) (552)
Increase in unrealized appreciation of investments 481 605
Other 261 (29)
-------- -------
Net (loss) income $ (482) $ 24
======== =======
</TABLE>
Note 5. Stock Option Plan
The Company applies APB No. 25, "Accounting for Stock Issued to
Employees" (APB 25), and related interpretations in accounting for its
stock-based compensation plan. In accordance with SFAS 123, "Accounting for
Stock-Based Compensation" (SFAS 123), the Company elected to continue to apply
the provisions of APB 25 and provide pro forma disclosure of the Company's net
operating income and net increase in shareholders' equity resulting from
operations calculated as if compensation costs were computed in accordance with
SFAS 123. The Company is providing this information for the post-RIC period as
discussed in Notes 1 and 2 and from the time the 1997 Stock Option Plan (the
1997 Plan) was established by the Company. The 1997 Plan provides for the
granting of options to purchase up to 1,328 shares of Common Stock at a price of
not less than the fair market value of the Common Stock on the date of grant to
employees of the Company. On May 14, 1998, the Company authorized 500 additional
shares to be granted under the 1997 Plan. As of December 31, 1998, there are 195
shares available to be granted under the 1997 Plan.
Options granted under the 1997 Plan may be either incentive stock
options within the meaning of Section 422 of the Code or nonstatutory stock
options. Only employees of the Company and its subsidiaries are eligible to
receive incentive stock options under the 1997 Plan; such options generally vest
over a three year period. Incentive stock options must have a per share exercise
price of no less than the fair market value on the date of the grant.
Nonstatutory stock options granted under the 1997 Plan must have a per share
exercise price of no less than the fair market value on the date of the grant.
Options granted under the 1997 Plan may be exercised for a period of no more
than ten years from the date of grant.
F-13
<PAGE>
<TABLE>
<CAPTION>
Year Ended Three Months Ended
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Net operating income
as reported $14,788 $2,270
pro forma $13,609 $2,030
Net increase in shareholder equity resulting from operations
as reported $16,915 $2,437
pro forma $15,737 $2,197
</TABLE>
The effects of applying SFAS 123 for providing pro forma disclosures
are not likely to be representative of the effects on reported net operating
income and net increase in shareholders' equity resulting from operations for
future years.
For options granted during the year ended December 31, 1998, the
Company estimated a fair value per option on the date of grant of $4.72 using a
Black-Scholes option pricing model and the following assumptions: dividend yield
7.9%, risk free interest rate 5.1%, expected volatility factor .51, and expected
lives of the options of 7 years.
For options granted during the three months ended December 31, 1997,
the Company estimated a fair value per option on the date of grant of $2.44
using a Black-Scholes option pricing model and the following assumptions;
dividend yield 6.5%, risk free interest rate 6.5%, expected volatility factor
.25, and expected lives of the options of 7 years.
A summary of the status of the Company's stock option plans as of and
for the year ended December 31, 1998 and as of and for the three months ended
December 31, 1997 is as follows:
<TABLE>
<CAPTION>
Year Ended December 31, Three Months Ended December 31,
1998 1997
---------------------------------- -----------------------------------
Weighted- Weighted-
Average Exercise Average Exercise
Common Stock Price Common Stock Price
------------ ----- ------------ -----
<S> <C> <C> <C> <C>
Options outstanding, beginning of period 1,297 $15.00 -- --
Granted 692 $18.42 1,303 $15.00
Exercised (28) $15.00 -- --
Canceled (328) $22.38 (6) $15.00
----- ------ ----- ------
Options outstanding, end of year 1,633 $14.96 1,297 $15.00
===== ====== ===== ======
Options exercisable at year end 1,633 1,297
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted- Number Weighted
Outstanding at Average Weighted Exercisable at Average
December 31, Remaining Average December 31, Exercisable
Range of Exercise Prices 1998 Contractual Life Exercise Price 1998 Price
- ------------------------ ---- ---------------- -------------- ---- -----
<S> <C> <C> <C> <C> <C>
Less than $14.01 62 9.7 years $14.00 62 $14.00
$14.01 to $15.00 1,571 8.9 years $15.00 1,571 $15.00
----- --------- ------ ----- ------
$14.00 to $15.00 1,633 8.9 years $14.96 1,633 $14.96
===== ========= ====== ===== ======
</TABLE>
In 1998, the Company issued 20 shares of Common Stock to an officer of
the Company in exchange for a note receivable in the amount of $300. The
transaction was executed pursuant to the 1997 Stock Option Plan, which allows
the Company to lend to its employees funds to pay for the exercise of stock
options. All loans made under this arrangement are fully secured by the value of
the Common Stock purchased. Interest is charged and paid on such loans at the
Applicable Federal Rate as defined in the Internal Revenue Code.
F-14
<PAGE>
On November 6, 1997, the Board of Directors authorized the
establishment of a stock option plan for the non-employee directors. The
Reinvestment Plan was approved by shareholders at the annual meeting held on May
14, 1998. The Company is awaiting approval of the Reinvestment Plan by the
Securities and Exchange Commission ("SEC"). Pending SEC approval, the Board of
Directors has authorized the Company to issue 15 options to each of the six
non-employee directors.
Note 6. Related Parties
Pursuant to a commitment entered into prior to the Company's IPO, ACS
Partners I, L.P., a Delaware partnership, was formed in 1997 with a wholly-owned
subsidiary of the Company, as sole general partner, and two principals of the
Company, as limited partners, to allow the principals the opportunity to
co-invest in a transaction with the Company. Pursuant to the terms of the
partnership agreement with ACS Partners I, L.P., the Company, through its
wholly-owned subsidiary as sole general partner, has all discretion over the
purchase, sale, restructuring and disposition of the assets of ACS Partners I,
L.P. Upon completion of its IPO, the Company became subject to the 1940 Act and
an application was made to the SEC for an exemption from those provisions of the
1940 Act that could be construed as prohibiting an investment of the type made
by ACS Partners I, L.P. To date, the SEC has not acted on the Company's
exemption request. As of December 31, 1998 and December 31, 1997, principals of
the Company had invested $260 in ACS Partners I, L.P. for investment commitments
issued prior to the Company's IPO.
The Company and CIC have entered into an expense sharing agreement
whereby CIC reimburses the Company for expenses paid by the Company on CIC's
behalf.
Note 7. Notes Payable
During December, 1998, the Company borrowed $80,948 secured by
government agency securities with a fair value of $89,948. The interest rate on
the Note was 4.25% and the note was fully repaid on January 4, 1999.
During November, 1998, the Company entered into a credit agreement with
two banks under which the Company has the ability to borrow up to $30 million.
Interest on borrowings is accrued and paid monthly at the prime rate (7.75% at
December 31, 1998). At December 31, 1998, the outstanding balance was $30
million, which is due in October, 2000. The credit facility is secured by the
certain investments of the Company.
During December, 1998, the Company borrowed $5 million from a
corporation. Interest is accrued and paid monthly at 7.75% and the principal of
the note is due on March 31, 1999.
During the year ended December 31, 1998, the nine months ended
September 30, 1997 and the year ended December 31, 1996, the cash paid for
interest was approximately $56, $88, and $43, respectively. The weighted average
interest rates, including amortization of deferred finance costs, for the year
ended December 31, 1998, the nine months ended September 30, 1997 and the year
ended December 31, 1996 and 1995 were 5.9%, 16.9%, and 17.3%, respectively.
Due to the short term of the borrowings, the fair value of the notes
payable approximates cost.
Note 8. Income Taxes
The Company operates so as to qualify to be taxed as a RIC under the
Internal Revenue Code. Generally, a RIC is entitled to deduct dividends it pays
to its shareholders from its income to determine taxable income. The Company has
distributed and currently intends to distribute sufficient dividends to
eliminate taxable income. Therefore, the statement of operations contains no
provision for income taxes for the year ended December 31, 1998 and the three
months ended December 31, 1997.
During the pre-RIC periods, the Company operated under Subchapter C of
the Internal Revenue Code and calculated its tax provision pursuant to Statement
of Financial Accounting Standards No. 109. Deferred income taxes were determined
based on the differences between financial reporting and tax basis of assets and
liabilities.
