================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarter Ended June 30, 1999.
/ / Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number: 814-00149
AMERICAN CAPITAL STRATEGIES, LTD.
(Exact name of registrant as specified in its charter)
Delaware 52-145-1377
------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3 Bethesda Metro Center, Suite 860
Bethesda, Maryland 20814
(Address of principal executive office)
(301) 951-6122
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes |X|. No |_|.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. The number of shares
of the issuer's Common Stock, $.01 par value, outstanding as of August 11, 1999
was 16,961,925.
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<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheets as of June 30, 1999 and December 31, 1998......................................1
Schedules of Investments as of June 30, 1999 and December 31, 1998............................2
Statements of Operations for the three and six months ended
June 30, 1999 and 1998...............................................................6
Statement of Shareholders' Equity for the six months ended
June 30, 1999 and 1998...............................................................7
Statements of Cash Flows for the six months ended
June 30, 1999 and 1998...............................................................8
Financial Highlights for the six months ended
June 30, 1999 and 1998...............................................................9
Notes to Financial Statements.................................................................10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation
Overview......................................................................................14
Results of Operations.........................................................................15
Financial Condition, Liquidity and Capital Resources..........................................17
Portfolio Credit Quality......................................................................18
Impact of the Year 2000.......................................................................18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................20
Item 2. Changes in Securities.........................................................................20
Item 3. Defaults upon Senior Securities...............................................................20
Item 4. Submission of Matters to a Vote of Security Holders...........................................20
Item 5. Other Information.............................................................................20
Item 6. Exhibits and Reports on Form 8-K..............................................................21
Signature..............................................................................................21
</TABLE>
i
<PAGE>
PART I. FINANCIAL INFORMATION
AMERICAN CAPITAL STRATEGIES, LTD.
BALANCE SHEETS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------- ------------
<S> <C> <C>
Assets
Investments at fair value (cost of $270,029 and $252,718, respectively) $274,802 $254,983
Cash and cash equivalents 13,718 6,149
Investment in unconsolidated operating subsidiary 5,570 6,386
Due from unconsolidated operating subsidiary 1,758 778
Interest receivable 2,329 1,561
Other 2,318 162
-------- --------
Total assets $300,495 $270,019
======== ========
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 1,800 $ 126
Accrued dividends payable -- 1,222
Notes payable 59,992 85,948
Revolving credit facility 82,900 30,000
------- --------
Total liabilities 144,692 117,296
Shareholders' equity:
Undesignated preferred stock, $0.01 par value, 5,000 shares authorized, 0
issued and outstanding -- --
Common stock, $.01 par value, 70,000 shares authorized, and 11,962 and
11,081 issued and outstanding, respectively 120 111
Capital in excess of par value 158,448 145,245
Notes receivable from sale of common stock (13,911) (300)
Undistributed (distributions in excess of) net realized earnings 856 (116)
Unrealized appreciation of investments 10,290 7,783
-------- --------
Total shareholders' equity 155,803 152,723
-------- --------
Total liabilities and shareholders' equity $300,495 $270,019
======== ========
</TABLE>
See accompanying notes.
2
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
JUNE 30, 1999
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
<S> <C> <C> <C>
Senior Debt--14.49%
- -------------------
BIW Connector Systems, LLC Manufacturing $ 3,404 $ 3,404
Chance Coach, Inc. (2) Bus Manufacturer 1,178 1,178
JAG Industries, Inc. (2) Manufacturing 1,200 1,200
Confluence Holdings Corp. Canoes & Kayaks 14,500 14,500
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Euro-Caribe, Inc. (2) Meat Processing 6,883 6,883
Patriot Medical Technologies, Inc. Repair Services 3,000 3,000
Tube City, Inc. Mill Services 9,700 9,700
------------ ------------
Subtotal $ 40,615 $ 40,615
Subordinated Debt--49.19%
- -------------------------
BIW Connector Systems, LLC. Manufacturing $ 6,770 $ 6,770
Westwind Group Holdings, Inc. Restaurant 2,956 2,956
JAG Industries, Inc. (2) Manufacturing 2,358 2,358
Specialty Transportation Services, Inc. Waste Hauler 455 455
Chance Coach, Inc. (2) Bus Manufacturer 7,267 7,267
The L.A. Studios, Inc. Audio Production 2,430 2,430
Decorative Surfaces International, Inc. (2) Decorative Paper & Vinyl Mfg. 5,544 5,544
New Piper Aircraft, Inc. Aircraft Manufacturing 17,937 17,937
Electrolux, LLC Vacuum Cleaner 7,607 7,607
Cycle Gear, Inc. Motor Cycle Accessories 647 647
Confluence Holdings Corp. Canoes & Kayaks 5,756 5,756
Euro-Caribe, Inc. (2) Meat Processing 8,937 8,937
