GLADSTONE INVESTMENT CORPORATION\DE
10-Ks and 10-Qs
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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended March 31, 2011
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 814-00704
GLADSTONE INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
| Delaware | 83-0423116 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 1521 Westbranch Drive, Suite 200 | ||
| McLean, Virginia | 22102 | |
| (Address of principal executive offices) | (Zip Code) |
(703) 287-5800
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Common Stock, $0.001 par value per share | NASDAQ Global Select Market | |
| (Title of each class) | (Name of exchange on which registered) |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. YES
o
NO
þ
Indicate by check if the registrant is not required to file reports pursuant to Section 13 or
Section 15 (d) of the Act. YES
o
NO
þ
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 (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES
þ
NO
o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). YES
o
NO
o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this 10-K or
any amendment to this Form 10-K.
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated
filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
|
Large accelerated filer
o
|
Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
|
|
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the
Exchange Act). YES
o
NO
þ
The aggregate market value of the voting stock held by non-affiliates of the Registrant on
September 30, 2010, based on the closing price on that date of $6.70 on the NASDAQ Global Select
Market, was $147,936,891. For the purposes of calculating this amount only, all directors and
executive officers of the Registrant have been treated as affiliates. There were 22,080,133 shares
of the Registrant’s Common Stock, $0.001 par value, outstanding as of May 20, 2011.
Documents Incorporated by Reference.
Portions of the Registrant’s Proxy Statement relating to the
Registrant’s 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of
this Annual Report on Form 10-K as indicated herein.
GLADSTONE INVESTMENT CORPORATION
FORM 10-K FOR THE FISCAL YEAR ENDED
MARCH 31, 2011
FORM 10-K FOR THE FISCAL YEAR ENDED
MARCH 31, 2011
TABLE OF CONTENTS
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Table of Contents
FORWARD-LOOKING STATEMENTS
All statements contained herein, other than historical facts, may constitute “forward-looking
statements.” These statements may relate to, among other things, future events or our future
performance or financial condition. In some cases, you can identify forward-looking statements by
terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,”
“growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,”
“likely” or the negative of such terms or comparable terminology. These forward-looking statements
involve known and unknown risks, uncertainties and other factors that may cause our actual results,
levels of activity, performance or achievements to be materially different from any future results,
levels of activity, performance or achievements expressed or implied by such forward-looking
statements. Such factors include, among others: (1) further adverse changes in the economy and the
capital markets; (2) risks associated with negotiation and consummation of pending and future
transactions; (3) the loss of one or more of our executive officers, in particular David Gladstone,
Terry Lee Brubaker, George Stelljes III or David Dullum; (4) changes in our business strategy; (5)
availability, terms and deployment of capital; (6) changes in our industry, interest rates,
exchange rates or the general economy; (7) the degree and nature of our competition; and (8) those
factors described in the “Risk Factors” section of this Form 10-K. We caution readers not to place
undue reliance on any such forward-looking statement. We undertake no obligation to publicly update
or revise any forward-looking statements, whether as a result of new information, future events or
otherwise, after the date of this Form 10-K.
In this Annual Report on Form 10-K, or Annual Report, the “Company,” “we,” “us,” and “our” refer to
Gladstone Investment Corporation and its wholly-owned subsidiaries unless the context otherwise
indicates. Dollar amounts are in thousands unless otherwise indicated.
| ITEM 1. | BUSINESS |
Overview
We were established primarily for the purpose of investing in subordinated loans, mezzanine debt,
preferred stock and warrants to purchase common stock of small and medium-sized companies in
connection with buyouts and other recapitalizations. When we invest in buyouts we do so with the
management team of the portfolio companies and with other buyout funds. We also sometimes invest
in senior secured loans, common stock and, to a much lesser extent, senior and subordinated
syndicated loans. Our investment objective is to generate both current income and capital gains
through these debt and equity instruments.
We were incorporated under the General Corporation Laws of the State of Delaware on February 18,
2005. On June 22, 2005 we completed an initial public offering and commenced operations. We operate
as a closed-end, non-diversified management investment company and have elected to be treated as a
business development company (“BDC”) under the Investment Company Act of 1940, as amended (the
“1940 Act”). For federal income tax purposes, we have elected to be treated as a regulated
investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the
“Code”). In order to continue to qualify as a RIC for federal income tax purposes and obtain
favorable RIC tax treatment, we must meet certain requirements, including certain minimum
distribution requirements.
We seek to achieve returns through current income generated from senior, subordinated and mezzanine
debt, and capital gains from the sale of preferred stock, warrants to purchase common stock and
common stock that we purchase in connection with buyouts and recapitalizations of small and
mid-sized companies with established management teams. We seek to make investments that generally
range between $10 million and $40 million each, although this investment size may vary
proportionately as the size of our capital base changes. Typically, our investments mature in no
more than seven years and accrue interest at fixed or variable rates with floors in place. We
invest either by ourselves or jointly with other buyout funds and/or management of the portfolio
company, depending on the opportunity. If we are participating in an investment with one or more
co-investors, our investment is likely to be smaller than if we were to be investing alone.
We expect that our target portfolio over time will primarily include the following three categories
of investments in private companies:
| • | Subordinated Debt and Mezzanine Debt. We anticipate that, over time, much of the capital that we invest will be in the form of subordinated or mezzanine debt. Most of our mezzanine and subordinated loans are collateralized by a subordinated lien on some or all of the assets of the borrower. We structure most of our mezzanine and subordinated loans with variable interest rates, but some are fixed rate loans. In either event, we structure the loans at rates of interest that provide us with significant current interest income and generally have interest rate floors to protect against declining interest rates. Our subordinated and mezzanine loans typically have maturities of five to seven years and provide for interest-only payments in the early years, with amortization of principal deferred to the later years of the mezzanine loans. In some cases, we may enter into loans that, by their terms, convert into equity or additional debt securities or defer payments of interest for the first few years after our investment. |
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Table of Contents
| Our subordinated and mezzanine debt investments may include equity features, such as warrants or options to buy a significant common stock ownership interest in the portfolio company, or success fees if the business is sold. If a portfolio company appreciates in value, we may achieve additional investment returns from any equity interests we hold. If we are a minority interest holder, we may structure the warrants to provide provisions protecting our rights as a minority-interest holder, such as the right to sell the warrants back to the company upon the occurrence of specified events. In many cases, we also obtain registration rights in connection with these equity interests, which may include demand and co-registration rights. | |||
| • | Preferred Stock, Warrants to Purchase Common Stock and Common Stock. We also acquire preferred stock, warrants to purchase common stock or common stock, or a combination of the three, in connection with a buyout or recapitalization. These investments are generally in combination with an investment in one of our debt products. With respect to preferred stock, warrants to purchase common stock or common stock investments, we target an investment return substantially higher than our investments in loans. However, we can offer no assurance that we can achieve such a return with respect to any investment or our portfolio as a whole. The features of the preferred stock we receive vary by transaction but may include priority distribution rights, superior voting rights, redemption rights, liquidation preferences and other provisions intended to protect our interests. Generally speaking, warrants to purchase common stock and common stock do not have any current income and its value is realized, if at all, upon the sale of the business or following the company’s initial public offering. | ||
| • | Senior Secured Debt. We may provide senior secured acquisition financing for some portfolio companies. We typically structure these senior secured loans to have terms of three to five years, and they may provide for limited principal payments in the first few years of the term of the loan. We generally obtain security interests in the assets of our portfolio companies that will serve as collateral in support of the repayment of these senior loans. This collateral usually takes the form of first priority liens on the assets of the portfolio company. The interest rates on our senior secured loans are generally variable rates based on the London Interbank Offered Rate (“LIBOR”). |
Investment Concentrations
Approximately 38.2% of the aggregate fair value of the Company’s investment portfolio at March 31,
2011 was comprised of senior term debt, 41.0% was senior subordinated term debt, and 20.8% was
preferred and common equity securities or their equivalents. At March 31, 2011, the Company had
investments in 17 portfolio companies with an aggregate fair value of $153.3 million, of which
Venyu Solutions, Inc. (“Venyu”), Acme Cryogenics, Inc. (“Acme”) and Cavert II Holding Corp.
(“Cavert”), collectively, comprised approximately $63.2 million, or 41.2% of the Company’s total
investment portfolio, at fair value. The following table outlines our investments by security type
at March 31, 2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Cost | Fair Value | Cost | Fair Value | |||||||||||||
|
Senior term debt
|
$ | 64,566 | $ | 58,627 | $ | 102,446 | $ | 94,359 | ||||||||
|
Senior subordinated term debt
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74,602 | 62,806 | 79,799 | 71,112 | ||||||||||||
|
Preferred equity
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52,922 | 25,398 | 40,728 | 20,425 | ||||||||||||
|
Common equity/Equivalents
|
5,102 | 6,454 | 4,594 | 20,962 | ||||||||||||
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Total Investments
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$ | 197,192 | $ | 153,285 | $ | 227,567 | $ | 206,858 | ||||||||
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Investments at fair value consisted of the following industry classifications at March 31,
2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Percentage of | Percentage of Total | |||||||||||||||
| Fair Value | Total Investments | Fair Value | Investments | |||||||||||||
|
Containers, packaging and glass
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$ | 29,029 | 19.0 | % | $ | 18,731 | 9.1 | % | ||||||||
|
Electronics
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25,012 | 16.3 | — | — | ||||||||||||
|
Chemicals, plastics and rubber
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19,906 | 13.0 | 13,585 | 6.6 | ||||||||||||
|
Cargo transport
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13,183 | 8.6 | 9,394 | 4.5 | ||||||||||||
|
Diversified/Conglomerate manufacturing
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12,746 | 8.3 | 43,054 | 20.8 | ||||||||||||
|
Machinery
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10,431 | 6.8 | 60,692 | 29.3 | ||||||||||||
|
Buildings and real estate
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10,120 | 6.6 | 10,220 | 4.9 | ||||||||||||
|
Home and office furnishings/Consumer products
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8,627 | 5.6 | 9,374 | 4.5 | ||||||||||||
|
Automobile
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7,560 | 4.9 | 9,040 | 4.4 | ||||||||||||
|
Aerospace and defense
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6,659 | 4.4 | 17,099 | 8.3 | ||||||||||||
|
Oil and gas
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4,931 | 3.2 | 4,943 | 2.4 | ||||||||||||
|
Printing and publishing
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3,073 | 2.0 | 2,895 | 1.4 | ||||||||||||
|
Telecommunications
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1,499 | 1.0 | 7,831 | 3.8 | ||||||||||||
|
Diversified/Conglomerate service
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509 | 0.3 | — | — | ||||||||||||
|
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Total Investments
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$ | 153,285 | 100.0 | % | $ | 206,858 | 100.0 | % | ||||||||
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Table of Contents
The investments at fair value were included in the following geographic regions of the United
States at March 31, 2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Percentage of | Percentage of | |||||||||||||||
| Fair Value | Total Investments | Fair Value | Total Investments | |||||||||||||
|
South
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$ | 92,172 | 60.1 | % | $ | 60,363 | 29.2 | % | ||||||||
|
Northeast
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38,126 | 24.9 | 81,276 | 39.3 | ||||||||||||
|
West
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12,746 | 8.3 | 16,124 | 7.8 | ||||||||||||
|
Midwest
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10,241 | 6.7 | 49,095 | 23.7 | ||||||||||||
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Total Investments
|
$ | 153,285 | 100.0 | % | $ | 206,858 | 100.0 | % | ||||||||
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The geographic region indicates the location of the headquarters for our portfolio companies.
A portfolio company may have a number of other business locations in other geographic regions.
Our Investment Adviser and Administrator
Gladstone Management Corporation (our “Adviser”) is our affiliate and investment adviser and is led
by a management team which has extensive experience in our lines of business. Our Adviser also has
an affiliate, Gladstone Administration, LLC (our “Administrator”), which employs our chief
financial officer, chief compliance officer, treasurer, internal counsel and their respective
staffs. Excluding our chief financial officer, all of our executive officers serve as directors or
executive officers, or both, of the following of our affiliates: Gladstone Commercial Corporation
(“Gladstone Commercial”), a publicly traded real estate investment trust; Gladstone Capital
Corporation (“Gladstone Capital”), a publicly traded BDC and RIC; our Adviser; and our
Administrator. Our treasurer is also an executive officer of Gladstone Securities, LLC (“Gladstone
Securities”), another of our affiliates, a broker-dealer registered with the Financial Industry
Regulatory Authority (“FINRA”).
Our Adviser and Administrator also provide investment advisory and administrative services,
respectively, to our affiliates Gladstone Commercial; Gladstone Capital; Gladstone Partners Fund,
L.P., a private partnership fund formed primarily to co-invest with us and Gladstone Capital;
Gladstone Land Corporation, a private agricultural real estate company owned by David Gladstone,
our chairman and chief executive officer; and Gladstone Lending Corporation (“Gladstone Lending”),
a private corporation that has filed a registration statement on Form N-2 with the Securities and
Exchange Commission (“SEC”), but which has not yet commenced operations. In the future, our Adviser
and Administrator may provide investment advisory and administrative services, respectively, to
other funds and companies, both public and private.
We have been externally managed by our Adviser pursuant to an investment advisory and
administrative agreement since our inception. Our Adviser was organized as a corporation under the
laws of the State of Delaware on July 2, 2002, and is a registered investment adviser under the
Investment Advisers’ Act of 1940, as amended. Our Adviser is headquartered in McLean, Virginia, a
suburb of Washington, D.C., and our Adviser also has offices in New York, Illinois, Texas and
Connecticut.
Investment Process
Overview of Investment and Approval Process
To originate investments, our Adviser’s investment professionals use an extensive referral network
comprised primarily of private equity sponsors, venture capitalists, leveraged buyout funds,
investment bankers, attorneys, accountants, commercial bankers and business brokers. Our Adviser’s
investment professionals review information received from these and other sources in search of
potential financing opportunities. If a potential opportunity matches our investment objectives,
the investment professionals will seek an initial screening of the opportunity with our president,
David Dullum, to authorize the submission of an indication of interest (“IOI”) to the prospective
portfolio company. If the prospective portfolio company passes this initial screening and the IOI
is accepted by the prospective company, the investment professionals will seek approval to issue a
letter of intent (“LOI“) from the Adviser’s investment committee, which is composed of David
Gladstone (our chairman and chief executive officer), Terry Lee Brubaker (our co-vice chairman,
chief operating officer and secretary) and George Stelljes III (our co-vice chairman and chief
investment officer), to the prospective company. If this LOI is issued, then our Adviser’s
investment professionals, or those of Gladstone Securities, will conduct a thorough due diligence
investigation and create a detailed business analysis summarizing the prospective portfolio
company’s historical financial statements, industry, competitive position and management team and
analyzing its conformity to our general investment criteria. The investment professionals then
present this investment profile to our Adviser’s investment committee, which must approve each
investment. Further, each investment is available for review by the members of our Board of
Directors, a majority of whom are not “interested persons” as defined in Section 2(a)(19) of the
1940 Act.
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Table of Contents
Prospective Portfolio Company Characteristics
We have identified certain characteristics that we believe are important in identifying and
investing in prospective portfolio companies. The criteria listed below provide general guidelines
for our investment decisions, although not all of these criteria may be met by each portfolio
company.
| § | Value-and-Income Orientation and Positive Cash Flow. Our investment philosophy places a premium on fundamental analysis from an investor’s perspective and has a distinct value-and-income orientation. In seeking value, we focus on companies in which we can invest at relatively low multiples of earnings before interest, taxes, depreciation and amortization (“EBITDA”) and that have positive operating cash flow at the time of investment. In seeking income, we seek to invest in companies that generate relatively high and stable cash flow to provide some assurance that they will be able to service their debt and pay any required distributions on preferred stock. Typically, we do not expect to invest in start-up companies or companies with speculative business plans. | ||
| § | Experienced Management. We generally require that our portfolio companies have experienced management teams. We also require the portfolio companies to have in place proper incentives to induce management to succeed and to act in concert with our interests as investors, including having significant equity or other interests in the financial performance of their companies. | ||
| § | Strong Competitive Position in an Industry. We seek to invest in target companies that have developed strong market positions within their respective markets and that we believe are well-positioned to capitalize on growth opportunities. We seek companies that demonstrate significant competitive advantages versus their competitors, which we believe will help to protect their market positions and profitability. | ||
| § | Exit Strategy. We seek to invest in companies that we believe will provide a stable stream of cash flow that is sufficient to repay the loans we make to them while reinvesting for the growth of their respective businesses. We target such internally generated cash flow to allow our portfolio companies to pay interest on, and repay the principal of, our investments. This is a major factor in our investment thesis and evaluation of risk. In addition, we also seek to invest in companies whose business models and expected future cash flows offer attractive possibilities for capital appreciation on any equity interests we may obtain or retain. These capital appreciation possibilities include strategic acquisitions by other industry participants or financial buyers, initial public offerings of common stock, or other capital market transactions. | ||
| § | Liquidation Value of Assets. The prospective liquidation value of the assets, if any, collateralizing loans in which we invest is an important factor in our investment analysis. We emphasize both tangible assets, such as accounts receivable, inventory, equipment, and real estate, and intangible assets, such as intellectual property, customer lists, networks, and databases, although the relative weight we place on these asset classes will vary by company and industry. |
Extensive Due Diligence
Our Adviser and Gladstone Securities conducts what we believe are extensive due diligence
investigations of our prospective portfolio companies and investment opportunities. Our due
diligence investigation of a prospective portfolio company may begin with a review of publicly
available information and generally includes some or all of the following:
| § | a review of the prospective portfolio company’s historical and projected financial information; | ||
| § | visits to the prospective portfolio company’s business site(s); | ||
| § | interviews with the prospective portfolio company’s management, employees, customers and vendors; | ||
| § | review of all loan documents; | ||
| § | background checks on the prospective portfolio company’s management team; and | ||
| § | research on the prospective portfolio company’s products, services or particular industry and its competitive position. |
Upon completion of a due diligence investigation and a decision to proceed with an investment in a
buyout, recapitalization or other growth plan, our Adviser’s investment professionals who have
primary responsibility for the investment present the investment opportunity to our Adviser’s
investment committee. The investment committee determines whether to pursue the potential
investment. Additional due diligence of a potential investment may be conducted on our behalf by
attorneys and independent accountants prior to the closing of the investment, as well as other
outside advisers, as appropriate.
We also rely on the long-term relationships that our Adviser’s investment professionals have with
venture capitalists, leveraged buyout funds, investment bankers, commercial bankers, private equity
sponsors, and business brokers. In addition, the extensive direct experiences of our executive
officers and managing directors in the operations of and providing debt and equity capital to small
and medium-sized private businesses plays a significant role in our investment evaluation and
assessment of risk.
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Investment Structure
Once we have determined that a prospective acquisition, buyout or recapitalization meets our
standards and investment criteria, we work with the management of that company and other capital
providers to structure the transaction in a way that provides us the greatest opportunity to
maximize our return on the investment, while providing appropriate incentives to management of the
company. As we described in the Overview section above, the capital classes through which we
typically structure a deal may include subordinated and mezzanine debt, senior secured debt and
preferred and common equity. Through our risk management process, we seek to limit the downside
risk of our investments by:
| § | making investments with an expected total return (including both interest and potential equity appreciation) that we believe compensates us for the credit risk of the investment; | ||
| § | seeking collateral or superior positions in the portfolio company’s capital structure where possible; | ||
| § | incorporating put rights and call protection into the investment structure where possible; and | ||
| § | negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility as possible in managing their businesses, consistent with the need for the preservation of our capital. |
We expect to hold most of our investments in subordinated debt, mezzanine debt or equity interests
until maturity or repayment, but we will sell our investments earlier if a liquidity event takes
place, such as the sale or recapitalization of a portfolio company or, in the case of an equity
investment in a company, its initial public offering. Occasionally, we may sell some or all of our
subordinated debt, mezzanine debt or equity interests in a portfolio company to a third party, such
as an existing investor in the portfolio company, through a privately negotiated transaction.
Temporary Investments
Pending investment in our target market of small and medium-sized companies, we invest our
otherwise uninvested cash primarily in cash, cash items, government securities or high-quality debt
securities maturing in one year or less from the time of investment, to which we refer collectively
as temporary investments, so that at least 70% of our assets are “qualifying assets,” for purposes
of the business development company provisions of the 1940 Act. For information regarding
regulations to which we are subject and the definition of “qualifying assets,” see “—Regulation as
a Business Development Company.”
Hedging Strategies
Although it has not yet happened, nor do we expect this to happen in the near future, when one of
our portfolio companies goes public, we may undertake hedging strategies with regard to any equity
interests that we may have in that company. We may mitigate risks associated with the volatility of
publicly traded securities by, for example, selling securities short or writing or buying call or
put options. Hedging against a decline in the value of such investments in public companies would
not eliminate fluctuations in the values of such investments or prevent losses if the values of
such investments decline, but would establish or enhance a hedging strategy to seek to protect our
investment in such securities. Therefore, by engaging in hedging transactions, we would seek to
moderate the decline in the value of our hedged investments in public companies. However, such
hedging transactions would also limit our opportunity to gain from an increase in the value of our
investment in the public company. Hedging strategies can pose risks to us and our stockholders;
however we believe that such activities are manageable because they will be limited to only a
portion of our portfolio.
In April 2010, we, through our wholly-owned subsidiary, Gladstone Business Investment, LLC
(“Business Investment”), entered into a third amended and restated credit agreement providing for a
$50.0 million revolving line of credit (the “Credit Facility”) arranged by Branch Banking and Trust
Company (“BB&T”). Pursuant to our Credit Facility, we have agreed to enter into interest rate cap
agreements, in connection with the borrowings that we make under our Credit Facility. We currently
hold one interest rate cap agreement, which is not designated as a hedge for accounting purposes.
Section 12(a)(3) of the 1940 Act prohibits us from effecting a short sale of any security “in
contravention of such rules and regulations or orders as the [SEC] may prescribe as necessary or
appropriate in the public interest or for the protection of investors . . .” However, to date, the
SEC has not promulgated regulations under this statute, it is possible that such regulations could
be promulgated in the future in a way that would require us to change any hedging strategies that
we may adopt. In addition, our ability to engage in short sales may be limited by the 1940 Act’s
leverage limitations. We will only engage in hedging activities in compliance with applicable laws
and regulations.
Competitive Advantages
A large number of entities compete with us and make the types of investments that we seek to make
in small and medium-sized privately-owned businesses. Such competitors include private equity
funds, leveraged buyout funds, venture capital funds, investment banks and other equity and
non-equity based investment funds, and other financing sources, including traditional financial
services
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companies such as commercial banks. Many of our competitors are substantially larger than we are
and have considerably greater funding sources that are not available to us. In addition, certain of
our competitors may have higher risk tolerances or different risk assessments, which could allow
them to consider a wider variety of investments, establish more relationships and build their
market shares. Furthermore, many of these competitors are not subject to the regulatory
restrictions that the 1940 Act imposes on us as a business development company. However, we believe
that we have the following competitive advantages over other providers of financing to small and
mid-sized businesses.
Management expertise
David Gladstone, our chairman and chief executive officer, is also the chairman and chief executive
officer of our Adviser and its affiliated companies (the “Gladstone Companies”), and has been
involved in all aspects of the Gladstone Companies’ investment activities, including serving as a
member of our Adviser’s investment committee. David Dullum is our president and has extensive
experience in private equity investing in middle market companies. Terry Lee Brubaker is our
co-vice chairman, chief operating officer and secretary, and has substantial experience in
acquisitions and operations of companies. George Stelljes III is our co-vice chairman and chief
investment officer and has extensive experience in leveraged finance. Messrs. Gladstone, Dullum,
Brubaker and Stelljes have principal management responsibility for our Adviser as its senior
executive officers. These individuals dedicate a significant portion of their time to managing our
investment portfolio. Our senior management has extensive experience providing capital to small and
mid-sized companies and has worked together for more than 10 years. In addition, we have access to
the resources and expertise of our Adviser’s investment professionals and support staff who possess
a broad range of transactional, financial, managerial, and investment skills.
Increased access to investment opportunities developed through proprietary research capability and
an extensive network of contacts
Our Adviser seeks to identify potential investments both through active origination and due
diligence and through its dialogue with numerous management teams, members of the financial
community and potential corporate partners with whom our Adviser’s investment professionals have
long-term relationships. We believe that our Adviser’s investment professionals have developed a
broad network of contacts within the investment, commercial banking, private equity and investment
management communities, and that their reputation in investment management enables us to identify
well-positioned prospective portfolio companies which provide attractive investment opportunities.
Additionally, our Adviser expects to generate information from its professionals’ network of
accountants, consultants, lawyers and management teams of portfolio companies and other companies.
Disciplined, value-and-income-oriented investment philosophy with a focus on preservation of
capital
In making its investment decisions, our Adviser focuses on the risk and reward profile of each
prospective portfolio company, seeking to minimize the risk of capital loss without foregoing the
potential for capital appreciation. We expect our Adviser to use the same value-and-income-oriented
investment philosophy that its professionals use in the management of the other Gladstone Companies
and to commit resources to management of downside exposure. Our Adviser’s approach seeks to reduce
our risk in investments by using some or all of the following approaches:
| § | focusing on companies with good market positions, established management teams and good cash flow; | ||
| § | investing in businesses with experienced management teams; | ||
| § | engaging in extensive due diligence from the perspective of a long-term investor; | ||
| § | investing at low price-to-cash flow multiples; and | ||
| § | adopting flexible transaction structures by drawing on the experience of the investment professionals of our Adviser and its affiliates. |
Longer investment horizon with attractive publicly traded model
Unlike private equity and venture capital funds that are typically organized as finite-life
partnerships, we are not subject to standard periodic capital return requirements. The partnership
agreements of most private equity and venture capital funds typically provide that these funds may
only invest investors’ capital once and must return all capital and realized gains to investors
within a finite time period, often seven to 10 years. These provisions often force private equity
and venture capital funds to seek returns on their investments by causing their portfolio companies
to pursue mergers, public equity offerings, or other liquidity events more quickly than might
otherwise be optimal or desirable, potentially resulting in both a lower overall return to
investors and an adverse impact on their portfolio companies. We believe that our flexibility to
make investments with a long-term view and without the capital return requirements of traditional
private investment vehicles provides us with the opportunity to achieve greater long-term returns
on invested capital.
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Flexible transaction structuring
We believe our Adviser’s broad expertise and ability to draw upon many years of combined experience
enables it to identify, assess, and structure investments successfully across all levels of a
company’s capital structure and manage potential risk and return at all stages of the economic
cycle. We are not subject to many of the regulatory limitations that govern traditional lending
institutions such as banks. As a result, we are flexible in selecting and structuring investments,
adjusting investment criteria and transaction structures, and, in some cases, the types of
securities in which we invest. We believe that this approach enables our Adviser to identify
attractive investment opportunities that will continue to generate current income and capital gain
potential throughout the economic cycle, including during turbulent periods in the capital markets.
One example of our flexibility is our ability to exchange our publicly-traded stock for the stock
of an acquisition target in a tax-free reorganization under the Code. After completing an
acquisition in such an exchange, we can restructure the capital of the small company to include
senior and subordinated debt.
Leverage
For the purpose of making investments other than temporary investments and to take advantage of
favorable interest rates, we may issue senior debt securities up to the maximum amount permitted by
the 1940 Act. The 1940 Act currently permits us to issue senior debt securities and preferred
stock, to which we refer collectively as senior securities, in amounts such that our asset
coverage, as defined in the 1940 Act, is at least 200% after each issuance of senior securities. We
may also incur such indebtedness to repurchase our common stock. As a result of issuing senior
securities, we are exposed to the risks of leverage. Although borrowing money for investments
increases the potential for gain, it also increases the risk of a loss. A decrease in the value of
our investments will have a greater impact on the value of our common stock to the extent that we
have borrowed money to make investments. There is a possibility that the costs of borrowing could
exceed the income we receive on the investments we make with such borrowed funds. In addition, our
ability to pay distributions or incur additional indebtedness would be restricted if asset coverage
is less than twice our indebtedness. If the value of our assets declines, we might be unable to
satisfy that test. If this happens, we may be required to liquidate a portion of our loan portfolio
and repay a portion of our indebtedness at a time when a sale may be disadvantageous. Furthermore,
any amounts that we use to service our indebtedness will not be available for distributions to our
stockholders. Our Board of Directors is authorized to provide for the issuance of preferred stock
with such preferences, powers, rights and privileges as it deems appropriate, provided that such an
issuance adheres to the requirements of the 1940 Act. See “—Regulation as a Business Development
Company—Asset Coverage” for a discussion of our leveraging constraints.
Ongoing Management of Investments and Portfolio Company Relationships
Our Adviser’s investment professionals actively oversee each investment by evaluating the portfolio
company’s performance and working collaboratively with the portfolio company’s management to find
and incorporate best resources and practices that help us achieve our expected investment
performance.
Monitoring
Our Adviser’s investment professionals monitor the financial performance, trends, and changing
risks of each portfolio company on an ongoing basis to determine if each is performing within
expectations and to guide the portfolio company’s management in taking the appropriate course of
action. Our Adviser employs various methods of evaluating and monitoring the performance of our
investments in portfolio companies, which can include the following:
| § | Monthly analysis of financial and operating performance; | ||
| § | Assessment of the portfolio company’s performance against its business plan and our investment expectations; | ||
| § | Assessment of the investment’s risks; | ||
| § | Participation in portfolio company board of directors or management meetings; | ||
| § | Assessment of portfolio company management, sponsor, governance and strategic direction; | ||
| § | Assessment of the portfolio company’s industry and competitive environment; and | ||
| § | Review and assessment of the portfolio company’s operating outlook and financial projections. |
Relationship Management
Our Adviser’s investment professionals interact with various parties involved with a portfolio
company, or investment, by actively engaging with internal and external constituents, including:
| § | Management; | ||
| § | Boards of directors; |
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| § | Financial sponsors; | ||
| § | Capital partners; and | ||
| § | Advisers and consultants. |
Managerial Assistance and Services
As a business development company, we make available significant managerial assistance to our
portfolio companies and provide other services to such portfolio companies. Neither we nor our
Adviser currently receives fees in connection with the managerial assistance we make available. At
times, our Adviser provides other services to certain of our portfolio companies and it receives
fees for these other services. 50% of certain of these fees and 100% of others are credited against
the base management fee that we would otherwise be required to pay to our Adviser.
Valuation Process
The following is a general description of the steps we take each quarter to determine the value of
our investment portfolio. We value our investments in accordance with the requirements of the 1940
Act. We value securities for which market quotations are readily available at their market value.
We value all other securities and assets at fair value as determined in good faith by our Board of
Directors. In determining the value of our investments, our Adviser has established an investment
valuation policy (the “Policy”). The Policy has been approved by our Board of Directors and each
quarter the Board of Directors reviews whether our Adviser has applied the Policy consistently and
votes whether or not to accept the recommended valuation of our investment portfolio. Due to the
uncertainty inherent in the valuation process, such estimates of fair value may differ
significantly from the values that would have been obtained had a ready market for the securities
existed. Investments for which market quotations are readily available are recorded in our
financial statements at such market quotations. With respect to any investments for which market
quotations are not readily available or reliable, we perform the following valuation process each
quarter:
| § | Our quarterly valuation process begins with each portfolio company or investment being initially assessed by our Adviser’s investment professionals responsible for the investment, using the Policy. | ||
| § | Preliminary valuation conclusions are then discussed with our management, and documented, along with any independent opinions of value provided by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”), for review by our Board of Directors. | ||
| § | Our Board of Directors reviews this documentation and discusses the information provided by our management, and the opinions of value provided by SPSE to arrive at a determination that the Policy has been followed for determining the aggregate fair value of our portfolio of investments. |
Our valuation policies, procedures and processes are more fully described under “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting
Policies—Investment Valuation.”
Investment Advisory and Management Agreement
We entered into an investment advisory and management agreement with our Adviser (the “Advisory
Agreement”), which is controlled by our chairman and chief executive officer. In accordance with
the Advisory Agreement, we pay the Adviser fees as compensation for its services, consisting of a
base management fee and an incentive fee. On July 7, 2010, our Board of Directors approved the
renewal of our Advisory Agreement with our Adviser through August 31, 2011.
Base Management Fee
The base management fee is computed and payable quarterly and is assessed at an annual rate
of 2.0% computed on the basis of the value of our average gross assets at the end of the two
most recently completed quarters, which are total assets, including investments made with
proceeds of borrowings, less any uninvested cash or cash equivalents resulting from
borrowings. Overall, the base management fee cannot exceed 2.0% of total assets (as reduced
by cash and cash equivalents pledged to creditors) during any given fiscal year. In addition,
the following three items are potential adjustments to the base management fee calculation.
| • | Loan Servicing Fees | ||
| Our Adviser also services the loans held by our wholly owned subsidiary, Gladstone Business Investment, LLC (“Business Investment”), in return for which our Adviser receives a 2.0% annual fee based on the monthly aggregate outstanding balance of loans pledged under our Credit Facility. Since we own these loans, all loan servicing fees paid to our Adviser are treated as reductions directly against the 2.0% base management fee under the Advisory Agreement. |
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| • | Senior Syndicated Loan Fee Waiver | ||
| Our Board of Directors accepted an unconditional and irrevocable voluntary waiver from the Adviser to reduce the annual 2.0% base management fee on senior syndicated loan participations to 0.5%, to the extent that proceeds resulting from borrowings were used to purchase such syndicated loan participations, for the years ended March 31, 2011 and 2010. | |||
| • | Portfolio Company Fees | ||
| Under the Advisory Agreement, our Adviser has also provided and continues to provide managerial assistance and other services to our portfolio companies and may receive fees for services other than managerial assistance. 50% of certain of these fees and 100% of others are credited against the base management fee that we would otherwise be required to pay to our Adviser. |
Incentive Fee
The incentive fee consists of two parts: an income-based incentive fee and a capital
gains-based incentive fee. The income-based incentive fee rewards the Adviser if our
quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of
our net assets (the “hurdle rate”). We will pay the Adviser an income incentive fee with
respect to our pre-incentive fee net investment income in each calendar quarter as follows:
| • | no incentive fee in any calendar quarter in which its pre-incentive fee net investment income does not exceed the hurdle rate (7.0% annualized); | ||
| • | 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in any calendar quarter (8.75% annualized); and | ||
| • | 20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized). |
Quarterly Incentive Fee Based on Net Investment Income
Pre-incentive fee net investment income
(expressed as a percentage of the value of net assets)
(expressed as a percentage of the value of net assets)
Percentage of pre-incentive fee net investment income
allocated to income-related portion of incentive fee
allocated to income-related portion of incentive fee
The second part of the incentive fee is a capital gains-based incentive fee that is
determined and payable in arrears as of the end of each fiscal year (or upon termination of
the Advisory Agreement, as of the termination date), and equals 20% of our realized capital
gains as of the end of the fiscal year. In determining the capital gains-based incentive fee
payable to our Adviser, we calculate the cumulative aggregate realized capital gains and
cumulative aggregate realized capital losses since our inception, and the aggregate
unrealized capital depreciation as of the date of the calculation, as applicable, with
respect to each of the investments in our portfolio. For this purpose, cumulative aggregate
realized capital gains, if any, equals the sum of the differences between the net sales price
of each investment, when sold, and the original cost of such investment since our inception.
Cumulative aggregate realized capital losses equals the sum of the amounts by which the net
sales price of each investment, when sold, is less than the original cost of such investment
since our inception. Aggregate unrealized capital depreciation equals the sum of the
difference, if negative, between the valuation of each investment as of the applicable
calculation date and the original cost of such investment. At the end of the applicable year,
the amount of capital gains that serves as the basis for our calculation of the capital
gains-based incentive fee equals the cumulative aggregate realized capital gains less
cumulative aggregate realized capital losses, less aggregate unrealized capital depreciation,
with respect to our portfolio of investments. If this number is positive at the end of such
year, then the capital gains-based incentive fee for such year equals 20.0% of such amount,
less the aggregate amount of any capital gains-based incentive fees paid in respect of our
portfolio in all prior years.
Additionally, in accordance with accounting principles generally accepted in the United
States (“GAAP”), we did not accrue a capital gains-based incentive fee for the year ended
March 31, 2011. This GAAP accrual is calculated using the aggregate cumulative realized
capital gains and losses and aggregate cumulative unrealized capital depreciation included in
the calculation of the capital gains-based incentive fee plus the aggregate cumulative
unrealized capital appreciation. If such
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amount is positive at the end of a period, then GAAP requires us to record a capital
gains-based incentive fee equal to 20% of such amount, less the aggregate amount of actual
capital gains-based incentive fees paid in all prior years. If such amount is negative, then
there is no accrual for such year. GAAP requires that the capital gains-based incentive fee
accrual consider the cumulative aggregate unrealized capital appreciation in the calculation,
as a capital gains-based incentive fee would be payable if such unrealized capital
appreciation were realized. There can be no assurance that such unrealized capital
appreciation will be realized in the future. There was no GAAP accrual for a capital
gains-based incentive fee for the years ended March 31, 2010 or 2009, either.
Administration Agreement
We have entered into an administration agreement with our Administrator (the “Administration
Agreement”), whereby we pay separately for administrative services. The Administration Agreement
provides for payments equal to our allocable portion of our Administrator’s overhead expenses in
performing its obligations under the Administration Agreement, including, but not limited to, rent
and salaries and benefits expenses of our chief financial officer, chief compliance officer,
treasurer, internal counsel and their respective staffs. Our allocable portion of expenses is
derived by multiplying our Administrator’s total allocable expenses by the percentage of our total
assets at the beginning of the quarter in comparison to the total assets at the beginning of the
quarter of all companies managed by the Adviser under similar agreements. On July 7, 2010, our
Board of Directors approved the renewal of our Administration Agreement with our Administrator
through August 31, 2011.
Material U.S. Federal Income Tax Considerations
Regulated Investment Company Status
To maintain the qualification for treatment as a RIC under Subchapter M of the Code, we must
distribute to our stockholders, for each taxable year, at least 90% of our investment company
taxable income, which is generally our ordinary income plus short-term capital gains. We refer to
this as the annual distribution requirement. We must also meet several additional requirements,
including:
| • | Business Development Company Status. At all times during the taxable year, we must maintain our status as a business development company. | ||
| • | Income source requirements. At least 90% of our gross income for each taxable year must be from dividends, interest, payments with respect to securities loans, gains from sales or other dispositions of securities or other income derived with respect to our business of investing in securities, and net income derived from an interest in a qualified publicly traded partnership. | ||
| • | Asset diversification requirements. As of the close of each quarter of our taxable year: (1) at least 50% of the value of our assets must consist of cash, cash items, U.S. government securities, the securities of other regulated investment companies and other securities to the extent that (a) we do not hold more than 10% of the outstanding voting securities of an issuer of such other securities and (b) such other securities of any one issuer do not represent more than 5% of our total assets, and (2) no more than 25% of the value of our total assets may be invested in the securities of one issuer (other than U.S. government securities or the securities of other regulated investment companies), or of two or more issuers that are controlled by us and are engaged in the same or similar or related trades or businesses or in the securities of one or more qualified publicly traded partnerships. |
In the first quarter of the fiscal year ended March 31, 2010, we sold 29 senior syndicated loans
(collectively the, “Syndicated Loan Sales”) that were held in our portfolio of investments at March
31, 2009 to various investors in the syndicated loan market to repay amounts outstanding under our
prior line of credit with Deutsche Bank AG (the “Prior Credit Facility”), which matured in April
2009 and was not extended by Deutsche Bank AG. Such sales changed our asset composition in a
manner that has affected our ability to meet the 50% threshold requirement of the asset
diversification test applicable to RICs under the Code, which we refer to as the 50% threshold.
Failure to meet the 50% threshold alone will not result in our loss of RIC status. In circumstances
where the failure to meet the quarterly 50% threshold is the result of fluctuations in the value of
assets, including as a result of the sale of assets, we will still be deemed to have satisfied the
asset diversification test and, therefore, maintain our RIC status, as long as we have not made any
new investments, including additional investments in our portfolio companies (such as advances
under outstanding lines of credit), since the time that we fell below the 50% threshold. At March
31, 2011, similar to other quarterly measurement dates subsequent to the Syndicated Loan Sales, we
satisfied the 50% threshold through the purchase of short-term qualified securities, which was
funded primarily through a short-term loan agreement. Subsequent to
the March 31, 2011, measurement
date, the short-term qualified securities matured, and we repaid the short-term loan, at which time
we again fell below the 50% threshold. As of the date of this filing, we remain below the 50%
threshold. Thus, while we currently qualify as a RIC despite our current inability to meet the 50%
threshold and potential inability to do so in the future, our RIC status will be threatened if we
make a new or additional investment before regaining consistent compliance with the 50% threshold. If we make
such a new or additional investment and fail to regain compliance with the
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50% threshold prior to the next quarterly measurement date following such investment, we will be in
non-compliance with the RIC rules and will have thirty days to “cure” our failure of the asset
diversification test to avoid our loss of RIC status. Potential cures for failure of the asset
diversification test include raising additional equity or debt capital, and changing the
composition of our assets, which could include full or partial divestitures of investments, such
that we would once again meet or exceed the 50% threshold. In addition, a RIC may be able to cure a
failure to meet the asset diversification requirements (i) in certain circumstances by disclosing
the assets that cause the RIC to fail to satisfy the diversification test and disposing of those
assets within the time provided by law, or (ii) in other circumstances by paying an additional
corporate-level tax and by disposing of assets within the time provided by law.
Until the composition of our assets is above the required 50% threshold, we will continue to seek
to deploy similar purchases of qualified securities using short-term loans that would allow us to
satisfy the 50% threshold, thereby allowing us to make additional investments. There can be no
assurance, however, that we will be able to enter into such a transaction on reasonable terms, if
at all. We also continue to explore a number of other strategies, including changing the
composition of our assets, which could include full or partial divestitures of investments, and
raising additional equity or debt capital, such that we would once again regularly meet or exceed
the 50% threshold. Our ability to implement any of these strategies will be subject to market
conditions and a number of risks and uncertainties that are, in part, beyond our control.
Failure to Qualify as a RIC.
If we are unable to qualify for treatment as a RIC and unable to cure
a failure to qualify, we will be subject to tax on all of our taxable income at regular corporate
rates. We would not be able to deduct distributions to stockholders, nor would we be required to
make such distributions. Distributions would be taxable to our stockholders as dividend income to
the extent of our current and accumulated earnings and profits. Subject to certain limitations
under the Code, corporate distributees would be eligible for the dividends received deduction.
Distributions in excess of our current and accumulated earnings and profits would be treated first
as a return of capital to the extent of the stockholder’s tax basis, and then as a gain realized
from the sale or exchange of property. If we fail to meet the RIC requirements for more than two
consecutive years and then seek to requalify as a RIC, we would be required to recognize a gain to
the extent of any unrealized appreciation on our assets unless we make a special election to pay
corporate-level tax on any such unrealized appreciation recognized during the succeeding 10-year
period. Absent such special election, any gain we recognized would be deemed distributed to our
stockholders as a taxable distribution.
Qualification as a RIC.
If we qualify as a RIC and distribute to stockholders each year in a
timely manner at least 90% of our investment company taxable income, we will not be subject to
federal income tax on the portion of our taxable income and gains we distribute to stockholders. We
would, however, be subject to a 4% nondeductible federal excise tax if we do not distribute,
actually or on a deemed basis, 98% of our ordinary income and 98.2% of our capital gains. For the
calendar year ended December 31, 2010, we incurred $24 in excise taxes.
The excise tax would apply only to the amount by which the required distributions exceed the amount
of income we distribute, actually or on a deemed basis, to stockholders. We will be subject to
regular corporate income tax, currently at rates up to 35%, on any undistributed income, including
both ordinary income and capital gains. We intend to retain some or all of our capital gains, but
to treat the retained amount as a deemed distribution. In that case, among other consequences, we
will pay tax on the retained amount, each stockholder will be required to include its share of the
deemed distribution in income as if it had been actually distributed to the stockholder and the
stockholder will be entitled to claim a credit or refund equal to its allocable share of the tax we
pay on the retained capital gain. The amount of the deemed distribution net of such tax will be
added to the stockholder’s cost basis for its common stock. Since we expect to pay tax on any
retained capital gains at our regular corporate capital gain tax rate, and since that rate is in
excess of the maximum rate currently payable by individuals on long-term capital gains, the amount
of tax that individual stockholders will be treated as having paid will exceed the tax they owe on
the capital gain dividend and such excess may be claimed as a credit or refund against the
stockholder’s other tax obligations. A stockholder that is not subject to U.S. federal income tax
or tax on long-term capital gains would be required to file a U.S. federal income tax return on the
appropriate form in order to claim a refund for the taxes we paid. In order to utilize the deemed
distribution approach, we must provide written notice to the stockholders after the close of the
relevant tax year. We will also be subject to alternative minimum tax, but any tax preference items
would be apportioned between us and our stockholders in the same proportion that distributions,
other than capital gain dividends, paid to each stockholder bear to our taxable income determined
without regard to the dividends paid deduction.