The components of the income tax provision were as follows:
Nine Months
Ended Year Ended
September 30, 1997 December 31, 1996
------------------ -----------------
Current provision $ 2 $ 39
Deferred provision 2,126 120
------ ----
$2,128 $159
------ ----
F-15
<PAGE>
The differences between taxes at the Federal statutory tax rate and the
effective tax rate were as follows:
Nine Months
Ended Year Ended
September 30, December 31,
1997 1996
---- ----
Statutory rate $1,803 $125
State taxes 342 15
Change in valuation
Allowance -- (26)
Other (17) 45
------ ----
Effective rate $2,128 $159
====== ====
During the nine months ended September 30, 1997 and the year ended
December 31, 1996, cash paid for income taxes was approximately $2 and $1,
respectively.
The aggregate gross and net unrealized appreciation over the cost for
Federal income tax purposes was $2,265, $7,414, and $3,399 as of December 31,
1998, December 31, 1997 and 1996, respectively. The aggregate cost of securities
for Federal income tax purposes was $252,718, $132,870 and $581, as of December
31, 1998, December 31,1997 and 1996, respectively.
As discussed in Note 1, the Company had been taxed under subchapter C
prior to October 1, 1997, when the Company converted to a subchapter M
corporation for Federal income tax purposes. As a subchapter M corporation, the
Company is entitled to deduct dividends it pays to shareholders from its income
to determine taxable income. The Company has distributed and intends to
distribute sufficient dividends to eliminate taxable income. As a result, the
Company does not have a provision for income taxes for the year ended December
31, 1998 and the three months ended December 31, 1997.
The Company requested a ruling in June 1997 from the IRS seeking to
clarify the tax consequences of the conversion from taxation under subchapter C
to subchapter M. The Company was seeking to avoid having to incur a tax
liability associated with the unrealized appreciation of assets whose fair
market value exceeded their basis upon the ruling from the IRS in regards to the
treatment of the unrecognized gain. Provided the Company meets all the
requirements to be taxed as a RIC, it will be permitted to elect to be subject
to rules similar to the rules of Section 1374 of the Internal Revenue Code with
respect to any unrealized gain inherent in its assets, upon its conversion to
RIC status ("built-in gain"). Generally, this treatment allows the deferring of
recognition of the built-in gain. If the Company were to divest itself of any
assets in which it had built-in gains prior to the end of a ten year recognition
period, the Company would then be subject to the extent of its built-in gain.
Note 9. Commitments and Contingencies
The Company has non-cancelable operating leases for office space and
office equipment. The leases expire over the next seven years and contain
provisions for certain annual rental escalations. Rent expense for operating
leases for the year ended December 31, 1998, the three months ended December 31,
1997, the nine months ended September 30, 1997 and the year ended December 31,
1996 was approximately $60, $73, $97, and $101, respectively.
Future minimum lease payments under non-cancelable operating leases at
December 31, 1998 were as follows:
1999 $ 240
2000 241
2001 248
2002 236
2003 and thereafter 374
------
Total $1,339
======
F-16
<PAGE>
In addition, at December 31, 1998, the Company had commitments $7.4
million to three portfolio companies. These commitments are composed of two
working capital credit facilities and one acquisition credit facility. The
commitments are subject to the borrowers meeting certain criteria. The terms of
the borrowings subject to commitment are comparable to the terms of other debt
securities in the Company's portfolio.
Note 10. Employee Stock Ownership Plan
The Company maintains an ESOP, which includes all employees and is
fully funded on a pro rata basis by the Company and its wholly owned subsidiary,
CIC. Contributions are made at the Company's discretion up to the lesser of $30
or 25% of annual compensation expense for each employee. Employees are not fully
vested until completing five years of service. For the year ended December 31,
1998, the Company and CIC contributed $97 to the ESOP, or 3% of total eligible
employee compensation.
The Company sponsors an employee stock ownership trust to act as the
depository of employer contributions to the ESOP as well as to administer and
manage the actual trust assets which are deposited into the ESOP.
Note 11. Capital Stock
In July, 1997, all unearned ESOP shares became earned and were
allocated to the ESOP accounts of the Company's employees. Pursuant to the
Company's Class A preferred stock declaration, the Class A preferred stock held
by the ESOP was converted into Common Stock on a one share to one share basis.
The Company also contributed an additional 529 shares of Common Stock to the
ESOP.
In August 1997, the Company increased its authorized shares of
unallocated preferred stock to 5,000 and increased its authorized shares of
Common Stock to 20,000.
On August 27, 1997, the Company declared a stock split effective August
29, 1997, effected in the form of a stock dividend pursuant to which each
outstanding share of Common Stock was effectively converted into .029859 shares.
Outstanding shares and per share amounts for all periods presented have been
restated to reflect this stock split.
On August 29, 1997, the Company completed its IPO and sold 10,382
shares of its Common Stock at a price of $15.00 per share. Pursuant to the terms
of the Company's agreement with the underwriter of the offering, the Company
issued 443 Common Stock warrants ("Warrants") to the underwriter. The Warrants
have a term of five years from the date of issuance and may be exercised at a
price of $15.00 per share.
The Company declared dividends of $14,849, or $1.34 per share for the
year ended December 31, 1998; at year end, $1,222 remained accrued and
undistributed to shareholders. For the three months ended December 31, 1997, the
Company distributed $2,324, or $0.21 per share, to its shareholders. For Federal
income tax purposes, the distributions were 100% from ordinary income. In
addition, in accordance with regulations governing RIC's, the Company notified
shareholders of its intention to periodically repurchase its outstanding Common
Stock. Following release of this notification, the Company repurchased 23 shares
of it Common Stock at a weighted average price of $10.12 per share.
F-17
<PAGE>
Note 12. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the year ended December 31, 1998 and the three months
ended December 31, 1997. For all other periods, earnings per share is not
presented since it is not considered meaningful due to the IPO and
reorganization of the Company as a RIC.
<TABLE>
<CAPTION>
Year Ended Three Months Ended
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Numerator for basic and diluted net increase in
shareholders' equity resulting from operations $16,915 $ 2,437
Denominator for basic-weighted average shares 11,068 11,069
Employee stock options 269 251
Warrants 87 85
------- -------
Dilutive potential shares 356 334
Denominator for diluted 11,424 11,405
------- -------
Basic earnings per share $ 1.53 $ 0.22
Diluted earnings per share $ 1.48 $ 0.21
</TABLE>
Note 13. Subsequent Events
During February 1999, the Company obtained a commitment for a $100,000
credit facility. The credit facility is funded by a commercial paper conduit and
requires the Company to create ACAS Funding, a bankruptcy remote wholly-owned
subsidiary. The Company is required to make a capital contribution of $115,000
consisting of loans and any related equity warrants to ACAS Funding. ACAS
Funding will then acquire loans and related equity warrants originated by the
Company and may borrow up to 50% of the eligible loan balance subject to certain
concentration limits. The term of the facility is two years and interest on
borrowings will be charged at LIBOR plus 2.50%. The full amount of principal is
due at the end of the term and interest is payable monthly.
F-18
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
BALANCE SHEETS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------- --------
<S> <C> <C>
Assets
Investments at fair value (cost of $247,238 and $252,718, respectively) $251,489 $254,983
Cash and cash equivalents 1,231 6,149
Investment in unconsolidated operating subsidiary 5,991 6,386
Due from unconsolidated operating subsidiary 1,818 778
Interest receivable 2,030 1,561
Other 992 162
-------- --------
Total assets $263,551 $270,019
======== ========
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 914 $ 126
Accrued dividends payable -- 1,222
Notes payable 77,091 85,948
Revolving credit facility 30,000 30,000
------- -------
Total liabilities 108,005 117,296
Shareholders' equity:
Undesignated preferred stock, $0.01 par value, 5,000 shares authorized,
0 issued and outstanding -- --
Common stock, $.01 par value, 20,000 shares authorized, and 11,122 and
11,081 issued and outstanding, respectively 111 111
Capital in excess of par value 145,879 145,245
Note receivable from sale of common stock (580) (300)
Undistributed (distributions in excess of) net realized earnings 372 (116)
Unrealized appreciation of investments 9,764 7,783
-------- --------
Total shareholders' equity 155,546 152,723
-------- --------
Total liabilities and shareholders' equity $263,551 $270,019
======== ========
</TABLE>
See accompanying notes.