ConStar International, Inc. Electrical 18,816 18,816
Centennial Broadcasting, Inc. Radio Stations 15,970 15,970
Lion Brewery, Inc. (2) Malt Beverages 5,959 5,959
Auxi-Health, Inc. Home Health Care 10,085 10,085
Patriot Medical Technologies, Inc. Repair Services 2,094 2,094
Erie County Plastics Corporation Molded Plastic Manufacturing 8,830 8,830
Aeriform Corporation Packaged Industrial Gas 7,500 7,500
------------ ------------
Subtotal $ 137,918 $ 137,918
Convertible Preferred Stock--1.08%
- ----------------------------------
Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer $ 2,000 $ 2,337
Decorative Surfaces International, Inc. (2) prime rate plus 4%
dividend convertible into 2.9% of Co. Decorative Paper & Vinyl Mfg. 684 684
------------ ------------
Subtotal $ 2,684 $ 3,021
Common Stock Warrants(1)--10.30%
- --------------------------------
BIW Connector Systems, LLC 8% of LLC Manufacturing $ 652 $ 483
Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 258
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 442
Specialty Transportation Services, Inc. up to 39.1% of Co. Waste Hauler 694 1,007
Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 4,919
The L.A. Studios, Inc. 17% of Co. Audio Production 902 820
Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 6,804
New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,528
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 1,162
ConStar International, Inc. 17.5% of Co. Electrical 3,914 3,914
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
Erie County Plastics Corporation 8.9% of Co. Molded Plastic Manufacturing 1,170 1,170
------------ ------------
Subtotal $ 25,517 $ 28,884
</TABLE>
3
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
JUNE 30, 1999
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
<S> <C> <C> <C>
Common Stock and Membership Interests(1) - 1.56%
- ------------------------------------------------
Specialty Transportation Services, Inc. 9.1% of Co. Waste Hauler $ 500 $ 458
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,337
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 916
Confluence Holdings Corp. 0.7% of Co. Canoes & Kayaks 45 45
ConStar International, Inc. 2.8% Electrical 616 616
------------ ------------
Subtotal 3,303 4,372
------------ ------------
Subtotal--non-publicly traded securities--76.60% 210,037 214,810
Government Securities--21.40%
- -----------------------------
FHLB Discount Note due 7/1/99 59,992 59,992
------------ ------------
Total Investments 270,029 27,802
Investment in Unconsolidated Operating Subsidiary--1.99%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. Investment Banking 403 5,570
------------ ------------
Totals $ 270,432 $ 280,372
============ ============
</TABLE>
(1) Non-income producing
(2) Affiliated company
See accompanying notes.
4
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
DECEMBER 31, 1998
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Industry Cost Fair Value
-------- ---- ----------
<S> <C> <C> <C>
Senior Debt--9.47%
- ------------------
Four S Baking Company (2) Baking $ 1,266 $ 1,266
BIW Connector Systems, LLC. Manufacturing 3,404 3,404
Chance Coach, Inc. (2) Bus Manufacturer 1,286 1,286
JAG Industries, Inc. (2) Manufacturing 1,200 1,200
Confluence Holdings Corp. Canoes & Kayaks 9,675 9,675
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Euro-Caribe, Inc. (2) Meat Processing 7,181 7,181
------------ ------------
Subtotal 24,762 24,762
Subordinated Debt--41.37%
- -------------------------
Four S Baking Company (2) Baking 1,588 1,588
BIW Connector Systems, LLC. Manufacturing 6,710 6,710
Westwind Group Holdings, Inc. Restaurant 2,932 2,932
JAG Industries, Inc. (2) Manufacturing 2,335 2,335
Specialty Transportation Services, Inc. (2) Waste Hauler 7,368 7,368
Chance Coach, Inc. (2) Bus Manufacturer 7,060 7,060
The L.A. Studios, Inc. Audio Production 2,393 2,393
Decorative Surfaces International, Inc. (2) 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
Euro-Caribe, Inc. (2) Meat Processing 8,905 8,905
Starcom Holdings, Inc. Electrical 12,839 12,839
Centennial Broadcasting, Inc. Radio Stations 15,040 15,040
------------ ------------
Subtotal 108,116 108,116
Convertible Preferred Stock--2.10%
- ----------------------------------
Four S Baking Company (2) 15% dividend convertible into
10.89% of Co. Baking 2,756 2,756
Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,079
Decorative Surfaces International, Inc. (2) 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) 3.26% of Co. Baking 462 600
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 540
Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 421
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 465
Specialty Transportation Services, Inc. (2) Up to 39.1% 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
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
Starcom Holdings, Inc. 17.5% of Co. Electrical 3,171 3,171
------------ ------------
Subtotal 20,382 22,011
Common Stock and Member ship Interests(1) - 1.69%
- -------------------------------------------------
Four-S Baking Company (2) 5.5% of Co. Baking 966 1,004
Specialty Transportation Services, Inc. (2) 9.1% of Co. Waste Hauler 500 784
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,131
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 246
ConStar International, Inc. 2.8% Electrical 500 500
------------ ------------
Subtotal 4,108 4,665
------------ ------------
Subtotal--non-publicly traded securities--63.15% 162,770 165,035
Government Securities--34.41%
- -----------------------------
FHLB Discount Note due 1/4/99 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) Affiliated company
See accompanying notes.