If we acquire debt obligations that were originally issued at a discount, which would generally
include loans we make that are accompanied by warrants, that bear interest at rates that are not
either fixed rates or certain qualified variable rates or that are not unconditionally payable at
least annually over the life of the obligation, we will be required to include in taxable income
each year a portion of the original issue discount (“OID”) that accrues over the life of the
obligation. Such OID will be included in our investment company taxable income even though we
receive no cash corresponding to such discount amount. As a result, we may be required to make
additional distributions corresponding to such OID amounts in order to satisfy the annual
distribution requirement and to continue to qualify as a RIC or to avoid the 4% excise tax. In this
event, we may be required to sell temporary investments or other assets to meet the RIC
distribution requirements. Through March 31, 2011, we incurred no OID income.
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Taxation of Our U.S. Stockholders
Distributions.
For any period during which we qualify for treatment as a RIC for federal income
tax purposes, distributions to our stockholders attributable to our investment company taxable
income generally will be taxable as ordinary income to stockholders to the extent of our current or
accumulated earnings and profits. Any distributions in excess of our earnings and profits will
first be treated as a return of capital to the extent of the stockholder’s adjusted basis in his or
her shares of common stock and thereafter as gain from the sale of shares of our common stock.
Distributions of our long-term capital gains, reported by us as such, will be taxable to
stockholders as long-term capital gains regardless of the stockholder’s holding period for its
common stock and whether the distributions are paid in cash or invested in additional common stock.
Corporate stockholders are generally eligible for the 70% dividends received deduction with respect
to ordinary income, but not for capital gains dividends to the extent such amount reported by us
does not exceed the dividends received by us from domestic corporations. Any dividend declared by
us in October, November or December of any calendar year, payable to stockholders of record on a
specified date in such a month and actually paid during January of the following year, will be
treated as if it were paid by us and received by the stockholders on December 31 of the previous
year. In addition, we may elect to relate a dividend back to the prior taxable year if we (1)
declare such dividend prior to the later of the due date for filing our return for that taxable
year or the 15
th
day of the ninth month following the close of the taxable year, (2)
make the election in that return, and (3) distribute the amount in the 12-month period following
the close of the taxable year but not later than the first regular dividend payment of the same
type following the declaration. Any such election will not alter the general rule that a
stockholder will be treated as receiving a dividend in the taxable year in which the distribution
is made, subject to the October, November, December rule described above.
If a stockholder participates in our dividend reinvestment plan, any distributions reinvested under
the plan will be taxable to the stockholder to the same extent, and with the same character, as if
the stockholder had received the distribution in cash. The stockholder will have an adjusted basis
in the additional common shares purchased through the plan equal to the amount of the reinvested
distribution. The additional shares will have a new holding period commencing on the day following
the day on which the shares are credited to the stockholder’s account.
Sale of Our Shares.
A U.S. stockholder generally will recognize taxable gain or loss if the U.S.
stockholder sells or otherwise disposes of his, her or its shares of our common stock. Any gain
arising from such sale or disposition generally will be treated as long-term capital gain or loss
if the U.S. stockholder has held his, her or its shares for more than one year. Otherwise, it will
be classified as short-term capital gain or loss. However, any capital loss arising from the sale
or disposition of shares of our common stock held for six months or less will be treated as
long-term capital loss to the extent of the amount of capital gain dividends received, or
undistributed capital gain deemed received, with respect to such shares. Under the tax laws in
effect as of the date of this filing, individual U.S. stockholders are subject to a maximum federal
income tax rate of 15% on their net capital gain (
i.e.
the excess of realized net long-term capital
gain over realized net short-term capital loss for a taxable year) including any long-term capital
gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary
income currently payable by individuals. Corporate U.S. stockholders currently are subject to
federal income tax on net capital gain at the same rates applied to their ordinary income
(currently up to a maximum of 35%). Capital losses are subject to limitations on use for both
corporate and non-corporate stockholders.
Backup Withholding.
We may be required to withhold federal income tax, or backup withholding,
currently at a rate of 28%, from all taxable distributions to any non-corporate U.S. stockholder
(1) who fails to furnish us with a correct taxpayer identification number or a certificate that
such stockholder is exempt from backup withholding, or (2) with respect to whom the Internal
Revenue Service (“IRS”) notifies us that such stockholder has failed to properly report certain
interest and dividend income to the IRS and to respond to notices to that effect. An individual’s
taxpayer identification number is generally his or her social security number. Any amount withheld
under backup withholding is allowed as a credit against the U.S. stockholder’s federal income tax
liability, provided that proper information is provided to the IRS.
Regulation as a Business Development Company
We are 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. As such, we are subject to
regulation under the 1940 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 we may not change the nature of our business so as to cease to be, or to withdraw our
election as, a business development company unless approved by a majority of our outstanding
“voting securities,” as defined in the 1940 Act.
We intend to conduct our business so as to retain our status as a business development company. A
business development company may use capital provided by public stockholders and from other sources
to invest in long-term private investments in businesses. A business development company provides
stockholders the ability to retain the liquidity of a publicly traded stock while sharing in the
possible benefits, if any, of investing in primarily privately owned companies. In general, a
business development company must
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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 qualifying assets, as described in Section 55(a)
(1) – (3) of the 1940 Act.
Qualifying Assets
Under the 1940 Act, a business development company may not acquire any asset other than assets of
the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets,
unless, at the time the acquisition is made, qualifying assets, other than certain interests in
furniture, equipment, real estate, or leasehold improvements (“operating assets”) represent at
least 70% of the company’s total assets, exclusive of operating assets. The types of qualifying
assets in which we may invest under the 1940 Act include, but are not limited to, 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 generally defined in the 1940 Act as any issuer which: |
| (a) | is organized under the laws of, and has its principal place of business in, any State or States in the United States; | ||
| (b) | is not an investment company (other than a small business investment company wholly owned by the business development company or otherwise excluded from the definition of investment company); and | ||
| (c) | satisfies one of the following: |
| (i) | it does not have any class of securities with respect to which a broker or dealer may extend margin credit; | ||
| (ii) | it is controlled by the business development company and for which an affiliate of the business development company serves as a director; | ||
| (iii) | it has total assets of not more than $4 million and capital and surplus of not less than $2 million; | ||
| (iv) | it does not have any class of securities listed on a national securities exchange; or | ||
| (v) | it has a class of securities listed on a national securities exchange, with an aggregate market value of outstanding voting and non-voting equity of less than $250 million. |
| (2) | Securities received in exchange for or distributed on or with respect to securities described in (1) above, or pursuant to the exercise of options, warrants or rights relating to such securities. | ||
| (3) | Cash, cash items, government securities or high quality debt securities maturing in one year or less from the time of investment. |
Asset Coverage
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one
class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at
least 200% immediately after each such issuance. In addition, while senior securities are
outstanding, we must make provisions to prohibit any distribution to our stockholders or the
repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the
time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our
total assets for temporary purposes. The 1940 Act requires, among other things, that (1)
immediately after issuance and before any dividend or distribution is made with respect to our
common stock or before any purchase of our common stock is made, the preferred stock, together with
all other senior securities, must not exceed an amount equal to 50% of our total assets after
deducting the amount of such dividend, distribution or purchase price, as the case may be, and (2)
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.
Significant Managerial Assistance
A business development company generally must make available significant managerial assistance to
issuers of certain of its portfolio securities that the business development company counts as a
qualifying asset for the 70% test described above. Making available significant managerial
assistance means, among other things, any arrangement whereby the business development company,
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. Significant managerial assistance also includes the exercise of a
controlling influence over the management and policies of the portfolio company. However, with
respect to certain, but not all such securities, where the business development company 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, or the business development
company may exercise such control jointly.
Investment Policies
We seek to achieve a high level of current income and capital gains through investments in debt
securities and preferred and common stock that we acquired in connection with buyout and other
recapitalizations. The following investment policies, along with these investment objectives, may
not be changed without the approval of our Board of Directors:
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| § | We will at all times conduct our business so as to retain our status as a business development company. In order to retain that status, we must be operated for the purpose of investing in certain categories of qualifying assets. In addition, we may not acquire any assets (other than non-investment assets necessary and appropriate to our operations as a business development company or qualifying assets) if, after giving effect to such acquisition, the value of our “qualifying assets” is less than 70% of the value of our total assets. We anticipate that the securities we seek to acquire, as well as temporary investments, will generally be qualifying assets. | ||
| § | We will at all times endeavor to conduct our business so as to retain our status as a RIC under the Code. In order to do so, we must meet income source, asset diversification and annual distribution requirements. We may issue senior securities, such as debt or preferred stock, to the extent permitted by the 1940 Act for the purpose of making investments, to fund share repurchases, or for temporary emergency or other purposes. |
With the exception of our policy to conduct our business as a business development company, these
policies are not fundamental and may be changed without stockholder approval.
Code of Ethics
We and our Adviser have each adopted a code of ethics and business conduct applicable to our
officers, directors and all employees of our Adviser and our Administrator that complies with the
guidelines set forth in Item 406 of Regulation S-K of the Securities Act of 1933, as amended (the
“Securities Act”). As required by the 1940 Act, this code establishes procedures for personal
investments, restricts certain transactions by our personnel and requires the reporting of certain
transactions and holdings by our personnel. A copy of this code is available for review, free of
charge, at our website at www.GladstoneInvestment.com. We intend to provide any required
disclosure of any amendments to or waivers of the provisions of this code by posting information
regarding any such amendment or waiver to our website within four days of its effectiveness.
Compliance Policies and Procedures
We and our Adviser have adopted and implemented written policies and procedures reasonably designed
to prevent violation of the federal securities laws, and our Board of Directors is required to
review these compliance policies and procedures annually to assess their adequacy and the
effectiveness of their implementation. We have designated a chief compliance officer, John
Dellafiora, Jr., who also serves as chief compliance officer for our Adviser.
Staffing
We do not currently have any employees and do not expect to have any employees in the foreseeable
future. Currently, services necessary for our business are provided by individuals who are
employees of our Adviser or our Administrator pursuant to the terms of the Advisory Agreement and
the Administration Agreement, respectively. Excluding our chief financial officer, each of our
executive officers is an employee or officer, or both, of our Adviser and our Administrator. No
employee of our Adviser and our Administrator will dedicate all of his or her time to us. However,
we expect that 25-30 full time employees of our Adviser and our Administrator will spend
substantial time on our matters during the remainder of calendar year 2011 and all of calendar year
2012. To the extent we acquire more investments, we anticipate that the number of employees of our
Adviser and our Administrator who devote time to our matters will increase.
As of May 20, 2011, our Adviser and Administrator collectively had 52 full-time employees. A
breakdown of these employees is summarized by functional area in the table below:
| Number of Individuals | Functional Area | |||
| 9 |
Executive Management
|
|||
| 33 |
Investment Management, Portfolio Management and Due Diligence
|
|||
| 10 |
Administration, Accounting, Compliance, Human Resources, Legal and Treasury
|
|||
Available Information:
Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments, if any, to those reports filed pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”) are available free of charge
through our website at www.gladstoneinvestment.com. A request for any of these reports may also be
submitted to us by sending a written request addressed to Investor Relations Manager, Gladstone
Investment Corporation, 1521 Westbranch Drive, Suite 200, McLean, VA 22102, or by calling our
toll-free investor relations line at 1-866-366-5745. The public may read and copy materials that we
file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549.
Information on the operation of the Public Reference Room may be obtained by calling the SEC at
1-800-SEC-0330. The SEC also maintains a website that contains reports, proxy and information
statements, and other information regarding issuers that file electronically with the SEC at
www.sec.gov.
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| ITEM 1A. | RISK FACTORS |
An investment in our securities involves a number of significant risks and other factors relating
to our structure and investment objectives. As a result, we cannot assure you that we will achieve
our investment objectives. You should consider carefully the following information before making an
investment in our securities.
Risks Related to the Economy
The current state of the economy and the capital markets increases the possibility of adverse
effects on our financial position and results of operations. Continued economic adversity could
impair our portfolio companies’ financial positions and operating results and affect the industries
in which we invest, which could, in turn, harm our operating results. Continued adversity in the
capital markets could impact our ability to raise capital and reduce our volume of new investments.
The United States is beginning to recover from the recession that largely began in late 2007.
Despite signs of economic improvement and stabilization in both the equity and debt markets,
however, conditions within the global credit markets generally continue to experience dislocation
and stress. As a result, we do not know if adverse conditions will again intensify, and we are
unable to gauge the full extent to which the disruptions will affect us. The longer these
uncertain conditions persist, the greater the probability that these factors could continue to
increase our costs of, and significantly limit our access to, debt and equity capital and, thus,
have an adverse effect on our operations and financial results. Many of the companies in which we
have made or will make investments are also susceptible to these unstable economic conditions,
which may affect the ability of one or more of our portfolio companies to repay our loans or engage
in a liquidity event, such as a sale, recapitalization or initial public offering. These unstable
economic conditions could also disproportionately impact some of the industries in which we invest,
causing us to be more vulnerable to losses in our portfolio, which could cause the number of our
non-performing assets to increase and the fair value of our portfolio to decrease. The unstable
economic conditions may also decrease the value of collateral securing some of our loans as well as
the value of our equity investments which would decrease our ability to borrow under our line of
credit or raise equity capital, thereby further reducing our ability to make new investments.
The unstable economic conditions have affected the availability of credit generally and we have
seen a reduction in committed funding under our line of credit from $125.0 million to $50.0 million
and the withdrawal of Deutsche Bank AG as a committed lender. Moreover, during the first quarter
of fiscal year 2010, we were forced to sell 29 of the 32 senior syndicated loans that were held in
our portfolio of investments at March 31, 2009 in order to repay amounts outstanding under our
Prior Credit Facility. The loans, in aggregate, had a cost value of approximately $104.2 million,
or 29.9% of the cost value of our total investments, and an aggregate fair value of approximately
$69.8 million, or 22.2% of the fair value of our total investments, at March 31, 2009. As a result
of these sales, we received approximately $69.2 million in net cash proceeds and recorded a
realized loss of approximately $34.6 million. Our current line of credit limits our distributions
to stockholders and, as a result, beginning in fiscal year 2010, we decreased our monthly cash
distribution rate by 50.0% as compared to the prior year period in an effort to more closely align
our distributions to our net investment income, though we had subsequently increased our
distributions by 12.5% in April 2011. We do not know when market conditions will fully stabilize,
if adverse conditions will intensify or the full extent to which the disruptions will continue to
affect us. Also, it is possible that persistent instability of the financial markets could have
other unforeseen material effects on our business.
We may experience fluctuations in our quarterly and annual results based on the impact of inflation
in the United States.
The majority of our portfolio companies are in industries that are directly impacted by inflation,
such as manufacturing and consumer goods and services. Our portfolio companies may not be able to
pass on to customers increases in their costs of production which could greatly affect their
operating results, impacting their ability to repay our loans. In addition, any projected future
decreases in our portfolio companies’ operating results due to inflation could adversely impact the
fair value of those investments. Any decreases in the fair value of our investments could result in
future unrealized losses and therefore reduce our net assets resulting from operations.
Risks Related to Our External Management
We are dependent upon our key management personnel and the key management personnel of our Adviser,
particularly David Gladstone, George Stelljes III, Terry Lee Brubaker and David Dullum, and on the
continued operations of our Adviser, for our future success.
We have no employees. Our chief executive officer, president and chief investment officer, chief
operating officer and chief financial officer, and the employees of our Adviser, do not spend all
of their time managing our activities and our investment portfolio. We are particularly dependent
upon David Gladstone, George Stelljes III, Terry Lee Brubaker and David Dullum in this regard. Our
executive officers and the employees of our Adviser allocate some, and in some cases a material
portion, of their time to businesses and activities that are not related to our business. We have
no separate facilities and are completely reliant on our Adviser, which has significant discretion
as to the implementation and execution of our business strategies and risk management practices. We
are subject to the risk of discontinuation of our Adviser’s operations or termination of the
Advisory Agreement and the risk that, upon such event,
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no suitable replacement will be found. We
believe that our success depends to a significant extent upon our Adviser and that discontinuation
of its operations could have a material adverse effect on our ability to achieve our investment
objectives.
Our incentive fee may induce our Adviser to make certain investments, including speculative
investments.
The management compensation structure that has been implemented under the Advisory Agreement may
cause our Adviser to invest in high risk investments or take other risks. In addition to its
management fee, our Adviser is entitled under the Advisory Agreement to receive incentive
compensation based in part upon our achievement of specified levels of income. In evaluating
investments and other management strategies, the opportunity to earn incentive compensation based
on net income may lead our Adviser to place undue emphasis on the maximization of net income at the
expense of other criteria, such as preservation of capital, maintaining sufficient liquidity, or
management of credit risk or market risk, in order to achieve higher incentive compensation.
Investments with higher yield potential are generally riskier or more speculative. This could
result in increased risk to the value of our investment portfolio.
We may be obligated to pay our Adviser incentive compensation even if we incur a loss.
The Advisory Agreement entitles our Adviser to incentive compensation for each fiscal quarter in an
amount equal to a percentage of the excess of our investment income for that quarter (before
deducting incentive compensation, net operating losses and certain other items) above a threshold
return for that quarter. When calculating our incentive compensation, our pre-incentive fee net
investment income excludes realized and unrealized capital losses that we may incur in the fiscal
quarter, even if such capital losses result in a net loss on our statement of operations for that
quarter. Thus, we may be required to pay our Adviser incentive compensation for a fiscal quarter
even if there is a decline in the value of our portfolio or we incur a net loss for that quarter.
For additional information on incentive compensation under the Advisory Agreement with our Adviser,
see “Business—Investment Advisory and Management Agreement.”
For example, during fiscal 2010, based on the Advisory Agreement, our Adviser was entitled to an
incentive fee of $588 even though we incurred a loss of $4.4 million for the quarter ended December
31, 2009, resulting primarily from a decline in the value of our portfolio. The Adviser’s board
of directors subsequently irrevocably waived and credited $102 of the incentive fee, resulting in a
net incentive fee for the fiscal year ended March 31, 2010 of $486.
Our Adviser’s failure to identify and invest in securities that meet our investment criteria or
perform its responsibilities under the Advisory Agreement may adversely affect our ability for
future growth.
Our ability to achieve our investment objectives will depend on our ability to grow, which in turn
will depend on our Adviser’s ability to identify and invest in securities that meet our investment
criteria. Accomplishing this result on a cost-effective basis will be largely a function of our
Adviser’s structuring of the investment process, its ability to provide competent and efficient
services to us, and our access to financing on acceptable terms. The senior management team of our
Adviser has substantial responsibilities under the Advisory Agreement. In order to grow, our
Adviser will need to hire, train supervise and manage new employees successfully. Any failure to
manage our future growth effectively could have a material adverse effect on our business,
financial condition and results of operations.
There are significant potential conflicts of interest which could impact our investment returns.
Our executive officers and directors, and the officers and directors of our Adviser, serve or may
serve as officers, directors or principals of entities that operate in the same or a related line
of business as we do or of investment funds managed by our affiliates. Accordingly, they may have
obligations to investors in those entities, the fulfillment of which might not be in the best
interests of us or our stockholders. For example, Mr. Gladstone, our chairman and chief executive
officer, is the chairman of the board and chief executive officer of our Adviser, Gladstone Capital
and Gladstone Commercial and the sole stockholder of Gladstone Land. In addition, Mr. Brubaker, our
co-vice chairman, chief operating officer and secretary is the vice chairman, chief operating
officer and secretary of our Adviser, Gladstone Capital and Gladstone Commercial. Mr. Stelljes, our
co-vice chairman and chief investment officer, is also the president and chief investment officer
of our Adviser, Gladstone Capital and Gladstone Commercial. Mr. Dullum, our president and a
director, is a senior managing director of our Adviser and a director of Gladstone Capital and
Gladstone Commercial. Moreover, our Adviser may establish or sponsor other investment vehicles
which from time to time may have potentially overlapping investment objectives with those of ours
and accordingly may invest in, whether principally or secondarily, asset classes similar to those
we target. For example, our Adviser filed a registration statement with the Securities and Exchange
Commission for a proposed initial public offering of common stock of Gladstone Lending Corporation,
a proposed fund that would primarily invest in first and second lien term loans. While our Adviser
generally has broad authority to make investments on behalf of the investment vehicles that it
advises, our Adviser has adopted investment allocation procedures to address these potential
conflicts and intends to direct investment opportunities to the Gladstone affiliate with the
investment strategy that most closely fits the investment opportunity. Nevertheless, the management
of our Adviser may face conflicts in the allocation of investment opportunities to other entities
managed by our Adviser. As a result, it is possible that we may not be given the opportunity to
participate in certain investments made
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by other members of our Adviser and its affiliated
companies or investment funds managed by investment managers affiliated with our Adviser.
In certain circumstances, we may make investments in a portfolio company in which one of our
affiliates has or will have an investment, subject to satisfaction of any regulatory restrictions
and, where required, to the prior approval of our Board of Directors. As of March 31, 2011, our
Board of Directors has approved the following types of co-investment transactions:
| § | Our affiliate, Gladstone Commercial, may lease property to portfolio companies that we do not control under certain circumstances. Our Adviser may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria of Gladstone Commercial and (iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial. We expect that any such negotiations between Gladstone Commercial and our portfolio companies would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours. | ||
| § | We may invest simultaneously with our affiliate Gladstone Capital in senior syndicated loans whereby neither we nor any affiliate has the ability to dictate the terms of the loans. | ||
| § | Additionally, pursuant to an exemptive order granted by the Securities and Exchange Commission, our Adviser may sponsor a private investment fund to co-invest with us and Gladstone Capital in accordance with the terms and conditions of the order. |
Certain of our officers who are also officers of our Adviser may from time to time serve as
directors of certain of our portfolio companies. If an officer serves in such capacity with one of
our portfolio companies, such officer will owe fiduciary duties to all stockholders of the
portfolio company, which duties may from time to time conflict with the interests of our
stockholders.
In the course of our investing activities, we will pay management and incentive fees to our Adviser
and will reimburse our Administrator for certain expenses it incurs. As a result, investors in our
common stock will invest on a “gross” basis and receive distributions on a “net” basis after
expenses, resulting in, among other things, a lower rate of return than one might achieve through
our investors themselves making direct investments. As a result of this arrangement, there may be
times when the management team of our Adviser has interests that differ from those of our
stockholders, giving rise to a conflict.
Our Adviser is not obligated to provide a waiver of the base management fee, which could negatively
impact our earnings and our ability to maintain our current level of distributions to our
stockholders.
The Advisory Agreement provides for a base management fee based on our gross assets. Since our 2008
fiscal year, our Board of Directors has accepted on a quarterly basis voluntary, unconditional and
irrevocable waivers to reduce the annual 2.0% base management fee on senior syndicated loan
participations to 0.5% to the extent that proceeds resulting from borrowings were used to purchase
such syndicated loan participations, and any waived fees may not be recouped by our Adviser in the
future. However, our Adviser is not required to issue these or other waivers of fees under the
Advisory Agreement, and to the extent our investment portfolio grows in the future, we expect these
fees will increase. If our Adviser does not issue these waivers in future quarters, it could
negatively impact our earnings and may compromise our ability to maintain our current level of
distributions to our stockholders, which could have a material adverse impact on our stock price.
Our business model is dependent upon developing and sustaining strong referral relationships with
investment bankers, business brokers and other intermediaries.
We are dependent upon informal relationships with investment bankers, business brokers and
traditional lending institutions to provide us with deal flow. If we fail to maintain our
relationship with such funds or institutions, or if we fail to establish strong referral
relationships with other funds, we will not be able to grow our portfolio of investments and fully
execute our business plan.
Risks Related to Our External Financing
In recent years, creditors have significantly curtailed their lending to business development
companies, including us. Because of the limited amount of committed funding under our line of
credit, we will have limited ability to fund new investments if we are unable to expand the facility.
On April 13, 2010, through Business Investment, we entered into a third amended and restated credit
agreement providing for a $50.0 million revolving line of credit (the “Credit Facility”) arranged
by Branch Banking and Trust Company (“BB&T”) as administrative agent. Key Equipment Finance Company
Inc. also joined the Credit Facility as a committed lender. Committed funding under the Credit
Facility was reduced from the $125.0 million under our Prior Credit Facility and Deutsche Bank AG,
which was a committed lender under the Prior Credit Facility, elected not to participate in the
Credit Facility and withdrew its commitment. The Credit Facility may be expanded up to $125.0
million through the addition of other committed lenders to the facility. However, if additional
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lenders are unwilling to join the facility on its terms, we will be unable to expand the facility
and thus will continue to have limited availability to finance new investments under our line of
credit. The Credit Facility matures on April 13, 2012, and if the facility is
not renewed or extended by this date, all principal and interest will be due and payable within one
year of maturity. Between the maturity date and April 13, 2013, our lenders have the right to apply
all interest income to amounts outstanding under the Credit Facility. As of May 20, 2011 we had
$41.7 million of borrowing capacity under the Credit Facility. There can be no guarantee that we
will be able to renew, extend or replace the Credit Facility upon its maturity in 2012 on terms
that are favorable to us, if at all. Our ability to expand the Credit Facility, and to obtain
replacement financing at the time of its maturity, will be constrained by then-current economic
conditions affecting the credit markets. In the event that we are not able to expand the Credit
Facility, or to renew, extend or refinance the Credit Facility at the time of its maturity, this
could have a material adverse effect on our liquidity and ability to fund new investments, our
ability to make distributions to our stockholders and our ability to qualify as a RIC under the
Code.
Our business plan is dependent upon external financing, which is constrained by the limitations of
the 1940 Act.
Our business requires a substantial amount of cash to operate and grow. We may acquire such
additional capital from the following sources:
| • | Senior Securities. We may issue debt securities, other evidences of indebtedness (including borrowings under our line of credit) and possibly preferred stock, up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us, as a business development company, to issue debt securities, and preferred stock, which we refer to collectively as senior securities, in amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of senior securities. As a result of issuing senior securities, we will be exposed to the risks associated with leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we receive on the investments we make with such borrowed funds. In addition, our ability to pay distributions or incur additional indebtedness would be restricted if asset coverage is not at least twice our indebtedness. If the value of our assets declines, we might be unable to satisfy that test. If this happens, we may be required to liquidate a portion of our loan portfolio and repay a portion of our indebtedness at a time when a sale, to the extent possible given the limited market for many of our investments, may be disadvantageous. Furthermore, any amounts that we use to service our indebtedness will not be available for distributions to our stockholders. | |
| • | Common Stock. Because we are constrained in our ability to issue debt for the reasons given above, we are dependent on the issuance of equity as a financing source. If we raise additional funds by issuing more common stock or senior securities convertible into or exchangeable for our common stock, the percentage ownership of our stockholders at the time of the issuance would decrease and our common stock may experience dilution. In addition, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. In addition, under the 1940 Act, we will generally not be able to issue additional shares of our common stock at a price below net asset value per share to purchasers, other than to our existing stockholders, through a rights offering without first obtaining the approval of our stockholders and our independent directors. If we were to sell shares of our common stock below our then current net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. For example, if we sell an additional 10% of our common stock at a 5% discount from net asset value, a stockholder who does not participate in that offering for its proportionate interest will suffer net asset value dilution of up to 0.5% or $5 per $1,000 of net asset value. This imposes constraints on our ability to raise capital when our common stock is trading at below net asset value, as it has for the last year. |
A change in interest rates may adversely affect our profitability and our hedging strategy may
expose us to additional risks.
We anticipate using a combination of equity and long-term and short-term borrowings to finance our
investment activities. As a result, a portion of our income will depend upon the difference between
the rate at which we borrow funds and the rate at which we loan these funds. Higher interest rates
on our borrowings will decrease the overall return on our portfolio.
Ultimately, we expect approximately 80% of the loans in our portfolio to be at variable rates
determined on the basis of a LIBOR rate and approximately 20% to be at fixed rates. As of March 31,
2011, our portfolio had approximately 0.2% of the total loans at cost at variable rates,
approximately 71.7% of the total loans at cost at variable rates with floors and approximately
28.1% of the total loans at cost at fixed rates.
We currently hold one interest rate cap agreement. While hedging activities may insulate us against
adverse fluctuations in interest rates, they may also limit our ability to participate in the
benefits of lower interest rates with respect to the hedged portfolio. Adverse developments
resulting from changes in interest rates or any future hedging transactions could have a material
adverse effect on our business, financial condition and results of operations. Our ability to
receive payments pursuant to an interest rate cap agreement is linked to the ability of the
counter-party to that agreement to make the required payments. To the extent that the counter-party
to the
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agreement is unable to pay pursuant to the terms of the agreement, we may lose the hedging
protection of the interest rate cap agreement.
In addition to regulatory limitations on our ability to raise capital, our line of credit contains
various covenants which, if not complied with, could accelerate our repayment obligations under the
facility, thereby materially and adversely affecting our liquidity, financial condition, results of
operations and ability to pay distributions.
We will have a continuing need for capital to finance our loans. In order to maintain RIC status,
we will be required to distribute to our stockholders at least 90% of our ordinary income and
short-term capital gains on an annual basis. Accordingly, such earnings will not be available to
fund additional investments. Therefore, we entered into a Credit Facility, which provides us with
a revolving credit line facility of $50.0 million, of which $41.7 million was available for
borrowings as of May 20, 2011. The Credit Facility permits us to fund additional loans and
investments as long as we are within the conditions set out in the credit agreement. Current market
conditions have forced us to write down the value of a portion of our assets as required by the
1940 Act and fair value accounting rules. These are not realized losses but constitute adjustment
in asset values for purposes of financial reporting and for collateral value for the Credit
Facility. As assets are marked down in value, the amount we can borrow on the Credit Facility
decreases.
As a result of the Credit Facility, we are subject to certain limitations on the type of loan
investments we make, including restrictions on geographic concentrations, sector concentrations,
loan size, dividend payout, payment frequency and status, and average life. The credit agreement
also requires us to comply with other financial and operational covenants, which require us to,
among other things, maintain certain financial ratios, including asset and interest coverage and a
minimum net worth. As of March 31, 2011, we were in compliance with these covenants; however, our
continued compliance with these covenants depends on many factors, some of which are beyond our
control. In particular, depreciation in the valuation of our assets, which valuation is subject to
changing market conditions that remain very volatile, affects our ability to comply with these
covenants.
During the year ended March 31, 2011, net unrealized depreciation on our investments was $23.2
million, which reflected the reversal of $21.9 million in unrealized appreciation resulting from
our realized gains. Excluding reversals, we had $1.3 million in unrealized depreciation for the
year ended March 31, 2011. During the year ended March 31, 2010, net unrealized appreciation on
our investments was $14.3 million, which reflected the reversal of $35.7 million in unrealized
depreciation resulting from our realized losses. Excluding reversals, we had $21.4 million in
unrealized depreciation for the year ended March 31, 2010. Given
the volatility in the
capital markets, the cumulative unrealized depreciation in our portfolio may increase in future
periods and threaten our ability to comply with the covenants under the Credit Facility.
Accordingly, there are no assurances that we will continue to comply with these covenants. Under
the Credit Facility, we are also required to maintain our status as a BDC under the 1940 Act and as
a RIC under the Code. Because of changes in our asset portfolio, due to significant sales of
Non-Control/Non-Affiliate investments during fiscal 2010, there is a significant possibility that
we may not meet the asset diversification threshold under the Code’s rules applicable to a RIC as
of our next quarterly testing date, June 30, 2011. Although this failure alone, in our current
situation, will not cause us to lose our RIC status, our status could be jeopardized if we make any
new investments, including additional investments in our portfolio companies (such as advances
under our outstanding lines of credit). For more information on our current RIC
status, see “Material U.S. Federal Income Tax Considerations — Regulated Investment Company
Status.” Our failure to satisfy these covenants could result in foreclosure by our lenders, which
would accelerate our repayment obligations under the facility and thereby have a material adverse
effect on our business, liquidity, financial condition, results of operations and ability to pay
distributions to our stockholders.
Any inability to renew, extend or replace our line of credit on terms favorable to us, or at all,
could adversely impact our liquidity and ability to fund new investments or maintain distributions
to our stockholders.
Availability under the Credit Facility will terminate on April 13, 2012 and if the facility is not
renewed or extended by such date, all principal and interest will be due and payable on April 13,
2013, one year after the date of maturity. Between the maturity date and April 13, 2013, our
lenders have the right to apply all interest income to amounts outstanding under the Credit
Facility. As of May 20, 2011, there were no borrowings outstanding on the Credit Facility. There
can be no guarantee that we will be able to renew, extend or replace the Credit Facility on terms
that are favorable to us, or at all. Our ability to obtain replacement financing will be
constrained by current economic conditions affecting the credit markets. Consequently, any renewal,
extension or refinancing of the Credit Facility will potentially result in significantly higher interest
rates and related charges and may impose significant restrictions on the use of borrowed funds with
regard to our ability to fund investments or maintain distributions to stockholders. If we are
unable to secure replacement financing, we may be forced to sell certain assets on disadvantageous
terms, which may result in realized losses, and such realized losses could materially exceed the
amount of any unrealized depreciation on these assets as of our most recent balance sheet date,
which would have a material adverse effect on our results of operations. In addition to selling
assets, or as an alternative, we may issue equity in order to repay amounts outstanding under the
line of credit. Based on the recent trading prices of our stock, such an equity offering may have a
substantial dilutive impact on our existing stockholders’ interest in our earnings and assets and
voting interest in us.
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Risks Related to Our Investments
We operate in a highly competitive market for investment opportunities.
A large number of entities compete with us and make the types of investments that we seek to make
in small and mid-sized companies. We compete with public and private buyout funds, commercial and
investment banks, commercial financing companies, and, to the extent they provide an alternative
form of financing, hedge funds. Many of our competitors are substantially larger and have
considerably greater financial, technical, and marketing resources than we do. For example, some
competitors may have a lower cost of funds and access to funding sources that are not available to
us. In addition, some of our competitors may have higher risk tolerances or different risk
assessments, which would allow them to consider a wider variety of investments and establish more
relationships than us. Furthermore, many of our competitors are not subject to the regulatory
restrictions that the 1940 Act imposes on us as a business development company. The competitive
pressures we face could have a material adverse effect on our business, financial condition and
results of operations. Also, as a result of this competition, we may not be able to take advantage
of attractive investment opportunities from time to time, and we can offer no assurance that we
will be able to identify and make investments that are consistent with our investment objective. We
do not seek to compete based on the interest rates we offer, and we believe that some of our
competitors may make loans with interest rates that will be comparable to or lower than the rates
we offer. We may lose investment opportunities if we do not match our competitors’ pricing, terms
and structure. However, if we match our competitors’ pricing, terms and structure, we may
experience decreased net interest income and increased risk of credit loss.
Our investments in small and medium-sized portfolio companies are extremely risky and could cause
you to lose all or a part of your investment.
Investments in small and medium-sized portfolio companies are subject to a number of significant
risks including the following:
| § | Small and medium-sized businesses are likely to have greater exposure to economic downturns than larger businesses. Our portfolio companies may have fewer resources than larger businesses, and thus the recent recession, and any further economic downturns or recessions, are more likely to have a material adverse effect on them. If one of our portfolio companies is adversely impacted by a recession, its ability to repay our loan or engage in a liquidity event, such as a sale, recapitalization or initial public offering would be diminished. | ||
| § | Small and medium-sized businesses may have limited financial resources and may not be able to repay the loans we make to them. Our strategy includes providing financing to portfolio companies that typically is not readily available to them. While we believe that this provides an attractive opportunity for us to generate profits, this may make it difficult for the portfolio companies to repay their loans to us upon maturity. A borrower’s ability to repay its loan may be adversely affected by numerous factors, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. A deterioration in a borrower’s financial condition and prospects usually will be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing on any guarantees we may have obtained from the borrower’s management. Although we will sometimes seek to be the senior, secured lender to a borrower, in most of our loans we expect to be subordinated to a senior lender, and our interest in any collateral would, accordingly, likely be subordinate to another lender’s security interest. | ||
| § | Small and medium-sized businesses typically have narrower product lines and smaller market shares than large businesses. Because our target portfolio companies are smaller businesses, they will tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, our portfolio companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing and other capabilities and a larger number of qualified managerial and technical personnel. | ||
| § | There is generally little or no publicly available information about these businesses. Because we seek to invest in privately-owned businesses, there is generally little or no publicly available operating and financial information about our potential portfolio companies. As a result, we rely on our officers, our Adviser and its employees and consultants to perform due diligence investigations of these portfolio companies, their operations and their prospects. We may not learn all of the material information we need to know regarding these businesses through our investigations. | ||
| § | Small and medium-sized businesses generally have less predictable operating results. We expect that our portfolio companies may have significant variations in their operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position or may be adversely affected by changes in the business cycle. Our portfolio companies may not meet net income, cash flow and other coverage tests typically imposed by their senior lenders. A borrower’s failure to |
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| satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially, foreclosure on its senior credit facility, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the borrower’s ability to repay our loan would be jeopardized. | |||
| § | Small and medium-sized businesses are more likely to be dependent on one or two persons. Typically, the success of a small or medium-sized business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on our borrower and, in turn, on us. | ||
| § | Small and medium-sized businesses may have limited operating histories. While we intend to target stable companies with proven track records, we may make loans to new companies that meet our other investment criteria. Portfolio companies with limited operating histories will be exposed to all of the operating risks that new businesses face and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers. |
Because the loans we make and equity securities we receive when we make loans are not publicly
traded, there is uncertainty regarding the value of our privately held securities that could
adversely affect our determination of our net asset value.
Our portfolio investments are, and we expect will continue to be, in the form of securities that
are not publicly traded. The fair value of securities and other investments that are not publicly
traded may not be readily determinable. Our Board of Directors has established an investment
valuation policy and consistently applied valuation procedures used to determine the fair value of
these securities quarterly. These procedures for the determination of value of many of our debt
securities rely on the opinions of value submitted to us by SPSE or the use of internally developed
discounted cash flow (“DCF”) methodologies or indicative bid price (“IBP”) offered by the
respective originating syndication agent’s trading desk, or secondary desk, specifically for our
syndicated loans, or internal methodologies based on the total enterprise value (“TEV”) of the
issuer used for certain of our equity investments. SPSE will only evaluate the debt portion of our
investments for which we specifically request evaluation, and SPSE may decline to make requested
evaluations for any reason in its sole discretion. However, to date, SPSE has accepted each of our
requests for evaluation.
Our use of these fair value methods is inherently subjective and is based on estimates and
assumptions of each security. In the event that we are required to sell a security, we may
ultimately sell for an amount materially less than the estimated fair value calculated by SPSE, or
utilizing the TEV, IBP or the DCF methodology. During April and May of 2009, we completed the sale
of 29 of the 32 senior syndicated loans that were held in our portfolio of investments at March 31,
2009 to various investors in the syndicated loan market. As a result of these sales, we received
approximately $69.2 million in net cash proceeds, which was approximately $34.6 million less than
the cost value of such investments recorded as of December 31, 2008.
Our procedures also include provisions whereby our Adviser will establish the fair value of any
equity securities we may hold where SPSE or third-party agent banks are unable to provide
evaluations. The types of factors that may be considered in determining the fair value of our debt
and equity securities include some or all of the following:
| § | the nature and realizable value of any collateral; | ||
| § | the portfolio company’s earnings and cash flows and its ability to make payments on its obligations; | ||
| § | the markets in which the portfolio company does business; | ||
| § | the comparison to publicly traded companies; and | ||
| § | discounted cash flow and other relevant factors. |
Because such valuations, particularly valuations of private securities and private companies, are
not susceptible to precise determination, may fluctuate over short periods of time, and may be
based on estimates, our determinations of fair value may differ from the values that might have
actually resulted had a readily available market for these securities been available.
A portion of our assets are, and will continue to be, comprised of equity securities that are
valued based on internal assessment using our own valuation methods approved by our Board of
Directors, without the input of SPSE or any other third-party evaluator. We believe that our equity
valuation methods reflect those regularly used as standards by other professionals in our industry
who value equity securities. However, determination of fair value for securities that are not
publicly traded, whether or not we use the recommendations of an independent third-party evaluator,
necessarily involves the exercise of subjective judgment. Our net asset value could be adversely
affected if our determinations regarding the fair value of our investments were materially higher
than the values that we ultimately realize upon the disposal of such securities.
The lack of liquidity of our privately held investments may adversely affect our business.
We will generally make investments in private companies whose securities are not traded in any
public market. Substantially all of the investments we presently hold and the investments we expect
to acquire in the future are, and will be, subject to legal and other restrictions on resale and
will otherwise be less liquid than publicly traded securities. The illiquidity of our investments
may make it difficult for us to quickly obtain cash equal to the value at which we record our
investments if the need arises. This could cause us to
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miss important investment opportunities. In
addition, if we are required to liquidate all or a portion of our portfolio quickly, we may record
substantial realized losses upon liquidation. In addition, we may face other restrictions on our
ability to liquidate an investment
in a portfolio company to the extent that we, our Adviser or our respective officers, employees or
affiliates have material non-public information regarding such portfolio company.
Due to the uncertainty inherent in valuing these securities, our determinations of fair value may
differ materially from the values that could be obtained if a ready market for these securities
existed. Our net asset value could be materially affected if our determinations regarding the fair
value of our investments are materially different from the values that we ultimately realize upon
our disposal of such securities.
Our financial results could be negatively affected if a significant portfolio investment fails to
perform as expected.
Our total investment in companies may be significant individually or in the aggregate. As a result,
if a significant investment in one or more companies fails to perform as expected, our financial
results could be more negatively affected and the magnitude of the loss could be more significant
than if we had made smaller investments in more companies. This risk is heightened as a result of
our sale of the majority of senior syndicated loans in the quarter ended June 30, 2009. As a
result of these sales and other exits, the total number of portfolio companies in which we hold
investments decreased from 46 at March 31, 2009 to 17 at March 31, 2011. Our five largest
investments represented 58.1% of the fair value of our total portfolio at March 31, 2011, compared
to 48.7% at March 31, 2009. Any disposition of a significant investment in one or more companies
may negatively impact our net investment income and limit our ability to pay distributions.
When we are a debt or minority equity investor in a portfolio company,
we may not be in a position to control the entity, and its management may
make decisions that could decrease the value of our investment.
We
anticipate that some of our investments will continue to be either debt or minority equity
investments in our portfolio companies. Therefore, we are and will remain subject to risk that a
portfolio company may make business decisions with which we disagree, and the shareholders and
management of such company may take risks or otherwise act in ways that do not serve our best
interests. As a result, a portfolio company may make decisions that could decrease the value of our
portfolio holdings. In addition, we will generally not be in a position to control any portfolio
company by investing in its debt securities.
We typically invest in transactions involving acquisitions, buyouts and recapitalizations of
companies, which will subject us to the risks associated with change in control transactions.
Our strategy includes making debt and equity investments in companies in connection with
acquisitions, buyouts and recapitalizations, which subjects us to the risks associated with change
in control transactions. Change in control transactions often present a number of uncertainties.
Companies undergoing change in control transactions often face challenges retaining key employees
and maintaining relationships with customers and suppliers. While we hope to avoid many of these
difficulties by participating in transactions where the management team is retained and by
conducting thorough due diligence in advance of our decision to invest, if our portfolio companies
experience one or more of these problems, we may not realize the value that we expect in connection
with our investments, which would likely harm our operating results and financial condition.
Prepayments of our investments by our portfolio companies could adversely impact our results of
operations and reduce our return on equity.
In addition to risks associated with delays in investing our capital, we are also subject to the
risk that investments that we make in our portfolio companies may be repaid prior to maturity. We
will first use any proceeds from prepayments to repay any borrowings outstanding on our line of
credit. In the event that funds remain after repayment of our outstanding borrowings, then we will
generally reinvest these proceeds in government securities, pending their future investment in new
debt and/or equity securities. These government securities will typically have substantially lower
yields than the debt securities being prepaid and we could experience significant delays in
reinvesting these amounts. As a result, our results of operations could be materially adversely
affected if one or more of our portfolio companies elects to prepay amounts owed to us.
Additionally, prepayments could negatively impact our return on equity, which could result in a
decline in the market price of our common stock.
Higher taxation of our portfolio companies may impact our quarterly and annual operating results.