F-19
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
MARCH 31, 1999
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
Senior Debt--10.92%
- -------------------
<S> <C> <C> <C>
BIW Connector Systems, LLC Manufacturing $ 3,404 $ 3,404
Chance Coach, Inc. (2) Bus Manufacturer 1,232 1,232
JAG Industries, Inc. (2) Manufacturing 1,200 1,200
Confluence Holdings Corp. Canoes & Kayaks 11,475 11,475
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Euro-Caribe, Inc. (2) Meat Processing 7,062 7,062
Patriot Medical Technologies, Inc. Repair Services 3,000 3,000
-------- --------
Subtotal 28,123 28,123
Subordinated Debt--46.89%
- -------------------------
BIW Connector Systems, LLC. Manufacturing 6,740 6,740
Westwind Holdings, Inc Restaurant 2,945 2,945
JAG Industries, Inc. (2) Manufacturing 2,346 2,346
Specialty Transportation Services, Inc. Waste Hauler 7,386 7,386
Chance Coach, Inc. (2) Bus Manufacturer 7,171 7,171
The L.A. Studios, Inc. Audio Production 2,411 2,411
Decorative Surfaces International, Inc. (2) Decorative Paper & 5,516 5,516
Vinyl Mfg.
New Piper Aircraft, Inc. Aircraft Manufacturing 17,897 17,897
Electrolux, LLC Vacuum Cleaner 7,563 7,563
Cycle Gear, Inc. Motor Cycle Accessories 639 639
Confluence Holdings Corp. Canoes & Kayaks 5,226 5,226
Euro-Caribe, Inc. (2) Meat Processing 8,921 8,921
ConStar International, Inc. Electrical 12,877 12,877
Centennial Broadcasting, Inc. Radio Stations 15,495 15,495
Lion Brewery, Inc. (2) Malt Beverages 5,958 5,958
Auxi-Health, Inc. Home Health Care 9,532 9,532
Patriot Medical Technologies, Inc. Repair Services 2,090 2,090
-------- --------
Subtotal 120,713 120,713
Convertible Preferred Stock--1.12%
- ----------------------------------
Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,214
Decorative Surfaces International, Inc. (2) prime rate
plus 4% dividend convertible into 2.9% of Co. Decorative Paper & 665 665
Vinyl Mfg. -------- --------
Subtotal 2,665 2,879
Common Stock Warrants(1)--10.70%
- --------------------------------
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 513
Westwind Holdings, Inc. 5% of Co. Restaurant 350 271
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 454
Specialty Transportation Services, Inc. up to 40% of Co. Waste Hauler 694 1,007
Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 4,839
The L.A. Studios, Inc. 17% of Co. Audio Production 902 839
Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & 4,571 6,805
Vinyl Mfg.
New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,528
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 642
Cycle Gear, Inc. 16.5% of Co. Motor Cycle Accessories 374 374
Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,319
Euro-Caribe, Inc. (2) 37% of Co. Meat Processing 1,110 1,110
ConStar International, Inc. 17.5% of Co. Electrical 3,171 3,171
Lion Brewery, Inc. (2) 54% of Co. Malt Beverages 675 675
Auxi Health, Inc. 20% of Co. Home Health Care 2,599 2,599
Patriot Medical Technologies, Inc. 17% of Co. Repair Services 410 410
-------- --------
Subtotal 23,850 27,556
Common Stock (1)--1.25%
- ------------------------
Specialty Transportation Services, Inc. 9.1% of Co. Waste Hauler 500 458
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,269
ConStar International, Inc. 2.8% Electrical 500 500
-------- --------
Subtotal 2,896 3,227
-------- --------
Subtotal--non-publicly traded securities--63.15% 178,247 182,498
Government Securities--26.79%
- -----------------------------
FMC Discount Note due 4/1/99 68,991 68,991
-------- --------
Total Investments 247,238 251,489
Investment in Unconsolidated Operating Subsidiary--2.33%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. Investment Banking 403 5,991
-------- --------
Totals $247,641 $257,480
======== ========
</TABLE>
(1) Non-income producing
(2) Affiliate
See accompanying notes.
F-20
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Operating income:
Interest and dividend income $ 5,854 $ 2,680
Loan fees 666 612
------- -------
6,520 3,292
Total operating income
Operating expenses:
Salaries and benefits 310 170
General, administrative and other 294 274
Interest 794 --
------- -------
Total operating expenses 1,398 444
Operating income before equity in (losses) earnings of
unconsolidated operating subsidiary 5,122 2,848
Equity in (loss) earnings of unconsolidated operating subsidiary (395) 101
-------- -------
Net operating income 4,727 2,949
Net realized gain on investments 316 --
Increase in unrealized appreciation of investments 1,981 28
------- -------
Net increase in shareholders' equity resulting from operations $ 7,024 $ 2,977
======= =======
Net operating income per share Basic $ 0.43 $ 0.27
Diluted $ 0.42 $ 0.26
Net increase in shareholders' equity Basic $ 0.63 $ 0.27
resulting from operations per share Diluted $ 0.62 $ 0.26
Weighted average shares of Basic 11,070 11,069
common stock outstanding Diluted 11,279 11,480
</TABLE>
See accompanying notes.
F-21
<PAGE>
AMERICAN CAPITAL STRATEGIES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Capital in Notes Receivable Undistributed Unrealized Total
Common Stock Excess of From Sale of Net Realized Appreciation Shareholders'
Shares Amount Par Value Common Stock Earnings Investments Equity
------ ------ --------- ------------ -------- ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997 11,069 $ 111 $144,940 $ -- $ (55) $ 5,656 $150,652
Net increase in shareholder's
equity resulting from
operations -- -- -- -- 2,949 28 2,977
Distributions -- -- -- -- (2,767) -- (2,767)
-------- -------- -------- -------- -------- -------- --------
Balance at March 31, 1998 11,069 $ 111 $144,940 $ -- $ 127 $ 5,684 $150,862
======== ======== ======== ======== ======== ======== ========
Balance at December 31, 1998 11,081 $ 111 $145,245 $ (300) $ (116) $ 7,783 $152,723
Issuance of common stock under
the 1997 Stock Option Plan 20 -- 280 -- -- -- 280
Issue of common stock under the
Dividend Reinvestment Plan 11 -- 188 -- -- -- 188
Issuance of restricted stock 10 -- 166 -- -- -- 166
Issuance of note receivable from
sale of common stock -- -- -- (280) -- -- (280)
Net increase in shareholders'
equity resulting from
operations -- -- -- -- 5,043 1,981 7,024
Distributions -- -- -- -- (4,555) -- (4,555)
-------- -------- -------- -------- -------- -------- --------
Balance at March 31, 1999 11,122 $ 111 $145,879 $ (580) $ 372 $ 9,764 $155,546
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes.
F-22
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
March 31, March 31,
1999 1998
-------------- -----------
<S> <C> <C>
Operating activities
Net increase in shareholders' equity resulting from operations $ 7,024 $ 2,977
Adjustments to reconcile net increase in shareholders' equity resulting from
operations to net cash provided by operating activities:
Unrealized appreciation of investments (1,981) (28)
Net realized gain on investments (316) --
Net amortization of securities -- (845)
Accretion of loan discounts (408) (89)
Amortization of deferred finance costs 25 --
Amortization of goodwill 63 --
Increase in interest receivable (469) (402)
Increase in accrued payment-in-kind dividend and interest (380) --
(Increase) decrease in due from unconsolidated subsidiary 1,040) 149
Increase in other assets (153) (80)
Increase in accounts payable and accrued liabilities 788 116
Loss (earnings) of unconsolidated operating subsidiary 395 (101)
------- ---------
Net cash provided by operating activities 3,548 1,697
Investing activities
Proceeds from sale or maturity of investments 15,774 32,080
Principal repayments 6,860 303
Purchase of investments (28,012) (29,715)
Purchase of securities (6,900) --
--------- ---------
Net cash (used in) provided by investing activities (12,278) 2,668
Financing activities
Drawings on revolving credit facilities, net 10,000 --
Increase in deferred financing costs (599) --
Issuance of common stock 188 --
Distributions paid 5,777) (2,767)
------- ---------
Net cash provided by (used in) financing activities 3,812 (2,767)
------- ---------
Net (decrease) increase in cash and cash equivalents (4,918) 1,598
Cash and cash equivalents at beginning of period 6,149 8,862
------- ---------
Cash and cash equivalents at end of period $ 1,231 $ 10,460
======= =========
Non-cash financing activities:
Note receivable issued in exchange for common stock $ 280 $ --
Net repayment of margin borrowings through sale of securities 18,857 --
</TABLE>
See accompanying notes.