5
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Operating income:
Interest and dividend income $ 6,490 $ 3,161 $ 12,344 $ 5,841
Loan fees 665 523 1,331 1,135
--------- ------------ ------------- -----------
Total operating income 7,155 3,684 13,675 6,976
Operating expenses:
Salaries and benefits 188 208 498 378
General, administrative and other 385 164 654 437
Interest 1,077 -- 1,896 --
--------- ------------ ------------- -----------
Total operating expenses 1,650 372 3,048 815
Operating income before equity in (loss)
earnings of unconsolidated operating
subsidiary 5,505 3,312 10,627 6,161
Equity in (loss) earnings of unconsolidated
operating subsidiary (421) 111 (816) 212
--------- ------------ ------------- -----------
Net operating income 5,084 3,423 9,811 6,373
Net realized gain on investments 551 -- 867 --
Increase (decrease) in unrealized appreciation
of investments 526 (8) 2,507 20
--------- ------------ ------------- -----------
Net increase in shareholders' equity resulting
from operations $ 6,161 $ 3,415 $ 13,185 $ 6,393
========= ============ ============= ===========
Net operating income per share:
Basic $ 0.46 $ 0.31 $ 0.88 $ 0.58
Diluted $ 0.44 $ 0.29 $ 0.85 $ 0.55
Net increase in shareholders' equity resulting
from operations per common share:
Basic $ 0.55 $ 0.31 $ 1.19 $ 0.58
Diluted $ 0.53 $ 0.29 $ 1.15 $ 0.55
Weighted average shares of Basic 11,131 11,069 11,102 11,069
Common stock outstanding Diluted 11,666 11,689 11,498 11,585
Dividends declared per share $ 0.43 $ 0.29 $ 0.84 $ 0.54
</TABLE>
See accompanying notes.
6
<PAGE>
AMERICAN CAPITAL STRATEGIES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Notes
Capital in Receivable Undistributed Unrealized Total
Common Stock Excess of From Sale of Net Realized Appreciation Shareholders'
Shares Amount Par Value Common Stock Earnings of 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 shareholders'
equity resulting from -- -- -- -- 6,373 20 6,393
operations
Distributions -- -- -- -- (5,978) -- (5,978)
--------- --------- ---------- ---------- ---------- ----------- -----------
Balance at June 30, 1998 11,069 $ 111 $ 144,940 $ -- $ 340 $ 5,676 $ 151,067
========= ========= ========== ========== ========== =========== ===========
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 851 9 12,698 -- -- -- 12,707
Issue of common stock under the
Dividend Reinvestment Plan 20 -- 339 -- -- -- 339
Issuance of restricted stock 10 -- 166 -- -- -- 166
Issuance of notes receivable
from sale of common stock -- -- -- (13,611) -- -- (13,611)
Net increase in shareholders'
equity resulting from -- -- -- -- 10,678 2,507 13,185
operations
Distributions -- -- -- -- (9,706) -- (9,706)
--------- --------- ---------- ---------- ---------- ----------- -----------
Balance at June 30, 1999 11,962 $ 120 $ 158,448 $ (13,911) $ 856 $ 10,290 $ 155,803
========= ========= ========== ========== ========== =========== ===========
</TABLE>
See accompanying notes.