The adverse effect of current unstable economic conditions on federal, state and municipality
revenues may induce these government entities to raise various taxes to make up for lost revenues.
Additional taxation may have an adverse affect on our portfolio companies’ earnings and reduce
their ability to repay our loans to them, thus affecting our quarterly and annual operating
results.
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Our portfolio is concentrated in a limited number of companies and industries, which subjects us to
an increased risk of significant loss if any one of these companies does not repay us or if the
industries experience downturns.
As of March 31, 2011, we had investments in 17 portfolio companies, of which there were three
investments, Venyu Solutions, Inc., Acme Cryogenics, Inc., and Cavert II Holdings Corp. that
comprised approximately $63.2 million or 41.2% of our total investment portfolio, at fair value. A
consequence of a limited number of investments is that the aggregate returns we realize may be
substantially adversely affected by the unfavorable performance of a small number of such loans or
a substantial write-down of any one investment. Beyond our regulatory and income tax
diversification requirements, we do not have fixed guidelines for industry concentration and our
investments could potentially be concentrated in relatively few industries. In addition, while we
do not intend to invest 25% or more of our total assets in a particular industry or group of
industries at the time of investment, it is possible that as the values of our portfolio companies
change, one industry or a group of industries may comprise in excess of 25% of the value of our
total assets. As of March 31, 2011, 19.0% of our total investments, at fair value, were invested in
containers, packaging and glass companies and 16.3% of our total investments, at fair value, were
invested in electronics companies. As a result, a downturn in an industry in which we have invested
a significant portion of our total assets could have a materially adverse effect on us.
Our investments are typically long term and will require several years to realize liquidation
events.
Since we generally make five to seven year term loans and hold our loans and related warrants or
other equity positions until the loans mature, you should not expect realization events, if any, to
occur over the near term. In addition, we expect that any warrants or other equity positions that
we receive when we make loans may require several years to appreciate in value and we cannot give
any assurance that such appreciation will occur.
The disposition of our investments may result in contingent liabilities.
Currently, all of our investments involve private securities. In connection with the
disposition of an investment in private securities, we may be required to make representations
about the business and financial affairs of the underlying portfolio company typical of those made
in connection with the sale of a business. We may also be required to indemnify the purchasers of
such investment to the extent that any such representations turn out to be inaccurate or with
respect to certain potential liabilities. These arrangements may result in contingent liabilities
that ultimately yield funding obligations that must be satisfied through our return of certain
distributions previously made to us.
There may be circumstances where our debt investments could be subordinated to claims of other
creditors or we could be subject to lender liability claims.
Even though we have structured some of our investments as senior loans, if one of our
portfolio companies were to go bankrupt, depending on the facts and circumstances, including the
extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy
court might re-characterize our debt investments and subordinate all, or a portion, of our claims
to that of other creditors. Holders of debt instruments ranking senior to our investments
typically would be entitled to receive payment in full before we receive any distributions. After
repaying such senior creditors, such portfolio company may not have any remaining assets to use to
repay its obligation to us. We may also be subject to lender liability claims for actions taken by
us with respect to a borrower’s business or in instances in which we exercised control over the
borrower. It is possible that we could become subject to a lender’s liability claim, including as
a result of actions taken in rendering significant managerial assistance.
Portfolio company litigation could result in additional costs and the diversion of management time
and resources.
In the course of providing significant managerial assistance to certain of our portfolio companies,
we sometimes serve as directors on the boards of such companies. To the extent that litigation
arises out of our investments in these companies, we may be named as a defendant in such
litigation, which could result in additional costs and the diversion of management time and
resources.
We may not realize gains from our equity investments and other yield enhancements.
When we make a subordinated loan, we may receive warrants to purchase stock issued by the borrower
or other yield enhancements, such as success fees. Our goal is to ultimately dispose of these
equity interests and realize gains upon our disposition of such interests. We expect that, over
time, the gains we realize on these warrants and other yield enhancements will offset any losses we
experience on loan defaults. However, any warrants we receive may not appreciate in value and, in
fact, may decline in value and any other yield enhancements, such as success fees, may not be
realized. Accordingly, we may not be able to realize gains from our equity interests or other yield
enhancements and any gains we may recognize might not be sufficient to offset losses we experience
on our loan portfolio.
Although, during the fiscal year ended March 31, 2011, we successfully achieved realized gains of
$23.5 million in aggregate with the sale of A. Stucki Holding Corp. (“A. Stucki”) in June 2010 and
Chase II Holding Corp. (“Chase”) in December 2010, these were the first management-supported buyout
liquidity events since the inception of our fund in 2005. There can be no guarantees that such
realized gains can be achieved in future periods and the impact of such sales on our results of
operations for the fiscal 2011 should not be relied upon as being indicative of performance in
future periods.
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Any unrealized depreciation we experience on our investment portfolio may be an indication of
future realized losses, which could reduce our income available for distribution.
As a business development company we are required to carry our investments at market value or, if
no market value is ascertainable, at fair value as determined in good faith by or under the
direction of our Board of Directors. Decreases in the market values or fair values of our
investments will be recorded as unrealized depreciation. Since our inception, we have, at times,
incurred a cumulative net unrealized depreciation of our portfolio. Any unrealized depreciation in
our investment portfolio could result in realized losses in the future and ultimately in reductions
of our income available for distribution to stockholders in future periods.
Risks Related to Our Regulation and Structure
We currently do not meet the 50% threshold of the asset diversification test applicable to RICs
under the Code. If we make any additional investment in the future, including advances under
outstanding lines of credit to our portfolio companies, and remain below this threshold as of June
30, 2011, or any subsequent quarter end, we would lose our RIC status unless we are able to cure
such failure within 30 days of the quarter end.
In order to maintain RIC status under the Code, in addition to other requirements, as of the close
of each quarter of our taxable year, we must meet the asset diversification test, which requires
that at least 50% of the value of our assets consist of cash, cash items, U.S. government
securities, the securities of other RICs and other securities to the extent such other securities
of any one issuer do not represent more than 5% of our total assets or more than 10% of the voting
securities of such issuer. As a result of changes in the makeup of our assets during April and May
2009, due to the Syndicated Loan Sales, we fell below the 50% threshold. At March 31, 2011, as
with each quarterly measurement date following the Syndicated Loan Sales, we satisfied the 50%
threshold through the purchase of short-term qualified securities, which was funded primarily
through a short-term loan agreement. Subsequent to the March 31
st
measurement date, the
short-term qualified securities matured, and we repaid the short-term loan, at which time we again
fell below the 50% threshold. Until the composition of our assets is above the required 50%
threshold, we will continue to seek to deploy similar purchases of qualified securities using
short-term loans that would allow us to satisfy the asset diversification test, thereby allowing us
to make new or additional investments. There can be no assurance, however, that we will be able to
enter into such a transaction on reasonable terms, if at all. Failure to meet this threshold alone
does not result in loss of our RIC status in our current situation. In circumstances where the
failure to meet the 50% threshold as of a quarterly measurement date is the result of fluctuations
in the value of assets, including in our case as a result of the sale of assets, we are still
deemed under the rules to have satisfied the asset diversification test and, therefore, maintain
our RIC status, as long as we have not made any new investments, including additional investments
in our portfolio companies (such as advances under outstanding lines of credit), since the time
that we fell below the 50% threshold. Thus, while we currently qualify as a RIC despite our
current inability to meet the 50% threshold and potential inability to do so in the future, if we
make any new or additional investments before regaining compliance with the asset diversification
test, our RIC status will be threatened. Because, in most circumstances, we are contractually
required to advance funds on outstanding lines of credit upon the request of our portfolio
companies, we may have a limited ability to avoid adding to existing investments in a manner that
would cause us to fail the asset diversification test as of June 30, 2011 or as of subsequent
quarterly measurement dates.
If we were to make a new or additional investment before regaining compliance with the 50%
threshold, and we did not regain compliance prior to the next quarterly measurement date following
such investment, we would have thirty days to “cure” our failure to meet the 50% threshold to avoid
our loss of RIC status. Potential cures for failure of the asset diversification test include
raising additional equity or debt capital as we have done, or changing the composition of our
assets, which could include full or partial divestitures of investments, such that we would once
again meet or exceed the 50% threshold. Our ability to implement any of these cures would be
subject to market conditions and a number of risks and uncertainties that would be, in part, beyond
our control. Accordingly, we cannot guarantee you that we would be successful in curing any
failure of the asset diversification test, which would subject us to corporate level tax. For
additional information about the consequences of failing to satisfy the RIC qualification, see
“—We will be subject to corporate level tax if we are unable to satisfy Internal Revenue Code
requirements for RIC qualification.”
We will be subject to corporate-level tax if we are unable to satisfy Code requirements for RIC
qualification.
To maintain our qualification as a RIC, we must meet income source, asset diversification and
annual distribution requirements. The annual distribution requirement is satisfied if we distribute
at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual
basis. Because we use leverage, we are subject to certain asset coverage ratio requirements under
the 1940 Act and could, under certain circumstances, be restricted from making distributions
necessary to qualify as a RIC. Warrants we receive with respect to debt investments will create
“original issue discount,” which we must recognize as ordinary income, increasing the amounts we
are required to distribute to maintain RIC status. Because such warrants will not produce
distributable cash for us at the same time as we are required to make distributions in respect of
the related original issue discount, we will need to use cash from other sources to satisfy such
distribution requirements. The asset diversification requirements must be met at the end of each
calendar
quarter. If we fail to meet these tests, we may need to quickly dispose of certain investments to
prevent the loss of RIC status. Since most of our investments will be illiquid, such dispositions,
if even possible, may not be made at prices advantageous to us and, in fact,
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may result in
substantial losses. If we fail to qualify as a RIC for any reason and become fully subject to
corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the
amount of income available for distribution, and the actual amount distributed. Such a failure
would have a material adverse effect on us and our shares. For additional information regarding
asset coverage ratio and RIC requirements, see “Business—Material U.S. Federal Income Tax
Considerations—Regulated Investment Company Status.”
From time to time, some of our debt investments may include success fees that would generate
payments to us if the business is ultimately sold. Because the satisfaction of these success fees,
and the ultimate payment of these fees, is uncertain, we do not recognize them as income until we
have received payment. We sought and received a private letter ruling from the Internal Revenue
Service (“IRS”) related to our tax treatment for success fees. In the ruling, executed by our
consent on January 3, 2011, we, in effect, will continue to account for the recognition of income
from the success fees upon receipt, or when the amount becomes fixed. However, starting January 1,
2011, the tax characterization of the success fee amount will be treated as ordinary income. Prior
to January 1, 2011, we had treated the success fee amount as a realized gain for tax
characterization purposes. The private letter ruling does not require us to retroactively change
the capital gains treatment of the success fees received prior to January 1, 2011. As a result, we
will be required to distribute such amounts to our stockholders in order to maintain RIC status for
success fees we receive after January 1, 2011.
Changes in laws or regulations governing our operations, or changes in the interpretation thereof,
and any failure by us to comply with laws or regulations governing our operations may adversely
affect our business.
We and our portfolio companies are subject to regulation by laws at the local, state and federal
levels. These laws and regulations, as well as their interpretation, may be changed from time to
time. Accordingly, any change in these laws or regulations, or their interpretation, or any failure
by us or our portfolio companies to comply with these laws or regulations may adversely affect our
business. For additional information regarding the regulations to which we are subject, see
“Business—Material U.S. Federal Income Tax Considerations—Regulated Investment Company Status”
and “Business—Regulation as a Business Development Company.”
Provisions of the Delaware General Corporation Law and of our certificate of incorporation and
bylaws could restrict a change in control and have an adverse impact on the price of our common
stock.
We are subject to provisions of the Delaware General Corporation Law that, in general, prohibit any
business combination with a beneficial owner of 15% or more of our common stock for three years
unless the holder’s acquisition of our stock was either approved in advance by our Board of
Directors or ratified by the Board of Directors and stockholders owning two-thirds of our
outstanding stock not owned by the acquiring holder. Although we believe these provisions
collectively provide for an opportunity to receive higher bids by requiring potential acquirers to
negotiate with our Board of Directors, they would apply even if the offer may be considered
beneficial by some stockholders.
We have also adopted other measures that may make it difficult for a third party to obtain control
of us, including provisions of our certificate of incorporation classifying our Board of Directors
in three classes serving staggered three-year terms, and provisions of our certificate of
incorporation authorizing our Board of Directors to induce the issuance of additional shares of our
stock. These provisions, as well as other provisions of our certificate of incorporation and
bylaws, may delay, defer, or prevent a transaction or a change in control that might otherwise be
in the best interests of our stockholders.
Risks Related to an Investment in Our Common Stock
We may experience fluctuations in our quarterly and annual operating results.
We may experience fluctuations in our quarterly and annual operating results due to a number of
factors, including, among others, variations in our investment income, the interest rates payable
on the debt securities we acquire, the default rates on such securities, the level of our expenses,
variations in and the timing of the recognition of realized and unrealized gains or losses, the
level of our expenses, the degree to which we encounter competition in our markets, and general
economic conditions, including the impacts of inflation. The majority of our portfolio companies
are in industries that are directly impacted by inflation, such as manufacturing and consumer goods
and services. Our portfolio companies may not be able to pass on to customers increases in their
costs of production which could greatly affect their operating results, impacting their ability to
repay our loans. In addition, any projected future decreases in our portfolio companies’ operating
results due to inflation could adversely impact the fair value of those investments. Any decreases
in the fair value of our investments could result in future realized and unrealized losses and
therefore reduce our net assets resulting from operations. As a result of these factors, results
for any period should not be relied upon as being indicative of performance in future periods.
There is a risk that you may not receive distributions.
Our current intention is to distribute at least 90% of our ordinary income and short-term capital
gains to our stockholders on a quarterly basis by paying monthly distributions. We expect to retain
net realized long-term capital gains to supplement our equity
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capital and support the growth of our
portfolio, although our Board of Directors may determine in certain cases to distribute these
gains. In addition, our line of credit restricts the amount of distributions we are permitted to
make. We cannot assure you that we will achieve investment results or maintain a tax status that
will allow or require any specified level of cash distributions.
Distributions by us have and may in the future include a return of capital.
Our Board of Directors declares monthly distributions based on estimates of taxable income for each
fiscal year, which may differ, and in the past have differed, from actual results. Because our
distributions are based on estimates of taxable income that may differ from actual results, future
distributions payable to our stockholders may also include a return of capital. Moreover, to the
extent that we distribute amounts that exceed our accumulated earnings and profits, these
distributions constitute a return of capital. A return of capital represents a return of a
stockholder’s original investment in shares of our stock and should not be confused with a
distribution from earnings and profits. Although return of capital distributions may not be
taxable, such distributions may increase an investor’s tax liability for capital gains upon the
sale of our shares by reducing the investor’s tax basis for such shares. Such returns of capital
reduce our asset base and also adversely impact our ability to raise debt capital as a result of
the leverage restrictions under the 1940 Act, which could have a material adverse impact on our
ability to make new investments.
The market price of our shares may fluctuate significantly.
The trading price of our common stock may fluctuate substantially. Due to the extreme volatility
and disruption that have affected the capital and credit markets for over a year, we have
experienced greater than usual stock price volatility.
The market price and marketability of our shares may from time to time be significantly affected by
numerous factors, including many over which we have no control and that may not be directly related
to us. These factors include, but are not limited to, the following:
| § | general economic trends and other external factors; | ||
| § | price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies; | ||
| § | significant volatility in the market price and trading volume of shares of RICs, business development companies or other companies in our sector, which is not necessarily related to the operating performance of these companies; | ||
| § | changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies; | ||
| § | loss of business development company status; | ||
| § | loss of RIC status; | ||
| § | changes in our earnings or variations in our operating results; | ||
| § | changes in the value of our portfolio of investments; | ||
| § | any shortfall in our revenue or net income or any increase in losses from levels expected by securities analysts; | ||
| § | departure of key personnel; | ||
| § | operating performance of companies comparable to us; | ||
| § | short-selling pressure with respect to our shares or business development companies generally; | ||
| § | the announcement of proposed, or completed, offerings of our securities, including a rights offering; and | ||
| § | loss of a major funding source. |
Fluctuations in the trading prices of our shares may adversely affect the liquidity of the trading
market for our shares and, if we seek to raise capital through future equity financings, our
ability to raise such equity capital.
The issuance of subscription rights to our existing stockholders may dilute the ownership and
voting powers by existing stockholders in our common stock, dilute the net asset value of their
shares and have a material adverse effect on the trading price of our common stock.
In April 2008 we completed an offering of transferable rights to subscribe for additional shares of
our common stock, or subscription rights. We determined to raise equity in this manner primarily
because of the capital raising constraints applicable to us under the 1940 Act when our stock is
trading below its net asset value per share, as it was at the time of the offering. In the event
that we again issue
subscription rights to our existing stockholders, there is a significant possibility that the
rights offering will dilute the ownership interest and voting power of stockholders who do not
fully exercise their subscription rights. Stockholders who do not fully exercise their subscription
rights should expect that they will, upon completion of the rights offering, own a smaller
proportional interest in the Company than would otherwise be the case if they fully exercised their
subscription rights. In addition, because the subscription price
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of the rights offering is likely
to be less than our most recently determined net asset value per share, our stockholders are likely
to experience an immediate dilution of the per share net asset value of their shares as a result of
the offer. As a result of these factors, any future rights offerings of our common stock, or our
announcement of our intention to conduct a rights offering, could have a material adverse impact on
the trading price of our common stock.
Shares of closed-end investment companies frequently trade at a discount from net asset value.
Shares of closed-end investment companies frequently trade at a discount from net asset value.
Since our inception, our common stock has at times traded above and below net asset value. During
the past year, our common stock has traded consistently, and at times significantly, below net
asset value. Subsequent to March 31, 2011, our stock has traded at discounts of up to 23.3% of our
net asset value per share, which was $9.00 as of March 31, 2011. This characteristic of shares of
closed-end investment companies is separate and distinct from the risk that our net asset value per
share will decline. As with any stock, the price of our shares will fluctuate with market
conditions and other factors. If shares are sold, the price received may be more or less than the
original investment. Whether investors will realize gains or losses upon the sale of our shares
will not depend directly upon our net asset value, but will depend upon the market price of the
shares at the time of sale. Since the market price of our shares will be affected by such factors
as the relative demand for and supply of the shares in the market, general market and economic
conditions and other factors beyond our control, we cannot predict whether the shares will trade
at, below or above our net asset value. Under the 1940 Act, we are generally not able to issue
additional shares of our common stock at a price below net asset value per share to purchasers
other than our existing stockholders through a rights offering without first obtaining the approval
of our stockholders and our independent directors. Additionally, at times when our stock is trading
below its net asset value per share, our dividend yield may exceed the weighted average returns
that we would expect to realize on new investments that would be made with the proceeds from the
sale of such stock, making it unlikely that we would determine to issue additional shares in such
circumstances. Thus, for as long as our common stock trades below net asset value we will be
subject to significant constraints on our ability to raise capital through the issuance of common
stock. Additionally, an extended period of time in which we are unable to raise capital may
restrict our ability to grow and adversely impact our ability to increase or maintain our
distributions.
Stockholders may incur dilution if we sell shares of our common stock in one or more offerings at
prices below the then current net asset value per share of our common stock.
At our most recent annual meeting, our stockholders approved a proposal designed to allow us to
access the capital markets in a way that absent stockholder approval, we are generally unable to
due to restrictions applicable to business development companies under the 1940 Act. Specifically,
our stockholders approved a proposal that authorizes us to sell shares of our common stock below
the then current net asset value per share of our common stock in one or more offerings for a
period of one year. At the upcoming annual stockholders meeting, scheduled for August 4, 2011, our
stockholders will be asked to vote in favor of this proposal for another year. During the past
year, our common stock has traded consistently, and at times significantly, below net asset value.
Any decision to sell shares of our common stock below the then current net asset value per share of
our common stock would be subject to the determination by our Board of Directors that such issuance
is in our and our stockholders’ best interests.
If we were to sell shares of our common stock below net asset value per share, such sales would
result in an immediate dilution to the net asset value per share. This dilution would occur as a
result of the sale of shares at a price below the then current net asset value per share of our
common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and
assets and voting interest in us than the increase in our assets resulting from such issuance. The
greater the difference between the sale price and the net asset value per share at the time of the
offering, the more significant the dilutive impact would be. Because the number of shares of common
stock that could be so issued and the timing of any issuance is not currently known, the actual
dilutive effect, if any, cannot be currently predicted. However, if, for example, we sold an
additional 10% of our common stock at a 5% discount from net asset value, a stockholder who did not
participate in that offering for its proportionate interest would suffer net asset value dilution
of up to 0.5% or $5 per $1,000 of net asset value.
Other Risks
We could face losses and potential liability if intrusion, viruses or similar disruptions to our
technology jeopardize our confidential information, whether through breach of our network security
or otherwise.
Maintaining our network security is of critical importance because our systems store highly
confidential financial models and portfolio company information. Although we have implemented, and
will continue to implement, security measures, our technology platform is and will continue to be
vulnerable to intrusion, computer viruses or similar disruptive problems caused by transmission
from unauthorized users. The misappropriation of proprietary information could expose us to a risk
of loss or litigation.
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Terrorist attacks, acts of war, or national disasters may affect any market for our common stock,
impact the businesses in which we invest, and harm our business, operating results, and financial
conditions.
Terrorist acts, acts of war, or national disasters have created, and continue to create, economic
and political uncertainties and have contributed to global economic instability. Future terrorist
activities, military or security operations, or national disasters could further weaken the
domestic/global economies and create additional uncertainties, which may negatively impact the
businesses in which we invest directly or indirectly and, in turn, could have a material adverse
impact on our business, operating results, and financial condition. Losses from terrorist attacks
and national disasters are generally uninsurable.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
| ITEM 2. | PROPERTIES |
We do not own any real estate or other physical properties materially important to our operations.
Our Adviser is the current leaseholder of all properties in which we operate. We occupy these
premises pursuant to the Advisory Agreement and Administration Agreement. Our Adviser and
Administrator are headquartered in McLean, Virginia and our Adviser also has operations in New
York, Illinois, Texas and Connecticut.
| ITEM 3. | LEGAL PROCEEDINGS |
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any
material legal proceeding threatened against us.
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Our common stock is traded on the Nasdaq Global Select Market under the symbol “GAIN” The following
table reflects, by quarter, the high and low closing prices per share of our common stock on the
Nasdaq Global Select Market, the closing sale price as a percentage of net asset value (“NAV”) and
quarterly distributions declared per share for each fiscal quarter during the last two fiscal
years. Amounts presented for each fiscal quarter of 2011 and 2010 represent the cumulative amount
of the distributions declared per share for the months composing such quarter.
| Quarter | Closing Sales Price | Discount of | Discount of | Declared | ||||||||||||||||||||||||
| Ended | NAV (1) | High | Low | High to NAV (2) | Low to NAV (2) | Distributions | ||||||||||||||||||||||
|
FY 2011
|
6/30/10 | $ | 8.86 | $ | 6.89 | $ | 5.13 | 22 | % | 42 | % | $ | 0.12 | |||||||||||||||
|
|
9/30/10 | 8.43 | 6.93 | 5.52 | 18 | 35 | 0.12 | |||||||||||||||||||||
|
|
12/31/10 | 9.00 | 7.90 | 6.61 | 12 | 27 | 0.12 | |||||||||||||||||||||
|
|
3/31/11 | 9.00 | 8.28 | 6.92 | 8 | 23 | 0.12 | |||||||||||||||||||||
|
|
||||||||||||||||||||||||||||
|
FY 2010
|
6/30/09 | $ | 9.19 | $ | 5.38 | $ | 3.52 | 41 | % | 62 | % | $ | 0.12 | |||||||||||||||
|
|
9/30/09 | 8.24 | 5.37 | 4.02 | 35 | 51 | 0.12 | |||||||||||||||||||||
|
|
12/31/09 | 7.93 | 5.11 | 4.41 | 36 | 44 | 0.12 | |||||||||||||||||||||
|
|
3/31/10 | 8.74 | 6.23 | 4.61 | 29 | 47 | 0.12 | |||||||||||||||||||||
| (1) | NAV per share is determined as of the last day in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period. | |
| (2) | The discounts set forth in these columns represent the high or low, as applicable, closing price per share for the relevant quarter minus the NAV per share as of the end of such quarter, and therefore may not reflect the discount to NAV per share on the date of the high and low closing prices. |
As of May 17, 2011 there were approximately 30 beneficial owners of our common stock.
Distributions
We currently intend to distribute in the form of cash distributions a minimum of 90% of our
ordinary income and short-term capital gains, if any, on a quarterly basis to our stockholders in
the form of monthly distributions. We intend to retain some or all of our long-term capital gains,
but to designate the retained amount as a deemed distribution, after giving effect to any prior
year realized losses that are carried forward, to supplement our equity capital and support the
growth of our portfolio. However, in certain cases our Board of Directors may choose to distribute
our net realized long-term capital gains by paying a one-time special distribution.
Recent Sales of Unregistered Securities and Purchases of Equity Securities
We did not sell any unregistered shares of common stock or repurchase any shares of our common
stock during the fiscal year ended March 31, 2011.
| ITEM 6. | SELECTED FINANCIAL DATA |
The following consolidated selected financial data for the fiscal years ended March 31, 2011, 2010,
2009, 2008 and 2007, are derived from our audited consolidated financial statements. The other data
included at the bottom of the table is unaudited. The data should be read in conjunction with our
consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included elsewhere in this report.
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GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED SELECTED FINANCIAL AND OTHER DATA
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)
CONSOLIDATED SELECTED FINANCIAL AND OTHER DATA
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)
| Year Ended March 31, | ||||||||||||||||||||
| 2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
|
Statement of operations data:
|
||||||||||||||||||||
|
Total investment income
|
$ | 26,064 | $ | 20,785 | $ | 25,812 | $ | 27,894 | $ | 17,262 | ||||||||||
|
Total expenses net of credits from Adviser
|
9,893 | 10,187 | 12,424 | 14,842 | 6,114 | |||||||||||||||
|
|
||||||||||||||||||||
|
Net investment income
|
16,171 | 10,598 | 13,388 | 13,052 | 11,148 | |||||||||||||||
|
|
||||||||||||||||||||
|
Net gain (loss) on investments
|
268 | (21,669 | ) | (24,837 | ) | (13,993 | ) | (3,879 | ) | |||||||||||
|
|
||||||||||||||||||||
|
Net increase (decrease) in net assets resulting from operations
|
$ | 16,439 | $ | (11,071 | ) | $ | (11,449 | ) | $ | (941 | ) | $ | 7,269 | |||||||
|
|
||||||||||||||||||||
|
|
||||||||||||||||||||
|
Per share data
(1)
:
|
||||||||||||||||||||
|
Net increase (decrease) in net assets resulting
from operations per common share—basic and
diluted
|
$ | 0.74 | $ | (0.50 | ) | $ | (0.53 | ) | $ | (0.06 | ) | $ | 0.44 | |||||||
|
Net investment income before net gain (loss) on
investments per common share—basic and diluted
|
0.73 | 0.48 | 0.62 | 0.79 | 0.67 | |||||||||||||||
|
Cash distributions declared per share
|
0.48 | 0.48 | 0.96 | 0.93 | 0.86 | |||||||||||||||
|
Statement of assets and liabilities data:
|
||||||||||||||||||||
|
Total assets
|
$ | 241,109 | $ | 297,161 | $ | 326,843 | $ | 352,293 | $ | 323,590 | ||||||||||
|
Net assets
|
198,829 | 192,978 | 214,802 | 206,445 | 222,819 | |||||||||||||||
|
Net asset value per share
|
9.00 | 8.74 | 9.73 | 12.47 | 13.46 | |||||||||||||||
|
Common shares outstanding
|
22,080,133 | 22,080,133 | 22,080,133 | 16,560,100 | 16,560,100 | |||||||||||||||
|
Weighted common shares outstanding—basic and
diluted
|
22,080,133 | 22,080,133 | 21,545,936 | 16,560,100 | 16,560,100 | |||||||||||||||
|
Senior securities data:
|
||||||||||||||||||||
|
Borrowings under line of credit
(2)
|
$ | — | $ | 27,812 | $ | 110,265 | $ | 144,835 | $ | 100,000 | ||||||||||
|
Short term loan
(2)
|
40,000 | 75,000 | — | — | — | |||||||||||||||
|
Asset coverage ratio
(3)
|
534 | % | 281 | % | 293 | % | 242 | % | 323 | % | ||||||||||
|
Asset coverage per unit
(4)
|
$ | 5,344 | $ | 2,814 | $ | 2,930 | $ | 2,422 | $ | 3,228 | ||||||||||
|
Other unaudited data:
|
||||||||||||||||||||
|
Number of portfolio companies
|
17 | 16 | 46 | 52 | 47 | |||||||||||||||
|
Average size of portfolio company investment at
cost
|
$ | 11,600 | $ | 14,223 | $ | 7,586 | $ | 6,746 | $ | 5,843 | ||||||||||
|
Principal amount of new investments
|
43,634 | 4,788 | 49,959 | 175,255 | 182,953 | |||||||||||||||
|
Proceeds from loan repayments and investments sold
|
97,491 | 90,240 | 46,742 | 96,437 | 61,167 | |||||||||||||||
|
Weighted average yield on investments
(5)
|
11.39 | % | 11.02 | % | 8.22 | % | 8.91 | % | 8.72 | % | ||||||||||
|
Total return
(6)
|
38.56 | 79.80 | (51.65 | ) | (31.54 | ) | 4.36 | |||||||||||||
| (1) | Per share data for net increase (decrease) in net assets resulting from operations is based on the weighted average common stock outstanding for both basic and diluted. | |
| (2) | See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our level of indebtedness. | |
| (3) | As a business development company, the Company is generally required to maintain an asset coverage ratio of at least 200% of total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to total borrowings and guaranty commitments. Asset coverage ratio is the ratio of the carrying value of our total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. | |
| (4) | Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per one thousand dollars of indebtedness. | |
| (5) | Weighted average yield on investments equals interest income on investments divided by the annualized weighted average investment balance throughout the year. | |
| (6) | Total return equals the increase (decrease) of the ending market value over the beginning market value plus monthly distributions divided by the monthly beginning market value. |
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| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following analysis of our financial condition and results of operations should be read in
conjunction with our financial statements and the notes thereto contained elsewhere in this Form
10-K. Except per share amounts, dollar amounts are in thousands unless otherwise indicated.
OVERVIEW
General
We were incorporated under the General Corporation Laws of the State of Delaware on February 18,
2005. We were primarily established for the purpose of investing in subordinated loans, mezzanine
debt, preferred stock and warrants to purchase common stock of small and medium-sized companies in
connection with buyouts and other recapitalizations. We also invest in senior secured loans, common
stock and, to a much lesser extent, senior and subordinated syndicated loans. Our investment
objective is to generate both current income and capital gains through these debt and equity
instruments. We operate as a closed-end, non-diversified management investment company and have
elected to be treated as a business development company (“BDC”) under the Investment Company Act of
1940, as amended (the “1940 Act”). In addition, for tax purposes, we have elected to be treated as
a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the
“Code”).
Business Environment
While economic conditions generally appear to be improving, we remain cautious about a long-term
economic recovery. The recent recession in general, and the disruptions in the capital markets in
particular, have impacted our liquidity options and increased the cost of debt and equity capital.
Many of our portfolio companies, as well as those that we evaluate for possible investment, are
impacted by these economic conditions, and if these conditions persist, it may affect their ability
to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial
public offering. While these conditions are challenging, we are seeing an increase in the number of
new investment opportunities consistent with our investing strategy of providing subordinated debt
with equity enhancement features and direct equity in support of
management and sponsor-led buyouts
of small and medium-sized companies.
These new investment opportunities translated into two new proprietary deals during the year ended
March 31, 2011. In October 2010, we invested $25.0 million in Venyu Solutions, Inc. (“Venyu”),
consisting of subordinated debt and preferred equity. Venyu, headquartered in Baton Rouge,
Louisiana, is a leader in commercial-grade, customizable solutions for data protection, data
hosting and disaster recovery. In December 2010, we invested $10.5 million in Precision Southeast,
Inc. (“Precision”), consisting of senior debt and preferred and common equity. Precision,
headquartered in Myrtle Beach, South Carolina, is a custom injection molding company, focused on
the filtration, consumer and industrial markets. Subsequent to our fiscal year end, in April 2011,
we invested $16.4 million in Mitchell Rubber Products, Inc. (“Mitchell Rubber”), consisting of
subordinated debt and equity. Mitchell Rubber, headquartered in City of Industry, California,
develops, mixes, and molds rubber compounds for specialized applications in the non-tire rubber
market.
The increased investing opportunities in the marketplace also presented opportunities for us to
achieve realized gains and other income. We achieved a significant amount of liquidity and
realized gains with the sales of A. Stucki Holding Corp. (“A. Stucki”) in June 2010 and Chase II
Holding Corp. (“Chase”) in December 2010. The sale of our equity in A. Stucki resulted in net
cash proceeds to us of $21.4 million, and a realized gain of $16.6 million. In connection with the
equity sale, we accrued and received cash dividend proceeds of $0.3 million from our preferred
stock investment in A. Stucki. At the same time, we received $30.6 million in payment of our
principal, accrued interest and success fees on the loans to A. Stucki. Additionally, immediately
prior to the sale of A. Stucki, we received a special distribution of property with a fair value of
$0.5 million, which was recorded as dividend income and is reflected as a Control investment,
Neville Limited, on our
Consolidated Schedule of Investments
as of March 31, 2011. The net cash
proceeds to us from the sale of our equity in Chase were $13.9 million, resulting in a realized
gain of $6.9 million. In connection with the equity sale, we accrued and received cash dividend
proceeds of $4.0 million from our preferred stock investment. At the same time, we received $22.9
million in repayment of our principal, accrued interest and success fees on the loans to Chase.
Subsequent to our fiscal year end, we sold our equity investment in and received partial redemption
of our preferred stock, while investing new subordinated debt, in Cavert II Holding Corporation
(“Cavert”) as part of a recapitalization. The gross cash proceeds to the Company from the sale of
our equity in Cavert were $5.6 million, resulting in a realized gain of $5.5 million. At the same
time, we received $2.3 million in a partial redemption of our preferred stock, received $0.7
million in preferred dividends and invested $5.7 million in new subordinated debt of Cavert.
The A. Stucki, Chase, and Cavert sales were our first management-supported buyout liquidity events,
and each was an equity investment success, highlighting our investment strategy of striving to
achieve returns through current income from debt investments and capital gains from equity
investments. We will strive to utilize this liquidity and the borrowing availability under our
Credit
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Facility to make new investments to potentially increase our net investment income and generate
capital gains to enhance our ability to pay dividends to our stockholders.
Due to losses realized during the fiscal year ended March 31, 2010, which occurred in connection
with the Syndicated Loan Sales, described below, which were available to offset future realized
gains, we were not required to distribute the realized gains from the A. Stucki and Chase sales to
stockholders during the fiscal year ended March 31, 2011. The economic conditions in 2008 and 2009
had affected the general availability of credit, and, as a result, during the quarter ended June
30, 2009, we sold 29 senior syndicated loans that were held in our portfolio of investments at
March 31, 2009 to various investors in the syndicated loan market (the “Syndicated Loan Sales”) to
repay amounts outstanding under our prior line of credit with Deutsche Bank AG (the “Prior Credit
Facility”), which matured in April 2009. These loans, in aggregate, had a cost value of
approximately $104.2 million, or 29.9% of the cost of our total investments, and an aggregate fair
value of approximately $69.8 million, or 22.2% of the fair value of our total investments, at March
31, 2009. As a result of the settlement of the Syndicated Loan Sales and other exits, as well as
one new syndicated loan investment, at March 31, 2011, we had two remaining syndicated loans.
Collectively, these sales have changed our asset composition in a manner that has affected our
ability to satisfy certain elements of the Code’s rules for maintenance of our RIC status. To
maintain our status as a RIC, in addition to other requirements, as of the close of each quarter of
our taxable year, we must meet the asset diversification test, which requires that at least 50% of
the value of our assets consist of cash, cash items, U.S. government securities or certain other
qualified securities (the “50% threshold”). During the quarter ended March 31, 2011, we again fell
below the required 50% threshold.
Failure to meet the 50% threshold alone will not result in our loss of RIC status. In circumstances
where the failure to meet the 50% threshold is the result of fluctuations in the value of assets,
including as a result of the sale of assets, we will still be deemed to have satisfied the 50%
threshold and, therefore, maintain our RIC status, provided that we have not made any new
investments, including additional investments in our existing portfolio companies (such as advances
under outstanding lines of credit), since the time that we fell below the 50% threshold. At March
31, 2011, we satisfied the 50% threshold primarily through the purchase of short-term qualified
securities, which was funded through a short-term loan agreement. Subsequent to the March 31, 2011
measurement date, the short-term qualified securities matured and we repaid the short-term loan.
See “—Recent Developments—Short-Term Loan” for more information regarding this transaction. As
of the date of this filing, we remain below the 50% threshold.
Thus, while we currently qualify as a RIC despite our recent inability to meet the 50% threshold
and potential inability to do so in the future, if we make any new or additional investments before
regaining compliance with the asset diversification test, our RIC status will be threatened. If we
make a new or additional investment and fail to regain compliance with the 50% threshold on the
next quarterly measurement date following such investment, we will be in non-compliance with the
RIC rules and will have thirty days to “cure” our failure to meet the 50% threshold to avoid the
loss of our RIC status. Potential cures for failure of the asset diversification test include
raising additional equity or debt capital, or changing the composition of our assets, which could
include full or partial divestitures of investments, such that we would once again exceed the 50%
threshold on a consistent basis.
Until the composition of our assets is above the required 50% threshold on a consistent basis, we
will continue to seek to deploy similar purchases of qualified securities using short-term loans
that would allow us to satisfy the 50% threshold, thereby allowing us to make additional
investments. There can be no assurance, however, that we will be able to enter into such a
transaction on reasonable terms, if at all. We also continue to explore a number of other
strategies, including changing the composition of our assets, which could include full or partial
divestitures of investments, and raising additional equity or debt capital, such that we would once
again exceed the 50% threshold on a consistent basis. Our ability to implement any of these
strategies will be subject to market conditions and a number of risks and uncertainties that are,
in part, beyond our control.
The Syndicated Loan Sales significantly changed the overall composition and reduced the total size
of our portfolio. Because the Syndicated Loan Sales were from our Non-Control/Non-Affiliate
investment category, the fair value of our Non-Control/Non-Affiliate investments decreased from
30.2% to 9.6% of our total portfolio from March 31, 2009 to March 31, 2011, respectively. In
addition, the size of our portfolio decreased because we exited or received principal prepayments
in the aggregate of $200.2 million in investments, at cost, partially offset by $48.4 million in
disbursements to new and existing portfolio companies, from March 31, 2009 to March 31, 2011. We
expect the overall composition of our investment portfolio to continue to consist of primarily
Control and Affiliate investments.
On April 13, 2010, through our wholly-owned subsidiary, Gladstone Business Investment, LLC
(“Business Investment”), we entered into a third amended and restated credit agreement providing
for a $50.0 million, two year revolving line of credit (the “Credit Facility”), arranged by Branch
Banking and Trust Company (“BB&T”) as administrative agent. Key Equipment Finance Company Inc. also
joined the Credit Facility as a committed lender. The Credit Facility’s maturity date is April 13,
2012, and if it is not renewed or extended by then, all principal and interest will be due and
payable one year later, on or before April 13, 2013. Advances under the Credit Facility were
modified to generally bear interest at the 30-day London Interbank Offered Rate (“LIBOR”) (subject
to a minimum rate of 2.0%), plus 4.5% per annum, with a commitment fee of 0.50% per annum on
undrawn amounts when advances outstanding are above 50.0% of the commitment and 1.0% on undrawn
amounts if the advances outstanding are below 50.0% of the commitment. In connection with the
Credit Facility renewal, we paid an upfront fee of 1.0%. The Credit Facility limits payments on
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distributions to the aggregate net investment income for each of the twelve month periods ended
March 31, 2011 and 2012. Other
significant changes to the Credit facility include a reduced minimum net worth covenant, which was
modified to $155.0 million plus 50.0% of all equity and subordinated debt raised after April 13,
2010 and to maintain “asset coverage” with respect to “senior securities representing indebtedness”
of at least 200%, in accordance with Section 18 of the 1940 Act. As of May 20, 2011, there was no
balance outstanding under the Credit Facility, and $41.7 million was available for borrowing due to
certain limitations on our borrowing base.
Challenges in the current market are intensified for us by certain regulatory limitations under the
Code and the 1940 Act, as well as contractual restrictions under the agreement governing our Credit
Facility that further constrain our ability to access the capital markets. To maintain our
qualification as a RIC, we must satisfy, among other requirements, an annual distribution
requirement to pay out at least 90% of our ordinary income and short-term capital gains to our
stockholders. Because we are required to distribute our income in this manner, and because the
illiquidity of many of our investments makes it difficult for us to finance new investments through
the sale of current investments, our ability to make new investments is highly dependent upon
external financing. Our external financing sources include the issuance of equity securities, debt
securities or other leverage, such as borrowings under our line of credit. Our ability to seek
external debt financing, to the extent that it is available under current market conditions, is
further subject to the asset coverage limitations of the 1940 Act, which require us to have at
least a 200% asset coverage ratio, meaning, generally, that for every dollar of debt, we must have
two dollars of assets.
Market conditions have also affected the trading price of our common stock and thus our ability to
finance new investments through the issuance of equity. On May 20, 2011, the closing market price
of our common stock was $6.90, which represented a 23.3% discount to our March 31, 2011 net asset
value (“NAV”) per share of $9.00. When our stock trades below NAV, as it has consistently since
September 30, 2008, our ability to issue equity is constrained by provisions of the 1940 Act, which
generally prohibits the issuance and sale of our common stock at an issuance price below NAV per
share without stockholder approval other than through sales to our then-existing stockholders
pursuant to a rights offering. At our annual meeting of stockholders held on August 5, 2010, our
stockholders approved a proposal which authorizes us to sell shares of our common stock at a price
below our then current NAV per share for a period of one year from the date of approval, provided
that our Board of Directors makes certain determinations prior to any such sale. This proposal is
in effect until our next annual stockholders meeting on August 4, 2011, at which time we will ask
our stockholders to vote in favor of this proposal for another year.
Unstable economic conditions may also continue to decrease the value of collateral securing some of
our loans, as well as the value of our equity investments, which has impacted and may continue to
impact our ability to borrow under our Credit Facility. Additionally, our Credit Facility contains
covenants regarding the maintenance of certain minimum loan concentrations and net worth covenants,
which are affected by the decrease in value of our portfolio. Failure to meet these requirements
would result in a default which, if we are unable to obtain a waiver from our lenders, would result
in the acceleration of our repayment obligations under our Credit Facility. As of March 31, 2011,
we were in compliance with all of the Credit Facility’s covenants.
We expect that, given these regulatory and contractual constraints in combination with current
market conditions, debt and equity capital may be costly or difficult for us to access in the near
term. However, in light of the A. Stucki, Chase and Cavert sales and resulting liquidity, the
general stabilization of our portfolio valuations over the past year and increased investing
opportunities that we see in our target markets, as demonstrated by our three new investments in
Venyu, Precision and Mitchell Rubber totaling $52.2 million, we are cautiously optimistic about the
long term prospects for the U.S. economy and have shifted our near-term strategy to include making
conservative investments in businesses that we believe will weather the current economic conditions
and that are likely to produce attractive long-term returns for our stockholders. We will also,
where prudent and possible, consider the sale of lower-yielding investments. This should result in
increased investment activity when compared to our activity over the past year, but our access to
capital may be limited or challenged and other events beyond our control may still encumber our
ability to make new investments in the future.
Investment Highlights
During the fiscal year ended March 31, 2011, we disbursed $36.3 million in new debt and equity
investments, and we extended $7.3 million of investments to existing portfolio companies through
revolver draws or additions to term notes. Also, during the fiscal year ended March 31, 2011, we
exited two equity investments for aggregate proceeds of approximately $35.0 million, and we
received scheduled and unscheduled contractual principal repayments of approximately $62.5 million.
Since our initial public offering in June 2005 through March 31, 2011, we have made 153 investments
in 91 companies for a total of approximately $626.5 million, before giving effect to principal
repayments on investments and divestitures.
Recent Developments
Short-Term Loan
For every quarter end since June 30, 2009 (the “measurement dates”), we satisfied the 50%
threshold, in part, through the purchase of short-term qualified securities, which was funded
primarily through a short-term loan agreement. Subsequent to each of the
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measurement dates, the short-term qualified securities matured and we repaid the short-term loan,
at which time we again fell below the 50% threshold.