F-23
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
FINANCIAL HIGHLIGHTS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Per Share Data(1)
Net asset value at beginning of the period $ 13.80 $ 13.61
Net operating income 0.43 0.27
Increase in unrealized appreciation on investments 0.20 --
-------- -------
Net increase in shareholders' equity from operations $ 0.63 $ 0.27
Distribution of net investment income 0.41 0.25
------- -------
Net asset value at end of period $ 14.02 $ 13.63
Per share market value at beginning of period $ 17.250 $ 18.125
Per share market value at end of period $ 17.125 $ 22.125
Total return (2) 1.65% 23.45%
Shares outstanding at end of period 11,122 11,069
Ratio/Supplemental Data
Net assets at end of period $155,546 $150,862
Ratio of operating expenses to average net assets 0.91% 0.29%
Ratio of net operating income to average net assets 3.07% 1.96%
</TABLE>
(1) Basic per share data.
(2) Amounts were not annualized for the results of the three month periods
ended March 31, 1999 and 1998.
See accompanying notes.
F-24
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(In thousands except per share data)
Note 1. Unaudited Interim Financial Statements
Interim financial statements of American Capital Strategies, Ltd. (the
"Company") are prepared in accordance with generally accepted accounting
principles ("GAAP") for the interim financial information and pursuant to the
requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain disclosures accompanying annual financial statements
prepared in accordance with GAAP are omitted. In the opinion of management, all
adjustments, consisting solely of normal recurring accruals, necessary for the
fair presentation of financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results that ultimately may be achieved for the year. The interim
financial statements and notes thereto should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K/A for
the year ended December 31, 1998, as filed with the Securities and Exchange
Commission.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses and disclosure of contingent assets and liabilities. Actual results
could differ from those estimates.
Note 2. Organization
American Capital Strategies, Ltd., a Delaware corporation (the
"Company"), was incorporated in 1986 to provide financial advisory services to
and invest in middle market companies. On August 29, 1997, the Company completed
an initial public offering ("IPO") of 10,382 shares of common stock ("Common
Stock"), and became a non-diversified closed end investment company that has
elected to be treated as a business development company ("BDC") under the
Investment Company Act of 1940, as amended ("1940 Act"). On October 1, 1997, the
Company began operations so as to qualify to be taxed as a regulated investment
company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the
Internal Revenue Code of 1986 as amended (the "Code"). As contemplated by these
transactions, the Company materially changed its business plan and format from
structuring and arranging financing for buyout transactions on a fee for
services basis to primarily being a lender to and investor in middle market
companies. The Company's investment objectives are to achieve current income
from the collection of interest and dividends, as well as long-term growth in
its shareholders' equity through appreciation in value of the Company's equity
interests. The Company provides financial advisory services to businesses
through ACS Capital Investments Corporation ("CIC"), a wholly-owned subsidiary.
The Company is headquartered in Bethesda, Maryland, and has offices in New York,
Boston, Pittsburgh, San Francisco, Chicago, and Dallas.
Note 3. Investment in Unconsolidated Operating Subsidiary
As discussed in Note 2, CIC is an operating subsidiary of the Company
and is accounted for under the equity method effective October 1, 1997. The
investment in CIC is carried at fair value as determined by the Board of
Directors.
Condensed financial information for CIC is as follows:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Assets
Investments in portfolio companies, at fair value $ 9,657 $10,837
Other assets, net 2,532 1,359
------- -------
Total assets $12,189 $12,196
======= =======
Liabilities and Shareholder's Equity
Deferred income taxes $ 2,678 $ 2,921
Due to parent 1,818 778
Other liabilities 1,702 2,111
Shareholder's equity 5,991 6,386
------- -------
Total liabilities and shareholder's equity $12,189 $ 101
======= =======
</TABLE>
F-25
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 1998
-------------- ------------------
<S> <C> <C>
Operating income $1,435 $1,779
Operating expense 2,044 1,546
------ ------
Net operating loss (609) 233
Realized gains on investments 925 --
Change in unrealized appreciation of investments (954) (96)
Other income (expense) 243 (36)
------ ------
Net (loss) income $ (395) $ 101
====== ======
</TABLE>
Note 4. Notes Payable
During March 1999, the Company borrowed $62,091 secured by government
agency securities with a fair value of $68,991. The interest rate on the Note
was 6.0% and the note was fully repaid on April 1, 1999.
During November 1998, the Company entered into a credit agreement with
two banks under which the Company has the ability to borrow up to $30 million.
Interest on borrowings is accrued and paid monthly at the prime rate (7.75% at
March 31, 1999). At March 31, 1999, the outstanding balance was $30 million,
which is due in October, 2000. The credit facility is secured by certain
investments of the Company.
During February 1999, the Company borrowed $15 million from a
corporation. Interest is accrued and paid monthly at 7.75%. The note was fully
repaid on April 30, 1999.
Due to the short term of the borrowings, the fair value of the notes
payable approximates cost.
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility. In connection with the closing, the Company established ACS
Funding Trust I (the "Trust"), an affiliated business trust and contributed or
sold to the Trust approximately $157,000 in loans. Subject to certain
conditions, the Company will remain servicer of the loans. Simultaneously with
the initial contribution, the Trust entered into a loan agreement with First
Union Capital Markets Corp., as deal agent, and certain other parties providing
for loans in an amount up to 50% of the eligible loan balance subject to certain
concentration limits. The term of the facility is two years and interest on
borrowings will be charged at LIBOR plus 2.50%. The full amount of principal is
payable over two years beginning at the end of the term and interest is payable
monthly. The transfer of assets to the Trust and the related borrowings by the
Trust will be treated as a financing arrangement by the Company under Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities."
Note 5. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three months ended March 31, 1999 and the three
months ended March 31, 1998.
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Numerator for basic and diluted net increase in
shareholders' equity resulting from operations $ 7,024 $ 2,977
Denominator for basic-weighted average shares 11,070 11,069
Employee stock options 196 307
Warrants 13 104
------- -------
Dilutive potential shares 209 411
Denominator for diluted 11,279 11,480
------- -------
Basic earnings per share $ 0.63 $ 0.27
Diluted earnings per share $ 0.62 $ 0.26
</TABLE>
F-26
<PAGE>
Note 6. Realized Gain on Investments
During March, 1999, the Company sold its investment in Four S Baking
Company. The Company's investment included senior debt, subordinated debt,
preferred stock, common stock and common stock warrants. The Company received
$7,163 in total proceeds from the sale and recognized a net realized gain of
$316. The realized gain was comprised of a $331 realization of unamortized loan
discounts on the subordinated debt and a net loss of $15 on the common stock and
warrants. In addition, the Company earned prepayment fees of $87 from the early
repayment of the senior and subordinated debt. In conjunction with the sale, no
dealer, salesman or other person is authorized hereby to give any information or
to make any representation not contained in this prospectus or any prospectus
supplement and, if given or made, such information or representation must not be
relied upon as having been authorized by the company or any underwriter or
agent. This prospectus and any prospectus supplement does not constitute an
offer to sell or a solicitation or any offer to buy any security other than the
securities offered hereby, nor does it constitute an offer to sell or a
solicitation of an offer to buy any securities offered hereby to any person in
any jurisdiction in which it is unlawful to make such an offer or solicitation
to such person. Neither the delivery of this prospectus or any prospectus
supplement nor any sale made hereunder or thereunder shall under any
circumstances imply that the information contained herein or therein is correct
as of any date subsequent to their respective dates.
Note 7. Subsequent Events
On May 6, 1999 the Company received stockholder approval to increase
the number of authorized shares of Common Stock from 20,000 to 70,000.