7
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Six Months Six Months
Ended Ended
June 30, June 30,
1999 1998
----------- ----------
<S> <C> <C>
Operating activities
Net increase in shareholders' equity resulting from operations $ 13,185 $ 6,393
Adjustments to reconcile net increase in shareholders' equity resulting
from operations to net cash provided by operating activities:
Unrealized appreciation of investments (2,507) (20)
Net realized gain on investments (867) --
Net amortization of securities -- (1,347)
Accretion of loan discounts (908) (293)
Amortization of deferred finance costs 280 --
Increase in interest receivable (768) (42)
Increase in accrued payment-in-kind dividend and interest (1,150) --
(Increase) decrease in due from unconsolidated subsidiary (980) 1,073
Increase in other assets (1,134) (83)
Increase in accounts payable and accrued liabilities 1,674 81
Equity in loss (earnings) of unconsolidated operating subsidiary 816 (212)
----------- ----------
Net cash provided by operating activities 7,641 5,550
Investing activities
Proceeds from sale or maturity of investments 22,519 84,080
Principal repayments 14,592 713
Purchase of investments (65,554) (68,810)
Purchase of securities (12,900) (47,412)
------------ ----------
Net cash used in investing activities (41,343) (31,429)
Financing activities
Drawings on revolving credit facilities, net 53,900 24,712
Increase in deferred financing costs (1,701) --
Issuance of common stock -- --
Distributions paid (10,928) (5,978)
------------ ----------
Net cash provided by financing activities 41,271 18,734
----------- ----------
Net increase (decrease) in cash and cash equivalents 7,569 (7,145)
Cash and cash equivalents at beginning of period 6,149 8,862
----------- ----------
Cash and cash equivalents at end of period $ 13,718 $ 1,717
=========== ==========
Non-cash financing activities:
- ------------------------------
Notes receivable issued in exchange for common stock $ 13,611 $ --
Net repayment of margin borrowings through sale of securities 26,956 --
</TABLE>
See accompanying notes.
8
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
FINANCIAL HIGHLIGHTS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Per Share Data(1)
Net asset value at beginning of the period $ 13.80 $ 13.61
Net operating income 0.88 0.58
Increase in unrealized appreciation on investments 0.31 --
------------ -------------
Net increase in shareholders' equity from operations $ 1.19 $ 0.58
Distribution of net investment income 0.84 0.54
Effect of Dilution from exercise of stock options 0.35 --
------------ -------------
Net asset value at end of period (2) $ 13.80 $ 13.65
Per share market value at beginning of period $ 17.250 $ 18.125
Per share market value at end of period $ 18.250 $ 22.875
Total return (3) 10.67% 29.19%
Shares outstanding at end of period 11,962 11,069
Ratio/Supplemental Data
Net assets at end of period $ 155,803 $ 151,067
Ratio of operating expenses to average net assets 1.98% 0.54%
Ratio of net operating income to average net assets 6.36% 4.22%
</TABLE>
(1) Basic per share data.
(2) Does not include contingently issuable shares.
(3) Amounts were not annualized for the results of the three month periods ended
June 30, 1999 and 1998.
See accompanying notes.
9
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(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 10,382,437 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>
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
Assets
Investments in portfolio companies, at fair value $ 10,178 $ 10,837
Other assets, net 1,670 1,359
-------------- -------------
Total assets $ 11,848 $ 12,196
============== =============
Liabilities and Shareholder's Equity
Deferred income taxes $ 2,420 $ 2,921
Due to parent 1,760 778
Other liabilities 2,098 2,111
Shareholder's equity 5,570 6,386
-------------- -------------
Total liabilities and shareholder's equity $ 11,848 $ 12,196
============== =============
</TABLE>
10
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Operating income $ 580 $ 2,102 $ 2,015 $ 3,880
Operating expense 1,781 1,917 3,825 3,462
------------ ------------- ------------ -------------
Net operating (loss) income (1,201) 185 (1,810) 418
Realized gains on investments -- -- 925 --
Increase (decrease) in unrealized
appreciation of investments 522 (33) (432) (129)
Other income (expense) 258 (41) 501 (77)
------------ ------------- ------------ -------------
Net (loss) income $ (421) $ 111 $ (816) $ 212
============ ============= ============ =============
</TABLE>
Note 4. Notes Payable
During June 1999, the Company borrowed $53,992 secured by government
agency securities with a fair value of $59,992. The interest rate on the Note
was 6.25% and the note was fully repaid on July 1, 1999.
During June 1999, the Company borrowed $6 million from a corporation.
Interest is accrued and paid monthly at 10.0%. The note was fully repaid on July
29, 1999.