Therefore, for the most recent quarter end, on March 30, 2011, we purchased $40.0 million
short-term United States Treasury Bills (“T-Bills”) through Jefferies & Company, Inc.
(“Jefferies”). The T-Bills were purchased using $4.0 million from existing T-Bills for collateral
and the proceeds from a $40.0 million short-term loan from Jefferies, with an effective annual
interest rate of approximately 0.65%. On April 7, 2011, when the T-Bills matured, we repaid the
$40.0 million loan from Jefferies.
Investment Activity
During our fiscal year ended March 31, 2011, we executed the following transactions with certain of
our portfolio companies:
| • | In April 2010, Interstate FiberNet, Inc. (“ITC”) made full repayment of its senior term debt owed to us resulting in the receipt of approximately $6.7 million in cash proceeds. | ||
| • | In May 2010, Cavert made full repayment of its senior term A debt owed to us resulting in the receipt of approximately $2.9 million in cash proceeds. | ||
| • | In June 2010, we sold our equity investment and received full repayment of our debt investment in A. Stucki in connection with the sale of 100% of the outstanding capital stock of A. Stucki. The net cash proceeds to us from the sale of our equity in A. Stucki were $21.4 million, resulting in a realized gain of $16.6 million, which includes a $0.3 million closing adjustment decrease during the three months ended December 31, 2010. In connection with the equity sale, we accrued and received dividend cash proceeds of $0.3 million from our preferred stock investment in A. Stucki. At the same time, we received $30.6 million in payment of our principal, accrued interest and success fees on the loans to A. Stucki. Additionally, immediately prior to the sale of A. Stucki, we received a special distribution of property with a fair value of $0.5 million, which was recorded as dividend income and has been reflected as a Control investment, Neville Limited, on our Consolidated Schedule of Investments since June 30, 2010. | ||
| • | In July and August 2010, we restructured Galaxy Tool Holding Corporation (“Galaxy”) by converting $12.3 million of our senior subordinated term note into preferred and common stock and investing an additional $3.2 million into preferred stock. After the restructuring, our investments at cost in Galaxy consisted of a $5.2 million senior subordinated term note, $19.6 million in preferred stock and $0.1 million in common stock. | ||
| • | In September 2010, Cavert prepaid $0.8 million of its success fee on its senior term debt and senior subordinated term debt. | ||
| • | In October 2010, we invested $25.0 million in a new Control investment, Venyu, consisting of subordinated debt and preferred equity. Venyu, headquartered in Baton Rouge, Louisiana, is a leader in commercial-grade, customizable solutions for data protection, data hosting and disaster recovery. | ||
| • | In October and November 2010, Mathey Investments, Inc. (“Mathey”) prepaid $0.4 million of its success fee on its senior term debt. | ||
| • | In November 2010, we participated in a syndicated loan, Fifth Third Processing Solutions (“Fifth Third”), at a cost of $0.5 million. | ||
| • | In December 2010, we invested $10.5 million in a new Control investment, Precision, consisting of senior debt and preferred and common equity. Precision, headquartered in Myrtle Beach, South Carolina, is a custom injection molding company, focused on the filtration, consumer and industrial markets. | ||
| • | In December 2010, we sold our equity investment and received full repayment of our debt investment in Chase in connection with Chase’s sale of 100% of its outstanding capital stock. The net cash proceeds to us from the sale of our equity in Chase were $13.9 million, resulting in a realized gain of $6.9 million. In connection with the equity sale, we accrued and received cash dividend proceeds of $4.0 million from our preferred stock investment in Chase. At the same time, we received $22.9 million in repayment of our principal, accrued interest and success fees on the loans to Chase. |
Refer to Note 14, “Subsequent Events” in the
Consolidated Financial Statements
included elsewhere
in this Form 10-K for investment activity occurring subsequent to March 31, 2011.
Registration Statement
On July 21, 2009, we filed a registration statement on Form N-2 (Registration No. 333-160720) that
was amended on October 2, 2009 and which the SEC declared effective on October 8, 2009. We filed a
post-effective amendment to such registration statement on August 24, 2010, which the SEC declared
effective on December 23, 2010. The registration statement permits us to issue, through one or
more transactions, up to an aggregate of $300.0 million in securities, consisting of common stock,
preferred stock, subscription rights, debt securities and warrants to purchase common stock, or a
combination of these securities
.
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Investment Strategy
We expect that our target portfolio over time will include mostly subordinated loans, mezzanine
debt, preferred stock, warrants to buy common stock and common stock. Structurally, subordinated
loans and mezzanine loans usually rank lower in priority of payment to senior debt, such as senior
bank debt, and may be unsecured. However, subordinated debt and mezzanine loans rank senior to
common and preferred equity in a borrower’s capital structure. Typically, subordinated debt and
mezzanine loans have elements of both debt and equity instruments, offering returns in the form of
interest payments associated with senior debt, while providing lenders an opportunity to
participate in the capital appreciation of a borrower, if any, through an equity position. Due to
its higher risk profile and often less restrictive covenants as compared to senior debt, mezzanine
debt generally earns a higher return than senior secured debt. Any warrants associated with
mezzanine loans are typically detachable, which allows lenders to receive repayment of their
principal on an agreed amortization schedule while retaining their equity interest in the borrower.
Mezzanine debt also may include a “put” feature, which permits the holder to sell its equity
interest back to the borrower at a price determined through a pre-determined formula.
Our primary investment focuses are situations involving buyouts and recapitalizations of small and
mid-sized companies with established management teams. We expect that our investments will
generally range between $10.0 million and $40.0 million each, although this investment size may
vary proportionately as the size of our capital base changes. Typically, our investments mature in
no more than seven years and accrue interest at fixed or variable rates. We intend to invest either
by ourselves or jointly with other buyout funds and/or management of the portfolio company,
depending on the opportunity. If we are participating in an investment with one or more
co-investors, then our investment is likely to be smaller than if we were investing alone.
Certain loan investments may have a form of interest that is not paid currently but is accrued and
added to the loan balance and paid at the end of the term. This interest is called paid in-kind
(“PIK”) interest. We generally seek investments that do not generate PIK interest as we have to pay
out this accrued interest as distributions to our stockholders and we may have to borrow money or
raise additional capital in order to meet the tax test for RICs by having to pay out at least 90%
of our income. As of March 31, 2011, one loan in our portfolio bore PIK interest, for which we
recorded $12 for the fiscal year ended March 31, 2011.
Because the majority of our portfolio loans consist of term debt of private companies who typically
cannot or will not expend the resources to have their debt securities rated by a credit rating
agency, we expect that several of the debt securities we acquire will be unrated. We cannot
accurately predict what ratings these loans might receive if they were rated, and thus cannot
determine whether or not they could be considered “investment grade” quality.
To the extent possible, our loans generally are collateralized by a security interest in the
borrower’s assets. Interest payments are generally made monthly or quarterly with amortization of
principal generally being deferred for several years. The principal amount of the loans and any
accrued but unpaid interest generally become due at maturity, generally at five to seven years.
When we receive a warrant to purchase stock in a borrower in connection with a loan, the warrant
will typically have an exercise price equal to the fair value of the portfolio company’s common
stock at the time of the loan and entitle us to purchase a modest percentage of the borrower’s
stock.
Original issue discount (“OID”) arises when we extend a loan and receive an equity interest in the
borrower at the same time. To the extent that the price paid for the equity is not at market value,
we must allocate part of the price paid for the loan to the value of the equity. Then the amount
allocated to the equity, the OID, must be amortized over the life of the loan. As with PIK
interest, the amortization of OID also produces income that must be recognized for purposes of
satisfying the distribution requirements for a RIC under Subchapter M of the Code, whereas the cash
is received, if at all, when the equity instrument is sold. We seek to avoid OID with all potential
investments under review, and as of March 31, 2011, we did not hold any investments with OID
income.
In addition, as a business development company under the 1940 Act, we are required to make
available significant managerial assistance to our portfolio companies. Our investment adviser,
Gladstone Management Corporation, or our Adviser, provides these services on our behalf through its
officers, who are also our officers. Currently, neither we nor our Adviser charges a fee for
managerial assistance; however, if our Adviser does receive fees for such managerial assistance,
our Adviser will credit the managerial assistance fees to the base management fee due from us to
our Adviser.
Our Adviser and Gladstone Securities, each an affiliate of ours, receive fees for certain services
they separately provide to certain of our portfolio companies. Such fees are generally paid
directly to our Adviser and Gladstone Securities, respectively, by the borrower or potential
borrower upon closing of the investment. When our Adviser receives such fees, 50% of certain of
those fees and 100% of others are credited against the base management fee that we pay to our
Adviser. Gladstone Securities provides certain of our portfolio companies with investment banking
and due diligence services; these fees do not impact the fees that we pay the Adviser.
Our Adviser also receives fees for monitoring and reviewing portfolio company investments. These
fees are generally paid annually or quarterly in advance to our Adviser throughout the life of the
investment. Fees of this nature are recorded as revenue by our Adviser when earned and are not
credited against the base management fee.
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We may receive fees for the origination and closing services we provides to portfolio companies
through our Adviser. These fees are
recognized as revenue by our Adviser upon closing
of the originated investment and are then credited against our base
management fee.
Prior to making an investment, we ordinarily enter into a non-binding letter of intent (“LOI”) with
the potential borrower. These LOIs are generally subject to a number of conditions, including, but
not limited to, the satisfactory completion of our due diligence investigations of the potential
borrower’s business, reaching agreement on the legal documentation for the loan, and the receipt of
all necessary consents. Upon execution of the LOI, the potential borrower generally pays the
Adviser a non-refundable fee for services rendered by the Adviser through the date of the LOI.
These fees are received by the Adviser and are offset against the base management fee payable to
the Adviser, which has the effect of reducing our expenses to the extent of any such fees received
by the Adviser.
In the event that we expend significant effort in considering and negotiating a potential
investment that ultimately is not consummated, we generally will seek reimbursement from the
proposed borrower for our reasonable expenses incurred in connection with the transaction,
including legal fees. Any amounts collected for expenses incurred by our Adviser in connection with
unconsummated investments will be reimbursed to our Adviser. Amounts collected for these expenses
incurred by us will be reimbursed to us and will be recognized in the period in which such
reimbursement is received, but there can be no guarantee that we will be successful in collecting
any such reimbursements.
Our Adviser and Administrator
Our Adviser is led by a management team which has extensive experience in our lines of business.
Our Adviser is controlled by David Gladstone, our chairman and chief executive officer. Mr.
Gladstone is also the chairman and chief executive officer of our Adviser. David Dullum is our
president and has extensive experience in private equity investing in middle market companies.
Terry Lee Brubaker is our co-vice chairman, chief operating officer and secretary and has
substantial experience in acquisitions and operations of companies. George Stelljes III is our
co-vice chairman and chief investment officer and has extensive experience in leveraged finance.
One affiliate of our Adviser is Gladstone Administration, LLC (our “Administrator”), which employs
our chief financial officer, chief compliance officer, treasurer, internal counsel and their
respective staffs.
Our Adviser and Administrator also provide investment advisory and administrative services,
respectively, to our affiliates, Gladstone Commercial Corporation (“Gladstone Commercial”), a
publicly traded real estate investment trust; Gladstone Capital Corporation (“Gladstone Capital”),
a publicly traded BDC and RIC; Gladstone Lending Corporation (“Gladstone Lending”), a proposed fund
that would primarily invest in first and second lien term loans; Gladstone Partners Fund, L.P., a
private partnership fund formed primarily to co-invest with us and Gladstone Capital and Gladstone
Land Corporation, a private agricultural real estate company. Excluding our chief financial
officer, all of our executive officers serve as either directors or executive officers, or both, of
our Adviser, our Administrator, Gladstone Commercial and Gladstone Capital. In the future, our
Adviser and Administrator may provide investment advisory and administrative services,
respectively, to other funds, both public and private.
Investment Advisory and Management Agreement
Under the amended and restated investment advisory and management agreement with our Adviser (the
“Advisory Agreement”), we pay our Adviser an annual base management fee of 2% of our average gross
assets, which is defined as total assets, including investments made with proceeds of borrowings,
less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the
two most recently completed quarters and appropriately adjusted for any share issuances or
repurchases during the current quarter.
We also pay our Adviser a two-part incentive fee under the Advisory Agreement. The first part of
the incentive fee is an income-based incentive fee which rewards our Adviser if our quarterly net
investment income (before giving effect to any incentive fee) exceeds 1.75% of our net assets (the
“hurdle rate”). The second part of the incentive fee is a capital gains-based incentive fee that is
determined and payable in arrears as of the end of each fiscal year (or upon termination of the
Advisory Agreement, as of the termination date), and equals 20% of our realized capital gains as of
the end of the fiscal year. In determining the capital gains-based incentive fee payable to our
Adviser, we will calculate the cumulative aggregate realized capital gains and cumulative aggregate
realized capital losses since our inception and the aggregate unrealized capital depreciation as
of the date of the calculation, as applicable, with respect to each of the investments in our
portfolio. The Adviser did not earn the capital gains portion of the incentive fee for the fiscal
year ended March 31, 2011.
We pay our direct expenses including, but not limited to, directors’ fees, legal and accounting
fees, stockholder related expenses, and directors and officers insurance under the Advisory
Agreement.
Since April 2008, our Board of Directors has accepted from our Adviser unconditional and
irrevocable voluntary waivers on a quarterly basis to reduce the annual 2.0% base management fee
on senior syndicated loans to 0.5% to the extent that proceeds resulting from borrowings were used
to purchase such syndicated loan participations. In addition to the base management and
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incentive fees under the Advisory Agreement, 50% of certain fees received by the Adviser from our
portfolio companies are credited against the investment advisory fee and paid to the Adviser.
The Adviser services our loan portfolio pursuant to a loan servicing agreement with Business
Investment in return for a 2.0% annual fee, based on the monthly aggregate outstanding loan balance
of the loans pledged under our Credit Facility.
On July 7, 2010, our Board of Directors approved the renewal of the Advisory Agreement with our
Adviser through August 31, 2011. We expect that the Board of Directors will approve a further one
year renewal in July 2011.
Administration Agreement
We have entered into an administration agreement with our Administrator (the “Administration
Agreement”), whereby we pay separately for administrative services. The Administration Agreement
provides for payments equal to our allocable portion of our Administrator’s overhead expenses in
performing its obligations under the Administration Agreement, including, but not limited to, rent
and salaries and benefits expenses of our chief financial officer, chief compliance officer,
treasurer, internal counsel and their respective staffs. Our allocable portion of expenses is
generally derived by multiplying our Administrator’s total allocable expenses by the percentage of
our total assets at the beginning of the quarter in comparison to the total assets at the beginning
of the quarter of all companies managed by the Adviser under similar agreements. On July 7, 2010,
our Board of Directors approved the renewal of our Administration Agreement with our Administrator
through August 31, 2011. We expect that the Board of Directors will approve a further one year
renewal in July 2011.
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RESULTS OF OPERATIONS
Comparison of the Fiscal Year Ended March 31, 2011 to the Fiscal Year Ended March 31, 2010
| For the fiscal year ended March 31, | ||||||||||||||||
| 2011 | 2010 | $ Change | % Change | |||||||||||||
|
INVESTMENT INCOME
|
||||||||||||||||
|
Interest income
|
$ | 15,722 | $ | 19,817 | $ | (4,095 | ) | (20.7 | )% | |||||||
|
Other income
|
10,342 | 968 | 9,374 | 968.4 | ||||||||||||
|
|
||||||||||||||||
|
Total investment income
|
26,064 | 20,785 | 5,279 | 25.4 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
EXPENSES
|
||||||||||||||||
|
Loan servicing fee
|
2,743 | 3,747 | (1,004 | ) | (26.8 | ) | ||||||||||
|
Base management fee
|
1,236 | 737 | 499 | 67.7 | ||||||||||||
|
Incentive fee
|
2,949 | 588 | 2,361 | 401.5 | ||||||||||||
|
Administration fee
|
753 | 676 | 77 | 11.4 | ||||||||||||
|
Interest expense
|
701 | 1,988 | (1,287 | ) | (64.7 | ) | ||||||||||
|
Amortization of deferred financing fees
|
491 | 1,618 | (1,127 | ) | (69.7 | ) | ||||||||||
|
Other
|
1,700 | 1,659 | 41 | 2.5 | ||||||||||||
|
|
||||||||||||||||
|
Expenses before credits from Adviser
|
10,573 | 11,013 | (440 | ) | (4.0 | ) | ||||||||||
|
Credits to fees
|
(680 | ) | (826 | ) | 146 | (17.7 | ) | |||||||||
|
|
||||||||||||||||
|
Total expenses net of credits to fee
|
9,893 | 10,187 | (294 | ) | (2.9 | ) | ||||||||||
|
|
||||||||||||||||
|
NET INVESTMENT INCOME
|
16,171 | 10,598 | 5,573 | 52.6 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
REALIZED AND UNREALIZED GAIN (LOSS) ON:
|
||||||||||||||||
|
Net realized gain (loss) on investments
|
23,489 | (35,923 | ) | 59,412 | NM | |||||||||||
|
Net realized loss on other
|
— | (53 | ) | 53 | (100.0 | ) | ||||||||||
|
Net unrealized (depreciation) appreciation on investments
|
(23,197 | ) | 14,305 | (37,502 | ) | NM | ||||||||||
|
Net unrealized (depreciation) appreciation on other
|
(24 | ) | 2 | (26 | ) | NM | ||||||||||
|
|
||||||||||||||||
|
Net gain (loss) on investments and other
|
268 | (21,669 | ) | 21,937 | NM | |||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM
OPERATIONS
|
$ | 16,439 | $ | (11,071 | ) | $ | 27,510 | NM | ||||||||
|
|
||||||||||||||||
NM = Not Meaningful
Investment Income
Total investment income increased by 25.4% for the year ended March 31, 2011, as compared to the
prior year. This increase was due mainly to success fee and dividend income resulting from our
exits from A. Stucki and Chase in June and December, 2010, respectively, and the success fee
prepayments from Cavert and Mathey, partially offset by an overall decrease in the size of our loan
portfolio, as compared to the prior year.
Interest income from our investments in debt securities decreased by 20.7% for the year ended March
31, 2011, as compared to the prior year for several reasons. The level of interest income from
investments is directly related to the balance, at cost, of the interest-bearing investment
portfolio outstanding during the period multiplied by the weighted average yield. The weighted
average cost basis of our interest-bearing investment portfolio during the year ended March 31,
2011 was approximately $138.1 million, compared to approximately $179.2 million for the prior year
period, due primarily to the Syndicated Loan Sales, the exits from A. Stucki and Chase, the
restructuring of Galaxy and the payoff of ITC, partially offset with new investments in Venyu and
Precision, subsequent to March 31, 2010. As of March 31, 2011 and 2010, one loan, ASH Holdings
Corp. (“ASH”), was on non-accrual, with a weighted average cost basis of $8.3 million and $6.6
million for the years ended March 31, 2011 and 2010, respectively.
The following table lists the interest income from investments for our five largest portfolio
company investments at fair value during the respective periods:
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| As of March 31, 2011 | Year Ended March 31, 2011 | ||||||||||||||||
| Investment | % of Total | ||||||||||||||||
| Company | Fair Value | % of Portfolio | Income | Investment Income | |||||||||||||
|
Venyu Solutions, Inc.
|
$ | 25,012 | 16.3 | % | $ | 1,056 | 4.1 | % | |||||||||
|
Acme Cryogenics, Inc.
|
19,906 | 13.0 | 1,737 | 6.7 | |||||||||||||
|
Cavert II Holding Corp.
|
18,252 | 11.9 | 1,675 | 6.4 | |||||||||||||
|
Noble Logistics, Inc.
|
13,183 | 8.6 | 1,468 | 5.6 | |||||||||||||
|
Danco Acquisition Corp.
|
12,746 | 8.3 | 1,599 | 6.1 | |||||||||||||
|
Subtotal—five largest investments
|
89,099 | 58.1 | 7,535 | 28.9 | |||||||||||||
|
Other portfolio companies
|
64,186 | 41.9 | 18,529 | 71.1 | |||||||||||||
|
Total investment portfolio
|
$ | 153,285 | 100.0 | % | $ | 26,064 | 100.0 | % | |||||||||
| As of March 31, 2010 | Year Ended March 31, 2010 | ||||||||||||||||
| Investment | % of Total | ||||||||||||||||
| Company | Fair Value | % of Portfolio | Income | Investment Income | |||||||||||||
|
A. Stucki Holding Corp.
|
$ | 50,379 | 24.3 | % | $ | 3,246 | 15.6 | % | |||||||||
|
Chase II Holdings Corp.
|
29,101 | 14.1 | 2,545 | 12.2 | |||||||||||||
|
Cavert II Holding Corp.
|
18,731 | 9.1 | 1,204 | 5.8 | |||||||||||||
|
Galaxy Tool Holding Corp.
|
17,099 | 8.3 | 2,361 | 11.4 | |||||||||||||
|
Danco Acquisition Corp.
|
13,953 | 6.7 | 1,661 | 8.0 | |||||||||||||
|
Subtotal—five largest investments
|
129,263 | 62.5 | 11,017 | 53.0 | |||||||||||||
|
Other portfolio companies
|
77,595 | 37.5 | 9,768 | 47.0 | |||||||||||||
|
Total investment portfolio
|
$ | 206,858 | 100.0 | % | $ | 20,785 | 100.0 | % | |||||||||
The weighted average yield on our interest-bearing investments, excluding cash and cash
equivalents, for the year ended March 31, 2011 was 11.4%, compared to 11.0% for the prior year.
The weighted average yield varies from period to period, based on the current stated interest rate
on interest-bearing investments. The increase in the weighted average yield for the year ended
March 31, 2011 resulted primarily from the sales of lower interest-bearing senior syndicated loans.
The composition of our investment portfolio was primarily Control and Affiliate investments as of
March 31, 2011.
Other income increased significantly due to our sales of A. Stucki and Chase and success fee
prepayments from Cavert and Mathey. We received an aggregate of $4.2 million in success fee income
resulting from our sales of A. Stucki and Chase in June and December 2010, respectively. In
addition, we recorded and collected $4.3 million of aggregate cash dividends on preferred shares of
A. Stucki and Chase. We also accrued and received a special dividend of property valued at $0.5
million in connection with the A. Stucki sale. In total, we recorded $9.0 million in other income
resulting from the sales of A. Stucki and Chase. During the year ended March 31, 2011, we also
recorded $0.8 million and $0.4 million in success fee income resulting from prepayments received
from Cavert and Mathey, respectively. Other income for the year ended March 31, 2010 primarily
consisted of $1.0 million of accrued cash dividends received from A. Stucki.
Operating Expenses
Total operating expenses, excluding any voluntary and irrevocable credits to the base management
and incentive fees, decreased slightly for the year ended March 31, 2011, primarily due to a
reduction in interest expense and the amortization of deferred financing fees associated with the
Credit Facility, partially offset by an increase in the incentive fee accrual, as compared to the
prior year.
Loan servicing fees decreased for the year ended March 31, 2011, as compared to the prior year.
These fees were incurred in connection with a loan servicing agreement between Business Investment
and our Adviser, which is based on the value of the aggregate outstanding balance of eligible loans
in our portfolio and were directly credited against the amount of the base management fee due to
our Adviser. The decrease in fees was a result of the reduced size of our pledged loan portfolio,
caused primarily by the A. Stucki and Chase exits in June and December 2010, respectively.
The net base management fee increased for the year ended March 31, 2011, as compared to the prior
year, which is reflective of a decrease in the loan servicing fee, which reduced the base
management fee, compared to the prior year. Likewise, due to the liquidation of the majority of our
syndicated loans, the credit received against the gross base management fee for investments in
syndicated loans was also reduced. However, the credit we received for fees paid to our Adviser
from our portfolio companies increased during the year ended March 31, 2011, due to fees earned on
the closing of new investments in Venyu and Precision. An incentive fee was earned by the Adviser
during the year ended March 31, 2011, due primarily to other income recorded in connection with the
A. Stucki and Chase sales. The incentive fee earned during the prior year was due primarily to a
one-time dividend prepayment received from A. Stucki. The base management and incentive fees are
computed quarterly, as described under
41
Table of Contents
“Investment Advisory and Management Agreement” in Note 4 of the notes to the accompanying
Consolidated Financial Statements
and are summarized in the following table:
| Year Ended March 31, | |||||||||
| 2011 | 2010 | ||||||||
|
Average total assets subject to base management fee
(1)
|
$ | 198,950 | $ | 224,200 | |||||
|
Multiplied by annual base management fee of 2%
|
2 | % | 2 | % | |||||
|
|
|||||||||
|
Unadjusted base management fee
|
3,979 | 4,484 | |||||||
|
|
|||||||||
|
Reduction for loan servicing fees
(2)
|
(2,743 | ) | (3,747 | ) | |||||
|
|
|||||||||
|
Base management fee
(2)
|
$ | 1,236 | $ | 737 | |||||
|
|
|||||||||
|
|
|||||||||
|
Credits to base management fee from Adviser:
|
|||||||||
|
Fee reduction for the waiver of 2.0% fee on senior syndicated loans to 0.5%
|
(15 | ) | (291 | ) | |||||
|
Credit for fees received by Adviser from the portfolio companies
|
(665 | ) | (433 | ) | |||||
|
|
|||||||||
|
Credit to base management fee from Adviser
(2)
|
(680 | ) | (724 | ) | |||||
|
|
|||||||||
|
|
|||||||||
|
Net base management fee
|
$ | 556 | $ | 13 | |||||
|
|
|||||||||
|
|
|||||||||
|
Incentive fee
(2)
|
$ | 2,949 | $ | 588 | |||||
|
Credit from voluntary, irrevocable waiver issued by Adviser’s board of directors
|
— | (102 | ) | ||||||
|
|
|||||||||
|
Net incentive fee
|
$ | 2,949 | $ | 486 | |||||
|
|
|||||||||
|
|
|||||||||
|
Total credits to fees:
|
|||||||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on senior
syndicated loans to 0.5%
|
$ | (15 | ) | $ | (291 | ) | |||
|
Credit for fees received by Adviser from portfolio companies
|
(665 | ) | (433 | ) | |||||
|
Incentive fee credit
|
— | (102 | ) | ||||||
|
|
|||||||||
|
Credit to base management and incentive fees from Adviser
(2)
|
$ | (680 | ) | $ | (826 | ) | |||
|
|
|||||||||
| (1) | Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and adjusted appropriately for any share issuances or repurchases during the periods. | |
| (2) | Reflected, in total, as a line item on the Consolidated Statement of Operations located elsewhere in this report. |
Interest expense decreased for the year ended March 31, 2011, as compared to the prior year
,
primarily due to decreased borrowings under the Credit Facility. The weighted average balance
outstanding on our Credit Facility during the year ended March 31, 2011 was approximately $2.9
million, as compared to $25.8 million in the prior year, a decrease of 88.8%. The effective
interest rate, excluding the impact of deferred financing fees, charged on our borrowings increased
under our Credit Facility during the year ended March 31, 2011 to 22.7%, up from 7.6% during the
prior year. The increase in the effective interest rate was due to the unused commitment fee,
which accrued at a higher rate and had a higher unused commitment base than our Prior Credit
Facility, and a lower balance of borrowings outstanding to which allocate the expenses during the
year ended March 31, 2011, when compared to the prior year.
We incurred minimal deferred financing costs with the renewal of the Credit Facility in April 2010,
and, as a result, our amortization of deferred financing fees decreased during the year ended March
31, 2011, as compared to the prior year. During the year ended March 31, 2010, we incurred
significant one-time costs related to the termination of our Prior Credit Facility and transition
to our Credit Facility, resulting in significant amortization of deferred financing fees during the
year.
Realized and Unrealized Gain (Loss) on Investments
Realized Losses
During the year ended March 31, 2011, we exited two proprietary investments, A. Stucki and Chase,
and one syndicated loan, ITC, for total proceeds of $92.5 million and recorded a realized gain of
$23.5 million. During the year ended March 31, 2010, we exited 30 senior syndicated loans and a
portion of another senior syndicated loan for aggregate proceeds of approximately $74.7 million in
cash and recorded a realized loss of approximately $35.9 million. These Syndicated Loan Sales and
recognition of realized losses resulted from the liquidity needs associated with the repayment of
amounts outstanding under our Prior Credit Facility that matured in April 2009.
Unrealized Appreciation and Depreciation
Net unrealized (depreciation) appreciation of investments is the net change in the fair value of
our investment portfolio during the reporting period, including the reversal of previously-recorded
unrealized appreciation or depreciation when gains and losses are
42
Table of Contents
actually realized. During the
year ended March 31, 2011, we recorded net unrealized depreciation on investments in the aggregate
amount of $23.2 million, which included the reversal of $21.9 million in aggregate unrealized
appreciation related to the A. Stucki and Chase sales. Excluding reversals, we had $1.3 million in
net unrealized depreciation for the year ended March 31, 2011. The unrealized (depreciation)
appreciation across our investments for the year ended March 31, 2011 was as follows:
| Year Ended March 31, 2011 | ||||||||||||||||||
| Unrealized | Reversal of | |||||||||||||||||
| Investment | Realized | Appreciation | Unrealized | Net Gain | ||||||||||||||
| Portfolio Company | Classification | Gain | (Depreciation) | Appreciation | (Loss) | |||||||||||||
|
Chase II Holding Corp.
|
Control | $ | 6,856 | $ | 3,753 | $ | (4,444 | ) | $ | 6,165 | ||||||||
|
Acme Cryogenics, Inc.
|
Control | — | 5,906 | — | 5,906 | |||||||||||||
|
Noble Logistics, Inc.
|
Affiliate | — | 4,489 | — | 4,489 | |||||||||||||
|
Cavert II Holding Corp.
|
Control | — | 2,446 | — | 2,446 | |||||||||||||
|
Survey Sampling, LLC
|
Non-Control/Non-Affiliate | — | 507 | — | 507 | |||||||||||||
|
Precision Southeast, Inc.
|
Control | — | 253 | — | 253 | |||||||||||||
|
American Greetings
Corporation
|
Non-Control/Non-Affiliate | — | 178 | — | 178 | |||||||||||||
|
Mathey Investments, Inc.
|
Control | — | 119 | — | 119 | |||||||||||||
|
Country Club Enterprises, LLC
|
Control | — | (309 | ) | — | (309 | ) | |||||||||||
|
Quench Holdings Corp.
|
Affiliate | — | (747 | ) | — | (747 | ) | |||||||||||
|
A. Stucki Holding Corp.
|
Control | 16,614 | — | (17,405 | ) | (791 | ) | |||||||||||
|
ASH Holdings Corp.
|
Control | — | (3,718 | ) | — | (3,718 | ) | |||||||||||
|
Galaxy Tool Holding Corp.
|
Control | — | (13,956 | ) | — | (13,956 | ) | |||||||||||
|
Other, net (<$100 Net)
|
Various | 19 | (250 | ) | (19 | ) | (250 | ) | ||||||||||
|
|
||||||||||||||||||
|
Total
|
$ | 23,489 | $ | (1,329 | ) | $ | (21,868 | ) | $ | 292 | ||||||||
|
|
||||||||||||||||||
The primary changes in our net unrealized depreciation for the year ended March 31, 2011 were
the reversal of previously recorded unrealized appreciation on the A. Stucki and Chase exits, the
unrealized depreciation recorded on Galaxy, which underwent a restructuring which resulted in the
conversion of $12.1 million of debt at fair value as of June 30, 2010 into preferred and common
equity, and a full markdown in fair value on ASH, which had a fair value of $0 as of March 31,
2011. Noteworthy appreciation was experienced in our equity holdings of Acme Cryogenics, Inc.
(“Acme”), Noble Logistics, Inc. and Cavert. Excluding the impact of Galaxy, A. Stucki and Chase,
the net unrealized appreciation recognized on our portfolio investments was primarily due to an
increase in certain comparable multiples and, to a lesser extent, the performance of some of our
portfolio companies used to estimate the fair value of our investments.
During the year ended March 31, 2010, we had net unrealized depreciation of investments in the
aggregate amount of $14.3 million, which included the reversal of $35.7 million in unrealized
depreciation, primarily related to the Syndicated Loan Sales. Excluding reversals, we had $21.4
million in net unrealized depreciation for the year ended March 31, 2010. The unrealized
appreciation (depreciation) across our investments for the year ended March 31, 2010 was as
follows:
| Year Ended March 31, 2010 | ||||||||||||||||||
| Reversal of | ||||||||||||||||||
| Unrealized | Unrealized | |||||||||||||||||
| Investment | Realized | Appreciation | (Appreciation) | Net Gain | ||||||||||||||
| Portfolio Company | Classification | Gain (Loss) | (Depreciation) | Depreciation | (Loss) | |||||||||||||
|
Cavert II Holding Corp.
|
Control | $ | — | $ | 3,162 | $ | — | $ | 3,162 | |||||||||
|
A. Stucki Holding Corp.
|
Control | — | 2,773 | — | 2,773 | |||||||||||||
|
Interstate FiberNet, Inc.
|
Non-Control/Non-Affiliate | (561 | ) | 2,564 | 561 | 2,564 | ||||||||||||
|
Quench Holdings Corp.
|
Affiliate | — | 1,032 | — | 1,032 | |||||||||||||
|
American Greetings Corp.
|
Non-Control/Non-Affiliate | — | 714 | — | 714 | |||||||||||||
|
B-Dry, LLC
|
Non-Control/Non-Affiliate | — | 370 | — | 370 | |||||||||||||
|
HMTBP Acquisition II Corp.
|
Non-Control/Non-Affiliate | (757 | ) | 142 | 755 | 140 | ||||||||||||
|
Syndicated Loan Sales, net
|
Non-Control/Non-Affiliate | (34,605 | ) | — | 34,422 | (183 | ) | |||||||||||
|
ASH Holdings Corp.
|
Control | — | (684 | ) | — | (684 | ) | |||||||||||
|
Mathey Investments, Inc.
(1)
|
Control | — | (838 | ) | — | (838 | ) | |||||||||||
|
Survey Sampling, LLC
|
Non-Control/Non-Affiliate | — | (1,161 | ) | — | (1,161 | ) | |||||||||||
|
Tread Corp.
|
Affiliate | — | (1,227 | ) | — | (1,227 | ) | |||||||||||
|
Danco Acquisition Corp.
|
Affiliate | — | (1,875 | ) | — | (1,875 | ) | |||||||||||
|
Noble Logistics, Inc.
|
Affiliate | — | (2,251 | ) | — | (2,251 | ) | |||||||||||
|
Country Club Enterprises, LLC
|
Control | — | (3,856 | ) | — | (3,856 | ) | |||||||||||
|
Galaxy Tool Holding Corp.
|
Control | — | (5,338 | ) | — | (5,338 | ) | |||||||||||
|
Chase II Holding Corp.
|
Control | — | (7,124 | ) | — | (7,124 | ) | |||||||||||
|
Acme Cryogenics, Inc.
|
Control | — | (7,836 | ) | — | (7,836 | ) | |||||||||||
|
|
||||||||||||||||||
|
Total
|
$ | (35,923 | ) | $ | (21,433 | ) | $ | 35,738 | $ | (21,618 | ) | |||||||
|
|
||||||||||||||||||
43
Table of Contents
| (1) | Investment was reclassified from an Affiliate investment to a Control investment in the third quarter of the year ended March 31, 2010. Net unrealized depreciation of $838 includes $260 of unrealized appreciation recorded while classified as an Affiliate investment and $1,098 of unrealized depreciation recorded while classified as a Control investment. |
The primary driver of our net unrealized appreciation for the year ended March 31, 2010 was
the reversal of previously-recorded unrealized depreciation on our senior syndicated loan sales.
Significant appreciation was also experienced in our equity holdings of Cavert and Stucki, as well
as in our debt position of ITC. Substantial depreciation occurred in our equity holdings of
several Control and Affiliate investments, most notably Acme, Chase, Galaxy, and Country Club
Enterprises. The unrealized depreciation recognized on our portfolio investments was due
predominantly to a reduction in certain comparable multiples and, to a lesser extent, the
performance of some of our portfolio companies used to estimate the fair value of our investments.
Over our entire investment portfolio, we recorded an aggregate of approximately $1.0 million of net
unrealized depreciation on our debt positions for the year ended March 31, 2011, while our equity
holdings experienced an aggregate of approximately $22.2 million of net unrealized depreciation.
At March 31, 2011, the fair value of our investment portfolio was less than our cost basis by
approximately $43.9 million, as compared to $20.7 million at March 31, 2010, representing net
unrealized depreciation of $23.2 million for the period. We believe that our aggregate investment
portfolio was valued at a depreciated value due primarily to the general instability of the loan
markets and resulting decrease in market multiples relative to where multiples were when we
originated the investments in our portfolio. Even though valuations have generally stabilized over
the past several quarters, our entire portfolio was fair valued at 77.7% of cost as of March 31,
2011. The unrealized depreciation of our investments does not have an impact on our current
ability to pay distributions to stockholders; however, it may be an indication of future realized
losses, which could ultimately reduce our income available for distribution.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the year ended March 31, 2011, we recorded a net increase in net assets resulting from
operations of $16.4 million as a result of the factors discussed above. For the year ended March
31, 2010, we recorded a net decrease in net assets resulting from operations of $11.1 million as a
result of the factors discussed above. Our net increase (decrease) in net assets resulting from
operations per basic and diluted weighted average common share for the years ended March 31, 2011
and 2010 was $0.74 and $(0.50), respectively.
44
Table of Contents
Comparison of the Fiscal Year Ended March 31, 2010 to the Fiscal Year Ended March 31, 2009
| For the fiscal year ended March 31, | |||||||||||||||||
| 2010 | 2009 | $ Change | % Change | ||||||||||||||
|
INVESTMENT INCOME
|
|||||||||||||||||
|
Interest income
|
$ | 19,817 | $ | 25,245 | $ | (5,428 | ) | (21.5 | )% | ||||||||
|
Other income
|
968 | 567 | 401 | 70.7 | |||||||||||||
|
|
|||||||||||||||||
|
Total investment income
|
20,785 | 25,812 | (5,027 | ) | (19.5 | ) | |||||||||||
|
|
|||||||||||||||||
|
|
|||||||||||||||||
|
EXPENSES
|
|||||||||||||||||
|
Loan servicing fee
|
3,747 | 5,002 | (1,255 | ) | (25.1 | ) | |||||||||||
|
Base management fee
|
737 | 1,699 | (962 | ) | (56.6 | ) | |||||||||||
|
Incentive fee
|
588 | — | 588 | NM | |||||||||||||
|
Administration fee
|
676 | 821 | (145 | ) | (17.7 | ) | |||||||||||
|
Interest expense
|
1,988 | 5,349 | (3,361 | ) | (62.8 | ) | |||||||||||
|
Amortization of deferred financing fees
|
1,618 | 323 | 1,295 | 400.9 | |||||||||||||
|
Other
|
1,659 | 1,704 | (45 | ) | (2.6 | ) | |||||||||||
|
|
|||||||||||||||||
|
Expenses before credits from Adviser
|
11,013 | 14,898 | (3,885 | ) | (26.1 | ) | |||||||||||
|
Credits to fees
|
(826 | ) | (2,474 | ) | 1,648 | (66.6 | ) | ||||||||||
|
|
|||||||||||||||||
|
Total expenses net of credits to fee
|
10,187 | 12,424 | (2,237 | ) | (18.0 | ) | |||||||||||
|
|
|||||||||||||||||
|
NET INVESTMENT INCOME
|
10,598 | 13,388 | (2,790 | ) | (20.8 | ) | |||||||||||
|
|
|||||||||||||||||
|
|
|||||||||||||||||
|
REALIZED AND UNREALIZED (LOSS) GAIN ON:
|
|||||||||||||||||
|
Net realized loss on investments
|
(35,923 | ) | (5,023 | ) | (30,900 | ) | 615.2 | ||||||||||
|
Net realized loss on other
|
(53 | ) | — | (53 | ) | NM | |||||||||||
|
Net unrealized appreciation (depreciation) on investments
|
14,305 | (19,814 | ) | 34,119 | NM | ||||||||||||
|
Net unrealized appreciation on other
|
2 | — | 2 | NM | |||||||||||||
|
|
|||||||||||||||||
|
Net loss on investments and other
|
(21,669 | ) | (24,837 | ) | 3,168 | (12.8 | ) | ||||||||||
|
|
|||||||||||||||||
|
|
|||||||||||||||||
|
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | (11,071 | ) | $ | (11,449 | ) | $ | 378 | (3.3 | )% | |||||||
|
|
|||||||||||||||||
NM = Not Meaningful
Investment Income
Total investment income decreased by 19.5% for the year ended March 31, 2010 as compared to the
prior year. This decrease was due mainly to a decrease in the size of our loan portfolio,
specifically the senior syndicated loans, as well as continuing decreases in the London Interbank
Offered Rate (“LIBOR”), as compared to the year ended March 31, 2009.
Interest income from our investments in debt securities decreased for the year ended March 31, 2010
as compared to the prior year several reasons. The level of interest income from investments is
directly related to the balance, at cost, of the interest-bearing investment portfolio outstanding
during the period multiplied by the weighted average yield.
The weighted average cost basis of our
interest-bearing investment portfolio during the year ended March 31, 2010 was approximately $179.2
million, compared to approximately $297.5 million for the prior year, due primarily to the
aggregate senior syndicated loan sales that occurred during the current fiscal year ended March 31,
2010. The weighted average cost basis of loans on non-accrual for the years ended March 31, 2010
and 2009 was $6.6 million and $12.0 million, respectively. The decrease in the non-accrual amount
is due to the write-off of two additional loans in the prior year that were on non-accrual during
fiscal year 2009. As of March 31, 2010, one loan, ASH, was on non-accrual.
Also contributing to the decrease in our interest income from investments in debt securities was a
decrease in the average LIBOR between the two fiscal years, which was approximately 0.28% for the
year ended March 31, 2010, as compared to 1.96% for the prior year.
The following table lists the interest income from investments for our five largest portfolio
company investments at fair value during the respective periods:
45
Table of Contents
| As of March 31, 2010 | Year Ended March 31, 2010 | ||||||||||||||||
| % of Total | |||||||||||||||||
| Company | Fair Value | % of Portfolio | Revenues | Revenues | |||||||||||||
|
A. Stucki Holding Corp.
|
$ | 50,379 | 24.3 | % | $ | 3,246 | 15.6 | % | |||||||||
|
Chase II Holdings Corp.
|
29,101 | 14.1 | 2,545 | 12.2 | |||||||||||||
|
Cavert II Holding Corp.
|
18,731 | 9.1 | 1,204 | 5.8 | |||||||||||||
|
Galaxy Tool Holding Corp.
|
17,099 | 8.3 | 2,361 | 11.4 | |||||||||||||
|
Danco Acquisition Corp.
|
13,953 | 6.7 | 1,661 | 8.0 | |||||||||||||
|
Subtotal—five largest investments
|
129,263 | 62.5 | 11,017 | 53.0 | |||||||||||||
|
Other portfolio companies
|
77,595 | 37.5 | 9,768 | 47.0 | |||||||||||||
|
Total investment portfolio
|
$ | 206,858 | 100.0 | % | $ | 20,785 | 100.0 | % | |||||||||
| As of March 31, 2009 | Year Ended March 31, 2009 | ||||||||||||||||
| % of Total | |||||||||||||||||
| Company | Fair Value | % of Portfolio | Revenues | Revenues | |||||||||||||
|
A. Stucki Holding Corp.
|
$ | 49,431 | 15.8 | % | $ | 2,716 | 10.5 | % | |||||||||
|
Chase II Holdings Corp.
|
40,880 | 13.0 | 2,811 | 10.9 | |||||||||||||
|
Galaxy Tool Holding Corp.
|
22,437 | 7.2 | 1,436 | 5.6 | |||||||||||||
|
Acme Cryogenics, Inc.
|
21,420 | 6.8 | 1,691 | 6.6 | |||||||||||||
|
Cavert II Holding Corp.
|
18,632 | 5.9 | 1,587 | 6.1 | |||||||||||||
|
Subtotal—five largest investments
|
152,800 | 48.7 | 10,241 | 39.7 | |||||||||||||
|
Other portfolio companies
|
161,130 | 51.3 | 15,571 | 60.3 | |||||||||||||
|
Total investment portfolio
|
$ | 313,930 | 100.0 | % | $ | 25,812 | 100.0 | % | |||||||||
The annualized weighted average yield on our portfolio, excluding cash and cash equivalents, for
the year ended March 31, 2010 was 11.02%, compared to 8.22% for the prior year.