F-27
<PAGE>
----------------
CONTENTS
<TABLE>
<S> <C>
Prospectus Summary......................................................................................................... 1
Risk Factors............................................................................................................... 5
Use of Proceeds............................................................................................................ 8
Price Range of Common Stock and Distributions.............................................................................. 9
Selected Financial Data.................................................................................................... 10
Management's Discussion and Analysis of Financial Condition and Results of Operations...................................... 11
Business................................................................................................................... 19
Portfolio Companies........................................................................................................ 24
Determination of Net Asset Value........................................................................................... 28
Management................................................................................................................. 29
Dividend Reinvestment Plan................................................................................................. 34
Description of the Securities.............................................................................................. 34
Certain Provisions of the Second Amended and Restated Certificate of Incorporation, as amended, and the
Second Amended and Restated Bylaws....................................................................................... 35
Regulation................................................................................................................. 37
Share Repurchases.......................................................................................................... 38
Plan of Distribution....................................................................................................... 38
Safekeeping, Transfer and Dividend Paying Agent and Registrar.............................................................. 39
Legal Matters.............................................................................................................. 39
Experts.................................................................................................................... 39
Table of Contents of Statement of Additional Information................................................................... 39
Index to Financial Statements.............................................................................................. F-1
</TABLE>
LOGO
[DATE]
<PAGE>
The information in this Statement of Additional Information is not
complete and may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is
effective. This Statement of Additional Information is not an offer to sell
these securities and is not soliciting an offer to buy these securities in any
state where the offer or sale is not permitted.
SUBJECT TO COMPLETION __________, 1999.
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENT OF ADDITIONAL INFORMATION __________, 1999
This Statement of Additional Information ("SAI") is not a prospectus,
and should be read in conjunction with the Prospectus dated __________, 1999
relating to this offering (the "Prospectus") and the accompanying prospectus
supplement, if any. A copy of the Prospectus may be obtained by calling American
Capital Strategies, Ltd. at (301) 951-6122 and asking for Shareholder Relations.
Terms not defined herein have the same meaning as given to them in the
Prospectus.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page in the Location
Statement of Related
of Additional Disclosure in
Information The Prospectus
----------- --------------
<S> <C> <C>
General Information and History...............................
Investment Objective and Policies.............................
Management....................................................
Compensation of Executive Officers and Directors..............
Compensation of Directors.....................................
Stock Option Awards...........................................
Committees of the Board of Directors..........................
Control Persons and Principal Holders of Securities...........
Investment Advisory Services..................................
Safekeeping, Transfer and Dividend Paying Agent and Registrar.
Accounting Services...........................................
Brokerage Allocation and Other Practices......................
Tax Status....................................................
</TABLE>
GENERAL INFORMATION AND HISTORY
This SAI contains information with respect to American Capital
Strategies, Ltd. (the "Company"). The Company, a Delaware corporation, was
incorporated in 1986 to provide financial advisory services to and invest in
middle market companies. On August 29, 1997, the Company completed an initial
public offering ("IPO") of 10,382,437 shares of its common stock ("Common
Stock") and became a non-diversified, closed end investment company that has
elected to be treated as a business development company ("BDC") under the
Investment Company Act of 1940, as amended ("1940 Act"). On October 1, 1997, the
Company began operations so as to qualify to be taxed as a regulated investment
company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the
Internal Revenue Code of 1986 as amended (the "Code").
INVESTMENT OBJECTIVE AND POLICIES
The Company's investment objectives are to achieve a high level of
current income from the collection of interest and advisory fees, as well as
long-term growth in its shareholders' equity through the appreciation in value
of the Company's equity interests in the companies in which it invests. The
Company will at all times conduct its business so as to retain its status as a
BDC and to qualify to be taxed as a RIC. The Company seeks to achieve its
investment objectives by lending to and investing primarily in middle market
companies in a variety of industries and in diverse geographic locations
primarily in the United States. At March 31, 1999 the Company's investment
portfolio totaled $182 million. A discussion of the selected financial data,
supplementary financial information and management's discussion and analysis of
financial condition and results of operations is included in the Prospectus.
SAI-1
<PAGE>
In addition to its core lending business, the Company also provides financial
advisory services to businesses through ACS Capital Investments Corporation
("CIC"), a wholly-owned subsidiary. The Company is headquartered in Bethesda,
Maryland, and has offices in New York, Boston, Pittsburgh, San Francisco,
Chicago, and Dallas.
MANAGEMENT
Compensation of Executive Officers and Directors
Under Commission rules applicable to BDCs, the Company is required to
set forth certain information regarding the compensation of certain of its
executive officers and directors.
The following table sets forth certain details of the aggregate
compensation paid to each of the three highest paid executive officers of the
Company during 1998, as well as to each of the Company's executive officers who
was also a director. For the aggregate compensation received by each
non-employee director, see "DIRECTOR COMPENSATION."
COMPENSATION TABLE
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension or
Aggregate Retirement Benefits Securities
Compensation Accrued As Part Of Underlying
Name of Person, Position From Company(1) Company Expense(2) Options/SARs(3)
------------------------ --------------- ------------------ ---------------
<S> <C> <C>
Malon Wilkus, President, Chief $363,853 $4,800 35,000
Executive Officer and Chairman of the Board
of Directors
David Gladstone, Vice Chairman of the $366,853 $4,800 --
Board of Directors
Adam Blumenthal, Executive Vice $412,710 $4,800 25,000
President, Secretary and Director
</TABLE>
- ------------------------------
(1) The aggregate compensation from the Company for Messrs. Wilkus, Gladstone
and Blumenthal includes salary in the amount of $150,000, $150,000 and $168,750
and bonus in the amount of $216,853, $216,853 and $243,960, respectively. The
executive officers did not receive any awards of restricted stock or any payouts
pursuant to a long-term incentive plan.
(2) Represents the value of the Company's Common Stock allocated in 1998 to the
executive officer's account in the Company ESOP. The named executive officer's
estimated annual benefits upon retirement are not determinable.
(3) On May 14, 1998, Messrs. Wilkus and Blumenthal were granted options to
purchase 35,000 and 25,000 shares of Common Stock, respectively, at an exercise
price of $23.50 per share that were due to expire on May 14, 2008. These options
were cancelled on September 14, 1998 in connection with an option repricing
pursuant to which Messrs. Wilkus and Blumenthal received options to purchase
35,000 and 25,000 shares of Common Stock, respectively, at an exercise price of
$15.00 per share due to expire on September 14, 2008. On the date of the
repricing, the closing price of the Company's Common Stock on the NASDAQ Stock
Market was $14.56 per share.
Compensation of Directors
Director Compensation
During 1998, each non-employee director received an annual retainer fee
of $10,000 and a fee of $1,000 for each meeting of the Board of Directors or
each separate committee meeting attended. For 1999, each non-employee director
will be paid an annual retainer of $10,000 and a fee of $1,000 for each meeting
of the Board of Directors or each separate committee meeting attended. Directors
are reimbursed for out-of-pocket expenses incurred in connection with Board and
committee meetings. Directors who are employees of the Company do not receive
additional compensation for service as a member of the Board of Directors.
SAI-2
<PAGE>
The following table sets forth the compensation received by each
non-employee director during 1998:
Name 1998 Compensation
- ---- -----------------
Robert L. Allbritton........................................ $17,000
Landon Butler (1)........................................... $12,000
Neil M. Hahl................................................ $25,000
Philip R. Harper............................................ $24,000
Stan Lundine................................................ $20,000
Alvin N. Puryear (2)........................................ $5,334
Stephen P. Walko............................................ $20,000
1 Resigned from the Board of Directors effective August 14, 1998.
2. Joined the Board of Directors effective September 15, 1998.
Stock Option Awards
The Company maintains two long term incentive plans in which executive
officers of the Company participate: (i) the ESOP in which all employees of the
Company are eligible to participate after meeting minimum service requirements
and (ii) the 1997 Stock Option Plan (the "Employee Option Plan"). The Company
maintains no stock appreciation rights plan or defined benefit or actuarial
plan.