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility; as of June 30, 1999, the facility was increased to a maximum
of $125,000. In connection with the closing, the Company established ACS Funding
Trust I (the "Trust"), an affiliated business trust and initially contributed or
sold to the Trust approximately $157,000 in loans. Through June 30, 1999 the
Company had sold or contributed an additional $37,000 in loans to the Trust.
Subject to certain conditions precedent, 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
balance of loans contributed, 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. The transfer of assets to the Trust and the related
borrowings by the Trust have been 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". As of June 30, 1999, the Company has $82,900 of borrowings
outstanding under this facility.
Due to the short term of the borrowings, the fair value of the notes
payable approximates cost.
Note 5. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three and six months ended June 30, 1999 and the
three and six months ended June 30, 1998.
11
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Numerator for basic and diluted net
increase in shareholders'
equity resulting from
operations $ 6,161 $ 3,415 $ 13,185 $ 6,393
Denominator for basic-weighted
average shares 11,131 11,069 11,102 11,069
Employee stock options 451 464 327 386
Warrants 84 156 69 130
------------ ------------ ------------ ------------
Dilutive potential shares 535 620 396 516
Denominator for diluted 11,666 11,689 11,498 11,585
------------ ------------ ------------ ------------
Basic earnings per share $ 0.55 $ 0.31 $ 1.19 $ 0.58
Diluted earnings per share $ 0.53 $ 0.29 $ 1.15 $ 0.55
</TABLE>
Note 6. Realized Gain on Investments
During March, 1999, the Company sold its investment in Four S Baking
Company ("Four S"). The Company's investment included senior debt, subordinated
debt, preferred stock, common stock and common stock warrants. The Company
received $7.2 million 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, the Company also recorded $177 of unrealized depreciation to
reverse previously recorded unrealized appreciation.
During June, 1999, the Company received a prepayment of subordinated
debt from Specialty Transportation Services, Inc. ("STS") in the amount of
$7,500. In conjunction with the repayment, the Company received prepayment fees
of $225 and recognized a realized gain of $551 from the realization of
unamortized original issue discount. At June 30, 1999, the Company's
subordinated debt investment in STS was $455.
Note 7. Interest Rate Risk Management
The Company enters into interest rate swap agreements with major banks
as part of its strategy to manage interest rate risks, to match fund its assets
and liabilities, and to fulfill its obligation under the terms of its credit
facility. The Company uses interest rate swap agreements for hedging and risk
management only and not for speculative purposes. During the quarter ended June
30, 1999, the Company entered into three interest rate basis swap agreements
with an aggregate notional amount of $37,275. Pursuant to these swap agreements,
the Company pays a variable rate equal to the prime lending rate (7.75% at June
30, 1999) and receives a weighted average rate of the 30-day LIBOR (4.94% at
June 30, 1999) plus 2.70%. The swaps have a remaining weighted average maturity
of approximately five years.
12
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
Note 8. Related Party Transactions
The Company has provided loans to employees for the exercise of options
under the 1997 Stock Option Plan. The loans require the current payment of
interest at the applicable federal interest rate in effect at the date of issue,
have varying terms not exceeding nine years and have been recorded as a
reduction of shareholders' equity. The loans are full recourse notes due
upon termination of employment and the stock purchased with the proceeds of the
loan is posted as collateral. During the six months ended June 30, 1999, the
Company issued $13,611 in loans to employees for the exercise of options. The
Company recognized interest income from these loans of $49 during the three
months ended June 30, 1999.
In addition to the above issued notes, the Company entered into
agreements to purchase split dollar life insurance for three officers. The
aggregate cost of these policies will be $2,638. The cost to the Company will
generally be amortized over a period equal to the shorter of ten years and as
long as each executive officer continues employment. During the period the loans
are outstanding, the Company will have a collateral interest in the cash value
and death benefit of these policies as security for the loans. Additionally, as
long as the policy premium is not fully amortized, the Company will have a
collateral interest in such items generally equal to the unamortized cost of the
policies. In the event of an individual's termination of employment with the
Company prior to the end of such ten year period, or, his election not to be
bound by non compete agreements, such individual must reimburse the company the
unamortized cost of his policy. In the event that such policies cannot be
obtained, the Company will make cash payments, over a ten-year period, to the
individuals in the same amount as would have been expended on the insurance
policies. Such payments will only be made in the event of continued employment.
In the event that the individual terminates employment with the Company, or
elects not to be bound by non compete agreements, payments will no longer be
made.