The
increase in the weighted average yield for the current year ended March 31, 2010 resulted primarily
from our sales of lower interest-bearing senior syndicated loans subsequent to March 31, 2009. The
composition of our investment portfolio was primarily Control and Affiliate investments as of March
31, 2010.
Other income increased for the year ended March 31, 2010, as compared the prior year, due to the
receipt of approximately $1.0 million of dividends from our preferred equity investment in Stucki. The
prior year balance was due to dividends received during the restructuring of our investment in
Quench Holdings Corp. The remaining balance in other income is comprised of other miscellaneous
income amounts.
Operating Expenses
Total operating expenses, excluding any voluntary and irrevocable credits to the base management
and incentive fees, decreased for the year ended March 31, 2010, primarily due to a reduction in
interest expense associated with the Credit Facility, as well as an overall decrease in the amount
of fees due to our Adviser, partially offset by an increase in the amortization of deferred
financing fees related to the Credit Facility entered into in April 2009, as compared to the prior
year.
Loan servicing fees decreased for the year ended March 31, 2010, as compared to the prior year.
These fees were incurred in connection with a loan servicing agreement between Business Investment
and our Adviser, which is based on the value of the aggregate outstanding balance of eligible loans
in our portfolio, and were directly credited against the amount of the base management fee due to
our Adviser. The decrease in fees is a result of the reduced size of our pledged loan portfolio,
caused primarily by the Syndicated Loan Sales.
The base management fee decreased for the year ended March 31, 2010, as compared to the prior year,
which is reflective of fewer total assets held during the 2010 fiscal year when compared to the
prior year. Likewise, due to the liquidation of the majority of our syndicated loans, the credit
received against the gross base management fee for investments in syndicated loans has also been
reduced. The base management fee is computed quarterly, as described under
“Investment Advisory and
Management Agreement”
in Note 4 of the notes to the accompanying consolidated financial statements
and is summarized in the table below:
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| Year Ended March 31, | ||||||||
| 2010 | 2009 | |||||||
|
Average total assets subject to base management fee
(1)
|
$ | 224,200 | $ | 335,050 | ||||
|
Multiplied by annual base management fee of 2%
|
2 | % | 2 | % | ||||
|
|
||||||||
|
Unadjusted base management fee
|
4,484 | 6,701 | ||||||
|
|
||||||||
|
Reduction for loan servicing fees
(2)
|
(3,747 | ) | (5,002 | ) | ||||
|
|
||||||||
|
Base management fee
(2)
|
$ | 737 | $ | 1,699 | ||||
|
|
||||||||
|
|
||||||||
|
Credits to base management fee from Adviser:
|
||||||||
|
Fee reduction for the waiver of 2.0% fee on senior syndicated loans to
0.5%
|
(291 | ) | (1,613 | ) | ||||
|
Credit for fees received by Adviser from the portfolio companies
|
(433 | ) | (861 | ) | ||||
|
|
||||||||
|
Credit to base management fee from Adviser
|
(724 | ) | (2,474 | ) | ||||
|
|
||||||||
|
|
||||||||
|
Net base management fee
|
$ | 13 | $ | (775 | ) | |||
|
|
||||||||
|
|
||||||||
|
Incentive fee
(2)
|
$ | 588 | $ | — | ||||
|
Credit from voluntary, irrevocable waiver issued by Adviser’s board of
directors
|
(102 | ) | — | |||||
|
|
||||||||
|
Net incentive fee
|
$ | 486 | $ | — | ||||
|
|
||||||||
|
|
||||||||
|
Total credits to fees:
|
||||||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on
senior syndicated loans to 0.5%
|
$ | (291 | ) | $ | (1,613 | ) | ||
|
Credit for fees received by Adviser from portfolio companies
|
(433 | ) | (861 | ) | ||||
|
Incentive fee credit
|
(102 | ) | — | |||||
|
|
||||||||
|
Credit to base management and incentive fees from Adviser
(2)
|
$ | (826 | ) | $ | (2,474 | ) | ||
|
|
||||||||
| (1) | Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the four most recently completed quarters and appropriately adjusted for any share issuances or repurchases during the current year. | |
| (2) | Reflected, in total, as a line item on the consolidated statement of operations located elsewhere in this report. |
An incentive fee was earned by the Adviser during the third quarter of the year ended March
31, 2010, due in part to a one-time dividend received from Stucki.
The administration fee decreased for the year ended March 31, 2010, as compared the prior year.
This decrease was also a result of fewer total assets held during the year ended March 31, 2010 in
relation to the other funds administered by our Administrator, as compared to the prior year. The
calculation of the administration fee is described in detail under
“Administration Agreement”
in
Note 4 of the notes to the accompanying consolidated financial statements.
Interest expense decreased for the year ended March 31, 2010, as compared to the prior year
primarily due to decreased borrowings under the Credit Facility, partially offset by increased
borrowing costs, during the year ended March 31, 2010. The weighted average balance outstanding on
our line of credit during the year ended March 31, 2010 was approximately $25.8 million, as
compared to $107.4 million in the prior year, a decrease of 76.0%. The effective interest rate,
excluding the impact of deferred financing fees, charged on our borrowings increased under our
Credit Facility during the year ended March 31, 2010 to 7.59%, up from 4.98% under our Prior Credit
Facility utilized during the prior fiscal year.
We incurred significant one-time costs related to the termination of our Prior Credit Facility and
transition to our Credit Facility, resulting in increased amortization of deferred financing fees
during the year ended March 31, 2010 when compared to the prior year.
Realized and Unrealized (Loss) Gain on Investments
Realized Losses
During the year ended March 31, 2010, we exited 30 senior syndicated loans and a portion of another
senior syndicated loan for aggregate proceeds of approximately $74.7 million in cash and recorded a
realized loss of approximately $35.9 million. For the year ended March 31, 2009, we recognized a
net loss on 10 sales and three early exits of senior syndicated loans in the aggregate amount of
approximately $5.0 million. The increase in realized losses is attributable to the Syndicated Loan
Sales, which resulted from the liquidity needs associated with the repayment of amounts outstanding
under our Prior Credit Facility that matured in April 2009.
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Table of Contents
Unrealized Appreciation and Depreciation
Net unrealized appreciation (depreciation) of investments is the net change in the fair value of
our investment portfolio during the reporting period, including the reversal of previously recorded
unrealized appreciation or depreciation when gains and losses are actually realized. During the
year ended March 31, 2010, we recorded net unrealized appreciation of investments in the aggregate
amount of $14.3 million, which included the reversal of $35.7 million in unrealized depreciation
related to sales during the year. Excluding reversals, we had $21.4 million in net unrealized
depreciation for the year ended March 31, 2010. During the prior year, we had net unrealized
depreciation of investments in the aggregate amount of $19.8 million. The unrealized appreciation
(depreciation) across our investments for the year ended March 31, 2010 was as follows:
| Year Ended March 31, 2010 | ||||||
| Net Unrealized | ||||||
| Investment | Appreciation | |||||
| Portfolio Company | Classification | (Depreciation) | ||||
|
Aggregate Non-Proprietary Investments
|
Non-Control / Non-Affiliate | $ | 37,997 | (1) | ||
|
Cavert II Holding Corp.
|
Control | 3,162 | ||||
|
A.Stucki Holding Corp.
|
Control | 2,773 | ||||
|
Quench Holdings Corp.
|
Affiliate | 1,032 | ||||
|
B-Dry, LLC
|
Non-Control / Non-Affiliate | 370 | ||||
|
ASH Holdings Corp.
|
Control | (684 | ) | |||
|
Mathey Investments, Inc.
|
Control | (838 | ) (2) | |||
|
Tread Corp.
|
Affiliate | (1,227 | ) | |||
|
Danco Acquisition Corp.
|
Affiliate | (1,875 | ) | |||
|
Noble Logistics, Inc.
|
Affiliate | (2,251 | ) | |||
|
Country Club Enterprises, LLC
|
Control | (3,856 | ) | |||
|
Galaxy Tool Holding Corp.
|
Control | (5,338 | ) | |||
|
Chase II Holdings Corp.
|
Control | (7,124 | ) | |||
|
Acme Cryogenics, Inc.
|
Control | (7,836 | ) | |||
|
|
||||||
|
Total:
|
$ | 14,305 | ||||
|
|
||||||
| (2) | Includes the reversal of approximately $35.7 million of previously-recorded unrealized depreciation relating to loans sold during the year ended March 31, 2010, as well as the net unrealized appreciation experienced during the year on Non-Control/Non-Affiliate investments held at March 31, 2010. | |
| (3) | Investment was reclassified from an Affiliate investment to a Control investment in the third quarter of the year ended March 31, 2010. Net unrealized depreciation of $838 includes $260 of unrealized appreciation recorded while classified as an Affiliate investment and $1,098 of unrealized depreciation recorded while classified as a Control investment. |
The primary driver of our net unrealized appreciation for the year ended March 31, 2010 was
the reversal of previously-recorded unrealized depreciation on our senior syndicated loan sales.
Significant appreciation was also experienced in our equity holdings of Cavert and Stucki, as well
as in our debt position of ITC. Substantial depreciation occurred in our equity holdings of
several Control and Affiliate investments, most notably Chase, Acme, Galaxy, and Country Club
Enterprises. The unrealized depreciation recognized on our portfolio investments was due
predominantly to a reduction in certain comparable multiples and, to a lesser extent, the
performance of some of our portfolio companies used to estimate the fair value of our investments.
The unrealized appreciation (depreciation) across our investments for the year ended March 31, 2009
was as follows:
| Year Ended March 31, 2009 | ||||||
| Net Unrealized | ||||||
| Investment | Appreciation | |||||
| Portfolio Company | Classification | (Depreciation) | ||||
|
A.Stucki Holding Corp.
|
Control | $ | 4,339 | |||
|
Chase II Holdings Corp.
|
Control | 2,874 | ||||
|
ASH Holdings Corp.
|
Control | 1,101 | ||||
|
Galaxy Tool Holding Corp.
|
Control | 1,027 | ||||
|
Tread Corp.
|
Affiliate | 418 | ||||
|
Quench Holdings Corp.
|
Affiliate | 392 | (1) | |||
|
Cavert II Holding Corp.
|
Control | 384 | ||||
|
Mathey Investments, Inc.
|
Affiliate | (260 | ) | |||
|
B-Dry, LLC
|
Non-Control / Non-Affiliate | (617 | ) | |||
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Table of Contents
| Year Ended March 31, 2009 | ||||||
| Net Unrealized | ||||||
| Investment | Appreciation | |||||
| Portfolio Company | Classification | (Depreciation) | ||||
|
Danco Acquisition Corp.
|
Affiliate | (1,908 | ) | |||
|
Acme Cryogenics, Inc.
|
Control | (4,143 | ) | |||
|
Noble Logistics, Inc.
|
Affiliate | (7,620 | ) | |||
|
Aggregate Non-Proprietary Investments
|
Non-Control / Non-Affiliate | (15,801 | ) | |||
|
|
||||||
|
Total:
|
$ | (19,814 | ) | |||
|
|
||||||
| (1) | Investment was reclassified from a Control investment to an Affiliate investment in the second quarter of fiscal year 2009. Net unrealized appreciation of $392 includes $3,447 of unrealized depreciation recorded while classified as a Control investment and $3,055 of unrealized appreciation recorded while classified as an Affiliate investment. |
The primary driver of our net unrealized depreciation the year ended March 31, 2009 was the
decline in value of our senior syndicated loans, which depreciated by $14.9 million, as well as
significant decreases in value of our equity holdings in Acme and our overall investment in Noble
Logistics. Partially offsetting these declines were sizeable appreciations in our equity holdings
of Stucki, Chase, and Quench.
Over our entire investment portfolio, we recorded an aggregate of approximately $35.1 million of
net unrealized appreciation on our debt positions for the year ended March 31, 2010, while our
equity holdings experienced an aggregate of approximately $20.8 million of net unrealized
depreciation. At March 31, 2010, the fair value of our investment portfolio was less than the cost
basis of our portfolio by approximately $20.7 million, as compared to $35.0 million at March 31,
2009, representing net unrealized appreciation of $14.3 million for the period. We believe that
our aggregate investment portfolio was valued at a depreciated value due primarily to the general
instability of the loan markets and resulting decrease in market multiples. Due to the continued
devaluations over the past year on our equity investments, our entire portfolio was fair valued at
90.9% of cost as of March 31, 2010. The unrealized depreciation of our investments does not have
an impact on our current ability to pay distributions to stockholders; however, it may be an
indication of future realized losses, which could ultimately reduce our income available for
distribution.
Net Decrease in Net Assets Resulting from Operations
For the year ended March 31, 2010, we recorded a net decrease in net assets resulting from
operations of $11.1 million as a result of the factors discussed above. For the year ended March
31, 2009, we recorded a net decrease in net assets resulting from operations of $11.4 million. Our
net decrease in net assets resulting from operations per basic and diluted weighted average common
share for the years ended March 31, 2010 and 2009 were $0.50 and $0.53, respectively.
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LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Net cash provided by operating activities for the year ended March 31, 2011 was approximately $67.1
million and consisted primarily of proceeds received from the A. Stucki and Chase sales and
principal payments received from existing investments, partially offset by disbursements for new
investments. Net cash provided by operating activities for the year ended March 31, 2010 was
approximately $99.3 million and consisted primarily of proceeds received from the Syndicated Loan
Sales and the net loss realized on those sales and principal payments received from existing
investments, partially offset by the unrealized appreciation experienced throughout our loan
portfolio during the year ended March 31, 2010.
At March 31, 2011, we had investments in equity of, loans to, or syndicated participations in, 17
private companies with an aggregate cost basis of approximately $197.2 million. At March 31, 2010,
we had investments in equity of, loans to or syndicated participations in 16 private companies with
an aggregate cost basis of approximately $227.6 million. The following table summarizes our total
portfolio investment activity during the years ended March 31, 2011 and 2010:
| Year ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Beginning investment portfolio, at fair value
|
$ | 206,858 | $ | 313,930 | ||||
|
New investments
|
35,814 | — | ||||||
|
Disbursements to existing investments
|
7,293 | 3,938 | ||||||
|
Scheduled principal repayments
|
(3,214 | ) | (3,294 | ) | ||||
|
Unscheduled principal repayments
|
(59,037 | ) | (11,390 | ) | ||||
|
Amortization of premiums and discounts
|
(8 | ) | (2 | ) | ||||
|
Proceeds from sales
|
(35,009 | ) | (74,706 | ) | ||||
|
Net realized gain (loss)
|
23,489 | (35,923 | ) | |||||
|
Net unrealized depreciation
|
(1,329 | ) | (21,433 | ) | ||||
|
Reversal of net unrealized (appreciation) depreciation
|
(21,868 | ) | 35,738 | |||||
|
Other cash activity, net
|
(231 | ) | — | |||||
|
Other non-cash activity, net
|
527 | — | ||||||
|
|
||||||||
|
Ending investment portfolio, at fair value
|
$ | 153,285 | $ | 206,858 | ||||
|
|
||||||||
The following table summarizes the contractual principal repayment and maturity of our
investment portfolio by fiscal year, assuming no voluntary prepayments, at March 31, 2011.
| Fiscal Year Ending March 31, | Amount | |||
|
2012
|
$ | 18,946 | ||
|
2013
|
33,866 | |||
|
2014
|
34,331 | |||
|
2015
|
21,942 | |||
|
2016
|
26,775 | |||
|
Thereafter
|
3,543 | |||
|
|
||||
|
Total contractual repayments
|
$ | 139,403 | ||
|
Investment in equity securities
|
58,023 | |||
|
Adjustments to cost basis on debt securities
|
(234 | ) | ||
|
|
||||
|
Total cost basis of investments held at March 31, 2011:
|
$ | 197,192 | ||
|
|
||||
Prior to our proprietary investments in Venyu in October 2010 and in Precision in December 2010,
our most recent proprietary investment in a new portfolio company occurred in November 2008. In
light of the A. Stucki and Chase sales and resulting liquidity, the general stabilization of our
portfolio valuations over the past year and the increased investing opportunities that we see in
our target markets, as demonstrated by our $25.0 million and $10.5 million investments in Venyu and
Precision, respectively, we are cautiously optimistic about the long-term prospects and have
shifted our investment activity from being focused primarily on retaining capital and building the
value of our existing portfolio companies to one that includes making new conservative investments
in businesses that we believe will weather the current economic conditions and that are likely to
produce attractive long-term returns for our stockholders. We will also, where prudent and
possible, consider the sale of lower-yielding investments. Increasing new investment activity over
the long run will require accessing capital markets, which continue to be challenging in these
unstable economic conditions, while ensuring that we can maintain our RIC status.
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Financing Activities
Net cash used in financing activities for the year ended March 31, 2011 was approximately $74.2
million, which was primarily a result of net repayments on our Credit Facility and short-term loan
in excess of borrowings by approximately $62.8 million, in addition to distributions paid to
stockholders of $10.6 million. Net cash used in financing activities for the year ended March 31,
2010 was approximately $18.8 million, which was primarily a result of net repayments on our Prior
Credit Facility and short-term loan in excess of borrowings by approximately $7.5 million, in
addition to our distributions paid to stockholders of $10.6 million.
Distributions
To qualify as a RIC and, therefore, avoid corporate level tax on the income we distribute to our
stockholders, we are required, under Subchapter M of the Code, to distribute at least 90% of our
ordinary income and short-term capital gains to our stockholders on an annual basis. In accordance
with these requirements, we declared and paid monthly cash distributions of $0.04 per common share
during each month of the fiscal years ended March 31, 2011 and 2010. In April 2011, our Board of
Directors declared a monthly distribution of $0.045 per common share for each of April, May and
June 2011. We declared these distributions based on our estimates of net taxable income for the
fiscal year.
For the fiscal year ended March 31, 2011, our distributions to stockholders of approximately $10.6
million were less than our taxable income over the same period. At year-end, we elected to treat a
portion of the first distribution paid after year-end as having been paid in the prior year, in
accordance with Section 855(a) of the Code. Additionally, the covenants in our Credit Facility
restrict the amount of distributions that we can pay out to be no greater than our net investment
income. For the year ended March 31, 2010, distributions to our stockholders equaled taxable income
available for distribution.
Section 19(a) Disclosure
Our Board of Directors estimates the source of the distributions at the time of their declaration,
as required by Section 19(a) of the 1940 Act. On a monthly basis, if required under Section 19(a),
we post a Section 19(a) notice through the Depository Trust Company’s Legal Notice System and also
sends to our registered stockholders a written Section 19(a) notice along with the payment of
distributions for any payment which includes a distribution estimated to be paid from any source
other than accumulative net investment income during the fiscal year. The estimates of the source
of the distribution are interim estimates based on GAAP that are subject to revision, and the exact
character of the distributions for tax purposes cannot be determined until our books and records
are finalized for the calendar year. Following the calendar year end, after we have determined
definitive information, if we have made distributions of taxable income (or return of capital), we
will deliver a Form 1099-DIV to our stockholders specifying such amount and the tax
characterization of such amount. Therefore, these estimates are made solely to comply with the
requirements of Section 19(a) of the 1940 Act and should not be relied upon for tax reporting or
any other purposes and could differ significantly from the actual character of distributions for
tax purposes.
Equity
On July 21, 2009, we filed a registration statement (the “Registration Statement”) with the SEC
that was amended on October 2, 2009 and which the SEC declared effective on October 8, 2009. We
filed a post-effective amendment to the Registration Statement on August 24, 2010, which the SEC
declared effective on December 23, 2010. The Registration Statement permits us to issue, through
one or more transactions, up to an aggregate of $300.0 million in securities, consisting of common
stock, preferred stock, subscription rights, debt securities, warrants to purchase common stock, or
a combination of these securities.
We anticipate issuing equity securities to obtain additional capital in the future. However, we
cannot determine the terms of any future equity issuances or whether we will be able to issue
equity on terms favorable to us, or at all. Additionally, when our common stock is trading below
net asset value, we will have regulatory constraints under the 1940 Act on our ability to obtain
additional capital in this manner. On March 31, 2011, our stock closed trading at $7.76,
representing a 13.8% discount to our NAV of $9.00 per share. Generally, the 1940 Act provides that
we may not issue stock for a price below NAV per share, without first obtaining the approval of our
stockholders and our independent directors, or through a rights offering.
Future Capital Resources
At our 2010 annual stockholders meeting, our stockholders approved a proposal that allows us to
sell shares of our common stock at a price below our then current net asset value per share should
we choose to do so. This proposal is in effect until our next annual stockholders meeting,
currently scheduled for August 4, 2011, at which time we will ask our stockholders to vote in favor
of this proposal for another year.
Revolving Credit Facility
On April 14, 2009, we entered into the Credit Facility, providing for a $50.0 million revolving
line of credit arranged by BB&T as administrative agent, replacing Deutsche Bank AG, which served
as administrative agent under our prior credit facility. Key
51
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Equipment Finance Company Inc. also
joined the Credit Facility as a committed lender. In connection with our entry into the Credit
Facility, we borrowed $43.8 million under the Credit Facility to repay in full all amounts
outstanding under the prior credit facility.
On April 13, 2010, we renewed the Credit Facility through Business Investment, by entering into a
third amended and restated credit agreement providing for a $50.0 million, two-year revolving line
of credit, which may be expanded up to $125.0 million through the addition of other committed
lenders to the facility. The Credit Facility’s maturity date is April 13, 2012, and if it is not
renewed or extended by then, all unpaid principal and interest will be due and payable on or before
April 13, 2013. Advances under the Credit Facility generally bear interest at the 30-day LIBOR
(subject to a minimum rate of 2.0%), plus 4.5% per annum, with a commitment fee of 0.50% per annum
on undrawn amounts when advances outstanding are above 50.0% of the commitment and 1.0% on undrawn
amounts if the advances outstanding are below 50.0% of the commitment. In connection with the
Credit Facility renewal, we paid an upfront fee of 1.0%. As of March 31, 2011, there was no balance
outstanding with approximately $33.9 million of availability under the Credit Facility.
The Credit Facility contains covenants that require Business Investment to maintain its status as a
separate legal entity; prohibit certain significant corporate transactions (such as mergers,
consolidations, liquidations or dissolutions); and restrict material changes to our credit and
collection policies without lenders’ consent. The facility also limits payments as distributions to
the aggregate net investment income for each of the twelve month periods ending March 31, 2011 and
2012. We are also subject to certain limitations on the type of loan investments we can make,
including restrictions on geographic concentrations, sector concentrations, loan size, dividend
payout, payment frequency and status, average life and lien property. The Credit Facility also
requires us to comply with other financial and operational covenants, which obligate us to, among
other things, maintain certain financial ratios, including asset and interest coverage, a minimum
net worth, and a minimum number of obligors required in the borrowing base of the credit agreement.
Additionally, we are subject to a performance guaranty that requires us to maintain (i) a minimum
net worth of $155.0 million plus 50% of all equity and subordinated debt raised after April 13,
2010, (ii) “asset coverage” with respect to “senior securities representing indebtedness” of at
least 200%, in accordance with Section 18 of the 1940 Act, and (iii) our status as a BDC under the
1940 Act and as a RIC under the Code. As of March 31, 2011, we were in compliance with all
covenants.
During May 2009, we cancelled our interest rate cap agreement with Deutsche Bank AG and entered
into a new interest rate cap agreement, which expired in May 2011, for a notional amount of $45.0
million that will effectively limit the interest rate on a portion of the borrowings under the
Credit Facility. We incurred a premium fee of approximately $39 in conjunction with this
agreement.
In April 2010, we entered into a forward interest rate cap agreement, effective May 2011 and
expiring in May 2012, for a notional amount of $45.0 million that will effectively limit the
interest rate on a portion of the borrowings under the line of credit pursuant to the terms of the
Credit Facility. We incurred a premium fee of approximately $41 in conjunction with this
agreement.
The administrative agent also requires that any interest or principal payments on pledged loans be
remitted directly by the borrower into a lockbox account, with The Bank of New York Mellon Trust
Company, N.A. as custodian. BB&T is also the trustee of the account and once a month remits the
collected funds to us. At May 20, 2011, the amount due from the custodian was approximately $1.4
million.
The Adviser services the loans pledged under the Credit Facility. As a condition to this servicing
arrangement, we executed a performance guaranty whereby the Adviser guaranteed it would comply with
all of its obligations under the Credit Facility. As of March 31, 2011 and May 20, 2011, we were in
compliance with the covenants under the performance guaranty.
Our continued compliance with these covenants, however, depends on many factors, some of which are
beyond our control. In particular, depreciation in the valuation of our assets, which is subject to
changing market conditions that are presently very volatile, affects our ability to comply with
these covenants. Our entire portfolio was fair valued at 77.7% of cost as of March 31, 2011. Given
the unstable capital markets, net unrealized depreciation in our portfolio may return in future
periods and threaten our ability to comply with the covenants under our Credit Facility.
Accordingly, there are no assurances that we will be able to continue to comply with these
covenants. Failure to comply with these covenants would result in a default, which, if we are
unable to obtain a waiver from the lenders, could accelerate our repayment obligations under the
Credit Facility and thereby have a material adverse impact on our liquidity, financial condition,
results of operations and ability to pay distributions to our stockholders, as more fully described
below.
The Credit Facility matures on April 13, 2012, and, if the facility is not renewed or extended by
this date, all unpaid principal and interest will be due and payable on or before April 13, 2013.
There can be no guarantee that we will be able to renew, extend or replace the Credit Facility on
terms that are favorable to us, or at all. Our ability to obtain replacement financing will be
constrained by then current economic conditions affecting the credit markets. If we are not able
to renew, extend or refinance the Credit Facility, this would likely have a material adverse effect
on our liquidity and ability to fund new investments or pay distributions to our stockholders. Our
inability to pay distributions could result in our failure to qualify as a RIC. Consequently, any
income or gains could become taxable at corporate rates. If we are unable to secure replacement
financing, we may be forced to sell certain assets on disadvantageous terms, which may result in
realized losses, such as those recorded in connection with the Syndicated Loan Sales,
which resulted in a realized loss of approximately $34.6 million during the quarter ended June 30,
2009. Such realized losses could materially exceed the amount of any unrealized depreciation on
these assets as of our most recent balance sheet date, which would
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have a material adverse effect on our results of operations. In addition to selling assets, or as an alternative, we may issue
equity in order to repay amounts outstanding under the Credit Facility. Based on the recent
trading prices of our stock, such an equity offering may have a substantial dilutive impact on our
existing stockholders’ interest in our earnings and assets and voting interest in us.
Short-Term Note
For every quarter end since June 30, 2009 (the “measurement dates”), we satisfied the 50%
threshold, primarily through the purchase of short-term qualified securities, which was funded
primarily through a short-term loan agreement. Subsequent to the measurement dates, the short-term
qualified securities matured and we repaid the short-term loan, at which time we again fell below
the 50% threshold. Therefore, for year end, on March 30, 2011, we purchased $40.0 million of
T-Bills through Jefferies. The T-Bills were purchased using $4.0 million from existing T-Bills for
collateral and the proceeds from a $40.0 million short-term loan from Jefferies, with an effective
annual interest rate of approximately 0.65%. On April 7, 2011, when the T-Bills matured, we repaid
the $40.0 million loan from Jefferies.
Contractual Obligations and Off-Balance Sheet Arrangements
We were not a party to any signed term sheets for potential investments as of March 31, 2011.
However, we have certain lines of credit with our portfolio companies that have not been fully
drawn. Since these lines of credit have expiration dates and we expect many will never be fully
drawn, the total line of credit commitment amounts do not necessarily represent future cash
requirements. We estimate the fair value of these unused line of credit commitments as of March
31, 2011 and March 31, 2010 to be nominal.
In October 2008, we executed a guaranty of a vehicle finance facility agreement (the “Finance
Facility”) between Ford Motor Credit Company and ASH. The Finance Facility provides ASH with a
line of credit of up to $0.8 million for component Ford parts used by ASH to build truck bodies
under a separate contract. Title and ownership of the parts is retained by Ford. The guaranty of
the Finance Facility will expire upon termination of the separate parts supply contract with Ford
or upon our replacement as guarantor. The Finance Facility is secured by all of the assets of
Business Investment. As of March 31, 2011, we have not been required to make any payments on the
guaranty of the Finance Facility, and we consider the credit risk to be remote and the fair value
of the guaranty to be minimal.
In February 2010, we executed a guaranty of a wholesale financing facility agreement (the “Floor
Plan Facility”) between Agricredit Acceptance, LLC (“Agricredit”) and Country Club Enterprise, LLC
(“CCE”). The Floor Plan Facility provides CCE with financing of up to $2.0 million to bridge the
time and cash flow gap between the order and delivery of golf cars to customers. The guaranty was
renewed in February 2011 and expires in February 2012, unless it is again renewed. In connection
with this guaranty and its subsequent renewal, we recorded aggregate premiums of $0.2 million from
CCE. As of March 31, 2011, we have not been required to make any payments on the guaranty of the
Floor Plan Facility, and we consider the credit risk to be remote and the fair value of the
guaranty to be minimal.
In April 2010, we executed a guaranty of vendor recourse for up to $2.0 million in individual
customer transactions (the “Recourse Facility”) between Wells Fargo Financial Leasing, Inc. and
CCE. The Recourse Facility provides CCE with the ability to provide vendor recourse up to a limit
of $2.0 million of transactions with long-time customers who lack the financial history to qualify
for third-party financing. In connection with this guaranty, we received a premium of $0.1 million
from CCE, which approximates fair value. As of March 31, 2011, we have not been required to make
any payments on the guaranty of the Recourse Facility, and we consider the credit risk to be remote
and the fair value of the guaranty to be minimal.
In accordance with GAAP, the unused portions of these commitments are not recorded on the
accompanying
Consolidated Statements of Assets and Liabilities
. The following table summarizes the
nominal dollar balance of unused line of credit commitments and guarantees as of March 31, 2011 and
March 31, 2010:
| As of March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Unused lines of credit
|
$ | 2,386 | $ | 1,814 | ||||
|
Guarantees
|
4,664 | 2,250 | ||||||
The following table shows our contractual obligations as of March 31, 2011:
| Payments Due by Period | ||||||||||||||||||||
| Less than 1 | ||||||||||||||||||||
| Contractual Obligations (1) | Year | 1-3 Years | 4-5 Years | After 5 Years | Total | |||||||||||||||
|
Borrowings:
|
||||||||||||||||||||
|
Short-term loan
(2)
|
$ | 40,000 | $ | — | $ | — | $ | — | $ | 40,000 | ||||||||||
|
Credit Facility
|
— | — | — | — | — | |||||||||||||||
|
|
||||||||||||||||||||
|
Total borrowings
|
$ | 40,000 | $ | — | $ | — | $ | — | $ | 40,000 | ||||||||||
|
|
||||||||||||||||||||
| (1) | Excludes the unused commitments to extend credit to our portfolio companies of $2.4 million, as discussed above. | |
| (2) | On April 7, 2011, we repaid the entire short-term loan. |
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Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with GAAP requires
management to make estimates and assumptions that affect the reported consolidated amounts of
assets and liabilities, including disclosure of contingent assets and liabilities at the date of
the financial statements, and revenues and expenses during the period reported. Actual results
could differ materially from those estimates. We have identified our investment valuation process
as our most critical accounting policy.
Investment Valuation
The most significant estimate inherent in the preparation of our consolidated financial statements
is the valuation of investments and the related amounts of unrealized appreciation and depreciation
of investments recorded.
General Valuation Policy:
We value our investments in accordance with the requirements of the 1940
Act. As discussed more fully below, we value securities for which market quotations are readily
available and reliable at their market value. We value all other securities and assets at fair
value, as determined in good faith by our Board of Directors.
ASC 820 defines fair value, establishes a framework for measuring fair value and expands
disclosures about assets and liabilities measured at fair value. ASC 820 provides a consistent
definition of fair value that focuses on exit price in the principal, or most advantageous, market
and prioritizes, within a measurement of fair value, the use of market-based inputs over
entity-specific inputs. ASC 820 also establishes the following three-level hierarchy for fair value
measurements based upon the transparency of inputs to the valuation of an asset or liability as of
the measurement date.
| • | Level 1 —inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; | ||
| • | Level 2 —inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and | ||
| • | Level 3 —inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect our own assumptions that market participants would use to price the asset or liability based upon the best available information. |
See Note 3, “
Investments”
in the accompanying notes to our
Consolidated Financial Statements
included elsewhere in this report for additional information regarding fair value measurements and
our adoption of ASC 820.
We use generally accepted valuation techniques to value our portfolio unless we have specific
information about the value of an investment to determine otherwise. From time to time we may
accept an appraisal of a business in which we hold securities. These appraisals are expensive and
occur infrequently but provide a third-party valuation opinion that may differ in results,
techniques and scopes used to value our investments. When these specific third-party appraisals
are engaged or accepted, we would use estimates of value provided by such appraisals and our own
assumptions, including estimated remaining life, current market yield and interest rate spreads of
similar securities, as of the measurement date, to value the investment we have in that business.
In determining the value of our investments, our Adviser has established an investment valuation
policy (the “Policy”). The Policy has been approved by our Board of Directors, and each quarter
our Board of Directors reviews whether our Adviser has applied the Policy consistently and votes
whether or not to accept the recommended valuation of our investment portfolio.
The Policy, which is summarized below, applies to the following categories of securities:
| • | Publicly-traded securities; | ||
| • | Securities for which a limited market exists; and | ||
| • | Securities for which no market exists. |
Valuation Methods:
Publicly-traded securities:
We determine the value of publicly-traded securities based on the
closing price for the security on the exchange or securities market on which it is listed and
primarily traded on the valuation date. To the extent that we own restricted securities that are
not freely tradable, but for which a public market otherwise exists, we will use the market value
of that security adjusted for any decrease in value resulting from the restrictive feature.
Securities for which a limited market exists:
We value securities that are not traded on an
established secondary securities market, but for which a limited market for the security exists,
such as certain participations in, or assignments of, syndicated loans, at the quoted bid price.
In valuing these assets, we assess trading activity in an asset class, evaluate variances in prices
and other market insights to determine if any available quote prices are reliable. If we conclude that quotes based
on active markets or trading activity
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may be relied upon, firm bid prices are requested; however,
if a firm bid price is unavailable, we base the value of the security upon the indicative bid price
(“IBP”) offered by the respective originating syndication agent’s trading desk, or secondary desk,
on or near the valuation date. To the extent that we use the IBP as a basis for valuing the
security, our Adviser may take further steps to consider additional information to validate that
price in accordance with the Policy.
In the event these limited markets become illiquid such that market prices are no longer readily
available, we will value our syndicated loans using alternative methods, such as estimated net
present values of the future cash flows or discounted cash flows (“DCF”). The use of a DCF
methodology follows that prescribed by ASC 820, which provides guidance on the use of a reporting
entity’s own assumptions about future cash flows and risk-adjusted discount rates when relevant
observable inputs, such as quotes in active markets, are not available. When relevant observable
market data does not exist, the alternative outlined in ASC 820 is the valuation of investments
based on DCF. For the purposes of using DCF to provide fair value estimates, we consider multiple
inputs such as a risk-adjusted discount rate that incorporates adjustments that market participants
would make both for nonperformance and liquidity risks. As such, we developed a modified discount
rate approach that incorporates risk premiums including, among others, increased probability of
default, or higher loss given default, or increased liquidity risk. The DCF valuations applied to
the syndicated loans provide an estimate of what we believe a market participant would pay to
purchase a syndicated loan in an active market, thereby establishing a fair value. We apply the
DCF methodology in illiquid markets until quoted prices are available or are deemed reliable based
on trading activity.
As of March 31, 2011, we assessed trading activity in syndicated loan assets and determined that
there continued to be market liquidity and a secondary market for these assets. Thus, firm bid
prices or IBPs were used to fair value our syndicated loans at March 31, 2011.
Securities for which no market exists:
The valuation methodology for securities for which no market
exists falls into three categories: (1) portfolio investments comprised solely of debt securities;
(2) portfolio investments in controlled companies comprised of a bundle of securities, which can
include debt and equity securities; and (3) portfolio investments in non-controlled companies
comprised of a bundle of investments, which can include debt and equity securities.
| (1) |
|
| In the case of Non-Public Debt Securities, we have engaged SPSE to submit opinions of value for our debt securities that are issued by portfolio companies in which we own no equity, or equity-like securities. SPSE’s opinions of value are based on the valuations prepared by our portfolio management team, as described below. We request that SPSE also evaluate and assign values to success fees when we determine that there is a reasonable probability of receiving a success fee on a given loan. SPSE will only evaluate the debt portion of our investments for which we specifically request evaluation, and may decline to make requested evaluations for any reason, at its sole discretion. Upon completing our collection of data with respect to the investments (which may include the information described below under “—Credit Information,” the risk ratings of the loans described below under “—Loan Grading and Risk Rating” and the factors described hereunder), this valuation data is forwarded to SPSE for review and analysis. SPSE makes its independent assessment of the data that we have assembled and assesses its independent data to form an opinion as to what they consider to be the market values for the securities. With regard to its work, SPSE has issued the following paragraph: |
SPSE provides evaluated price opinions which are reflective of what SPSE believes the bid
side of the market would be for each loan after careful review and analysis of descriptive,
market and credit information. Each price reflects SPSE’s best judgment based upon careful
examination of a variety of market factors. Because of fluctuation in the market and in
other factors beyond its control, SPSE cannot guarantee these evaluations. The evaluations
reflect the market prices, or estimates thereof, on the date specified. The prices are
based on comparable market prices for similar securities. Market information has been
obtained from reputable secondary market sources. Although these sources are considered
reliable, SPSE cannot guarantee their accuracy.
| SPSE opinions of the value of our debt securities that are issued by portfolio companies in which we do not own equity, or equity-like securities, are submitted to our Board of Directors along with our Adviser’s supplemental assessment and recommendation regarding valuation of each of these investments. Our Adviser generally accepts the opinion of value given by SPSE; however, in certain limited circumstances, such as when our Adviser may learn new information regarding an investment between the time of submission to SPSE and the date of our Board of Directors’ assessment, our Adviser’s conclusions as to value may differ from the opinion of value delivered by SPSE. Our Board of Directors then reviews whether our Adviser has followed its established procedures for determinations of fair value, and votes to accept or reject the recommended valuation of our investment portfolio. Our Adviser and our management recommended, and our Board of Directors voted to accept, the opinions of value delivered by |
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| SPSE on the loans in our portfolio as denoted on the Schedule of Investments included in our accompanying Consolidated Financial Statements . |
| Because there is a delay between when we close an investment and when the investment can be evaluated by SPSE, new loans are not valued immediately by SPSE; rather, management makes its own determination about the value of these investments in accordance with our valuation policy using the methods described herein. |
| (2) | Portfolio investments in controlled companies comprised of a bundle of investments, which can include debt and equity securities: The fair value of these investments is determined based on the total enterprise value (“TEV”) of the portfolio company, or issuer, utilizing a liquidity waterfall approach under ASC 820. For Non-Public Debt Securities and equity or equity-like securities (e.g. preferred equity, common equity, or other equity-like securities) that are purchased together as part of a package, where we have control or could gain control through an option or warrant security, both the debt and equity securities of the portfolio investment would exit in the mergers and acquisitions market as the principal market, generally through a sale or recapitalization of the portfolio company. In accordance with ASC 820, we apply the in-use premise of value which assumes the debt and equity securities are sold together. Under this liquidity waterfall approach, we continue to use the enterprise value methodology utilizing a liquidity waterfall approach to determine the fair value of these investments under ASC 820 if we have the ability to initiate a sale of a portfolio company as of the measurement date. Under this approach, we first calculate the TEV of the issuer by incorporating some or all of the following factors: |
| • | the issuer’s ability to make payments; | ||
| • | the earnings of the issuer; | ||
| • | recent sales to third parties of similar securities; | ||
| • | the comparison to publicly traded securities; and | ||
| • | DCF or other pertinent factors. |
| In gathering the sales to third parties of similar securities, we may gather and analyze industry statistics and use outside experts. Once we have estimated the TEV of the issuer, we subtract the value of all the debt securities of the issuer, which are valued at the contractual principal balance. Fair values of these debt securities are discounted for any shortfall of TEV over the total debt outstanding for the issuer. Once the values for all outstanding senior securities (which include the debt securities) have been subtracted from the TEV of the issuer, the remaining amount, if any, is used to determine the value of the issuer’s equity or equity like securities. If, in our Adviser’s judgment, the liquidity waterfall approach does not accurately reflect the value of the debt component, our Adviser may recommend that we use a valuation by SPSE, or if that is unavailable, a DCF valuation technique. |
| (3) | Portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities: We value Non-Public Debt Securities that are purchased together with equity or equity-like securities from the same portfolio company, or issuer, for which we do not control or cannot gain control as of the measurement date, using a hypothetical secondary market as our principal market. In accordance with ASC 820, we determine the fair value of these debt securities of non-control investments assuming the sale of an individual debt security using the in-exchange premise of value (as defined in ASC 820). As such, we estimate the fair value of the debt component using estimates of value provided by SPSE and our own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. Subsequent to June 30, 2009, for equity or equity-like securities of investments that we do not control or cannot gain control as of the measurement date, we estimate the fair value of the equity using the in-exchange premise of value based on factors such as the overall value of the issuer, the relative fair value of other units of account, including debt, or other relative value approaches. Consideration also is given to capital structure and other contractual obligations that may impact the fair value of the equity. Further, we may utilize comparable values of similar companies, recent investments and indices with similar structures and risk characteristics or our own assumptions in the absence of other observable market data, and may also employ DCF valuation techniques. |
| Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been obtained had a ready market for the securities existed, and the differences could be material. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned. There is no single standard for determining fair value in good faith, as fair value depends upon circumstances of each individual case. In general, fair value is the amount that we might reasonably expect to receive upon the current sale of the security in an arms-length transaction in the security’s principal market. |
Valuation Considerations:
From time to time, depending on certain circumstances, the Adviser may
use the following valuation considerations, including but not limited to:
| • | the nature and realizable value of the collateral; | ||
| • | the portfolio company’s earnings and cash flows and its ability to make payments on its obligations; | ||
| • | the markets in which the portfolio company does business; |
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| • | the comparison to publicly traded companies; and | ||
| • | DCF and other relevant factors. |
Because such valuations, particularly valuations of private securities and private companies, are
not susceptible to precise determination, may fluctuate over short periods of time, and may be
based on estimates, our determinations of fair value may differ from the values that might have
actually resulted had a readily available market for these securities been available.
Credit Information:
Our Adviser monitors a wide variety of key credit statistics that provide
information regarding our portfolio companies to help us assess credit quality and portfolio
performance. We and our Adviser participate in the periodic board meetings of our portfolio
companies in which we hold Control and Affiliate investments and also require them to provide
annual audited and monthly unaudited financial statements. Using these statements or comparable
information and board discussions, our Adviser calculates and evaluates the credit statistics.
Loan Grading and Risk Rating:
As part of our valuation procedures above, we risk rate all of our
investments in debt securities. For syndicated loans that have been rated by an Nationally
Recognized Statistical Rating Organization (“NRSRO”), we use the NRSRO’s risk rating for such
security. For all other debt securities, we use a proprietary risk rating system. Our risk rating
system uses a scale of 0 to 10, with 10 being the lowest probability of default. This system is
used to estimate the probability of default on debt securities and the probability of loss if there
is a default. These types of systems are referred to as risk rating systems and are used by banks
and rating agencies. The risk rating system covers both qualitative and quantitative aspects of the
business and the securities we hold. During the three months ended March 31, 2010, we modified our
risk rating model to incorporate additional factors in our qualitative and quantitative analysis.
While the overall process did not change, we believe the additional factors enhance the quality of
the risk ratings of our investments. No adjustments were made to prior periods as a result of this
modification.
For the debt securities for which we do not use a third-party NRSRO risk rating, we seek to have
our risk rating system mirror the risk rating systems of major risk rating organizations, such as
those provided by an NRSRO. While we seek to mirror the NRSRO systems, we cannot provide any
assurance that our risk rating system will provide the same risk rating as an NRSRO for these
securities. The following chart is an estimate of the relationship of our risk rating system to the
designations used by two NRSROs as they risk rate debt securities of major companies. Because our
system rates debt securities of companies that are unrated by any NRSRO, there can be no assurance
that the correlation to the NRSRO set out below is accurate. We believe our risk rating would be
significantly higher than a typical NRSRO risk rating because the risk rating of the typical NRSRO
is designed for larger businesses. However, our risk rating has been designed to risk rate the
securities of smaller businesses that are not rated by a typical NRSRO. Therefore, when we use our
risk rating on larger business securities, the risk rating is higher than a typical NRSRO rating.