ESOP. The Company maintains the ESOP for the benefit of its employees
and enables them to share in the growth of the Company. The ESOP is a
combination money purchase and stock bonus plan, designed to be invested
primarily in Common Stock of the Company and qualified under section 401(a) of
the Internal Revenue Code of 1986, as amended (the "Code"). The ESOP provides
that ESOP participants will receive allocations of Company stock at least equal
to 3% of their annual compensation, up to certain statutory maximums. The
Company has the ability to make additional contributions also subject to certain
statutory maximums. Each ESOP participant vests in his or her ESOP account over
a five-year period beginning on the date of first employment.
Option Plan. The Employee Option Plan was established for the purpose
of attracting and retaining executive officers and other key employees.
Non-employee Directors may not participate. Options for a maximum of 1,828,252
shares of Common Stock were subject to issuance under the Employee Option Plan.
Of such amount, options for 1,632,778 shares of Common Stock are outstanding and
options for shares of Common Stock have been exercised. The Compensation
Committee administers the Option Plan and may grant options for a maximum of
608,782 shares to any single participant. The Compensation Committee uses such
criteria as it deems important to determine who will receive awards and the
number of awarded options. The Compensation Committee has the authority to set
the exercise price for options and to adjust the exercise price following the
occurrence of events such as stock splits, dividends, distribution and
recapitalizations. Options may be exercised during a period of no more than ten
years following the date of grant. The Compensation Committee has the discretion
to set the vesting period for options and to permit the acceleration of vesting
under certain circumstances. Vesting is automatically accelerated upon the
occurrence of specified change of control transactions. The following table
shows for each of the named executive officers (1) the number of options that
were granted during 1998 under the Employee Option Plan, (2) out of the total
number of options granted to all employees, the percentage granted to the named
executive officer, (3) the exercise price, (4) the expiration date, and (5) the
potential realizable value of the options, assuming that the market price of the
underlying securities appreciates in value from the date of grant to the end of
the option term, at a 5% and 10% annualized rate.
<TABLE>
<CAPTION>
Potential Realizable
Number of Value at Assumed
Securities Percent of Total Annual Rates of Stock
Underlying Options Granted Exercise(1) or Appreciation for
Options to Employees in Base Price Expiration Option Term
Granted (#Shs.) Fiscal Year ($/Sh.) Date(2) 5%($) 10%($)
--------------- ---------------- -------------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Malon Wilkus 35,000 5.1% 15.00 9/14/2008 330,170 836,715
Adam Blumenthal 25,000 3.6% 15.00 9/14/2008 235,835 597,653
Roland Cline 15,000 2.2% 15.00 9/14/2008 141,501 358,592
John Erickson 25,000 3.6% 15.00 9/14/2008 235,835 597,653
Stephen L. Hester 5,000 0.7% 15.00 9/14/2008 47,167 119,531
</TABLE>
SAI-3
<PAGE>
(1) On September 14, 1998, the Company repriced each of the options previously
awarded to the named executive officers thereby changing the exercise price of
such options from $23.50 per share to $15.00 per share. On the date of the
repricing, the closing trading price of the Company's Common Stock on the NASDAQ
Stock Market was $14.56 per share.
(2) On September 14, 1998, the Company repriced each of the options previously
awarded to the named executive officers thereby changing the expiration date of
such options from May 14, 2008 to September 14, 2008.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth, as of March 22, 1999 (unless otherwise
indicated), the beneficial ownership of each current director, each nominee for
director, each of the executive officers named in the Compensation Table (the
"Compensated Persons"), the executive officers and directors as a group and each
stockholder known to management of the Company to own beneficially more than 5%
of the outstanding shares of Common Stock of the Company. Unless otherwise
indicated, the Company believes that the beneficial owner set forth in the table
has sole voting and investment power.
<TABLE>
<CAPTION>
Amount and Nature of
Name and Address of Beneficial Owner Beneficial Ownership Percent of Class/1/
- ------------------------------------ -------------------- -------------------
<S> <C> <C>
Capital Research and Management Company /2/ 695,000 6.3%
333 South Hope Street
Los Angeles, California 90071
Directors and Executive Officers
- --------------------------------
Malon Wilkus 828,567 /3/ 7.4%
3 Bethesda Metro Center
Suite 860
Bethesda, Maryland 20814
David Gladstone 682,893 /4/ 6.1%
3 Bethesda Metro Center
Suite 860
Bethesda, Maryland 20814
Adam Blumenthal 349,686 /5/ 3.1%
Roland Cline 218,601 /6/ 2.0%
John Erickson 32,228 /7/ *
Stephen L. Hester 61,019 /8/ *
Robert L. Allbritton 5,057 *
Neil M. Hahl 2,177 *
Philip R. Harper 3,265 *
Stan Lundine 400 *
Alvin N. Puryear 3,000 *
Stephen P. Walko 2,500 *
Officers and directors as a group (12 persons) 2,182,128 19.6%
</TABLE>
- -------------
* Less than one percent.
1 Pursuant to the rules of the Securities and Exchange Commission, shares of
Common Stock subject to options held by directors and executive officers of the
Company that are exercisable within 60 days of March 22, 1999, are deemed
outstanding for the purposes of computing such director's or executive officer's
beneficial ownership.
2 Capital Research and Management Company ("Capital"), a registered investment
advisor, is deemed to have beneficial ownership of 695,000 shares of Common
Stock believed to be outstanding as a result of acting as investment adviser to
various investment companies. The information in this footnote was obtained from
Schedule 13-G filed with the Securities and Exchange Commission by Capital for
calendar year 1998.
3 Includes 44,375 shares allocated to the account of Mr. Wilkus as a participant
in the ESOP over which Mr. Wilkus has voting power under the terms of the
Company ESOP and 117,428 shares issuable upon the exercise of options.
SAI-4
<PAGE>
4 Includes 2,246 shares allocated to the account of Mr. Gladstone as a
participant in the Company's Employee Stock Ownership Plan ("ESOP") over which
Mr. Gladstone has voting power under terms of the ESOP and 608,782 shares
issuable upon the exercise of options.
5 Includes 36,898 shares allocated to the account of Mr. Blumenthal as a
participant in the ESOP over which Mr. Blumenthal has voting power under terms
of the ESOP and 312,788 shares issuable upon the exercise of options.
6 Includes 37,569 shares allocated to the account of Mr. Cline as a participant
in the ESOP over which Mr. Cline has voting power under terms of the ESOP and
181,032 shares issuable upon the exercise of options.
7 Includes 228 shares allocated to the account of Mr. Erickson as a participant
in the ESOP over which Mr. Erickson has voting power and 25,000 shares issuable
upon the exercise of options, but does not include other shares owned by the
ESOP for which Mr. Erickson is the Trustee.
8 Includes 13,271 shares allocated to the account of Mr. Hester as a participant
in the ESOP over which Mr. Hester has voting power and 7,748 shares issuable
upon the exercise of options.
INVESTMENT ADVISORY SERVICES
The Company is internally managed and therefore has not entered into any
advisory agreement with, nor pays advisory fees to, an outside investment
adviser.
SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR
The Company's securities are held under a custodian agreement by
LaSalle Bank, N.A. The address of the custodian is 135 South LaSalle Street,
Chicago, IL 60603. The Company's assets are held under bank custodianship in
compliance with the 1940 Act. State Street Bank and Trust Company will act as
the Company's transfer and dividend paying agent and registrar. The principal
business address of State Street Bank and Trust Company is c/o EquiServe, L.P.,
150 Royall Street, mail stop 45-02-62, Canton, MA 02021.
EXPERTS
Ernst & Young LLP, independent auditors, have audited the Company's
financial statements and financial highlights at December 31, 1998 and 1997, and
for the year ended December 31, 1998, the three months ended December 31, 1997,
the nine months ended September 30, 1997, and the year ended December 31, 1996,
as set forth in their report. The Company has included its financial statements
and financial highlights in this Prospectus and elsewhere in the Registration
Statement in reliance upon Ernst & Young LLP's report on their authority as
experts in accounting and auditing.
BROKERAGE ALLOCATION AND OTHER PRACTICES
Since the Company generally acquires and disposes of its investments in
privately negotiated transactions, it infrequently uses brokers in the normal
course of business.
TAX STATUS
The following discussion is a general summary of the material federal
income tax considerations applicable to the Company and does not purport to be a
complete description of the income tax considerations. The discussion is based
upon the Code, Treasury Regulations thereunder, and administrative and judicial
interpretations thereof, each as of the date hereof, all of which are subject to
change. Prospective investors should consult their own tax advisors with respect
to tax considerations which pertain to their purchase of Securities. This
summary does not discuss any aspects of foreign, state or local tax laws.