Note 9. Subsequent Events
On August 11, 1999, the Company issued 5,000 shares of common stock for
an aggregate purchase price of $85,000 and granted the underwriters the option
to purchase up to 750 additional shares of common stock within thirty days for
an aggregate purchase price of $12,750. The net proceeds from the sale of the
5,000 shares of common stock, after deducting expenses and underwriting
discounts and commissions, are approximately $80,000. Subsequent to the common
stock issuance, the Company used $80,000 of the proceeds to repay outstanding
borrowings under its revolving credit facilities.
13
<PAGE>
Item 2. 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 the 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 Securities and Exchange 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, included elsewhere in this report
and in the Company's annual report on Form 10-K/A for the year ended December
31, 1998.
Overview
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
$214,810 and $165,035 at June 30, 1999 and December 31, 1998, respectively.
During the three months ended June 30, 1999 (the "Second Quarter 1999"), the
Company originated investments totaling $37,017 and advanced $525 previously
committed under working capital facilities. During the six months ended June 30,
1999 (the "1999 YTD Period"), the Company originated investments totaling
$62,879 and advanced $2,675 previously committed under working capital
facilities. During the 1999 YTD Period, the Company also received repayments of
loans of $14,700 and, in conjunction with the sale of one portfolio company, the
Company sold warrants of $600, common stock of $1,000, preferred stock of
$2,900, and received repayment of senior and subordinated debt of $2,800. As a
result, the total portfolio increased by 30% from December 31, 1998 to June 30,
1999. The weighted average effective interest rate on the investment portfolio
was 13.2% and 13.0%, respectively, at June 30, 1999 and December 31, 1998. A
summary of the composition of the Company's portfolio of non-publicly traded
securities at June 30, 1999 and December 31, 1998 is shown in the following
table:
June 30, 1999 December 31, 1998
------------- -----------------
Senior debt 18.9% 15.0%
Subordinated debt 64.2% 65.5%
Convertible preferred stock 1.4% 3.3%
Common stock warrants 13.4% 13.5%
Common stock 2.0% 2.7%
The Company expects its portfolio composition for the remainder of 1999
to be similar to its portfolio composition at June 30, 1999 and at December 31,
1998. The Company will continue to heavily weight its portfolio composition
toward investments in subordinated debt with detachable warrants.
14
<PAGE>
The following table shows the portfolio composition by industry
grouping:
June 30, 1999 December 31, 1998
------------- -----------------
Manufacturing 64.0% 66.1%
Health Care 5.9% --
Media 7.4% 9.1%
Construction 10.9% 10.0%
Wholesale & Retail 2.3% 7.4%
Transportation 0.9% 5.4%
Service 8.6% 2.0%
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 three primary elements. The first element is "Net
operating income (loss)," which 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. In addition, the
Company operates 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 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 is presented on
the equity method and, consistent with the equity method of accounting, the
portfolio companies owned by CIC are not reported separately by the Company.
15
<PAGE>
The operating results for the three and six months ended June 30, 1999
and June 30, 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Operating income $ 7,155 $ 3,684 $ 13,675 $ 6,976
Operating expenses 1,650 372 3,048 815
Equity in (loss) earnings of
unconsolidated operating
subsidiary (421) 111 (816) 212
------------- ------------- -------------- ------------
Net operating income 5,084 3,423 9,811 6,373
Net realized gain on investments
551 -- 867 --
Increase (decrease) in unrealized
appreciation of investments
526 (8) 2,507 20
------------- ------------- -------------- ------------
Net increase in shareholders'
equity resulting from
operations $ 6,161 $ 3,415 $ 13,185 $ 6,393
============= ============= ============== ============
</TABLE>
Total operating income for the Second Quarter 1999 and the 1999 YTD
Period increased 3,471, or 94%, and $6,699, or 96%, respectively, compared to
the three and six months ended June 30, 1998 (the "Second Quarter 1998" and the
"1998 YTD Period"). The increase in operating income is a result of the Company
closing 19 investments in private companies totaling $140 million between June
30, 1998 and June 30, 1999. For the Second Quarter 1999, operating income
consisted of $665 in loan fees, $6,323 in interest and dividends on non-publicly
traded securities and $167 in interest on government agency securities, bank
deposits, repurchase agreements and shareholder loans; for the Second Quarter
1998, operating income consisted of $523 in loan fees, $2,163 in interest and
dividends on non-publicly traded securities and $998 in interest on government
agency securities, bank deposits and repurchase agreements. The Second Quarter
1999 loan fees include $225 in prepayment fees collected as a result of the
repayment of $7.5 million in subordinated debt. For the 1999 YTD Period,
operating income consisted of $1,331 in loan fees, $12,136 in interest and
dividends on non-publicly traded securities and $208 in interest on government
agency securities, bank deposits repurchase agreements and shareholder loans;
for the 1998 YTD Period, operating income consisted of $1,135 in loan fees,
$3,370 in interest and dividends on non-publicly traded securities and $2,471 in
interest on government agency securities, bank deposits and repurchase
agreements. 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 Second Quarter 1999 increased $1,278, or
344%, over the same period in 1998. For the 1999 YTD Period, operating expenses
increased $2,233, or 274% over the six months ended June 30, 1999. The increase
for both periods is primarily due to the increase in interest expense from $0 in
the Second Quarter 1998 and the 1998 YTD Period to $1,077 and $1,896 for the
three and six months ended June 30, 1999, respectively. The increase in interest
expense resulted from the Company's $88.9 million in borrowings under credit
facilities between June 30, 1998 and June 30, 1999. The weighted average
interest rate on borrowings at June 30, 1999 was 7.1%. In addition operating
expenses also increased for the 1999 YTD Period due to the increase in salaries
and benefits from $378 for the six months ended June 30, 1998 to $498 in 1999.