The primary difference between our risk rating and the rating of a typical NRSRO is that our risk
rating uses more quantitative determinants and includes qualitative determinants that we believe
are not used in the NRSRO rating. It is our understanding that most debt securities of medium-sized
companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in
the middle market that would meet the definition of AAA, AA or A. Therefore, our scale begins with
the designation 10 as the best risk rating which may be equivalent to a BBB- or Baa3 from an NRSRO,
however, no assurance can be given that a 10 on our scale is equal to a BBB- or Baa3 on an NRSRO
scale.
| Company’s | First | Second | ||||
| System | NRSRO | NRSRO | Gladstone Investment’s Description (a) | |||
|
>10
|
Baa2 | BBB | Probability of Default (PD) during the next 10 years is 4% and the Expected Loss (EL) is 1% or less | |||
|
10
|
Baa3 | BBB- | PD is 5% and the EL is 1% to 2% | |||
|
9
|
Ba1 | BB+ | PD is 10% and the EL is 2% to 3% | |||
|
8
|
Ba2 | BB | PD is 16% and the EL is 3% to 4% | |||
|
7
|
Ba3 | BB- | PD is 17.8% and the EL is 4% to 5% | |||
|
6
|
B1 | B+ | PD is 22% and the EL is 5% to 6.5% | |||
|
5
|
B2 | B | PD is 25% and the EL is 6.5% to 8% | |||
|
4
|
B3 | B- | PD is 27% and the EL is 8% to 10% | |||
|
3
|
Caa1 | CCC+ | PD is 30% and the EL is 10% to 13.3% | |||
|
2
|
Caa2 | CCC | PD is 35% and the EL is 13.3% to 16.7% | |||
|
1
|
Caa3 | CC | PD is 65% and the EL is 16.7% to 20% | |||
|
0
|
N/A | D | PD is 85% or there is a payment of default and the EL is greater than 20% |
| (a) | The default rates set forth are for a 10-year term debt security. If a debt security is less than 10 years, then the probability of default is adjusted to a lower percentage for the shorter period, which may move the security higher on our risk rating scale |
The above scale gives an indication of the probability of default and the magnitude of the
loss if there is a default. Our policy is to stop accruing interest on an investment if we
determine that interest is no longer collectible. As of March 31, 2011 and 2010, one Control
investment, ASH, was on non-accrual with a fair value of zero and $2.2 million, respectively, which
represented zero and 1.0% of the fair value of all loans held in our portfolio at March 31, 2011
and 2010, respectively. Additionally, we do not risk rate our equity securities.
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The following table lists the risk ratings for all proprietary loans in our portfolio as of March
31, 2011 and 2010, representing approximately 95.8% and 93.5%, respectively, of all loans in our
portfolio at fair value at the end of each period:
| As of March 31, | ||||||||
| Rating | 2011 | 2010 | ||||||
|
Highest
|
9.0 | 9.0 | ||||||
|
Average
|
5.6 | 5.3 | ||||||
|
Weighted Average
|
5.9 | 5.9 | ||||||
|
Lowest
|
3.0 | 2.0 | ||||||
The risk rating for the syndicated loan that was not rated by an NRSRO, Survey Sampling, LLC, was
7.0 and 9.0 as of March 31, 2011 and 2010, respectively, representing approximately 1.2% and 0.7%,
respectively, of all loans in our portfolio at fair value at the end of each period. For loans
that are currently rated by an NRSRO, we risk rate such loans in accordance with the risk rating
systems of major risk rating organizations, such as those provided by an NRSRO. The weighted
average risk ratings for all loans in our portfolio that were rated by an NRSRO were BB+/Ba2 and
B/B2 as of March 31, 2011 and 2010, respectively, representing approximately 3.0% and 5.8%,
respectively, of all loans in our portfolio at fair value at the end of each period.
Tax Status
Federal Income Taxes
We intend to continue to qualify for treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M
of the Code. As a RIC, we are not subject to federal income tax on the portion of our taxable
income and gains distributed to stockholders. To qualify as a RIC, we must meet certain
source-of-income, asset diversification and annual distribution requirements. For more information
regarding the requirements we must meet as a RIC, see “—Business Environment.” Under the annual
distribution requirements, we are required to distribute to stockholders at least 90% of our
investment company taxable income, as defined by the Code. Our policy is to pay out as
distributions up to 100% of that amount.
In an effort to avoid certain excise taxes imposed on RICs, we currently intend to distribute
during each calendar year, an amount at least equal to the sum of (1) 98% of our ordinary income
for the calendar year, (2) 98% of our capital gains in excess of capital losses for the one-year
period ending on October 31 of the calendar year, and (3) any ordinary income and net capital gains
for preceding years that were not distributed during such years. However, we did pay an excise tax
of $24 for the calendar year ended December 31, 2010. Under the RIC Modernization Act, for excise
tax years beginning January 1, 2011, the minimum distribution requirement for capital gains income
has been raised to 98.2%.
We sought and received a private letter ruling from the Internal Revenue Service (“IRS”) related to
our tax treatment for success fees. In the ruling, executed by our consent on January 3, 2011, we,
in effect, will continue to account for the recognition of income from the success fees upon
receipt, or when the amount becomes fixed. However, starting January 1, 2011, the tax
characterization of the success fee amount was and will be treated as ordinary income. Prior to
January 1, 2011, we had treated the success fee amount as a realized gain for tax characterization
purposes. The private letter ruling does not require us to retroactively change the capital gains
treatment of the success fees received prior to January 1, 2011.
Revenue Recognition
Interest and Dividend Income Recognition
Interest income, adjusted for amortization of premiums and acquisition costs and for the accretion
of discounts, is recorded on the accrual basis to the extent that such amounts are expected to be
collected. Generally, when a loan becomes 90 days or more past due, or if our qualitative
assessment indicates that the debtor is unable to service its debt or other obligations, we will
place the loan on non-accrual status and cease recognizing interest income on that loan until the
borrower has demonstrated the ability and intent to pay contractual amounts due. However, we
remain contractually entitled to this interest. Interest payments received on non-accrual loans
may be recognized as income or applied to the cost basis depending upon management’s judgment.
Non-accrual loans are restored to accrual status when past due principal and interest are paid, and
in management’s judgment, are likely to remain current, or due to a restructuring such that the
interest income is deemed to be collectible. At March 31, 2011, one Control investment, ASH, was on
non-accrual with a fair value of $0. At March 31, 2010, ASH was on non-accrual with a fair value
of approximately $2.2 million, or 1.0% of the fair value of all loans held in our portfolio at
March 31, 2010.
We have one loan in our portfolio which contains a PIK provision. The PIK interest, computed at the
contractual rate specified in each loan agreement, is added to the principal balance of the loan
and recorded as income. To maintain ours status as a RIC, this non-cash source of income must be
paid out to stockholders in the form of distributions, even though we have not yet collected the
cash. We recorded PIK income of $12 for the year ended March 31, 2011. No PIK interest was recorded
during the year ended March 31, 2010.
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Success fees are recorded upon receipt. Success fees are contractually due upon a change of
control in a portfolio company and are recorded in Other income in the accompanying
Consolidated
Statements of Operations
. We recorded $5.4 million of success fees during the year ended March 31,
2011, $2.3 million of which resulted from the exit and payoff of Chase, $1.9 million from the exit
and payoff of A. Stucki, $0.8 million from a prepayment received from Cavert and $0.4 million from
a prepayment received from Mathey. Prior to the fiscal year ended March 31, 2011, we had not
recorded any success fees.
Dividend income on preferred equity securities is accrued to the extent that such amounts are
expected to be collected and that we have the option to collect such amounts in cash. During the
year ended March 31, 2011, we recorded and collected $4.0 million of dividends accrued on preferred
shares of Chase, recorded and collected $0.3 million of dividends on preferred shares of A. Stucki
and accrued and received a special dividend of property valued at $0.5 million in connection with
the A. Stucki sale. During the year ended March 31, 2010, we recorded and collected $1.0 million
of cash dividends on preferred shares of A. Stucki.
Recent Accounting Pronouncements
See Note 2, “Summary of Significant Accounting Policies” in the accompanying notes to our
Consolidated Financial Statements
included elsewhere in this report for a description and our
application of recent accounting pronouncements. Our adoption of these recent accounting
pronouncements did not have a material effect on our financial position and results of operations.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk includes risks that arise from changes in interest rates, foreign currency exchange
rates, commodity prices, equity prices and other market changes that affect market sensitive
instruments. The primary risk we believe we are exposed to is interest rate risk. While we expect
that ultimately approximately 20% of the loans in our portfolio will be made at fixed rates, with
approximately 80% made at variable rates or variables rates with a floor mechanism, all of our
variable-rate loans have rates associated with either the current LIBOR or Prime Rate. At March
31, 2011, our portfolio, at cost, consisted of the following breakdown in relation to all
outstanding debt investments:
| 0.2 | % |
Variable rates
|
||
| 71.7 |
Variable rates with a floor
|
|||
| 28.1 |
Fixed rates
|
|||
|
|
||||
| 100.0 | % |
Total
|
||
|
|
||||
The United States is beginning to recover from the recession that largely began in late 2007.
Despite signs of economic improvement, however, unstable economic conditions could adversely affect
the financial position and results of operations of certain of the middle-market companies in our
portfolio, which ultimately could lead to difficulty in meeting debt service requirements and an
increase in defaults. During the year ended March 31, 2010, we experienced write-downs across our
portfolio, most of which were due to reductions in comparable multiples and market pricing and to a
lesser extent reductions in the performance of certain portfolio companies used to estimate the
fair value of our investments. During the year ended March 31, 2011, our portfolio generally
stabilized as reflected by only $1.3 million in write-downs for the year, excluding reversals from
realizations. There can be no assurance that the performance of our portfolio companies will not
be further impacted by economic conditions, which could have a negative impact on our future
results.
In April 2009, we entered into a revolving line of credit with BB&T for up to $50.0 million.
Subsequently, we renewed the facility in April 2010 for an additional two years. Advances under
the line of credit will generally bear interest at the 30-day LIBOR rate (subject to a minimum rate
of 2.0%), plus 4.5% per annum, with a commitment fee of 0.50% per annum on undrawn amounts when
advances outstanding are above 50.0% of the commitment and will be 1.0% on undrawn amounts if the
advances outstanding are below 50.0% of the commitment. In connection with the facility, we paid
an upfront fee of 1.0%.
In May 2009, we entered into an interest rate cap agreement in connection with our line of credit.
We purchased this interest rate cap agreement, which expired in May 2011 and has a notional amount
of $45.0 million, for a one-time, up-front payment of $39. At March 31, 2011, the interest rate cap
agreement had a nominal fair value.
Additionally, in April 2010, we entered into a forward interest rate cap agreement, effective May
2011 and expiring in May 2012, in connection with our April 2010 renewal of the line of credit. We
paid a one-time, up-front fee of $41 for the forward interest rate cap agreement which has a
notional amount of $45.0 million. At March 31, 2011, the interest rate cap agreement had a fair
value of $4. Collectively, we have an interest rate cap agreement in place continuously through May
2012.
The current interest rate cap agreement entitle us to receive payments, if any, equal to the amount
by which interest payments on the current notional amount at the one month LIBOR exceed the
payments on the current notional amount at 6.0%. This agreement effectively caps our interest
payments on our line of credit borrowings, up to the notional amount of the interest rate cap over
the next year. This mitigates our exposure to increases in interest rates on our borrowings on our
line of credit, which are at variable rates.
59
Table of Contents
To illustrate the potential impact of changes in interest rates on our net increase in net assets
resulting from operations, we have performed the following analysis, which assumes that our balance
sheet remains constant and no further actions beyond the interest rate cap agreement are taken to
alter our existing interest rate sensitivity.
| (dollars in thousands) | Net Increase in | |||||||||||
| Increase in | Increase in | Net Assets Resulting from | ||||||||||
| Basis Point Change (1) | Interest Income | Interest Expense (2) | Operations | |||||||||
|
Up 300 basis points
|
$ | 385 | $ | — | $ | 385 | ||||||
|
Up 200 basis points
|
78 | — | 78 | |||||||||
|
Up 100 basis points
|
3 | — | 3 | |||||||||
| (1) | As of March 31, 2011, our effective average LIBOR was 0.24%; thus, a 100 basis point decrease could not occur. | |
| (2) | As of March 31, 2011, we had no borrowings outstanding. |
Although management believes that this analysis is indicative of our existing interest rate
sensitivity, it does not adjust for potential changes in credit quality, size and composition of
our loan portfolio on the balance sheet and other business developments that could affect net
increase in net assets resulting from operations. Accordingly, no assurances can be given that
actual results would not differ materially from the results under this hypothetical analysis.
We may also experience risk associated with investing in securities of companies with foreign
operations. We currently do not anticipate investing in debt or equity of foreign companies, but
some potential portfolio companies may have operations located outside the United States. These
risks include, but are not limited to, fluctuations in foreign currency exchange rates, imposition
of foreign taxes, changes in exportation regulations and political and social instability.
60
Table of Contents
Index to Consolidated Financial Statements
| 62 | ||||
| 63 | ||||
| 64 | ||||
| 65 | ||||
| 66 | ||||
| 67 | ||||
| 68 | ||||
| 72 |
61
Table of Contents
Report of Management on Internal Controls
To the Stockholders and Board of Directors of Gladstone Investment Corporation:
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our
internal control over financial reporting is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and include those policies and
procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable
assurance that our transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that our receipts and
expenditures are being made only in accordance with appropriate authorizations; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, we assessed the effectiveness
of our internal control over financial reporting as of March 31, 2011, using the criteria set forth
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control—Integrated Framework. Based on its assessment, management has concluded that our internal
control over financial reporting was effective as of March 31, 2011.
Our management’s assessment of the effectiveness of our internal control over financial reporting
as of March 31, 2011 has been audited by PricewaterhouseCoopers LLP, an independent registered
public accounting firm, as stated in their report which is included herein.
May 23, 2011
62
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Gladstone Investment Corporation:
In our opinion, the accompanying consolidated statements of assets and liabilities, including the
schedules of investments, and the related statements of operations, changes in net assets and cash
flows present fairly, in all material respects, the financial position of Gladstone Investment
Corporation (the “Company”) and its subsidiaries at March 31, 2011 and 2010, and the results of
their operations and their cash flows for each of the three years in the period ended March 31,
2011, in conformity with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedule listed in the index appearing under
Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. Also, in our opinion, the
Company maintained, in all material respects, effective internal control over financial reporting
as of March 31, 2011, based on criteria established in
Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company’s management is responsible for these financial statements and financial statement
schedule, for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our
responsibility is to express opinions on these financial statements, on the financial statement
schedule, and on the Company’s internal control over financial reporting based on our integrated
audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audits of the financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing the risk that a
material weakness exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included performing such other
procedures as we considered necessary in the circumstances. Our procedures included confirmation of
securities at March 31, 2011, by correspondence with the custodian, and where replies were not
received, we performed other auditing procedures. We believe that our audits provide a reasonable
basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
McLean, VA
May 23, 2011
May 23, 2011
63
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GLADSTONE INVESTMENT CORPORATION
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
| March 31, | ||||||||
| 2011 | 2010 | |||||||
|
ASSETS
|
||||||||
|
Investments at fair value
|
||||||||
|
Control investments (Cost of
$136,306
and $152,166, respectively)
|
$ | 104,062 | $ | 148,248 | ||||
|
Affiliate investments (Cost of
$45,145
and $52,727, respectively)
|
34,556 | 37,664 | ||||||
|
Non-Control/Non-Affiliate investments (Cost of
$15,741
and $22,674, respectively)
|
14,667 | 20,946 | ||||||
|
|
||||||||
|
Total investments (Cost of
$197,192
and $227,567, respectively)
|
153,285 | 206,858 | ||||||
|
Cash and cash equivalents
|
80,580 | 87,717 | ||||||
|
Restricted cash
|
4,499 | — | ||||||
|
Interest receivable
|
737 | 1,234 | ||||||
|
Due from Custodian
|
859 | 935 | ||||||
|
Deferred financing fees
|
373 | 83 | ||||||
|
Prepaid assets
|
224 | 221 | ||||||
|
Other assets
|
552 | 113 | ||||||
|
|
||||||||
|
TOTAL ASSETS
|
$ | 241,109 | $ | 297,161 | ||||
|
|
||||||||
|
|
||||||||
|
LIABILITIES
|
||||||||
|
Borrowings at fair value
|
||||||||
|
Short-term loan (Cost of
$40,000
and $75,000, respectively)
|
$ | 40,000 | $ | 75,000 | ||||
|
Credit Facility (Cost of
$0
and $27,800, respectively)
|
— | 27,812 | ||||||
|
|
||||||||
|
Total borrowings (Cost of
$40,000
and $102,800, respectively)
|
40,000 | 102,812 | ||||||
|
Accounts payable and accrued expenses
|
201 | 206 | ||||||
|
Fees due to Adviser
(1)
|
499 | 721 | ||||||
|
Fee due to Administrator
(1)
|
171 | 149 | ||||||
|
Other liabilities
|
1,409 | 295 | ||||||
|
|
||||||||
|
TOTAL LIABILITIES
|
42,280 | 104,183 | ||||||
|
|
||||||||
|
|
||||||||
|
NET ASSETS
|
$ | 198,829 | $ | 192,978 | ||||
|
|
||||||||
|
|
||||||||
|
ANALYSIS OF NET ASSETS
|
||||||||
|
Common stock, $0.001 par value per share, 100,000,000 shares authorized, 22,080,133
shares issued and outstanding at March 31, 2011 and 2010
|
$ | 22 | $ | 22 | ||||
|
Capital in excess of par value
|
257,192 | 257,206 | ||||||
|
Net unrealized depreciation of investment portfolio
|
(43,907 | ) | (20,710 | ) | ||||
|
Net unrealized depreciation of other
|
(76 | ) | (51 | ) | ||||
|
Undistributed net investment income
|
165 | — | ||||||
|
Accumulated net realized investment loss
|
(14,567 | ) | (43,489 | ) | ||||
|
|
||||||||
|
TOTAL NET ASSETS
|
$ | 198,829 | $ | 192,978 | ||||
|
|
||||||||
|
|
||||||||
|
NET ASSETS PER SHARE
|
$ | 9.00 | $ | 8.74 | ||||
|
|
||||||||
| (1) | Refer to Note 4— Related Party Transactions for additional information. |
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
64
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GLADSTONE INVESTMENT CORPORATION
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
| Year Ended March 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
|
INVESTMENT INCOME
|
||||||||||||
|
Interest income
|
||||||||||||
|
Control investments
|
$ | 10,108 | $ | 11,745 | $ | 11,306 | ||||||
|
Affiliate investments
|
4,003 | 5,677 | 5,378 | |||||||||
|
Non-Control/Non-Affiliate investments
|
1,578 | 2,393 | 8,494 | |||||||||
|
Cash and cash equivalents
|
33 | 2 | 67 | |||||||||
|
|
||||||||||||
|
Total interest income
|
15,722 | 19,817 | 25,245 | |||||||||
|
Other income
|
||||||||||||
|
Control investments
|
10,342 | 968 | — | |||||||||
|
Affiliate investments
|
— | — | 567 | |||||||||
|
|
||||||||||||
|
Total other income
|
10,342 | 968 | 567 | |||||||||
|
|
||||||||||||
|
Total investment income
|
26,064 | 20,785 | 25,812 | |||||||||
|
|
||||||||||||
|
|
||||||||||||
|
EXPENSES
|
||||||||||||
|
Loan servicing fee
(1)
|
2,743 | 3,747 | 5,002 | |||||||||
|
Base management fee
(1)
|
1,236 | 737 | 1,699 | |||||||||
|
Incentive fee
(1)
|
2,949 | 588 | — | |||||||||
|
Administration fee
(1)
|
753 | 676 | 821 | |||||||||
|
Interest expense
|
701 | 1,988 | 5,349 | |||||||||
|
Amortization of deferred financing fees
|
491 | 1,618 | 323 | |||||||||
|
Professional fees
|
473 | 626 | 532 | |||||||||
|
Stockholder related costs
|
273 | 295 | 485 | |||||||||
|
Insurance expense
|
293 | 262 | 222 | |||||||||
|
Directors fees
|
201 | 196 | 194 | |||||||||
|
Other expenses
|
460 | 280 | 271 | |||||||||
|
|
||||||||||||
|
Expenses before credits from Adviser
|
10,573 | 11,013 | 14,898 | |||||||||
|
Credits to fees from Adviser
(1)
|
(680 | ) | (826 | ) | (2,474 | ) | ||||||
|
|
||||||||||||
|
Total expenses net of credits to fees
|
9,893 | 10,187 | 12,424 | |||||||||
|
|
||||||||||||
|
|
||||||||||||
|
NET INVESTMENT INCOME
|
16,171 | 10,598 | 13,388 | |||||||||
|
|
||||||||||||
|
|
||||||||||||
|
REALIZED AND UNREALIZED GAIN (LOSS)
|
||||||||||||
|
Realized gain (loss) on sale of investments
|
23,489 | (35,923 | ) | (5,023 | ) | |||||||
|
Realized loss on other
|
— | (53 | ) | — | ||||||||
|
Net unrealized (depreciation) appreciation of investment portfolio
|
(23,197 | ) | 14,305 | (19,814 | ) | |||||||
|
Net unrealized (depreciation) appreciation of other
|
(24 | ) | 2 | — | ||||||||
|
|
||||||||||||
|
Net gain (loss) on investments and other
|
268 | (21,669 | ) | (24,837 | ) | |||||||
|
|
||||||||||||
|
|
||||||||||||
|
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS
|
$ | 16,439 | $ | (11,071 | ) | $ | (11,449 | ) | ||||
|
|
||||||||||||
|
|
||||||||||||
|
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS PER
COMMON SHARE
|
||||||||||||
|
Basic and diluted
|
$ | 0.74 | $ | (0.50 | ) | $ | (0.53 | ) | ||||
|
|
||||||||||||
|
|
||||||||||||
|
WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING
|
||||||||||||
|
Basic and diluted weighted average shares
|
22,080,133 | 22,080,133 | 21,545,936 | |||||||||
| (1) | Refer to Note 4— Related Party Transactions for additional information. |
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
65
Table of Contents
GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(IN THOUSANDS)
| Year Ended March 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
|
Operations:
|
||||||||||||
|
Net investment income
|
$ | 16,171 | $ | 10,598 | $ | 13,388 | ||||||
|
Realized gain (loss) on sale of investments
|
23,489 | (35,923 | ) | (5,023 | ) | |||||||
|
Realized loss on other
|
— | (53 | ) | — | ||||||||
|
Net unrealized (depreciation) appreciation of investment portfolio
|
(23,197 | ) | 14,305 | (19,814 | ) | |||||||
|
Net unrealized (depreciation) appreciation of other
|
(24 | ) | 2 | — | ||||||||
|
|
||||||||||||
|
Net increase (decrease) in net assets from operations
|
16,439 | (11,071 | ) | (11,449 | ) | |||||||
|
|
||||||||||||
|
|
||||||||||||
|
Capital transactions:
|
||||||||||||
|
Issuance of common stock
|
— | — | 41,290 | |||||||||
|
Shelf offering registration costs
|
10 | (155 | ) | (728 | ) | |||||||
|
|
||||||||||||
|
Net increase (decrease) in net assets from capital transactions
|
10 | (155 | ) | 40,562 | ||||||||
|
|
||||||||||||
|
|
||||||||||||
|
Distributions to stockholders from:
|
||||||||||||
|
Net investment income
|
(10,598 | ) | (10,598 | ) | (13,388 | ) | ||||||
|
Tax return on capital
|
— | — | (7,368 | ) | ||||||||
|
|
||||||||||||
|
Net decrease in net assets from distributions to stockholders
|
(10,598 | ) | (10,598 | ) | (20,756 | ) | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
Total increase (decrease) in net assets
|
5,851 | (21,824 | ) | 8,357 | ||||||||
|
Net assets at beginning of year
|
192,978 | 214,802 | 206,445 | |||||||||
|
|
||||||||||||
|
|
||||||||||||
|
Net assets at end of year
|
$ | 198,829 | $ | 192,978 | $ | 214,802 | ||||||
|
|
||||||||||||
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
66
Table of Contents
GLADSTONE INVESTMENT CORPORATION
(IN THOUSANDS)
| Year Ended March 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
||||||||||||
|
Net increase (decrease) in net assets resulting from operations
|
$ | 16,439 | $ | (11,071 | ) | $ | (11,449 | ) | ||||
|
Adjustments to reconcile net decrease in net assets resulting from operations to
net cash provided by operating activities:
|
||||||||||||
|
Purchase of investments
|
(43,634 | ) | (4,788 | ) | (49,959 | ) | ||||||
|
Principal repayments of investments
|
62,482 | 15,534 | 32,828 | |||||||||
|
Proceeds from sales of investments
|
35,009 | 74,706 | 13,914 | |||||||||
|
Net realized (gain) loss on sales of investments
|
(23,489 | ) | 35,923 | 5,023 | ||||||||
|
Net realized loss on other
|
— | 53 | — | |||||||||
|
Net unrealized depreciation (appreciation) of investment portfolio
|
23,197 | (14,305 | ) | 19,814 | ||||||||
|
Net unrealized depreciation (appreciation) of other
|
24 | (2 | ) | — | ||||||||
|
Net amortization of premiums and discounts
|
8 | 2 | 54 | |||||||||
|
Amortization of deferred financing fees
|
491 | 1,618 | 323 | |||||||||
|
Increase in restricted cash
|
(4,499 | ) | — | — | ||||||||
|
Decrease in interest receivable
|
497 | 266 | 162 | |||||||||
|
Decrease in due from custodian
|
76 | 1,771 | 1,693 | |||||||||
|
(Increase) decrease in prepaid assets
|
(3 | ) | (49 | ) | 308 | |||||||
|
(Increase) decrease in other assets
|
(435 | ) | 19 | 244 | ||||||||
|
(Decrease) increase in accounts payable and accrued expenses
|
(1 | ) | (1,077 | ) | 371 | |||||||
|
Increase (decrease) in administration fee payable to Administrator
(1)
|
22 | (30 | ) | (29 | ) | |||||||
|
(Decrease) increase in fees due to Adviser
(1)
|
(222 | ) | 534 | 276 | ||||||||
|
Increase in other liabilities
|
1,114 | 168 | 38 | |||||||||
|
|
||||||||||||
|
Net cash provided by operating activities
|
67,076 | 99,272 | 13,611 | |||||||||
|
|
||||||||||||
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
||||||||||||
|
Shelf offering registration proceeds (costs), net
|
10 | (155 | ) | 40,562 | ||||||||
|
Proceeds from short-term borrowings
|
207,401 | 290,000 | — | |||||||||
|
Repayments on short-term borrowings
|
(242,401 | ) | (215,000 | ) | — | |||||||
|
Borrowings from Credit Facility
|
24,000 | 107,500 | 123,850 | |||||||||
|
Repayments on Credit Facility
|
(51,800 | ) | (189,965 | ) | (158,420 | ) | ||||||
|
Purchase of derivative
|
(41 | ) | (39 | ) | — | |||||||
|
Deferred financing fees
|
(784 | ) | (534 | ) | (971 | ) | ||||||
|
Distributions paid
|
(10,598 | ) | (10,598 | ) | (20,756 | ) | ||||||
|
|
||||||||||||
|
Net cash used in financing activities
|
(74,213 | ) | (18,791 | ) | (15,735 | ) | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
|
(7,137 | ) | 80,481 | (2,124 | ) | |||||||
|
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
|
87,717 | 7,236 | 9,360 | |||||||||
|
|
||||||||||||
|
|
||||||||||||
|
CASH AND CASH EQUIVALENTS, END OF YEAR
|
$ | 80,580 | $ | 87,717 | $ | 7,236 | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
CASH PAID DURING YEAR FOR INTEREST
|
$ | 762 | $ | 2,182 | $ | 5,428 | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
NON-CASH ACTIVITIES
(2)
|
527 | 850 | 3,043 | |||||||||
|
|
||||||||||||
| (1) | Refer to Note 4— Related Party Transactions for additional information. | |
| (2) | 2011: | Non-cash activities represent real property distributed to shareholders of A.Stucki as a dividend prior to its sale in June 2010, from which the Company recorded dividend income of $515, and $12 of paid in-kind income from the Company’s syndicated loan to Survey Sampling, LLC. The distributed property is included in the Company’s Schedule of Investments at March 31, 2011, and its fair value was recognized as other income on the Company’s Statements of Operations during the year ended March 31, 2011. |
| 2010: | Non-cash activities represent an investment disbursement to Cavert II Holding Corp. for approximately $850 on their revolving line of credit, which proceeds were used to make the next four quarterly payments due under normal amortization for both their senior term A and senior term B loans in a non-cash transaction. | |
| 2009: | Non-cash activities represent the assumption of senior term notes from American Greetings Corporation in exchange for a settlement agreement related to RPG, a senior syndicated loan. | |
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
67
Table of Contents
GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED SCHEDULES OF INVESTMENTS
MARCH 31, 2011
(DOLLAR AMOUNTS IN THOUSANDS)
| Company (1) | Industry | Investment (2) | Principal | Cost | Fair Value | |||||||||||
|
CONTROL INVESTMENTS:
|
||||||||||||||||
|
Acme Cryogenics, Inc.
|
Manufacturing — manifolds and pipes for industrial gasses | Senior Subordinated Term Debt (11.5%, Due 3/2012) | $ | 14,500 | $ | 14,500 | $ | 14,500 | ||||||||
|
|
Senior Subordinated Term Debt (12.5%, Due 12/2011) | 415 | 415 | 415 | ||||||||||||
|
|
Preferred Stock (898,814 shares) (4)(7) | 6,984 | 4,991 | |||||||||||||
|
|
Common Stock (418,072 shares) (4)(7) | 1,045 | — | |||||||||||||
|
|
Common Stock Warrants (452,683 shares) (4)(7) | 24 | — | |||||||||||||
|
|
||||||||||||||||
|
|
22,968 | 19,906 | ||||||||||||||
|
|
||||||||||||||||
|
ASH Holdings Corp.
|
Retail and Service — school buses and parts | Revolving Credit Facility, $717 available (non-accrual, Due 3/2013) (4) | 3,283 | 3,241 | — | |||||||||||
|
|
Senior Subordinated Term Debt (non-accrual, Due 3/2013) (4) | 6,250 | 6,060 | — | ||||||||||||
|
|
Preferred Stock (2,500 shares) (4)(7) | 2,500 | — | |||||||||||||
|
|
Common Stock (1 share) (4)(7) | — | — | |||||||||||||
|
|
Common Stock Warrants (73,599 shares) (4)(7) | 4 | — | |||||||||||||
|
|
Guaranty ($750) | |||||||||||||||
|
|
||||||||||||||||
|
|
11,805 | — | ||||||||||||||
|
|
||||||||||||||||
|
Cavert II Holding Corp.
(10)
|
Manufacturing — bailing wire | Senior Term Debt (10.0%, Due 10/2012) (6) | 2,650 | 2,650 | 2,650 | |||||||||||
|
|
Senior Subordinated Term Debt (13.0%, Due 10/2014) | 4,671 | 4,671 | 4,671 | ||||||||||||
|
|
Preferred Stock (41,102 shares) (4)(7) | 4,110 | 5,354 | |||||||||||||
|
|
Common Stock (69,126 shares) (4)(7) | 69 | 5,577 | |||||||||||||
|
|
||||||||||||||||
|
|
11,500 | 18,252 | ||||||||||||||
|
|
||||||||||||||||
|
Country Club Enterprises, LLC
|
Service — golf cart distribution | Senior Subordinated Term Debt (16.3%, Due 11/2014) (5) | 8,000 | 8,000 | 7,560 | |||||||||||
|
|
Preferred Stock (2,380,000 shares) (4)(7) | 3,725 | — | |||||||||||||
|
|
Guaranty ($3,914) | |||||||||||||||
|
|
||||||||||||||||
|
|
11,725 | 7,560 | ||||||||||||||
|
|
||||||||||||||||
|
Galaxy Tool Holding Corp.
|
Manufacturing — aerospace and plastics | Senior Subordinated Term Debt (13.5%, Due 8/2013) | 5,220 | 5,220 | 5,220 | |||||||||||
|
|
Preferred Stock (4,111,907 shares) (4)(7) | 19,658 | 1,439 | |||||||||||||
|
|
Common Stock (48,093 shares) (4)(7) | 48 | — | |||||||||||||
|
|
||||||||||||||||
|
|
24,926 | 6,659 | ||||||||||||||
|
|
||||||||||||||||
|
Mathey Investments, Inc.
|
Manufacturing — pipe-cutting and pipe-fitting equipment | Revolving Credit Facility, $718 available (10.0%, Due 3/2012) (5) | 1,032 | 1,032 | 1,022 | |||||||||||
|
|
Senior Term Debt (10.0%, Due 3/2013) (5) | 2,375 | 2,375 | 2,345 | ||||||||||||
|
|
Senior Term Debt (12.0%, Due 3/2014) (5) | 3,727 | 3,727 | 3,643 | ||||||||||||
|
|
Senior Term Debt (2.5%, Due 3/2014) (5)(6) | 3,500 | 3,500 | 3,421 | ||||||||||||
|
|
Common Stock (37 shares) (4)(7) | 500 | — | |||||||||||||
|
|
Common Stock Warrants (21 shares) (4)(7) | 277 | — | |||||||||||||
|
|
||||||||||||||||
|
|
11,411 | 10,431 | ||||||||||||||
|
|
||||||||||||||||
|
Neville Limited
(9)
|
Real Estate — investments | Common Stock (100 shares) (4)(7) | 610 | 534 | ||||||||||||
|
|
||||||||||||||||
|
|
610 | 534 | ||||||||||||||
|
|
||||||||||||||||
|
Precision Southeast, Inc.
|
Manufacturing — injection molding and plastics | Revolving Credit Facility, $251 available (7.5%, Due 12/2011) | 749 | 749 | 749 | |||||||||||
|
|
Senior Term Debt (14.0%, Due 12/2015) | 7,775 | 7,775 | 7,775 | ||||||||||||
|
|
Preferred Stock (19,091 shares) (4)(7) | 1,909 | 1,948 | |||||||||||||
|
|
Common Stock (90,909 shares) (4)(7) | 91 | 305 | |||||||||||||
|
|
||||||||||||||||
|
|
10,524 | 10,777 | ||||||||||||||
|
|
||||||||||||||||
|
Tread Corp.
(8)
|
Manufacturing — storage and transport equipment | Senior Subordinated Term Debt (12.5%, Due 5/2013) (5) | 5,000 | 5,000 | 4,931 | |||||||||||
|
|
Preferred Stock (832,765 shares) (4)(7) | 833 | — | |||||||||||||
|
|
Common Stock (129,067 shares) (4)(7) | 1 | — | |||||||||||||
|
|
Common Stock Warrants (1,022,727 shares) (4)(7) | 3 | — | |||||||||||||
|
|
||||||||||||||||
|
|
5,837 | 4,931 | ||||||||||||||
|
|
||||||||||||||||
|
Venyu Solutions, Inc.
|
Service — online servicing suite | Senior Subordinated Term Debt (11.3%, Due 10/2015) | 7,000 | 7,000 | 7,000 | |||||||||||
|
|
Senior Subordinated Term Debt (14.0%, Due 10/2015) | 12,000 | 12,000 | 12,000 | ||||||||||||
|
|
Preferred Stock (5,400 shares) (4)(7) | 6,000 | 6,012 | |||||||||||||
|
|
||||||||||||||||
|
|
25,000 | 25,012 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Control Investments (represents 67.9% of total investments at fair value) | $ | 136,306 | $ | 104,062 | ||||||||||||
|
|
||||||||||||||||
68
Table of Contents
GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED SCHEDULES OF INVESTMENTS (Continued)
MARCH 31, 2011
(DOLLAR AMOUNTS IN THOUSANDS)
CONSOLIDATED SCHEDULES OF INVESTMENTS (Continued)
MARCH 31, 2011
(DOLLAR AMOUNTS IN THOUSANDS)
| Company (1) | Industry | Investment (2) | Principal | Cost | Fair Value | |||||||||||
|
AFFILIATE INVESTMENTS:
|
||||||||||||||||
|
Danco Acquisition Corp.
|
Manufacturing — machining and sheet metal work | Revolving Credit Facility, $400 available (10.0%, Due 10/2011) (5) | $ | 1,100 | $ | 1,100 | $ | 1,084 | ||||||||
|
|
Senior Term Debt (10.0%, Due 10/2012) (5) | 2,925 | 2,925 | 2,881 | ||||||||||||
|
|
Senior Term Debt (12.5%, Due 4/2013) (5) | 8,961 | 8,961 | 8,781 | ||||||||||||
|
|
Preferred Stock (25 shares) (4)(7) | 2,500 | — | |||||||||||||
|
|
Common Stock Warrants (420 shares) (4)(7) | 2 | — | |||||||||||||
|
|
||||||||||||||||
|
|
15,488 | 12,746 | ||||||||||||||
|
|
||||||||||||||||
|
Noble Logistics, Inc.
|
Service — aftermarket auto parts delivery | Revolving Credit Facility, $300 available (4.3%, Due 6/2011) (5) | 300 | 300 | 206 | |||||||||||
|
|
Senior Term Debt (9.2%, Due 12/2012) (5) | 7,227 | 7,227 | 4,951 | ||||||||||||
|
|
Senior Term Debt (10.5%, Due 12/2012) (5) | 3,650 | 3,650 | 2,500 | ||||||||||||
|
|
Senior Term Debt (10.5%, Due 12/2012) (5)(6) | 3,650 | 3,650 | 2,500 | ||||||||||||
|
|
Preferred Stock (1,075,000 shares) (4)(7) | 1,750 | 3,026 | |||||||||||||
|
|
Common Stock (1,682,444 shares) (4)(7) | 1,683 | — | |||||||||||||
|
|
||||||||||||||||
|
|
18,260 | 13,183 | ||||||||||||||
|
|
||||||||||||||||
|
Quench Holdings Corp.
|
Service — sales, installation and service of water coolers
|
Senior Subordinated Term Debt (10.0%, Due 8/2013) (5) | 8,000 | 8,000 | 6,000 | |||||||||||
|
|
Preferred Stock (388 shares) (4)(7) | 2,950 | 2,627 | |||||||||||||
|
|
Common Stock (35,242 shares) (4)(7) | 447 | — | |||||||||||||
|
|
||||||||||||||||
|
|
11,397 | 8,627 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Affiliate Investments (represents 22.5% of total investments at fair value) | $ | 45,145 | $ | 34,556 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
NON-CONTROL/NON-AFFILIATE INVESTMENTS:
|
||||||||||||||||
|
Syndicated Loans:
|
||||||||||||||||
|
Fifth Third Processing Solutions, LLC
(11)
|
Service — electronic payment processing | Senior Subordinated Term Debt (8.3%, Due 11/2017) (3) | $ | 500 | $ | 495 | $ | 509 | ||||||||
|
Survey Sampling, LLC
|
Service — telecommunications-based sampling | Senior Term Debt (10.7%, Due 12/2012) (3) | 2,306 | 2,308 | 1,499 | |||||||||||
|
|
||||||||||||||||
|
Subtotal — Syndicated Loans
|
2,803 | 2,008 | ||||||||||||||
|
|
||||||||||||||||
|
Non-syndicated Loans:
|
||||||||||||||||
|
American Greetings Corporation
|
Manufacturing and design — greeting cards | Senior Notes (7.4%, Due 6/2016) (3) | 3,043 | 3,043 | 3,073 | |||||||||||
|
|
||||||||||||||||
|
B-Dry, LLC
|
Service — basement waterproofer | Senior Term Debt (11.0%, Due 5/2014) (5) | 6,545 | 6,545 | 6,512 | |||||||||||
|
|
Senior Term Debt (11.5%, Due 5/2014) (5) | 3,050 | 3,050 | 3,035 | ||||||||||||
|
|
Common Stock Warrants (55 shares) (4)(7) | 300 | 39 | |||||||||||||
|
|
||||||||||||||||
|
|
9,895 | 9,586 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Non-Control/Non-Affiliate Investments (represents 9.6% of total investments at fair value) | $ | 15,741 | $ | 14,667 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| TOTAL INVESTMENTS (12) | $ | 197,192 | $ | 153,285 | ||||||||||||
|
|
||||||||||||||||
| (1) | Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company. | |
| (2) | Percentage represents the weighted average interest rates in effect at March 31, 2011, and due date represents the contractual maturity date. | |
| (3) | Valued based on the indicative bid price on or near March 31, 2011, offered by the respective syndication agent’s trading desk or secondary desk. | |
| (4) | Security is non-income producing. | |
| (5) | Fair value based on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc. at March 31, 2011. | |
| (6) | Last Out Tranche (“LOT”) of senior debt, meaning if the portfolio company is liquidated, the holder of the LOT is paid after the other senior debt and before the senior subordinated debt. | |
| (7) | Aggregates all shares of such class of stock owned by the Company without regard to specific series owned within such class, some series of which may or may not be voting shares or aggregates all warrants to purchase shares of such class of stock owned by the Company without regard to specific series of such class of stock such warrants allow the Company to purchase. | |
| (8) | In June 2010, an additional equity investment increased the Company’s fully-diluted ownership above 25%, resulting in the investment being reclassified as Control during the quarter ended June 30, 2010. | |
| (9) | In July 2010, Gladstone Neville Corp. changed its name to Neville Limited. | |
| (10) | In April 2011, the Company sold its equity investment, received partial redemption of its preferred stock and invested new subordinated debt in Cavert II Holding Corp. as part of a recapitalization. See Note 14, Subsequent Events , for more detail on this transaction. | |
| (11) | In May 2011, the Company received full repayment of its senior subordinated term debt to Fifth Third Processing Solutions, LLC. | |
| (12) | Aggregate gross unrealized depreciation for federal income tax purposes is $52,243; aggregate gross unrealized appreciation for federal income tax purposes is $8,336. Net unrealized depreciation is $43,907 based on a tax cost of $197,192. |
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
69
Table of Contents
GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED SCHEDULES OF INVESTMENTS
MARCH 31, 2010
(DOLLAR AMOUNTS IN THOUSANDS)
CONSOLIDATED SCHEDULES OF INVESTMENTS
MARCH 31, 2010
(DOLLAR AMOUNTS IN THOUSANDS)
| Company (1) | Industry | Investment (2) | Principal | Cost | Fair Value | |||||||||||
|
CONTROL INVESTMENTS:
|
||||||||||||||||
|
A. Stucki Holding Corp.
|
Manufacturing — railroad freight car products | Senior Term Debt (4.7%, Due 3/2012) | $ | 9,101 | $ | 9,101 | $ | 9,101 | ||||||||
|
|
Senior Term Debt (7.0%, Due 3/2012) (6) | 9,900 | 9,900 | 9,900 | ||||||||||||
|
|
Senior Subordinated Term Debt (13.0%, Due 3/2014) | 9,456 | 9,456 | 9,456 | ||||||||||||
|
|
Preferred Stock (43,867 shares) (7) | 4,387 | 4,529 | |||||||||||||
|
|
Common Stock (130,054 shares) (4)(7) | 130 | 17,393 | |||||||||||||
|
|
||||||||||||||||
|
|
32,974 | 50,379 | ||||||||||||||
|
|
||||||||||||||||
|
Acme Cryogenics, Inc.
|
Manufacturing — manifolds and pipes for industrial gasses
|
Senior Subordinated Term Debt (11.5%, Due 3/2012) | 14,500 | 14,500 | 13,585 | |||||||||||
|
|
Preferred Stock (898,814 shares) (4)(7) | 6,984 | — | |||||||||||||
|
|
Common Stock (418,072 shares) (4)(7) | 1,045 | — | |||||||||||||
|
|
Common Stock Warrants (452,683 shares) (4)(7) | 24 | — | |||||||||||||
|
|
||||||||||||||||
|
|
22,553 | 13,585 | ||||||||||||||
|
|
||||||||||||||||
|
ASH Holdings Corp.
|
Retail and Service — school buses and parts | Revolving Credit Facility, $496 available (non-accrual, Due 3/2013) (5) | 1,504 | 1,504 | 421 | |||||||||||
|
|
Senior Subordinated Term Debt (non-accrual, Due 3/2013) (5) | 6,250 | 6,250 | 1,750 | ||||||||||||
|
|
Preferred Stock (2,500 shares) (4)(7) | 2,500 | — | |||||||||||||
|
|
Common Stock (1 share) (4)(7) | — | — | |||||||||||||
|
|
Common Stock Warrants (73,599 shares) (4)(7) | 4 | — | |||||||||||||
|
|
Guaranty ($250) | |||||||||||||||
|
|
||||||||||||||||
|
|
10,258 | 2,171 | ||||||||||||||
|
|
||||||||||||||||
|
Cavert II Holding Corp.