The Company operates so as to qualify to be taxed as a "regulated
investment company" or "RIC" under Subchapter M of the Code and intends to
continue to maintain that status. If the Company distributes to stockholders
annually in a timely manner at least 90% of its "investment company taxable
income," as defined in the Code (i.e., net investment income, including accrued
original issue discount, and net short-term capital gains) (the "90%
Distribution Requirement"), it will not be subject to federal income tax on the
portion of its investment company taxable income and net capital gains (net
long-term capital gain in excess of net short-term capital
SAI-5
<PAGE>
loss) distributed to stockholders. In addition, if the Company distributes or is
treated as having distributed in a timely manner 98% of its capital gain net
income for each one-year period ending on October 31, and distributes 98% of its
net ordinary income for each calendar year (as well as any income not
distributed in prior years), it will not be subject to the 4% nondeductible
federal excise tax imposed with respect to certain undistributed income of RICs.
The Company generally will endeavor to distribute to stockholders all of its
investment company taxable income and its net capital gain, if any, for each
taxable year so that such Company will not incur income and excise taxes on its
earnings.
In order to qualify as a RIC for federal income tax purposes, the
Company must, among other things: (a) continue to qualify as a BDC under the
1940 Act, (b) derive in each taxable yar at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale of stock or securities, or other income derived with respect to its
business of investing in such stock or securities; and (c) diversify its
holdings so that at the end of each quarter of the taxable year (i) at least 50%
of the value of the Company's assets consists of cash, cash items, securities of
other RICs, U.S. government securities, and other securities if such other
securities of any one issuer do not represent more than 5% of the Company's
assets or 10% of the outstanding voting securities of the issuer, and (ii) no
more than 25% of the value of the Company's assets is invested in the securities
of one issuer (other than U.S. government securities or securities of other
RICS) or of two or more issuers that are controlled (as determined under
applicable Code rules) by the Company and are engaged in the same or similar or
related trades or businesses.
If the Company acquires or is deemed to have acquired debt obligations
that were issued originally at a discount or that otherwise are treated under
applicable tax rules as having original issue discount, the Company will be
required to include in income each year a portion of the original issue discount
that accrues over the life of the obligation regardless of whether cash
representing such income is received by the relevant entity in the same taxable
year and to make distributions accordingly.
Although it does not presently expect to do so, the Company is
authorized to borrow funds and to sell assets in order to satisfy distribution
requirements. However, under the 1940 Act, the Company is not permitted to make
distributions to stockholders while the Company's debt obligations and other
senior securities are outstanding unless certain "asset coverage" tests are met.
Moreover, the Company's ability to dispose of assets to meet its distribution
requirements may be limited by other requirements relating to its status as a
RIC, including the diversification requirements. If the Company disposes of
assets in order to meet distribution requirements, the Company may make such
dispositions at times which, from an investment standpoint, are not
advantageous.
If the Company fails to satisfy the 90% Distribution Requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in such year on all of its taxable income, regardless of whether the Company
makes any distributions to its stockholders. In addition, in that case, all of
the Company's distributions to its stockholders will be characterized as
ordinary income (to the extent of the Company's current and accumulated earnings
and profits).
SAI-6
<PAGE>
PART C - OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
1. Financial Statements:
Included in Parts A and B of the Registration Statement:
AMERICAN CAPITAL STRATEGIES, LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
AUDITED FINANCIAL STATEMENTS
Report of Independent Auditors................................................................................... F-
Balance Sheets as of December 31, 1998 and 1997.................................................................. F-
Schedules of Investments as of December 31, 1998 and 1997........................................................ F-
Statements of Operations for the year ended December 31, 1998, the three months ended December 31, 1997, the
nine months ended September 30, 1997 and the year end December 31, 1996........................................ F-
Statements of Shareholders' Equity for the years ended December 31, 1998, the three months ended December 31,
1997, the nine months ended September 30, 1997 and the year ended December 31, 1996............................ F-
Statements of Cash Flows for the years ended December 31, 1998, the three months ended December 31, 1997, the
nine months ended September 30, 1997 and the year ended December 31, 1996...................................... F-
Financial Highlights for the year ended December 31, 1998 and the three months ended December 31, 1997........... F-
Notes to Financial Statements.................................................................................... F-
UNAUDITED FINANCIAL STATEMENTS
Balance Sheets as of March 31, 1999 and 1998..................................................................... F-
Schedules of Investments as of March 31, 1999 and 1998........................................................... F-
Statements of Operations for the three months ended March 31, 1999 and 1998...................................... F-
Statements of Shareholders' Equity for the three months ended March 31, 1999 and 1998............................ F-
Statements of Cash Flows for the three months ended March 31, 1999 and 1998...................................... F-
Financial Highlights for the three months ended March 31, 1999 and 1998.......................................... F-
Notes to Financial Statements.................................................................................... F-
</TABLE>
2. Exhibits: [Update]
o * a. Second Amended and Restated Certificate of Incorporation,
incorporated herein by reference to Exhibit 2.a of the Amendment No. 1 to the
Form N-2 filed by the Company, filed on August 12, 1997 (Commission File No.
333-29943).
o * b. Second Amended and Restated Bylaws, incorporated herein by reference
to Exhibit 2.b of the Amendment No. 1 to the Form N-2 filed by the Company,
filed on August 12, 1997 (Commission File No. 333-29943).
o * d.1 Instruments defining the rights of holders of securities: See
Article IV of the Company's Second Amended and Restated Certificate of
Incorporation, incorporated herein by reference to Exhibit 2.a of the Amendment
No. 1 to the Form N-2 filed by the Company, filed on August 12, 1997 (Commission
File No. 333-29943).
o * d.2 Instruments defining the rights of holders of securities: See
Section I of the Company's Second Amended and Restated Bylaws, incorporated
herein by reference to Exhibit 2.b of the Amendment No. 1 to the Form N-2 filed
by the Company, filed on August 12, 1997 (Commission File No. 333-29943).
o * e. Dividend Reinvestment Plan, incorporated herein by reference to
Exhibit 2.e of the Pre-Effective Amendment No. 2 to the Registration Statement
on Form N-2 (Commission File No. 333-29943) filed on August 29, 1997.
o h.1 Form of Underwriting Agreement, to be filed by amendment.
o * i.1 Form of American Capital Strategies, Ltd. First Amended and
Restated Employee Stock Ownership Plan, incorporated herein by reference to
Exhibit i.1 of the Pre-Effective Amendment No. 1 to the Registration Statement
on Form N-2 (File No. 333-29943) filed on August 12, 1997.
o * i.2 Form of American Capital Strategies, Ltd. 1997 Stock Option Plan,
incorporated herein by reference to Exhibit i.2 of the Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 (File No. 333-29943), as
amended, filed on August 12, 1997.
o * i.3 Amended and Restated Employment Agreement between the Company and
David Gladstone, dated as of August 18, 1998, incorporated herein by reference
to Exhibit 10.1 on Form 10-Q for the quarter ended September 30, 1998, filed on
November 16, 1998.
o * i.4 Form of Employment Agreement between the Company and Malon Wilkus,
incorporated herein by reference to Exhibit i.4 of the Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 (File No. 333-29943) filed on
August 12, 1997.
o * i.5 Form of Employment Agreement between the Company and Adam
Blumenthal, incorporated herein by reference to Exhibit i.5 of the Pre-Effective
Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-29943)
filed on August 12, 1997.
o * i.6 Form of Employment Agreement between the Company and Stephen L.
Hester, incorporated herein by reference to Exhibit i.6 of the Pre-Effective
Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-29943)
filed on August 12, 1997.
o * i.7 Form of Employment Agreement between the Company and Roland Cline,
incorporated herein by reference to Exhibit i.7 of the Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 (File No. 333-29943) filed on
August 12, 1997.
o * j.1 Form of Loan Accounting Agreement between the Company and Riggs
Bank, N.A., incorporated herein by reference to Exhibit j.1 of the Pre-Effective
Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-29943)
filed on August 12, 1997.
o * j.2 Custodial Agreement between the Company and Riggs Bank, N.A.,
incorporated herein by reference to Exhibit j.2 of the Pre-Effective Amendment
Number 2 to the Registration Statement on Form N-2 (File No. 333-29943) filed on
August 29, 1997.
o * k.1 Form of Referral Agreement between the Company and Riggs Bank,
N.A., incorporated herein by reference to Exhibit k.1 of the Pre-Effective
Amendment Number 1 to the Registration Statement on Form N-2 (File No.