The Company had 34 and 23 employees at June 30, 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 $111 for Second Quarter 1998
to a loss of $(421) for Second Quarter 1999. For the six months ended June 30,
1999, equity in (loss) earnings of unconsolidated operating subsidiary decreased
$1,028 from the 1998 YTD Period. For the three months ended June 30, 1999, CIC's
results included $580 of operating income, $1,781 of operating expenses, $522 of
unrealized appreciation of investments, and $258 in other income. For the three
months ended June 30, 1998, CIC's results included $2,102 of operating income,
$1,917 of
16
<PAGE>
operating expenses, $33 of unrealized depreciation of investments, and $41 of
other expenses. For the 1999 YTD Period, CIC's results included $2,015 of
operating income, $3,825 of operating expenses, $925 of realized gains, $432 of
unrealized depreciation of investments, and $501 of 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 six months ended June 30, 1998, CIC recorded $3,880 in operating income,
$3,462 in operating expenses, $129 in unrealized depreciation of investments,
and $77 of other expenses. The decrease in CIC's earnings for both the Second
Quarter 1999 and the 1999 YTD Period was primarily attributable to the lower
investment banking fees generated during the Second Quarter 1999, which resulted
in a decrease in operating income of $1,522 and $1,865, respectively, for the
three and six month period ended June 30, 1999.
During the Second Quarter 1999, the Company recorded a realized gain of
$551 from the prepayment of $7.5 million of subordinated debt by STS. In
addition to this gain, for the six months ended June 30, 1999, the Company
recognized a realized gain of $316 on the sale of its investment of Four S.
Total proceeds from the sale of the Four S securities, which included senior
debt, subordinated debt, preferred stock, common stock warrants, and common
stock, were $7.2 million. The realized gains for the STS and Four S transactions
were comprised of the realization of 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
increase in unrealized appreciation of investments for the Second Quarter 1999
increased $534 over the Second Quarter 1998. The increase for Second Quarter
1999 was comprised of valuation increases of $599 at four portfolio companies
and valuation decreases of $734 at four portfolio companies. The increase in
unrealized appreciation for the 1999 YTD Period increased $2,487 due to
valuation increases of $3,014 at five portfolio companies and valuation
decreases of $383 at five portfolio companies.
Financial Condition, Liquidity, and Capital Resources
At June 30, 1999, the Company had $13,718 in cash and cash equivalents
and $59,992 in investments in Federal agency securities. In addition, the
Company had outstanding debt secured by assets of the Company of $82,900 in
borrowings under credit facilities and $59,992 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. On August 11, 1999, the Company completed a
secondary public equity offering and received net proceeds of approximately $80
million in exchange for 5,000 common shares. The Company has used proceeds from
the offering to pay down $80 million of outstanding borrowings under credit
facilities.
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility; this facility was increased to a $125,000 as of June 30, 1999.
In connection with the closing, the Company established ACS Funding Trust I (the
"Trust"), an affiliated business trust and initially contributed or sold to the
Trust approximately $157,000 in loans. The Company has subsequently sold or
contributed to the Trust an additional $37,000 in loans. Subject to certain
conditions precedent, 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 balance
of loans contributed, 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. The Company has used borrowings under this facility to repay
debt and to make investments in the debt and equity securities of middle market
companies; the Company intends to continue to use this facility in this fashion.
In order to manage interest rate risk associated with the floating rate
borrowings, the Company has entered into interest rate swap agreements. The
Company uses interest rate swap agreements for non-trading and non-speculative
purposes only.