|
Manufacturing — bailing wire | Senior Term Debt (8.3%, Due 10/2012) (11) | 2,875 | 2,875 | 2,875 | |||||||||||
|
|
Senior Term Debt (10.0%, Due 10/2012) (6) | 2,700 | 2,700 | 2,700 | ||||||||||||
|
|
Senior Subordinated Term Debt (13.0%, Due 10/2014) | 4,671 | 4,671 | 4,671 | ||||||||||||
|
|
Preferred Stock (41,102 shares) (4)(7) | 4,110 | 4,959 | |||||||||||||
|
|
Common Stock (69,126 shares) (4)(7) | 69 | 3,526 | |||||||||||||
|
|
||||||||||||||||
|
|
14,425 | 18,731 | ||||||||||||||
|
|
||||||||||||||||
|
Chase II Holdings Corp.
|
Manufacturing — traffic doors | Senior Term Debt (8.8%, Due 3/2011) | 7,700 | 7,700 | 7,700 | |||||||||||
|
|
Senior Term Debt (12.0%, Due 3/2011) (6) | 7,520 | 7,520 | 7,520 | ||||||||||||
|
|
Senior Subordinated Term Debt (13.0%, Due 3/2013) | 6,168 | 6,168 | 6,168 | ||||||||||||
|
|
Preferred Stock (69,608 shares) (4)(7) | 6,961 | 7,713 | |||||||||||||
|
|
Common Stock (61,384 shares) (4)(7) | 61 | — | |||||||||||||
|
|
||||||||||||||||
|
|
28,410 | 29,101 | ||||||||||||||
|
|
||||||||||||||||
|
Country Club Enterprises, LLC
|
Service — golf cart distribution | Senior Subordinated Term Debt (16.7%, Due 11/2014) (5) | 7,000 | 7,000 | 6,869 | |||||||||||
|
|
Preferred Stock (2,380,000 shares) (4)(7) | 3,725 | — | |||||||||||||
|
|
Guaranty ($2,000) | |||||||||||||||
|
|
||||||||||||||||
|
|
10,725 | 6,869 | ||||||||||||||
|
|
||||||||||||||||
|
Galaxy Tool Holding Corp.
|
Manufacturing — aerospace and plastics | Senior Subordinated Term Debt (13.5%, Due 8/2013) (5) | 17,250 | 17,250 | 17,099 | |||||||||||
|
|
Preferred Stock (4,111,907 shares) (4)(7) | 4,112 | — | |||||||||||||
|
|
Common Stock (48,093 shares) (4)(7) | 48 | — | |||||||||||||
|
|
||||||||||||||||
|
|
21,410 | 17,099 | ||||||||||||||
|
|
||||||||||||||||
|
Mathey Investments, Inc.
|
Manufacturing — pipe-cutting and pipe-fitting equipment
|
Revolving Credit Facility, $718 available (10.0%, Due 3/2011) (5) | 1,032 | 1,032 | 1,011 | |||||||||||
|
|
Senior Term Debt (10.0%, Due 3/2013) (5) | 2,375 | 2,375 | 2,328 | ||||||||||||
|
|
Senior Term Debt (17.0%, Due 3/2014) (5) (6) (10) | 7,727 | 7,727 | 6,974 | ||||||||||||
|
|
Common Stock (37 shares) (4)(7) | 500 | — | |||||||||||||
|
|
Common Stock Warrants (21 shares) (4)(7) | 277 | — | |||||||||||||
|
|
||||||||||||||||
|
|
11,411 | 10,313 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Control Investments (represents 71.7% of total investments at fair value) | $ | 152,166 | $ | 148,248 | ||||||||||||
|
|
||||||||||||||||
70
Table of Contents
GLADSTONE INVESTMENT CORPORATION
CONSOLIDATED SCHEDULES OF INVESTMENTS (Continued)
MARCH 31, 2010
(DOLLAR AMOUNTS IN THOUSANDS)
CONSOLIDATED SCHEDULES OF INVESTMENTS (Continued)
MARCH 31, 2010
(DOLLAR AMOUNTS IN THOUSANDS)
| Company (1) | Industry | Investment (2) | Principal | Cost | Fair Value | |||||||||||
|
AFFILIATE INVESTMENTS:
|
||||||||||||||||
|
Danco Acquisition Corp.
|
Manufacturing — machining and sheet metal work | Revolving Credit Facility, $600 available (10.0%, Due 10/2010) (5) | $ | 900 | $ | 900 | $ | 893 | ||||||||
|
|
Senior Term Debt (10.0%, Due 10/2012) (5) | 4,163 | 4,163 | 4,131 | ||||||||||||
|
|
Senior Term Debt (12.5%, Due 4/2013) (5) | 9,053 | 9,053 | 8,929 | ||||||||||||
|
|
Preferred Stock (25 shares) (4)(7) | 2,500 | — | |||||||||||||
|
|
Common Stock Warrants (420 shares) (4)(7) | 2 | — | |||||||||||||
|
|
||||||||||||||||
|
|
16,618 | 13,953 | ||||||||||||||
|
|
||||||||||||||||
|
Noble Logistics, Inc.
|
Service — aftermarket auto parts delivery | Revolving Credit Facility, $0 available (4.2%, Due 5/2010) (5) | 2,000 | 2,000 | 1,210 | |||||||||||
|
|
Senior Term Debt (9.3%, Due 12/2011) (5) | 6,227 | 6,227 | 3,767 | ||||||||||||
|
|
Senior Term Debt (10.5%, Due 12/2011) (5) (6) | 7,300 | 7,300 | 4,417 | ||||||||||||
|
|
Preferred Stock (1,075,000 shares) (4)(7) | 1,750 | — | |||||||||||||
|
|
Common Stock (1,682,444 shares) (4)(7) | 1,682 | — | |||||||||||||
|
|
||||||||||||||||
|
|
18,959 | 9,394 | ||||||||||||||
|
|
||||||||||||||||
|
Quench Holdings Corp.
|
Service — sales, installation and service of water coolers
|
Senior Subordinated Term Debt (10.0%, Due 8/2013) (5) | 8,000 | 8,000 | 6,150 | |||||||||||
|
|
Preferred Stock (388 shares) (4)(7) | 2,950 | 3,224 | |||||||||||||
|
|
Common Stock (35,242 shares) (4)(7) | 447 | — | |||||||||||||
|
|
||||||||||||||||
|
|
11,397 | 9,374 | ||||||||||||||
|
|
||||||||||||||||
|
Tread Corp.
|
Manufacturing — storage and transport equipment | Senior Subordinated Term Debt (12.5%, Due 5/2013) (5) | 5,000 | 5,000 | 4,943 | |||||||||||
|
|
Preferred Stock (750,000 shares) (4)(7) | 750 | — | |||||||||||||
|
|
Common Stock Warrants (1,022,727 shares) (4)(7) | 3 | — | |||||||||||||
|
|
||||||||||||||||
|
|
5,753 | 4,943 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Affiliate Investments (represents 18.2% of total investments at fair value) | $ | 52,727 | $ | 37,664 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
NON-CONTROL/NON-AFFILIATE INVESTMENTS:
|
||||||||||||||||
|
Syndicated Loans:
|
||||||||||||||||
|
Interstate FiberNet, Inc.
|
Service — provider of voice and data telecommunications services
|
Senior Term Debt (4.3%, Due 7/2013) (9) | $ | 6,762 | $ | 6,743 | $ | 6,762 | ||||||||
|
Survey Sampling, LLC
|
Service — telecommunications-based sampling | Senior Term Debt (9.5%, Due 5/2011) (3) | 2,375 | 2,385 | 1,069 | |||||||||||
|
|
||||||||||||||||
|
Subtotal — Syndicated Loans
|
9,128 | 7,831 | ||||||||||||||
|
|
||||||||||||||||
|
Non-syndicated Loans:
|
||||||||||||||||
|
American Greetings Corporation
|
Manufacturing and design — greeting cards | Senior Notes (7.4%, Due 6/2016) (3) | 3,043 | 3,043 | 2,895 | |||||||||||
|
B-Dry, LLC
|
Service — basement waterproofer | Senior Term Debt (10.5%, Due 5/2014) (5) | 6,613 | 6,613 | 6,596 | |||||||||||
|
|
Senior Term Debt (10.5%, Due 5/2014) (5) | 3,590 | 3,590 | 3,581 | ||||||||||||
|
|
Common Stock Warrants (55 shares) (4)(7) | 300 | 43 | |||||||||||||
|
|
||||||||||||||||
|
|
10,503 | 10,220 | ||||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| Total Non-Control/Non-Affiliate Investments (represents 10.1% of total investments at fair value) | $ | 22,674 | $ | 20,946 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
| TOTAL INVESTMENTS (11) | $ | 227,567 | $ | 206,858 | ||||||||||||
|
|
||||||||||||||||
| (1) | Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company. | |
| (2) | Percentage represents the weighted average interest rates in effect at March 31, 2010, and due date represents the contractual maturity date. | |
| (3) | Valued based on the indicative bid price on or near March 31, 2010, offered by the respective syndication agent’s trading desk or secondary desk. | |
| (4) | Security is non-income producing. | |
| (5) | Fair value based on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc. at March 31, 2010. | |
| (6) | Last Out Tranche of senior debt, meaning if the portfolio company is liquidated, the holder of the Last Out Tranche is paid after the other senior debt and before the senior subordinated debt. | |
| (7) | Aggregates all shares of such class of stock owned by the Company without regard to specific series owned within such class, some series of which may or may not be voting shares or aggregates all warrants to purchase shares of such class of stock owned by the Company without regard to specific series of such class of stock such warrants allow the Company to purchase. | |
| (8) | Restructured in December 2009, resulting in the Company owning 100% of Mathey Investments, Inc. and thus reclassifying it as a Control Investment. | |
| (9) | Security was paid off, at par, subsequent to March 31, 2010 and was valued based on the pay off. | |
| (10) | Loan was restructured into two separate term loans with face values of $3.7 million and $3.5 million effective February 2010. | |
| (11) | Loan was repaid, in full, subsequent to March 31, 2010. | |
| (12) | Aggregate gross unrealized depreciation for federal income tax purposes is $43,465; aggregate gross unrealized appreciation for federal income tax purposes is $22,756. Net unrealized depreciation is $20,709 based on a tax cost of $227,567. |
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
71
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GLADSTONE INVESTMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND AS OTHERWISE INDICATED)
Gladstone Investment Corporation (the “Company”) was incorporated under the General Corporation
Laws of the State of Delaware on February 18, 2005 and completed an initial public offering on June
22, 2005. The Company is a closed-end, non-diversified management investment company that has
elected to be treated as a business development company (“BDC”) under the Investment Company Act of
1940, as amended (the “1940 Act”). In addition, the Company has elected to be treated for tax
purposes as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as
amended (the “Code”). The Company’s investment objectives are to achieve a high level of current
income and capital gains by investing in debt and equity securities of established private
businesses.
Gladstone Business Investment, LLC (“Business Investment”), a wholly-owned subsidiary of the
Company, was established on August 11, 2006 for the sole purpose of owning the Company’s portfolio
of investments in connection with its line of credit. The financial statements of Business
Investment are consolidated with those of the Company.
The Company is externally managed by Gladstone Management Corporation (the “Adviser”), an affiliate
of the Company.
Basis of Presentation
These consolidated financial statements and the accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America and conform to Regulation
S-X under the Securities Exchange Act of 1934, as amended. Management believes it has made all
necessary adjustments so that the consolidated financial statements are presented fairly and that
all such adjustments are of a normal recurring nature. The accompanying consolidated financial
statements include the accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
Reclassifications
Certain amounts in the prior year’s financial statements have been reclassified to conform to the
presentation for the year ended March 31, 2011 with no effect to net increase (decrease) in net
assets resulting from operations.
Consolidation
Under Article 6 of Regulation S-X under the Securities Act of 1933, as amended, and the
authoritative accounting guidance provided by the AICPA Audit and Accounting Guide for Investment
Companies, the Company is not permitted to consolidate any subsidiary or other entity that is not
an investment company, including those in which the Company has a controlling interest.
Use of Estimates
Preparing financial statements requires management to make estimates and assumptions that affect
the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual
results may differ from those estimates.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments that are both readily convertible
to cash and have a maturity of three months or less at the time of purchase to be cash equivalents.
Items classified as cash equivalents include temporary investments in commercial paper, United
States Treasury securities and money-market funds. Cash and cash equivalents are carried at cost,
which approximates fair value. The Company places its cash and cash equivalents with financial
institutions, and, at times, cash held in checking accounts may exceed the Federal Deposit
Insurance Corporation insured limit. The Company seeks to mitigate this concentration of credit
risk by depositing funds with major financial institutions.
Restricted Cash
Restricted cash is cash held in escrow that was received as part of an asset sale.
72
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Classification of Investments
In accordance with the federal securities laws, the Company classifies portfolio investments on its
consolidated statements of assets and liabilities, its consolidated statements of operations and
its consolidated schedules of investments into the following categories:
| • | Control Investments — Control investments are generally those in which the Company owns more than 25% of the voting securities or has greater than 50% representation on the board of directors; | ||
| • | Affiliate Investments —Affiliate investments are generally those in which the Company owns from 5% to 25% of the voting securities and has less than 50% representation on the board of directors, or is otherwise deemed to be an affiliate of the Company under the 1940 Act; and | ||
| • | Non-Control/Non-Affiliate Investments —Non-Control/Non-Affiliate investments are generally those in which the Company owns less than 5% of the voting securities. |
Investment Valuation Policy
The Company carries its investments at fair value to the extent that market quotations are readily
available and reliable, and otherwise at fair value, as determined in good faith by its Board of
Directors. In determining the fair value of the Company’s investments, the Adviser has established
an investment valuation policy (the “Policy”). The Policy has been approved by the Company’s Board
of Directors, and each quarter the Board of Directors reviews whether the Adviser has applied the
Policy consistently and votes whether or not to accept the recommended valuation of the Company’s
investment portfolio.
The Company uses generally accepted valuation techniques to value its portfolio unless the Company
has specific information about the value of an investment to determine otherwise. From time to
time, the Company may accept an appraisal of a business in which the Company holds securities.
These appraisals are expensive and occur infrequently but provide a third-party valuation opinion
that may differ in results, techniques and scopes used to value the Company’s investments. When
these specific third-party appraisals are engaged or accepted, the Company uses estimates of value
provided by such appraisals and its own assumptions, including estimated remaining life, current
market yield and interest rate spreads of similar securities as of the measurement date, to value
the investment the Company has in that business.
The Policy, summarized below, applies to publicly-traded securities, securities for which a limited
market exists, and securities for which no market exists.
Publicly-traded securities:
The Company determines the value of publicly-traded securities based on
the closing price for the security on the exchange or securities market on which it is listed and
primarily traded on the valuation date. To the extent that the Company owns restricted securities
that are not freely tradable, but for which a public market otherwise exists, the Company will use
the market value of that security adjusted for any decrease in value resulting from the restrictive
feature.
Securities for which a limited market exists:
The Company values securities that are not traded on
an established secondary securities market, but for which a limited market for the security exists,
such as certain participations in, or assignments of, syndicated loans, at the quoted bid price.
In valuing these assets, the Company assesses trading activity in an asset class and evaluates
variances in prices and other market insights to determine if any available quote prices are
reliable. If the Company concludes that quotes based on active markets or trading activity may be
relied upon, firm bid prices are requested; however, if a firm bid price is unavailable, the
Company bases the value of the security upon the indicative bid price (“IBP”) offered by the
respective originating syndication agent’s trading desk, or secondary desk, on or near the
valuation date. To the extent that the Company uses the IBP as a basis for valuing the security,
the Adviser may take further steps to consider additional information to validate that price in
accordance with the Policy.
In the event these limited markets become illiquid such that market prices are no longer readily
available, the Company will value its syndicated loans using alternative methods, such as estimated
net present values of the future cash flows, or discounted cash flows (“DCF”). The use of a DCF
methodology follows that prescribed by the Financial Accounting Standards Board (“FASB”) Accounting
Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” which provides
guidance on the use of a reporting entity’s own assumptions about future cash flows and
risk-adjusted discount rates when relevant observable inputs, such as quotes in active markets, are
not available. When relevant observable market data does not exist, the alternative outlined in ASC
820 is the valuation of investments based on DCF. For the purposes of using DCF to provide fair
value estimates, the Company considers multiple inputs such as a risk-adjusted discount rate that
incorporates adjustments that market participants would make both for nonperformance and liquidity
risks. As such, the Company develops a modified discount rate approach that incorporates risk
premiums including, among others, increased probability of default, or higher loss given default or
increased liquidity risk. The DCF valuations applied to the syndicated loans provide an estimate of
what the Company believes a market participant would pay to purchase a syndicated loan in an active
market, thereby establishing a fair value. The Company will apply the DCF methodology in illiquid
markets until quoted prices are available or are deemed reliable based on trading activity.
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As of March 31, 2011, the Company assessed trading activity in its syndicated loan assets and
determined that there continued to be market liquidity and a secondary market for these assets.
Thus, firm bid prices or IBPs were used to fair value the Company’s syndicated loans at March 31,
2011.
Securities for which no market exists:
The valuation methodology for securities for which no market
exists falls into three categories: (1) portfolio investments comprised solely of debt securities;
(2) portfolio investments in controlled companies comprised of a bundle of securities, which can
include debt and equity securities; and (3) portfolio investments in non-controlled companies
comprised of a bundle of investments, which can include debt and equity securities.
| (1) | Portfolio investments comprised solely of debt securities: Debt securities that are not publicly traded on an established securities market, or for which a limited market does not exist (“Non-Public Debt Securities”), and that are issued by portfolio companies in which the Company has no equity, or equity-like securities, are fair valued in accordance with the terms of the Policy, which utilizes opinions of value submitted to the Company by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”). The Company may also submit paid in-kind (“PIK”) interest to SPSE for its evaluation when it is determined that PIK interest is likely to be received. |
| (2) | Portfolio investments in controlled companies comprised of a bundle of investments, which can include debt and equity securities: The fair value of these investments is determined based on the total enterprise value (“TEV”) of the portfolio company, or issuer, utilizing a liquidity waterfall approach under ASC 820 for the Company’s Non-Public Debt Securities and equity or equity-like securities (e.g. preferred equity, common equity, or other equity-like securities) that are purchased together as part of a package, where the Company has control or could gain control through an option or warrant security; both the debt and equity securities of the portfolio investment would exit in the mergers and acquisition market as the principal market, generally through a sale or recapitalization of the portfolio company. In accordance with ASC 820, the Company applies the in-use premise of value which assumes the debt and equity securities are sold together. Under this liquidity waterfall approach, the Company first calculates the TEV of the issuer by incorporating some or all of the following factors to determine the TEV of the issuer: |
| • | the issuer’s ability to make payments, | ||
| • | the earnings of the issuer, | ||
| • | recent sales to third parties of similar securities, | ||
| • | the comparison to publicly traded securities, and | ||
| • | DCF or other pertinent factors. |
| In gathering the sales to third parties of similar securities, the Company may reference industry statistics and use outside experts. Once the Company has estimated the TEV of the issuer, the Company will subtract the value of all the debt securities of the issuer, which are valued at the contractual principal balance. Fair values of these debt securities are discounted for any shortfall of TEV over the total debt outstanding for the issuer. Once the values for all outstanding senior securities (which include the debt securities) have been subtracted from the TEV of the issuer, the remaining amount, if any, is used to determine the value of the issuer’s equity or equity-like securities. If, in the Adviser’s judgment, the liquidity waterfall approach does not accurately reflect the value of the debt component, the Adviser may recommend that the Company use a valuation by SPSE, or, if that is unavailable, a DCF valuation technique. | ||
| (3) | Portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities: The Company values Non-Public Debt Securities that are purchased together with equity or equity-like securities from the same portfolio company, or issuer, for which the Company does not control or cannot gain control as of the measurement date, using a hypothetical secondary market as the Company’s principal market. In accordance with ASC 820, the Company determines its fair value of these debt securities of non-control investments assuming the sale of an individual debt security using the in-exchange premise of value. As such, the Company estimates the fair value of the debt component using estimates of value provided by SPSE and its own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. Subsequent to June 30, 2009, for equity or equity-like securities of investments for which the Company does not control or cannot gain control as of the measurement date, the Company estimates the fair value of the equity using the in-exchange premise of value based on factors such as the overall value of the issuer, the relative fair value of other units of account including debt, or other relative value approaches. Consideration is also given to capital structure and other contractual obligations that may impact the fair value of the equity. Further, the Company may utilize comparable values of similar companies, recent investments and indices with similar structures and risk characteristics or its own assumptions in the absence of other observable market data and may also employ DCF valuation techniques. |
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ
significantly from the values that would have been obtained had a ready market for the securities
existed, and the differences could be material. Additionally, changes in the market environment and
other events that may occur over the life of the investments may cause the gains or losses
ultimately realized on these investments to be different than the valuations currently assigned.
There is no single standard for determining fair
74
Table of Contents
value in good faith, as fair value depends upon circumstances of each individual case. In general,
fair value is the amount that the Company might reasonably expect to receive upon the current sale
of the security in an orderly transaction between market participants at the measurement date.
Refer to Note 3 below for additional information regarding fair value measurements and the
Company’s adoption of ASC 820.
Interest and Dividend Income Recognition
Interest income, adjusted for amortization of premiums and acquisition costs, the accretion of
discounts and the amortization of amendment fees, is recorded on the accrual basis to the extent
that such amounts are expected to be collected. Generally, when a loan becomes 90 days or more past
due, or if the Company’s qualitative assessment indicates that the debtor is unable to service its
debt or other obligations, the Company will place the loan on non-accrual status and cease
recognizing interest income on that loan until the borrower has demonstrated the ability and intent
to pay contractual amounts due. However, the Company remains contractually entitled to this
interest. Interest payments received on non-accrual loans may be recognized as income or applied
to the cost basis, depending upon management’s judgment. Non-accrual loans are restored to accrual
status when past due principal and interest are paid, and in management’s judgment, are likely to
remain current, or due to a restructuring such that the interest income is deemed to be
collectible. At March 31, 2011, one Control investment, ASH Holdings Corp. (“ASH”), was on
non-accrual with a fair value of $0. At March 31, 2010, ASH was on non-accrual with a fair value
of approximately $2.2 million, or 1.0% of the fair value of all loans held in the Company’s
portfolio at March 31, 2010.
The Company has one loan in its portfolio which contains a PIK provision. The PIK interest,
computed at the contractual rate specified in each loan agreement, is added to the principal
balance of the loan and recorded as income. To maintain the Company’s status as a RIC, this
non-cash source of income must be paid out to stockholders in the form of distributions, even
though the Company has not yet collected the cash. The Company recorded PIK income of $12 for the
year ended March 31, 2011. No PIK interest was recorded during the year ended March 31, 2010.
Success fees are recorded upon receipt. Success fees are contractually due upon a change of
control in a portfolio company and are recorded in Other income in the accompanying
Consolidated
Statements of Operations
. The Company recorded $5.4 million of success fees during the year ended
March 31, 2011, including $2.3 million from the exit and payoff of Chase II Holding Corp.
(“Chase”), $1.9 million from the exit and payoff of A. Stucki Holding Corp. (“A. Stucki”), $0.8
million from a prepayment received from Cavert II Holdings Corp. (“Cavert”) and $0.4 million from a
prepayment received from Mathey Investments, Inc. (“Mathey”). Prior to the current fiscal year, the
Company had not recorded any success fees.
Dividend income on preferred equity securities is accrued to the extent that such amounts are
expected to be collected and if the Company has the option to collect such amounts in cash. During
the year ended March 31, 2011, the Company recorded and collected $4.0 million of dividends accrued
on preferred shares of Chase, recorded and collected $0.3 million of dividends on preferred shares
of A. Stucki and accrued and received a special dividend of property valued at $0.5 million in
connection with the A. Stucki sale. During the year ended March 31, 2010, the Company recorded and
collected $1.0 million of cash dividends on preferred shares of A. Stucki.
Realized Gain or Loss and Unrealized Appreciation or Depreciation of Portfolio Investments
Gains or losses on the sale of investments are calculated by using the specific identification
method. Realized gain or loss is recognized at the trade date, typically when an investment is
disposed of and is computed as the difference between the Company’s cost basis in the investment at
the disposition date and the net proceeds received from such disposition. Unrealized appreciation
or depreciation displays the difference between the fair value of the investment and the cost basis
of such investment. The Company must determine the fair value of each individual investment on a
quarterly basis and record changes in fair value as unrealized appreciation or depreciation in its
consolidated statement of operations.
Deferred Financing Fees
Costs associated with the Company’s line of credit are deferred and amortized over the life of the
line of credit.
Related Party Costs
The Company has entered into an investment advisory and management agreement (the “Advisory
Agreement”) with the Adviser, which is controlled by the Company’s chairman and chief executive
officer. In accordance with the Advisory Agreement, the Company pays the Adviser fees as
compensation for its services, consisting of a base management fee and an incentive fee.
The Company has entered into an administration agreement (the “Administration Agreement”) with
Gladstone Administration, LLC (the “Administrator) whereby it pays separately for administrative
services. These fees are accrued when the services are performed and generally paid one month in
arrears. Refer to Note 4 for additional information regarding these related party costs and
agreements.
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Table of Contents
Federal Income Taxes
The Company intends to continue to qualify for treatment as a RIC under subchapter M of the Code,
which generally allows it to avoid paying corporate income taxes on any income or gains that it
distributes to the Company’s stockholders. The Company has distributed and intends to distribute
sufficient dividends to eliminate taxable income. The Company may also be subject to federal
excise tax if it does not distribute at least 98% of its investment company taxable income and 98%
of its capital gain net income in any calendar year. Under the RIC Modernization Act, for excise
tax years beginning January 1, 2011, the minimum distribution requirement for capital gains income
has been raised to 98.2%.
ASC 740, “Income Taxes” requires the evaluation of tax positions taken or expected to be taken in
the course of preparing the Company’s tax returns to determine whether the tax positions are
“more-likely-than-not” of being sustained by the applicable tax authorities. Tax positions not
deemed to satisfy the “more-likely-than-not” threshold would be recorded as a tax benefit or
expense in the current year. The Company has evaluated the implications of ASC 740, for all open
tax years and in all major tax jurisdictions, and determined that there is no material impact on
the consolidated financial statements. The Company’s federal tax returns for fiscal year 2008,
2009 and 2010 remain subject to examination by the Internal Revenue Service.
Distributions
Distributions to stockholders are recorded on the ex-dividend date. The Company is required to pay
out at least 90% of its ordinary income and short-term capital gains for each taxable year as a
distribution to its stockholders in order to maintain its status as a RIC under Subtitle A, Chapter
1 of Subchapter M of the Code. It is the policy of the Company to pay out as a dividend up to 100%
of those amounts. The amount to be paid out as a distribution is determined by the Board of
Directors each quarter and is based on the annual earnings estimated by the management of the
Company. Based on that estimate, a distribution is declared each quarter and is paid out monthly
over the course of the respective quarter. At year-end, the Company elected to treat a portion of
the first distribution paid after year-end as having been paid in the prior year, in accordance
with Section 855(a) of the Code. Additionally, at year-end the Company may pay a bonus
distribution, in addition to the monthly distributions, to ensure that it has paid out at least 90%
of its ordinary income and short-term capital gains for the year. The Company typically retains
long-term capital gains, if any, and does not pay them out as distributions. If the Company decides
to retain long-term capital gains, the portion of the retained capital gains will be subject to 35%
tax.
Recent Accounting Pronouncements
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, “Fair Value Measurement
(Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in
U.S. GAAP and IFRSs,” (“ASU 2011-04”) which results in a consistent definition of fair value and
common requirements for measurement of and disclosure about fair value between accounting
principles generally accepted in the United States (“GAAP”) and IFRS. ASU 2011-04 is effective for
interim and annual periods beginning after December 15, 2011. The Company is currently assessing
the potential impact that the adoption of ASU 2011-04 may have on the Company’s financial position
and results of operations.
ASC 820 defines fair value, establishes a framework for measuring fair value and expands
disclosures about assets and liabilities measured at fair value. ASC 820 provides a consistent
definition of fair value that focuses on exit price in the principal, or most advantageous, market
and prioritizes, within a measurement of fair value, the use of market-based inputs over
entity-specific inputs. ASC also establishes the following three-level hierarchy for fair value
measurements based upon the transparency of inputs to the valuation of an asset or liability as of
the measurement date.
| • | Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; | |
| • | Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and | |
| • | Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect the Company’s own assumptions that market participants would use to price the asset or liability based upon the best available information. |
As of March 31, 2011 and 2010, all of the Company’s investments were valued using Level 3 inputs.
The following table presents the financial instruments carried at fair value as of March 31, 2011,
by caption on the accompanying
Consolidated Statements of Assets and Liabilities
for each of the
three levels of hierarchy established by ASC 820:
76
Table of Contents
| As of March 31, 2011 | ||||||||||||||||
| Total Fair Value | ||||||||||||||||
| Reported in | ||||||||||||||||
| Consolidated | ||||||||||||||||
| Statement of | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Assets and Liabilities | |||||||||||||
|
Control Investments
|
||||||||||||||||
|
Senior term debt
|
$ | — | $ | — | $ | 21,605 | $ | 21,605 | ||||||||
|
Senior subordinated term debt
|
— | — | 56,297 | 56,297 | ||||||||||||
|
Preferred equity
|
— | — | 19,745 | 19,745 | ||||||||||||
|
Common equity/equivalents
|
— | — | 6,415 | 6,415 | ||||||||||||
|
|
||||||||||||||||
|
Total Control investments
|
— | — | 104,062 | 104,062 | ||||||||||||
|
|
||||||||||||||||
|
Affiliate Investments
|
||||||||||||||||
|
Senior term debt
|
— | — | 22,903 | 22,903 | ||||||||||||
|
Senior subordinated term debt
|
— | — | 6,000 | 6,000 | ||||||||||||
|
Preferred equity
|
— | — | 5,653 | 5,653 | ||||||||||||
|
|
||||||||||||||||
|
Total Affiliate investments
|
— | — | 34,556 | 34,556 | ||||||||||||
|
|
||||||||||||||||
|
Non-Control/Non-Affiliate Investments
|
||||||||||||||||
|
Senior term debt
|
— | — | 14,119 | 14,119 | ||||||||||||
|
Senior subordinated term debt
|
— | — | 509 | 509 | ||||||||||||
|
Common equity/equivalents
|
— | — | 39 | 39 | ||||||||||||
|
|
||||||||||||||||
|
Total Non-Control/Non-Affiliate
Investments
|
— | — | 14,667 | 14,667 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
Total Investments at fair value
|
$ | — | $ | — | $ | 153,285 | $ | 153,285 | ||||||||
|
|
||||||||||||||||
|
Cash Equivalents
|
60,000 | — | — | 60,000 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
Total Investments and Cash Equivalents
|
$ | 60,000 | $ | — | $ | 153,285 | $ | 213,285 | ||||||||
|
|
||||||||||||||||
The following table presents the financial instruments carried at fair value as of March 31,
2010, by caption on the accompanying
Consolidated Statements of Assets and Liabilities
for each of
the three levels of hierarchy established by ASC 820:
| As of March 31, 2010 | ||||||||||||||||
| Total Fair Value | ||||||||||||||||
| Reported in | ||||||||||||||||
| Consolidated | ||||||||||||||||
| Statement of | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Assets and Liabilities | |||||||||||||
|
Control Investments
|
||||||||||||||||
|
Senior term debt
|
$ | — | $ | — | $ | 50,110 | $ | 50,110 | ||||||||
|
Senior subordinated term debt
|
— | — | 60,018 | 60,018 | ||||||||||||
|
Preferred equity
|
— | — | 17,201 | 17,201 | ||||||||||||
|
Common equity/equivalents
|
— | — | 20,919 | 20,919 | ||||||||||||
|
|
||||||||||||||||
|
Total Control investments
|
— | — | 148,248 | 148,248 | ||||||||||||
|
|
||||||||||||||||
|
Affiliate Investments
|
||||||||||||||||
|
Senior term debt
|
— | — | 23,346 | 23,346 | ||||||||||||
|
Senior subordinated term debt
|
— | — | 11,094 | 11,094 | ||||||||||||
|
Preferred equity
|
— | — | 3,224 | 3,224 | ||||||||||||
|
|
||||||||||||||||
|
Total Affiliate investments
|
— | — | 37,664 | 37,664 | ||||||||||||
|
|
||||||||||||||||
|
Non-Control/Non-Affiliate Investments
|
||||||||||||||||
|
Senior term debt
|
— | — | 20,903 | 20,903 | ||||||||||||
|
Common equity/equivalents
|
— | — | 43 | 43 | ||||||||||||
|
|
||||||||||||||||
|
Total Non-Control/Non-Affiliate
Investments
|
— | — | 20,946 | 20,946 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
Total Investments at fair value
|
$ | — | $ | — | $ | 206,858 | $ | 206,858 | ||||||||
|
|
||||||||||||||||
|
Cash Equivalents
|
85,000 | — | — | 85,000 | ||||||||||||
|
|
||||||||||||||||
|
|
||||||||||||||||
|
Total Investments and Cash Equivalents
|
$ | 85,000 | $ | — | $ | 206,858 | $ | 291,858 | ||||||||
|
|
||||||||||||||||
77
Table of Contents
Changes in Level 3 Fair Value Measurements of Investments
The following tables provide a roll-forward in the changes in fair value during the year ended
March 31, 2011 and 2010 for all investments for which the Company determines fair value using
unobservable (Level 3) factors. When a determination is made to classify a financial instrument
within Level 3 of the valuation hierarchy, the determination is based upon the significance of the
unobservable factors to the overall fair value measurement. However, Level 3 financial instruments
typically include, in addition to the unobservable or Level 3 components, observable components
(that is, components that are actively quoted and can be validated to external sources).
Accordingly, the gains and losses in the table below include changes in fair value due in part to
observable factors that are part of the valuation methodology. Two tables are provided for each
period: the first table is broken out by investment classification, and the second table is broken
out by major security type.
Fair value measurements using unobservable data inputs (Level 3)
Fiscal Year 2011:
| Non-Control/ | ||||||||||||||||
| Control | Affiliate | Non-Affiliate | ||||||||||||||
| Investments | Investments | Investments | Total | |||||||||||||
|
Year ended March 31, 2011:
|
||||||||||||||||
|
Fair value as of March 31, 2010
|
$ | 148,248 | $ | 37,664 | $ | 20,946 | $ | 206,858 | ||||||||
|
Net realized gains
(1)
|
23,470 | — | 19 | 23,489 | ||||||||||||
|
Net unrealized (depreciation) appreciation
(2)
|
(6,476 | ) | 4,474 | 673 | (1,329 | ) | ||||||||||
|
Reversal of previously-recorded appreciation upon
realization
(2)
|
(21,849 | ) | — | (19 | ) | (21,868 | ) | |||||||||
|
Issuances / Originations
(3)
|
42,927 | 200 | 507 | 43,634 | ||||||||||||
|
Sales
|
(35,009 | ) | — | — | (35,009 | ) | ||||||||||
|
Settlements / Repayments
(4)
|
(53,002 | ) | (2,029 | ) | (7,459 | ) | (62,490 | ) | ||||||||
|
Transfers
(5)
|
5,753 | (5,753 | ) | — | — | |||||||||||
|
|
||||||||||||||||
|
Fair value as of March 31, 2011
|
$ | 104,062 | $ | 34,556 | $ | 14,667 | $ | 153,285 | ||||||||
|
|
||||||||||||||||
| Senior | Common | |||||||||||||||||||
| Senior | Subordinated | Preferred | Equity/ | |||||||||||||||||
| Term Debt | Term Debt | Equity | Equivalents | Total | ||||||||||||||||
|
Year ended March 31, 2011:
|
||||||||||||||||||||
|
Fair value as of March 31, 2010
|
$ | 94,359 | $ | 71,112 | $ | 20,425 | $ | 20,962 | $ | 206,858 | ||||||||||
|
Net realized gains
(1)
|
19 | — | — | 23,470 | 23,489 | |||||||||||||||
|
Net unrealized appreciation (depreciation)
(2)
|
2,167 | (3,109 | ) | (3,295 | ) | 2,908 | (1,329 | ) | ||||||||||||
|
Reversal of previously-recorded appreciation upon
realization
(2)
|
(19 | ) | — | (3,923 | ) | (17,926 | ) | (21,868 | ) | |||||||||||
|
Issuances / Originations
(3)
|
8,736 | 22,958 | 11,238 | 702 | 43,634 | |||||||||||||||
|
Sales
|
— | — | (11,347 | ) | (23,662 | ) | (35,009 | ) | ||||||||||||
|
Settlements / Repayments
(4)
|
(46,635 | ) | (15,855 | ) | — | — | (62,490 | ) | ||||||||||||
|
Transfers
(6)
|
— | (12,300 | ) | 12,300 | — | — | ||||||||||||||
|
|
||||||||||||||||||||
|
Fair value as of March 31, 2011
|
$ | 58,627 | $ | 62,806 | $ | 25,398 | $ | 6,454 | $ | 153,285 | ||||||||||
|
|
||||||||||||||||||||
Fiscal Year 2010:
| Non-Control/ | ||||||||||||||||
| Control | Affiliate | Non-Affiliate | ||||||||||||||
| Investments | Investments | Investments | Total | |||||||||||||
|
Year ended March 31, 2010:
|
||||||||||||||||
|
Fair value as of March 31, 2009
|
$ | 166,163 | $ | 53,027 | $ | 94,740 | $ | 313,930 | ||||||||
|
Net realized gains (losses)
(1)
|
— | — | (35,923 | ) | (35,923 | ) | ||||||||||
|
Net unrealized (depreciation) appreciation
(2)
|
(20,001 | ) | (4,061 | ) | 2,629 | (21,433 | ) | |||||||||
|
Reversal of previously-recorded depreciation upon
realization
(2)
|
— | — | 35,738 | 35,738 | ||||||||||||
|
Issuances / Originations
(3)
|
3,925 | 713 | 150 | 4,788 | ||||||||||||
|
Sales
|
— | — | (74,706 | ) | (74,706 | ) | ||||||||||
|
Settlements / Repayments
(4)
|
(12,968 | ) | (886 | ) | (1,682 | ) | (15,536 | ) | ||||||||
|
Transfers
(7)
|
11,129 | (11,129 | ) | — | — | |||||||||||
|
|
||||||||||||||||
|
Fair value as of March 31, 2010
|
$ | 148,248 | $ | 37,664 | $ | 20,946 | $ | 206,858 | ||||||||
|
|
||||||||||||||||
78
Table of Contents
| Senior | Common | |||||||||||||||||||
| Senior | Subordinated | Preferred | Equity/ | |||||||||||||||||
| Term Debt | Term Debt | Equity | Equivalents | Total | ||||||||||||||||
|
Year ended March 31, 2010:
|
||||||||||||||||||||
|
Fair value as of March 31, 2009
|
$ | 179,676 | $ | 72,062 | $ | 40,042 | $ | 22,150 | $ | 313,930 | ||||||||||
|
Net realized gains (losses)
(1)
|
(35,923 | ) | — | — | — | (35,923 | ) | |||||||||||||
|
Net unrealized appreciation (depreciation)
(2)
|
759 | (1,387 | ) | (19,617 | ) | (1,188 | ) | (21,433 | ) | |||||||||||
|
Reversal of previously-recorded depreciation upon
realization
(2)
|
35,738 | — | — | — | 35,738 | |||||||||||||||
|
Issuances / Originations
(3)
|
2,101 | 2,687 | — | — | 4,788 | |||||||||||||||
|
Sales
|
(74,706 | ) | — | — | — | (74,706 | ) | |||||||||||||
|
Settlements / Repayments
(4)
|
(13,786 | ) | (1,750 | ) | — | — | (15,536 | ) | ||||||||||||
|
Transfers
(8)
|
500 | (500 | ) | — | — | — | ||||||||||||||
|
|
||||||||||||||||||||
|
Fair value as of March 31, 2010
|
$ | 94,359 | $ | 71,112 | $ | 20,425 | $ | 20,962 | $ | 206,858 | ||||||||||
|
|
||||||||||||||||||||
| (1) | Included in the realized and unrealized gain (loss) section on the accompanying Consolidated Statement of Operations for the year ended March 31, 2011. | |
| (2) | Included in Net unrealized appreciation (depreciation) of investment portfolio on the accompanying Consolidated Statement of Operations for the year ended March 31, 2011. | |
| (3) | Includes PIK and other non-cash disbursements to portfolio companies. | |
| (4) | Includes amortization of premiums and discounts and other cost-adjustments. | |
| (5) | Transfer represents the cost basis as of March 31, 2010 of Tread Corporation, which was reclassified from an Affiliate to a Control investment during the three months ended June 30, 2010. | |
| (6) | Transfer represents $12.3 million of senior subordinated term debt of Galaxy Tool Holding Corp. at cost as of June 30, 2010 that was converted to preferred and common equity during the three months ended September 30, 2010. | |
| (7) | Transfer represents the cost basis of Mathey as of September 30, 2009, which was reclassified from an Affiliate to a Control investment during the three months ended December 31, 2009. | |
| (8) | Transfer represents the cost basis as of March 31, 2009 of Noble senior subordinated term debt that was converted into senior term debt during the three months ended June 30, 2009. |
Non-Proprietary Investment Activity
Non-proprietary investments are investments that were not originated by the Company. During the
year ended March 31, 2011, the Company invested in one non-proprietary investment, a syndicated
loan, to Fifth Third Processing Solutions (“Fifth Third”), at a cost of $0.5 million, and the
Company exited one non-proprietary investment, Interstate FiberNet, Inc., which made full repayment
of its senior term debt owed to the Company, resulting in the receipt of approximately $6.7 million
in cash proceeds. The non-proprietary loans in the Company’s investment portfolio, consisting of
all Non-Control/Non-Affiliate investments other than B-Dry, LLC, had a fair value of approximately
$5.1 million, or 3.3% of its total investments at March 31, 2011.
During April and May 2009, the Company sold 29 of the 32 senior syndicated loans that were held in
its portfolio of investments at March 31, 2009 to various investors in the syndicated loan market.
The loans, in the aggregate, had a cost value of approximately $104.2 million, or 29.9% of the cost
value of the Company’s total investments, and an aggregate fair value of approximately $69.8
million, or 22.2% of the fair value of the Company’s total investments, at March 31, 2009. As a
result of these sales, the Company received approximately $69.2 million in net cash proceeds and
recorded a realized loss of approximately $34.6 million.
Proprietary Investment Activity
During the fiscal year ended March 31, 2011, the Company executed the following transactions with
certain of its portfolio companies:
| • | In May 2010, Cavert made full repayment of its senior term A debt owed to the Company resulting in the receipt of approximately $2.9 million in cash proceeds. | ||
| • | In June 2010, the Company sold its equity investment and received full repayment of its debt investment in A. Stucki in connection with the sale of 100% of the outstanding capital stock of A. Stucki. The net cash proceeds to the Company from the sale of its equity in A. Stucki were $21.4 million, resulting in a realized gain of $16.6 million, which includes a $0.3 million closing adjustment decrease during the three months ended December 31, 2010. In connection with the equity sale, the Company accrued and received cash dividend proceeds of $0.3 million from its preferred stock investment in A. Stucki. At the same time, the Company received $30.6 million in repayment of its principal, accrued interest and success fees on the loans to A. Stucki. Additionally, immediately prior to the sale of A. Stucki, the Company received a special distribution of property with a fair value of $0.5 million, which was recorded as dividend income and is reflected as a Control investment, Neville Limited, on the accompanying Consolidated Schedule of Investments since June 30, 2010. | ||
| • | In July and August 2010, the Company restructured Galaxy Tool Holding Corp. (“Galaxy”) by converting $12.3 million of its senior subordinated term note into preferred and common stock and investing an additional $3.2 million into preferred |
79
Table of Contents
| stock. After the restructuring, the Company’s investments at cost in Galaxy consisted of a $5.2 million senior subordinated term note, $19.6 million in preferred stock and $0.1 million in common stock. | |||
| • | In September 2010, Cavert prepaid $0.8 million of its success fee on its senior term debt and senior subordinated term debt. | ||
| • | In October 2010, the Company invested $25.0 million in a Control investment, Venyu Solutions, Inc. (“Venyu”), consisting of subordinated debt and preferred equity. Venyu, headquartered in Baton Rouge, Louisiana, is a leader in commercial-grade, customizable solutions for data protection, data hosting and disaster recover. | ||
| • | In October and November 2010, Mathey prepaid $0.4 million of its success fee on its senior term debt. | ||
| • | In December 2010, the Company invested $10.5 million in a Control investment, Precision Southeast, Inc. (“Precision”), consisting of senior debt and preferred and common equity. Precision, headquartered in Myrtle Beach, South Carolina, is a custom injection molding company, focused on the filtration, consumer and industrial markets. | ||
| • | In December 2010, the Company sold its equity investment and received full repayment of its debt investment in Chase in connection with the sale of 100% of the outstanding capital stock of Chase. The net cash proceeds to the Company from the sale of its equity in Chase were $13.9 million, resulting in a realized gain of $6.9 million. In connection with the equity sale, the Company accrued and received cash dividend proceeds of $4.0 million from its preferred stock investment in Chase. At the same time, the Company received $22.9 million in repayment of its principal, accrued interest and success fees on the loans to Chase. |
Refer to Note 14, Subsequent Events, for investment activity occurring subsequent to March 31,
2011.