333-29943) filed on August 12, 1997.
C-1
<PAGE>
o * k.2 Form of Referral Agreement between the Company and NCB Development
Corporation, incorporated herein by reference to Exhibit k.2 of the
Pre-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File
No. 333-29943) filed on August 12, 1997.
o l. Opinion of Arnold & Porter, to be filed by amendment.
o n.1 Consent of Arnold & Porter: See exhibit 2.l, to be filed by
amendment.
o n.2 Consent of Ernst & Young LLP
o * r. Financial Data Schedule
- -------------------
* Previously filed.
C-2
<PAGE>
ITEM 25. MARKETING ARRANGEMENTS
The information contained under the heading "Plan of Distribution" on page of
the Prospectus is incorporated herein by reference, and any information
concerning any underwriters will be contained in the accompanying Prospectus
Supplement, if any.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
SEC Registration Fee...........................................
NASD Fee.......................................................
Nasdaq additional listing fee..................................
Blue Sky fees and expenses.....................................
Accounting fees and expenses...................................
Legal fees and expenses........................................
Printing and engraving.........................................
Registrar and transfer agent's fees............................
Miscellaneous fees and expenses................................
Total..........................................................
Note: All listed amounts are estimates.
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL
1) ACS Capital Investments Corporation, a Delaware corporation ("CIC");
100% of stock owned by the Company.
2) American Capital Strategies Labor Research, Inc., a Delaware
corporation; 85% of stock owned by the Company.
Note: Both of the subsidiaries above are included in the Company's consolidated
financial statements.
3) Employee Acquisition Corporation - 17, a Delaware corporation; 100%
of stock owned by CIC.
4) Employee Acquisition Corporation - 19, a Delaware corporation; 100%
of stock owned by CIC.
5) Employee Acquisition Corporation - 20, a Delaware corporation; 100%
of stock owned by CIC.
6) Employee Acquisition Corporation - 21, a Delaware corporation; 100%
of stock owned by CIC.
7) Employee Acquisition Corporation - 22, a Delaware corporation; 100%
of stock owned by CIC.
8) Employee Acquisition Corporation - 23, a Delaware corporation; 100%
of stock owned by CIC.
NOTE: Financial statements for the affiliates listed above as items
(3)-(8) have not been filed or included in the Company's consolidated financial
statements because such affiliates are not active, do not have any operations
and have no assets other than their respective stated capital.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
The following table sets forth the number of record holders of the
Company's securities at March 31, 1999.
Number of
TITLE OF CLASS Record Holders
- -------------- --------------
Common Stock, par value
$0.01 per share 208
Preferred Stock, par value
$0.01 per share 0
Warrants 1
Debt Securities 2
ITEM 29. INDEMNIFICATION
The Delaware General Corporation Law (Section 102) allows a corporation to
eliminate the personal liability of directors of a corporation to the
corporation or to any of its stockholders for monetary damage for a breach of
his fiduciary duty as a director, except in the case where the director breached
his duty of loyalty, failed to act in good faith, engaged in intentional
misconduct or knowingly violated a law, authorized the payment of a dividend or
approved a stock repurchase in violation of Delaware corporate law or obtained
an improper personal benefit. The Company's Second Amended and Restated
Certificate of Incorporation, as amended, contains a provision which eliminates
directors' personal liability as set forth above.
C-3
<PAGE>
The Delaware General Corporation Law (Section 145) gives Delaware corporations
broad powers to indemnify their present and former directors and officers and
those of affiliated corporations against expenses incurred in the defense of any
lawsuit to which they are made parties by reason of being or having been such
directors or officers, subject to specified conditions and exclusions, gives a
director or officer who successfully defends an action the right to be so
indemnified. Such indemnification is not exclusive of any other right to which
those indemnified may be entitled under any bylaw, agreement, vote of
stockholders or otherwise. The Company's Second Amended and Restated Certificate
of Incorporation, as amended, provides for indemnification authorized by Section
145 of the Delaware General Corporation Law.
See Article VII of the Company's Second Amended and Restated Certificate of
Incorporation, as amended, and Section VI of the Second Amended and Restated
Bylaws.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Not applicable.
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS
The Company will maintain at its principal office physical possession of each
account, book or other document required to be maintained by Section 31(a) of
the 1940 Act.
ITEM 32. MANAGEMENT SERVICES
Not applicable
ITEM 33. UNDERTAKINGS
The Registrant hereby undertakes:
(1) to suspend the offering of shares until the Prospectus is
amended if subsequent to the effective date of this Registration Statement, its
net asset value declines more than ten percent from its net asset value as of
the effective date of this Registration Statement;
(2) to file, during any period in which offers or sales are
being made, a post-effective amendment to this Registration Statement:
(i) to include any prospectus required by
Section 10(a) (3) of the Securities Act of 1933;
(ii) to reflect in the prospectus any facts or
events arising after the effective date of the Registration Statement (or the
most recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or decrease
in volume of securities offered (if the total dollar value of securities offered
would not exceed that which was registered) and any deviation from the low or
high end of the estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) under the
Securities Act of 1933 if, in the aggregate, the changes in volume and price
represent no more than a 20% change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the effective
Registration Statement; and
(iii) to include any material information with
respect to the plan of distribution not previously disclosed in the registration
statement or any material change to such information in the registration
statement.
(3) that, for the purpose of determining any liability under
the Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of Prospectus filed by the Registrant under Rule 497(h)
under the Securities Act of 1933 shall be deemed to be part of this Registration
Statement as of the time it was declared effective;
(4) to remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at the
termination of the offering;
(5) that, for the purpose of determining any liabilities under
the Securities Act of 1933, each post effective amendment that contains a form
of Prospectus shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of the securities at that time
shall be deemed to be the initial bona fide offering thereof.
(6) to send by first class mail or other means designed to
ensure equally prompt delivery, within two business days of receipt of a written
or oral request, any Statement of Additional Information.
Subject to the terms and conditions of Section 15(d) of the Securities
Exchange Act of 1934, the registrant hereby undertakes to file with the
Securities and Exchange Commission such supplementary and periodic information,
documents and reports as may be prescribed by any rule or regulation of the
Commission heretofore or hereafter duly adopted pursuant to authority conferred
in that section.
C-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Washington and District of Columbia, on the 26th day
of May 1999.
AMERICAN CAPITAL STRATEGIES, LTD.
By: /s/ Malon Wilkus
---------------------------------------
Malon Wilkus
President, Chief Executive Officer and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Malon Wilkus
- --------------------------- President, Chief Executive Officer and
Malon Wilkus Chairman of the Board of Directors May 26, 1999
(Principal Executive Officer)
- --------------------------- Vice Chairman of the Board of Directors May 26, 1999
David Gladstone
/s/ Adam Blumenthal
- --------------------------- Executive Vice President
Adam Blumenthal Secretary and Director May 26, 1999
/s/ John Erickson
- --------------------------- Chief Financial Officer
John Erickson (Principal Accounting and May 26, 1999
Financial Officer)
/s/ Robert L. Allbritton
- --------------------------- Director May 26, 1999
Robert L. Allbritton
/s/ Alvin N. Puryear
- --------------------------- Director May 26, 1999
Alvin N. Puryear
/s/ Neil M. Hahl
- --------------------------- Director May 26, 1999
Neil M. Hahl
- --------------------------- Director May 26, 1999
Philip R. Harper
- --------------------------- Director May 26, 1999
Stan Lundine
/s/ Stephen P. Walko
- --------------------------- Director May 26, 1999
Stephen P. Walko
</TABLE>
C-5
Exhibit 2.N.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated February 2, 1999, in the Registration Statement (Form
N-2 No. 333-_____) and related Prospectus of American Capital Strategies, Ltd.
dated May __, 1999.
/s/Ernst & Young LLP
May 21, 1999
Washington, DC