As a RIC, the Company is required to distribute annually 90% or more of
its net operating income and net realized short-term capital gains to
shareholders. In addition to the above noted equity offering and borrowings, the
Company anticipates having to issue additional debt or equity 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.
17
<PAGE>
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 loan grade was 3.1
and 3.2 at June 30, 1999 and December 31, 1998, respectively. In addition, all
of the Company's outstanding loans are performing and paying as agreed as of
June 30, 1999. At June 30, 1999, the Company's loan portfolio was graded as
follows:
Percentage of Total
Grade Investments at Value Portfolio
----- -------------------- ---------
4 $ 13,989 8.0%
3 161,088 91.8%
2 455 0.2%
1 -- --
------------- -----
175,532 100.0%
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 designation from the 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 October, 1999.
The Company is also evaluating the Year 2000 compliance of its
non-information technology systems, consisting of office equipment other than
computers and communications equipment. The Company has contacted the office
equipment vendors to obtain Year 2000 compliance designation. The Company has
completed the remediation, testing and implementation of these non-information
technology systems.
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 materially impact the Company's results of operations,
18
<PAGE>
liquidity, or capital resources. However, the Company has no means of ensuring
that external agents will be Year 2000 ready. The inability of external agents
to complete their Year 2000 resolution process in a timely fashion could
materially impact 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 95% 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 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 October, 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 Companies investment portfolio.
The magnitude of these material adverse effects on the portfolio companies and
the operating results and financial of the Company cannot be determined at this
time.
19
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Company, nor any of the Company's subsidiaries, is
currently subject to any material litigation nor, to the Company's knowledge, is
any material litigation threatened against the Company or any subsidiary, other
than routine litigation and administrative proceedings arising in the ordinary
course of business. Such proceedings are not expected to have a material adverse
effect on the business, financial conditions, or results of operation of the
Company or any subsidiary.
Item 2. Changes in Securities
Not Applicable.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
On May 6, 1999, the Company held its Annual Meeting of Stockholders.
Three matters were submitted to the stockholders for consideration:
1. Election of three Directors;
2. Proposal to approve an amendment to the Company's Second Amended and
Restated Certificate of Incorporation increasing the number of
authorized common shares of the Company;
3. Ratification of the selection of Ernst & Young LLP as auditors for
the fiscal year ending December 31, 1999.
The results of the shares voted with regard to each of these matters is
as follows:
1. Election of Three Directors:
Director For Against Withheld
-------- --- ------- --------
Adam Blumenthal 8,839,271 66,487 --
Neil M. Hahl 8,828,668 77,090 --
Stan Lundine 8,827,168 78,590 --
Continuing Directors whose terms did not expire at the annual
meeting were as follows: Robert L. Allbritton, David Gladstone,
Philip R. Harper, Alvin N. Puryear, Stephen P. Walko, and Malon
Wilkus.
2. Proposal to approve an amendment to the Company's Second Amended and
Restated Certificate of Incorporation increasing the number of
authorized common shares of the Company:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
6,442,145 2,419,879 43,733 --
3. Ratification of the selection of Ernst & Young LLP as auditors for
the fiscal year ending December 31, 1999:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
8,826,714 51,569 27,475 --
Item 5. Other Information
Not Applicable.
20
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
* 3.1. 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).
* 3.2. 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).
* 4.1. 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).
* 4.2. 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).
23.1. Consent of Arnold & Porter incorporated herein by reference to
Exhibit 23.1 of the Post-Effective Amendment No. 1 to the Form N-2 filed by the
Company on August 6, 1999 (Commission File No. 333-79377).
23.2. Consent of Ernst & Young LLP incorporated herein by reference to
Exhibit 23.2 of the Post-Effective Amendment No. 1 to the Form N-2 filed by the
Company on August 6, 1999 (Commission File No. 333-79377).
24. Power of Attorney, dated as of July 29, 1999, incorporated herein by
reference to Exhibit 24 of Post-Effective Amendment No. 1 to the Form N-2 filed
by the Company on August 6, 1999 (Commission File No. 333-79377).
- ------------------
* Previously filed.
Exhibit
Number Description
- ------- -----------
27 Financial Data Schedule
(b) The registrant has not filed any reports on a Current Report on
Form 8-K during the quarter for which this report 10-Q is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AMERICAN CAPITAL STRATEGIES, LTD.
By: /s/ John R. Erickson
-----------------------------------
John R. Erickson
Vice President and
Chief Financial Officer
Date: August 13, 1999
21
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
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<NAME> American Capital Strategies, Ltd.
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