Investment Concentrations
Approximately 38.2% of the aggregate fair value of the Company’s investment portfolio at March
31, 2011 was comprised of senior term debt, 41.0% was senior subordinated term debt, and 20.8% was
preferred and common equity securities or their equivalents. At March 31, 2011, the Company had
investments in 17 portfolio companies with an aggregate fair value of $153.3 million, of which
Venyu, Acme Cryogenics, Inc. (“Acme”) and Cavert, collectively comprised approximately $63.2
million, or 41.2% of the Company’s total investment portfolio, at fair value. The following table
outlines the Company’s investments by security type at March 31, 2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Cost | Fair Value | Cost | Fair Value | |||||||||||||
|
Senior term debt
|
$ | 64,566 | $ | 58,627 | $ | 102,446 | $ | 94,359 | ||||||||
|
Senior subordinated term debt
|
74,602 | 62,806 | 79,799 | 71,112 | ||||||||||||
|
Preferred equity
|
52,922 | 25,398 | 40,728 | 20,425 | ||||||||||||
|
Common equity/equivalents
|
5,102 | 6,454 | 4,594 | 20,962 | ||||||||||||
|
|
||||||||||||||||
|
Total Investments
|
$ | 197,192 | $ | 153,285 | $ | 227,567 | $ | 206,858 | ||||||||
|
|
||||||||||||||||
Investments at fair value consisted of the following industry classifications at March 31,
2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Percentage of | Percentage of | |||||||||||||||
| Fair Value | Total Investments | Fair Value | Total Investments | |||||||||||||
|
Containers, packaging and glass
|
$ | 29,029 | 19.0 | % | $ | 18,731 | 9.1 | % | ||||||||
|
Electronics
|
25,012 | 16.3 | — | — | ||||||||||||
|
Chemicals, plastics and rubber
|
19,906 | 13.0 | 13,585 | 6.6 | ||||||||||||
|
Cargo transport
|
13,183 | 8.6 | 9,394 | 4.5 | ||||||||||||
|
Diversified/Conglomerate manufacturing
|
12,746 | 8.3 | 43,054 | 20.8 | ||||||||||||
|
Machinery
|
10,431 | 6.8 | 60,692 | 29.3 | ||||||||||||
|
Buildings and real estate
|
10,120 | 6.6 | 10,220 | 4.9 | ||||||||||||
|
Home and office furnishings/Consumer products
|
8,627 | 5.6 | 9,374 | 4.5 | ||||||||||||
|
Automobile
|
7,560 | 4.9 | 9,040 | 4.4 | ||||||||||||
|
Aerospace and defense
|
6,659 | 4.4 | 17,099 | 8.3 | ||||||||||||
|
Oil and gas
|
4,931 | 3.2 | 4,943 | 2.4 | ||||||||||||
|
Printing and publishing
|
3,073 | 2.0 | 2,895 | 1.4 | ||||||||||||
|
Telecommunications
|
1,499 | 1.0 | 7,831 | 3.8 | ||||||||||||
|
Diversified/Conglomerate service
|
509 | 0.3 | — | — | ||||||||||||
|
|
||||||||||||||||
|
Total Investments
|
$ | 153,285 | 100.0 | % | $ | 206,858 | 100.0 | % | ||||||||
|
|
||||||||||||||||
80
Table of Contents
The investments at fair value were included in the following geographic regions of the United
States at March 31, 2011 and 2010:
| March 31, 2011 | March 31, 2010 | |||||||||||||||
| Percentage of | Percentage of | |||||||||||||||
| Fair Value | Total Investments | Fair Value | Total Investments | |||||||||||||
|
South
|
$ | 92,172 | 60.1 | % | $ | 60,363 | 29.2 | % | ||||||||
|
Northeast
|
38,126 | 24.9 | 81,276 | 39.3 | ||||||||||||
|
West
|
12,746 | 8.3 | 16,124 | 7.8 | ||||||||||||
|
Midwest
|
10,241 | 6.7 | 49,095 | 23.7 | ||||||||||||
|
|
||||||||||||||||
|
Total Investments
|
$ | 153,285 | 100.0 | % | $ | 206,858 | 100.0 | % | ||||||||
|
|
||||||||||||||||
The geographic region indicates the location of the headquarters for the Company’s portfolio
companies. A portfolio company may have a number of other business locations in other geographic
regions.
Investment Principal Repayments
The following table summarizes the contractual principal repayments and maturity of the Company’s
investment portfolio by fiscal year, assuming no voluntary prepayments, at March 31, 2011:
| Fiscal year ending March 31, | Amount | |||
|
2012
|
$ | 18,946 | ||
|
2013
|
33,866 | |||
|
2014
|
34,331 | |||
|
2015
|
21,942 | |||
|
2016
|
26,775 | |||
|
Thereafter
|
3,543 | |||
|
|
||||
|
Total contractual repayments
|
$ | 139,403 | ||
|
Investments in equity securities
|
58,023 | |||
|
Adjustments to cost basis on debt securities
|
(234 | ) | ||
|
|
||||
|
Total cost basis of investments held at March 31, 2011:
|
$ | 197,192 | ||
|
|
||||
Receivables from Portfolio Companies
Receivables from portfolio companies represent non-recurring costs incurred on behalf of portfolio
companies. The Company maintains an allowance for uncollectible receivables from portfolio
companies, which is determined based on historical experience and management’s expectations of
future losses. The Company charges the accounts receivable to the established provision when
collection efforts have been exhausted and the receivables are deemed uncollectible. As of March
31, 2011 and 2010, the Company had gross receivables from portfolio companies of $0.5 million and
$0.1 million, respectively. The allowance for uncollectible receivables was $0.1 million and $0
for March 31, 2011 and 2010, respectively.
Investment Advisory and Management Agreement
The following tables summarize the management fees, incentive fees and associated credits reflected
in the accompanying
Consolidated Statements of Operations
:
| Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Average total assets subject to base management fee
(1)
|
$ | 198,950 | $ | 224,200 | ||||
|
Multiplied by annual base management fee of 2%
|
2 | % | 2 | % | ||||
|
|
||||||||
|
Unadjusted base management fee
|
3,979 | 4,484 | ||||||
|
|
||||||||
|
Reduction for loan servicing fees
(2)
|
(2,743 | ) | (3,747 | ) | ||||
|
|
||||||||
|
Base management fee
(2)
|
$ | 1,236 | $ | 737 | ||||
|
|
||||||||
|
|
||||||||
|
Credits to base management fee from Adviser:
|
||||||||
|
Fee reduction for the waiver of 2.0% fee on senior syndicated loans to 0.5%
|
(15 | ) | (291 | ) | ||||
|
Credit for fees received by Adviser from the portfolio companies
|
(665 | ) | (433 | ) | ||||
|
|
||||||||
|
Credit to base management fee from Adviser
(2)
|
(680 | ) | (724 | ) | ||||
|
|
||||||||
|
|
||||||||
|
Net base management fee
|
$ | 556 | $ | 13 | ||||
|
|
||||||||
81
Table of Contents
| Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Incentive fee
(2)
|
$ | 2,949 | $ | 588 | ||||
|
Credit from voluntary, irrevocable waiver issued by Adviser’s board of
directors
|
— | (102 | ) | |||||
|
|
||||||||
|
Net incentive fee
|
$ | 2,949 | $ | 486 | ||||
|
|
||||||||
|
|
||||||||
|
Total credits to fees:
|
||||||||
|
Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on senior
syndicated loans to 0.5%
|
$ | (15 | ) | $ | (291 | ) | ||
|
Credit for fees received by Adviser from portfolio companies
|
(665 | ) | (433 | ) | ||||
|
Incentive fee credit
|
— | (102 | ) | |||||
|
|
||||||||
|
Credit to base management and incentive fees from Adviser
(2)
|
$ | (680 | ) | $ | (826 | ) | ||
|
|
||||||||
| (1) | Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and adjusted appropriately for any share issuances or repurchases during the periods. | |
| (2) | Reflected, in total, as a line item on the Consolidated Statement of Operations located elsewhere in this report. |
Base Management Fee
The base management fee is payable quarterly and assessed at an annual rate of 2.0%, computed
on the basis of the value of the Company’s average gross assets at the end of the two most
recently completed quarters, which are total assets, including investments made with proceeds
of borrowings, less any uninvested cash or cash equivalents resulting from borrowings. In
addition, the following three items are adjustments to the base management fee calculation.
| • | Loan Servicing Fees | ||
| The Adviser also services the loans held by Business Investment, in return for which it receives a 2.0% annual fee based on the monthly aggregate outstanding balance of loans pledged under the Company’s line of credit. Since the Company owns these loans, all loan servicing fees paid to the Adviser are treated as reductions directly against the 2.0% base management fee under the Advisory Agreement. | |||
| • | Senior Syndicated Loan Fee Waiver | ||
| The Company’s Board of Directors accepted an unconditional and irrevocable voluntary waiver from the Adviser to reduce the annual 2.0% base management fee on senior syndicated loan participations to 0.5%, to the extent that proceeds resulting from borrowings were used to purchase such senior syndicated loan participations, for the years ended March 31, 2011 and 2010. | |||
| • | Portfolio Company Fees | ||
| Under the Advisory Agreement, the Adviser has also provided, and continues to provide, managerial assistance and other services to the Company’s portfolio companies and may receive fees for services other than managerial assistance. 50% of certain of these fees and 100% of others are credited against the base management fee that the Company would otherwise be required to pay to the Adviser. |
Incentive Fee
The incentive fee consists of two parts: an income-based incentive fee and a capital
gains-based incentive fee. The income-based incentive fee rewards the Adviser if the
Company’s quarterly net investment income (before giving effect to any incentive fee) exceeds
1.75% of the Company’s net assets (the “hurdle rate”). The Company will pay the Adviser an
income-based incentive fee with respect to the Company’s pre-incentive fee net investment
income in each calendar quarter as follows:
| • | no incentive fee in any calendar quarter in which its pre-incentive fee net investment income does not exceed the hurdle rate (7.0% annualized); | ||
| • | 100% of the Company’s pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in any calendar quarter (8.75% annualized); and | ||
| • | 20% of the amount of the Company’s pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized). |
The second part of the incentive fee is a capital gains-based incentive fee that will be
determined and payable in arrears as of the end of each fiscal year (or upon termination of
the Advisory Agreement, as of the termination date), and equals 20% of the Company’s realized
capital gains as of the end of the fiscal year. In determining the capital gains-based
incentive fee payable to the Adviser, the Company will calculate the cumulative aggregate
realized capital gains and cumulative aggregate
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realized capital losses since the Company’s inception, and the aggregate unrealized capital
depreciation as of the date of the calculation, as applicable, with respect to each of the
investments in the Company’s portfolio. For this purpose, cumulative aggregate realized
capital gains, if any, equals the sum of the differences between the net sales price of each
investment, when sold, and the original cost of such investment since the Company’s
inception. Cumulative aggregate realized capital losses equals the sum of the amounts by
which the net sales price of each investment, when sold, is less than the original cost of
such investment since the Company’s inception. Aggregate unrealized capital depreciation
equals the sum of the difference, if negative, between the valuation of each investment as of
the applicable calculation date and the original cost of such investment. At the end of the
applicable year, the amount of capital gains that serves as the basis for the Company’s
calculation of the capital gains-based incentive fee equals the cumulative aggregate realized
capital gains less cumulative aggregate realized capital losses, less aggregate unrealized
capital depreciation, with respect to the Company’s portfolio of investments. If this number
is positive at the end of such year, then the capital gains-based incentive fee for such year
equals 20% of such amount, less the aggregate amount of any capital gains-based incentive
fees paid in respect of the Company’s portfolio in all prior years. No capital
gains-based incentive fee had been recorded for the Company from inception through March, 31,
2011, as cumulative unrealized capital depreciation exceeded cumulative realized capital
gains net of cumulative realized capital losses.
Additionally, in accordance with GAAP, the Company did not accrue a capital gains-based
incentive fee for the year ended March 31, 2011. This GAAP accrual is calculated using the
aggregate cumulative realized capital gains and losses and aggregate cumulative unrealized
capital depreciation included in the calculation of the capital gains-based incentive fee
plus the aggregate cumulative unrealized capital appreciation. If such amount is positive at
the end of a period, then GAAP require the Company to record a capital gains-based incentive
fee equal to 20% of such amount, less the aggregate amount of actual capital gains-based
incentive fees paid in all prior years. If such amount is negative, then there is no accrual
for such year. GAAP requires that the capital gains-based incentive fee accrual consider the
cumulative aggregate unrealized capital appreciation in the calculation, as a capital
gains-based incentive fee would be payable if such unrealized capital appreciation were
realized. There can be no assurance that such unrealized capital appreciation will be
realized in the future. There was no GAAP accrual for a capital gains-based incentive fee for
the years ended March 31, 2010 or 2009 either.
Administration Agreement
The Company has entered into an administration agreement (the “Administration Agreement”) with
Gladstone Administration, LLC (the “Administrator”), an affiliate of the Adviser whereby it pays
separately for administrative services. The Administration Agreement provides for payments equal to
the Company’s allocable portion of its Administrator’s overhead expenses in performing its
obligations under the Administration Agreement, including, but not limited to, rent and the
salaries and benefits expenses of the Company’s chief financial officer, chief compliance officer,
treasurer, internal counsel and their respective staffs. The Company’s allocable portion of
administrative expenses is derived by multiplying the Administrator’s total allocable expenses by
the percentage of the Company’s total assets at the beginning of the quarter in comparison to the
total assets at the beginning of the quarter of all companies managed by the Adviser under similar
agreements. The Company recorded fees to the Administrator on the consolidated statements of
operations of $0.8 million and $0.7 million for the years ended March 31, 2011 and 2010,
respectively.
Related Party Fees Due
Amounts due to related parties on the accompanying consolidated statements of assets and
liabilities were as follows:
| As of March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Base management fee due to Adviser
|
$ | 341 | $ | 16 | ||||
|
Loan servicing fee due to Adviser
|
157 | 219 | ||||||
|
Incentive fee due to Adviser
|
— | 486 | ||||||
|
Other
|
1 | — | ||||||
|
|
||||||||
|
Total fees due to Adviser
|
$ | 499 | $ | 721 | ||||
|
|
||||||||
|
Fee due to Administrator
|
$ | 171 | $ | 149 | ||||
|
|
||||||||
|
|
||||||||
|
Total related party fees due
|
$ | 670 | $ | 870 | ||||
|
|
||||||||
Credit Facility
On April 14, 2009, the Company, through its wholly-owned subsidiary, Business Investment, entered
into a second amended and restated credit agreement providing for a $50.0 million revolving line of
credit (the “Credit Facility”) arranged by Branch Banking and Trust Company (“BB&T”) as
administrative agent. Key Equipment Finance Inc. also joined the Credit Facility as a committed
lender. In connection with entering into the Credit Facility, the Company borrowed $43.8 million
under the Credit Facility to make a final
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payment in satisfaction of all unpaid principal and interest owed to Deutsche Bank AG under a prior
line of credit. On April 13, 2010, the Company, through Business Investment, entered into a third
amended and restated credit agreement providing for a $50.0 million, two year revolving line of
credit, which extended the maturity date of the Credit Facility to April 13, 2012. If the Credit
facility is not renewed or extended by April 13, 2012, all unpaid principal and interest will be
due and payable within one year of the maturity date. Advances under the Credit Facility generally
bear interest at the 30-day London Interbank Offered Rate (“LIBOR”) (subject to a minimum rate of
2.0%), plus 4.5% per annum, with a commitment fee of 0.50% per annum on undrawn amounts when
advances outstanding are above 50.0% of the commitment and 1.0% on undrawn amounts if the advances
outstanding are below 50.0% of the commitment. As of March 31, 2011, the Company had zero
outstanding with approximately $33.9 million of availability under the Credit Facility. For the
year ended March 31, 2011 and 2010, the Company had weighted average borrowings outstanding under
the Credit Facility of $2.9 million and $25.8 million, respectively, with a corresponding weighted
average effective interest rate of 22.7% and 7.6%, respectively.
Interest is payable monthly during the term of the Credit Facility. Available borrowings are
subject to various constraints imposed under the Credit Facility, based on the aggregate loan
balance pledged by Business Investment, which varies as loans are added and repaid, regardless of
whether such repayments are prepayments or made as contractually required.
The administrative agent also requires that any interest or principal payments on pledged loans be
remitted directly by the borrower into a lockbox account with The Bank of New York Mellon Trust
Company, N.A as custodian. BB&T is also the trustee of the account and once a month remits the
collected funds to the Company.
The Credit Facility contains covenants that require Business Investment to maintain its status as a
separate legal entity; prohibit certain significant corporate transactions (such as mergers,
consolidations, liquidations or dissolutions); and restrict material changes to the Company’s
credit and collection policies without the lenders’ consent. The Credit Facility also limits
payments on distributions to the aggregate net investment income for each of the twelve month
periods ending March 31, 2011 and 2012. The Company is also subject to certain limitations on the
type of loan investments it can make, including restrictions on geographic concentrations, sector
concentrations, loan size, dividend payout, payment frequency and status, average life and lien
property. The Credit Facility further requires the Company to comply with other financial and
operational covenants, which obligate the Company to, among other things, maintain certain
financial ratios, including asset and interest coverage, a minimum net worth, and a minimum number
of obligors required in the borrowing base of the credit agreement. Additionally, the Company is
subject to a performance guaranty that requires the Company to maintain (i) a minimum net worth of
$155.0 million plus 50.0% of all equity and subordinated debt raised after April 13, 2010, (ii)
“asset coverage” with respect to “senior securities representing indebtedness” of at least 200%, in
accordance with Section 18 of the 1940 Act, and (iii) its status as a BDC under the 1940 Act and as
a RIC under the Code. As of March 31, 2011, the Company was in compliance with all covenants.
Short-Term Loan
Similar to what has been done at the close of several of the prior quarters; the Company purchased
$40.0 million of short-term United States Treasury Bills (“T-Bills”) through Jefferies & Company,
Inc. (“Jefferies”) on March 30, 2011. The T-Bills were purchased using $4.0 million from existing
T-Bills for collateral and the proceeds from a $40.0 million short-term loan from Jefferies, with
an effective annual interest rate of approximately 0.65%. On April 7, 2011, when the T-Bills
matured, the Company repaid the $40.0 million loan from Jefferies.
Fair Value
The Company elected to apply ASC 825, “Financial Instruments,” specifically for the Credit Facility
and short-term loan, which was consistent with its application of ASC 820 to its investments. The
Company estimates the fair value of the Credit Facility using estimates of value provided by an
independent third party and its own assumptions in the absence of observable market data, including
estimated remaining life, credit party risk, current market yield and interest rate spreads of
similar securities as of the measurement date. Due to the eight-day duration of the short-term
loan, cost approximated fair value. As of March 31, 2011, all of the Company’s borrowings were
valued using Level 3 inputs. The following tables present the Credit Facility and short-term loan
carried at fair value as of March 31, 2011 and 2010, by caption on the accompanying
Consolidated
Statements of Assets and Liabilities
for each of the applicable three levels of hierarchy
established by ASC 820 and a roll-forward in the changes in fair value during the years ended March
31, 2011 and 2010:
| Level 3 - Borrowings | ||||||||
| Total Fair Value Reported in Consolidated | ||||||||
| Statements of Assets and Liabilities | ||||||||
| March 31, 2011 | March 31, 2010 | |||||||
|
Short-Term Loan
|
$ | 40,000 | $ | 75,000 | ||||
|
Credit Facility
|
— | 27,812 | ||||||
|
|
||||||||
|
Total
|
$ | 40,000 | $ | 102,812 | ||||
|
|
||||||||
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Table of Contents
| Total Fair Value | ||||||||||||
| Reported in | ||||||||||||
| Short-Term | Credit | Consolidated Statements | ||||||||||
| Loan | Facility | of Assets and Liabilities | ||||||||||
|
Year ended March 31, 2011:
|
||||||||||||
|
Fair value at March 31, 2010
|
$ | 75,000 | $ | 27,812 | $ | 102,812 | ||||||
|
Borrowings
|
207,401 | 24,000 | 231,401 | |||||||||
|
Repayments
|
(242,401 | ) | (51,800 | ) | (294,201 | ) | ||||||
|
Net unrealized depreciation of Credit
Facility
(1)
|
— | (12 | ) | (12 | ) | |||||||
|
|
||||||||||||
|
Fair value at March 31, 2011
|
$ | 40,000 | $ | — | $ | 40,000 | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
Year ended March 31, 2010:
|
||||||||||||
|
Fair value at March 31, 2009
(2)
|
$ | — | $ | 110,265 | $ | 110,265 | ||||||
|
Borrowings
|
290,000 | 107,500 | 397,500 | |||||||||
|
Repayments
|
(215,000 | (189,965 | ) | (404,965 | ) | |||||||
|
Net unrealized appreciation of Credit
Facility
(1)
|
— | 12 | 12 | |||||||||
|
|
||||||||||||
|
Fair value at March 31, 2010
|
$ | 75,000 | $ | 27,812 | $ | 102,812 | ||||||
|
|
||||||||||||
| (1) | Included in Net unrealized appreciation (depreciation) of other on the accompanying Consolidated Statement of Operations for the year ended March 31, 2011. | |
| (2) | ASC 825 was not adopted until the second quarter of fiscal year 2010; therefore, the Credit Facility is shown at its principal balance outstanding at March 31, 2009 in the table above. |
The fair value of the collateral under the Credit Facility was approximately $146.3 million
and $201.8 million at March 31, 2011 and 2010, respectively. The fair value of the collateral under
the short-term loan was approximately $44.0 million and $85.0 million as of March 31, 2011 and
2010, respectively.
In May 2009, the Company cancelled its interest rate cap agreement with Deutsche Bank AG and
entered into an interest rate cap agreement with BB&T that effectively limited the interest rate on
a portion of the borrowings under the line of credit pursuant to the terms of the Credit Facility.
The interest rate cap had a notional amount of $45.0 million at a cost of approximately $39. At
March 31, 2011, the interest rate cap agreement had a fair value of $0. The Company records changes
in the fair value of the interest rate cap agreement quarterly based on the current market
valuation at quarter end as unrealized depreciation or appreciation
of other on the
accompanying
Consolidated Statement of Operations
. The interest rate cap agreement expired in May
2011. The agreement provided that the Company’s interest rate or cost of funds on a portion of its
borrowings was capped at 6.5% when LIBOR was in excess of 6.5%.
In April 2010, the Company entered into a forward interest rate cap agreement, effective May 2011
and expiring in May 2012, with BB&T for a notional amount of $45.0 million that will effectively
limit the interest rate on a portion of the borrowings under the line of credit pursuant to the
terms of the Credit Facility. In conjunction with this agreement, the Company incurred a premium
fee of approximately $41. The agreement provides that the Company’s interest rate or cost of funds
on a portion of its borrowings will be capped at 6.0% when the LIBOR is in excess of 6.0%. At March
31, 2011, the interest rate cap agreement had a fair value of $4.
The use of a cap involves risks that are different from those associated with ordinary portfolio
securities transactions. Cap agreements may be considered to be illiquid. Although the Company will
not enter into any such agreements unless it believes that the other party to the transaction is
creditworthy, the Company does bear the risk of loss of the amount expected to be received under
such agreements in the event of default or bankruptcy of the agreement counterparty.
As of March 31, 2011 and 2010, 100,000,000 shares of common stock, $0.001 par value per share, were
authorized and 22,080,133 shares of common stock were outstanding.
Registration Statement
On July 21, 2009, the Company filed a registration statement on Form N-2 (Registration No.
333-160720) that was amended on October 2, 2009 and which the SEC declared effective on October 8,
2009. The Company filed a post-effective amendment to such registration statement on August 24,
2010, which the SEC declared effective on December 23, 2010. The registration statement permits
the Company to issue, through one or more transactions, up to an aggregate of $300.0 million in
securities, consisting of common stock, preferred stock, subscription rights, debt securities and
warrants to purchase common stock, or a combination of these securities
.
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The following table sets forth the computation of basic and diluted net decrease in net assets
resulting from operations per share for the years ended March 31, 2011 and 2010:
| Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Numerator for basic and diluted net increase
(decrease) in net assets resulting from operations per
share
|
$ | 16,439 | $ | (11,071 | ) | |||
|
Denominator for basic and diluted weighted average shares
|
22,080,133 | 22,080,133 | ||||||
|
|
||||||||
|
Basic and diluted net increase (decrease) in net
assets resulting from operations per share
|
$ | 0.74 | $ | (0.50 | ) | |||
|
|
||||||||
The Company’s Board of Directors declared the following monthly distributions per share for the
fiscal years 2011 and 2010:
| Distribution | ||||||||
| Declaration Date | Record Date | Payment Date | per Share | |||||
|
April 7, 2010
|
April 22, 2010 | April 30, 2010 | $ | 0.04 | ||||
|
April 7, 2010
|
May 20, 2010 | May 28, 2010 | 0.04 | |||||
|
April 7, 2010
|
June 22, 2010 | June 30, 2010 | 0.04 | |||||
|
July 7, 2010
|
July 22, 2010 | July 30, 2010 | 0.04 | |||||
|
July 7, 2010
|
August 23, 2010 | August 31, 2010 | 0.04 | |||||
|
July 7, 2010
|
September 22, 2010 | September 30, 2010 | 0.04 | |||||
|
October 5, 2010
|
October 21, 2010 | October 29, 2010 | 0.04 | |||||
|
October 5, 2010
|
November 19, 2010 | November 30, 2010 | 0.04 | |||||
|
October 5, 2010
|
December 23, 2010 | December 31, 2010 | 0.04 | |||||
|
January 11, 2011
|
January 21, 2011 | January 31, 2011 | 0.04 | |||||
|
January 11, 2011
|
February 21, 2011 | February 28, 2011 | 0.04 | |||||
|
January 11, 2011
|
March 21, 2011 | March 31, 2011 | 0.04 | |||||
|
|
||||||||
|
|
Total Fiscal Year 2011: | $ | 0.48 | |||||
|
|
||||||||
| Distribution | ||||||||
| Declaration Date | Record Date | Payment Date | per Share | |||||
|
April 16, 2009
|
April 27, 2009 | May 8, 2009 | $ | 0.04 | ||||
|
April 16, 2009
|
May 20, 2009 | May 29, 2009 | 0.04 | |||||
|
April 16, 2009
|
June 22, 2009 | June 30, 2009 | 0.04 | |||||
|
July 8, 2009
|
July 23, 2009 | July 31, 2009 | 0.04 | |||||
|
July 8, 2009
|
August 21, 2009 | August 31, 2009 | 0.04 | |||||
|
July 8, 2009
|
September 22, 2009 | September 30, 2009 | 0.04 | |||||
|
October 6, 2009
|
October 22, 2009 | October 30, 2009 | 0.04 | |||||
|
October 6, 2009
|
November 19, 2009 | November 30, 2009 | 0.04 | |||||
|
October 6, 2009
|
December 22, 2009 | December 31, 2009 | 0.04 | |||||
|
January 12, 2010
|
January 21, 2010 | January 29, 2010 | 0.04 | |||||
|
January 12, 2010
|
February 18, 2010 | February 26, 2010 | 0.04 | |||||
|
January 12, 2010
|
March 23, 2010 | March 31, 2010 | 0.04 | |||||
|
|
||||||||
|
|
Total Fiscal Year 2010: | $ | 0.48 | |||||
|
|
||||||||
Aggregate distributions declared and paid for the years ended March 31, 2011 and 2010 were
approximately $10.6 million, which were declared based on an estimate of taxable income for each of
those fiscal years. Taxable income available for distribution exceeded distributions declared and
paid for the year ended March 31, 2011. At year-end, the Company elected to treat a portion of the
first distribution paid after year-end as having been paid in the prior year, in accordance with
Section 855(a) of the Code. For the year ended March 31, 2010, distributions equaled taxable income
available for distribution.
Distribution of Income and Gains
Taxable income of the Company is declared and distributed to stockholders monthly. Net realized
gains from investment transactions, in excess of available capital loss carryforwards, would be
taxable to the Company if not distributed, and, therefore, generally will be distributed at least
annually.
The timing and characterization of certain income and capital gains distributions are determined
annually in accordance with federal tax regulations, which may differ from GAAP. These differences
primarily relate to items recognized as income for financial statement purposes and realized gains
for tax purposes. As a result, net investment income and net realized gain (loss) on investment
transactions for a reporting period may differ significantly from distributions during such period.
Accordingly, the Company may
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Table of Contents
periodically make reclassifications among certain of its capital accounts without impacting the net
asset value of the Company. Additionally, the following tables also include these adjustments for
the years ended March 31, 2011 and March 31, 2010, respectively.
The
Company’s components of net assets on a tax basis were as follows:
| Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Capital loss carryforward
|
$ | (14,585 | ) | $ | (43,507 | ) | ||
|
Undistributed ordinary income
|
495 | — | ||||||
|
Other temporary differences
|
(330 | ) | — | |||||
|
Other
|
18 | 18 | ||||||
|
Net unrealized depreciation of investments
|
(43,907 | ) | (20,710 | ) | ||||
|
Net unrealized depreciation of other
|
(76 | ) | (51 | ) | ||||
|
Common stock
|
22 | 22 | ||||||
|
Paid-in-capital
|
257,192 | 257,206 | ||||||
|
|
||||||||
|
Net assets
|
$ | 198,829 | $ | 192,978 | ||||
|
|
||||||||
The Company intends to retain realized gains to the extent of available capital loss
carryforwards. At March 31, 2011, the Company had $14,585 of capital loss carryforwards that expire
in 2018.
For the years ended March 31, 2011 and 2010, the Company recorded the following adjustment for
permanent book/tax differences to reflect tax character. The adjustment relates to the success
fees received prior to January 1, 2011, which were treated as capital gains for tax purposes.
Results of operations and net assets were not affected by this revision.
| Tax Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Undistributed net investment income
|
$ | (5,433 | ) | $ | — | |||
|
Accumulated net realized loss
|
5,433 | — | ||||||
The tax character of distributions paid to stockholders by the Company is summarized as
follows:
| Tax Year Ended March 31, | ||||||||
| 2011 | 2010 | |||||||
|
Distributions from ordinary income
|
$ | 10,598 | $ | 10,598 | ||||
|
Distributions from return of capital
|
— | — | ||||||
|
|
||||||||
|
Total Distributions
|
$ | 10,598 | $ | 10,598 | ||||
|
|
||||||||
The Company intends to continue to qualify for treatment as a RIC under subchapter M of the Code.
As a RIC, the Company will not be subject to federal income tax on the portion of its taxable
income and gains distributed to stockholders. To qualify as a RIC, the Company is required to
distribute at least 90% of its investment company taxable income, as defined by the Code. The
Company intends to distribute at least 90% of its ordinary income, and, as a result, no income tax
provisions have been recorded. The Company may, but does not intend to, pay out a return of
capital. The Company may also be subject to federal excise tax if it does not distribute at least
98% of its investment company taxable income in any calendar year and 98% of its capital gain net
income in any calendar year. Under the RIC Modernization Act, for excise tax years beginning
January 1, 2011, the minimum distribution requirement for capital gains income has been raised to
98.2%. The Company must also meet the asset diversification threshold under the Code’s rules
applicable to a RIC, which is referred to herein as the 50% threshold. For each quarter end since
June 30, 2009 (the “measurement dates”), the Company satisfied the 50% threshold through the
purchase of short-term qualified securities, which was funded primarily through a short-term loan
agreement. Subsequent to the measurement dates, the short-term qualified securities matured and the
Company repaid the short-term loan, at which time the Company again fell below the 50% threshold.
As of the date of this filing, the Company remains below the 50% threshold. Thus, while the
Company currently qualifies as a RIC despite its current inability to meet the 50% threshold and
potential inability to do so in the future, if the Company makes any additional investments before
regaining compliance with the asset diversification test, its RIC status will be threatened.
Failure to meet the 50% threshold alone will not result in loss of the Company’s RIC status in its
current situation. In circumstances where the failure to meet the 50% threshold as of a quarterly
measurement date is the result of fluctuations in the value of assets, including as a result of the
sale of assets, as in the Company’s present situation, the Company is still deemed to have
satisfied the asset diversification test and, therefore, maintain its RIC status, as long as it has
not made any new investments, including additional investments in its existing portfolio companies
(such as advances under outstanding lines of credit), since the time that it fell below the 50%
threshold. If the Company makes an investment and does not regain compliance with the 50%
threshold prior to the next quarterly measurement date following the investment, it would have
thirty days to “cure” its failure of the asset diversification test to avoid a loss of RIC status.
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Potential cures
for failure of the asset diversification test include raising additional equity or debt capital or
changing the composition of the Company’s assets, which could include full or partial divestitures
of investments, such that the Company would once again meet or exceed the 50% threshold.
At March 31, 2011, the Company was not party to any signed commitments for potential investments.
However, the Company has certain lines of credit with its portfolio companies that have not been
fully drawn. Since these lines of credit have expiration dates and the Company expects many will
never be fully drawn, the total line of credit commitment amounts do not necessarily represent
future cash requirements. The Company estimates the fair value of these unused line of credit
commitments as of March 31, 2011 and March 31, 2010 to be nominal.
In October 2008, the Company executed a guaranty of a vehicle finance facility agreement (the
“Finance Facility”) between Ford Motor Credit Company and ASH. The Finance Facility provides ASH
with a line of credit of up to $0.8 million for component Ford parts used by ASH to build truck
bodies under a separate contract. Title and ownership of the parts are retained by Ford. The
guaranty of the Finance Facility will expire upon termination of the separate parts supply contract
with Ford or upon replacement of the Company as guarantor. The Finance Facility is secured by all
of the assets of Business Investment. As of March 31, 2011, the Company has not been required to
make any payments on the guaranty of the Finance Facility, and the Company considers the credit
risk to be remote and the fair value of the guaranty to be minimal.
In February 2010, the Company executed a guaranty of a wholesale financing facility agreement (the
“Floor Plan Facility”) between Agricredit Acceptance, LLC (“Agricredit”) and Country Club
Enterprises, LLC (“CCE”). The Floor Plan Facility provides CCE with financing of up to $2.0
million to bridge the time and cash flow gap between the order and delivery of golf cars to
customers. The guaranty was renewed in February 2011 and expires in February 2012, unless it is
renewed again by the Company, CCE and Agricredit. In connection with this guaranty and its
subsequent renewal, the Company recorded aggregate premiums of $0.2 million from CCE. As of March
31, 2011, the Company has not been required to make any payments on the guaranty of the Floor Plan
Facility, and the Company considers the credit risk to be remote and the fair value of the guaranty
to be minimal.
In April 2010, the Company executed a guaranty of vendor recourse for up to $2.0 million in
individual customer transactions (the “Recourse Facility”) between Wells Fargo Financial Leasing,
Inc. and CCE. The Recourse Facility provides CCE with the ability to provide vendor recourse up to
a limit of $2.0 million on transactions with long-time customers who lack the financial history to
qualify for third party financing. In connection with this guaranty, the Company received a
premium of $0.1 million from CCE. As of March 31, 2011, the Company has not been required to make
any payments on the guaranty of the Recourse Facility, and the Company considers the credit risk to
be remote and the fair value of the guaranty to be minimal.
| Year Ended March 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
|
Per Share Data
(1)
|
||||||||||||
|
Net asset value at beginning of year
|
$ | 8.74 | $ | 9.73 | $ | 12.47 | ||||||
|
|
||||||||||||
|
Income from investment operations:
|
||||||||||||
|
Net investment income
(2)
|
0.73 | 0.48 | 0.62 | |||||||||
|
Realized gain (loss) on sale of investments
(2)
|
1.06 | (1.63 | ) | (0.23 | ) | |||||||
|
Net unrealized (depreciation) appreciation of investments
(2)
|
(1.05 | ) | 0.65 | (0.92 | ) | |||||||
|
|
||||||||||||
|
Total from investment operations
|
0.74 | (0.50 | ) | (0.53 | ) | |||||||
|
|
||||||||||||
|
Distributions from:
|
||||||||||||
|
Net investment income
|
(0.48 | ) | (0.48 | ) | (0.62 | ) | ||||||
|
Tax return on capital
|
— | — | (0.34 | ) | ||||||||
|
|
||||||||||||
|
Total distributions
(3)
|
(0.48 | ) | (0.48 | ) | (0.96 | ) | ||||||
|
|
||||||||||||
|
Effect of shelf offering:
|
||||||||||||
|
Shelf registration offering costs
|
— | (0.01 | ) | (0.03 | ) | |||||||
|
Effect on distribution of rights offering after record date
(4)
|
— | — | (1.22 | ) | ||||||||
|
|
||||||||||||
|
Total effect of shelf offering
|
— | (0.01 | ) | (1.25 | ) | |||||||
|
|
||||||||||||
|
|
||||||||||||
|
Net asset value at end of year
|
$ | 9.00 | $ | 8.74 | $ | 9.73 | ||||||
|
|
||||||||||||
|
|
||||||||||||
|
Per share market value at beginning of year
|
$ | 6.01 | $ | 3.67 | $ | 9.32 | ||||||
|
Per share market value at end of year
|
7.76 | 5.98 | 3.82 | |||||||||
|
Total return
(5)
|
38.56 | % | 79.80 | % | (51.65 | )% | ||||||
|
Shares outstanding at end of year
|
22,080,133 | 22,080,133 | 22,080,133 | |||||||||
88
Table of Contents
| Year Ended March 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
|
Statement of Assets and Liabilities Data:
|
||||||||||||
|
Net assets at end of year
|
$ | 198,829 | $ | 192,978 | $ | 214,802 | ||||||
|
Average net assets
(6)
|
192,893 | 191,112 | 230,738 | |||||||||
|
|
||||||||||||
|
Senior Securities Data:
|
||||||||||||
|
Total borrowings
|
$ | 40,000 | $ | 102,812 | $ | 110,265 | ||||||
|
Asset coverage ratio
(7)
|
534 | % | 281 | % | 293 | % | ||||||
|
Average coverage per unit
(8)
|
$ | 5,344 | $ | 2,814 | $ | 2,930 | ||||||
|
|
||||||||||||
|
Ratios/Supplemental Data:
|
||||||||||||
|
Ratio of expenses to average net assets
(9)(10)
|
5.48 | % | 5.76 | % | 6.46 | % | ||||||
|
Ratio of net expenses to average net assets
(9)(11)(12)
|
5.13 | % | 5.33 | % | 5.38 | % | ||||||
|
Ratio of net investment income to average net assets
(9)(13)
|
8.38 | % | 5.55 | % | 5.80 | % | ||||||
| (1) | Based on actual shares outstanding at the end of the corresponding period. | |
| (2) | Based on weighted average basic per share data. | |
| (3) | Distributions are determined based on taxable income calculated in accordance with income tax regulations, which may differ from amounts determined under accounting principles generally accepted in the United States of America. | |
| (4) | The effect of distributions from the stock rights offering after the record date represents the effect on net asset value of issuing additional shares after the record date of a distribution. | |
| (5) | Total return equals the change in the market value of the Company’s common stock from the beginning of the period, taking into account dividends reinvested in accordance with the terms of the Company’s dividend reinvestment plan. | |
| (6) | Calculated using the average of the balance of net assets at the end of each month of the reporting period. | |
| (7) | As a business development company, the Company is generally required to maintain an asset coverage ratio of at least 200% of total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to total borrowings and guaranty commitments. Asset coverage ratio is the ratio of the carrying value of the Company’s total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. | |
| (8) | Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per one thousand dollars of indebtedness. | |
| (9) | Amounts are annualized. | |
| (10) | Ratio of expenses to average net assets is computed using expenses before credits from the Adviser. | |
| (11) | Ratio of net expenses to average net assets is computed using total expenses net of credits to the management fee. | |
| (12) | Had the Company not received any voluntary waivers of fees due to the Adviser, the ratio of net expenses to average net assets would have been 5.14%, 5.54% and 6.08% for the fiscal years ended March 31, 2011, 2010 and 2009, respectively. | |
| (13) | Had the Company not received any voluntary waivers of fees due to the Adviser, the ratio of net investment income to average net assets would have been 8.38%, 5.34% and 5.10% for the fiscal years ended March 31, 2011, 2010 and 2009, respectively. |
| Year Ended March 31, 2011 | ||||||||||||||||
| Quarter Ended | Quarter Ended | Quarter Ended | Quarter Ended | |||||||||||||
| June 30, 2010 | September 30, 2010 | December 31, 2010 | March 31, 2011 | |||||||||||||
|
Total investment income
|
$ | 7,248 | $ | 4,301 | $ | 10,737 | $ | 3,778 | ||||||||
|
Net investment income
|
4,207 | 2,441 | 7,591 | 1,932 | ||||||||||||
|
Net increase (decrease) in
net assets resulting from
operations
|
5,368 | (6,859 | ) | 15,135 | 2,795 | |||||||||||
|
Net increase (decrease) in
net assets resulting from
operations per weighted
average common share
(basic & diluted)
|
$ | 0.24 | $ | (0.31 | ) | $ | 0.68 | $ | 0.13 | |||||||
| Year Ended March 31, 2010 | ||||||||||||||||
| Quarter Ended | Quarter Ended | Quarter Ended | Quarter Ended | |||||||||||||
| June 30, 2009 | September 30, 2009 | December 31, 2009 | March 31, 2010 | |||||||||||||
|
Total investment income
|
$ | 5,169 | $ | 4,943 | $ | 5,921 | $ | 4,752 | ||||||||
|
Net investment income
|
2,445 | 2,371 | 3,073 | 2,709 | ||||||||||||
|
Net (decrease) increase in
net assets resulting from
operations
|
(9,190 | ) | (18,090 | ) | (4,420 | ) | 20,629 | |||||||||
|
Net (decrease) increase in
net assets resulting from
operations per weighted
average common share
(basic & diluted)
|
$ | (0.42 | ) | $ | (0.82 | ) | $ | (0.20 | ) | $ | 0.93 | |||||
Portfolio Activity
During April and May 2011, the Company executed the following transactions:
| • | In April 2011, the Company recapitalized its investment in Cavert in which the Company received gross cash proceeds of $5.6 million from the sale of its common equity, resulting in a realized gain of $5.5 million, $2.3 million in a partial redemption of its preferred stock and $0.7 million in preferred dividends. At the same time, the Company invested $5.7 million in new subordinated debt in Cavert. Cavert will be reclassified from a Control investment to an Affiliate investment during the three months ending June 30, 2011. |
89
Table of Contents
| • | In April 2011, the Company invested $16.4 million in a new Control investment, Mitchell Rubber Products, Inc. (“Mitchell”), consisting of subordinated debt and preferred and common equity. Mitchell, headquartered in Mira Loma, California, develops, mixes and molds rubber compounds for specialized applications in the non-tire rubber market. | ||
| • | In May 2011, the Company received full repayment of its senior syndicated loan to Fifth Third Processing Solutions, LLC. As of March 31, 2011, both fair value and cost approximated net proceeds received of $0.5 million. |
Short-Term Loan
On March 30, 2011, the Company purchased $40.0 million of T-Bills through Jefferies. The T-Bills
were purchased using $4.0 million from existing T-Bills for collateral and the proceeds from a
$40.0 million short-term loan from Jefferies, with an effective annual interest rate of
approximately 0.65%. On April 7, 2011, when the T-Bills matured, the Company repaid the $40.0
million loan from Jefferies.
Distributions
On April 12, 2011, the Company’s Board of Directors increased the monthly distribution to
stockholders by 12.5% and declared the following monthly distributions:
| Record Date | Payment Date | Distribution per Share | ||||
|
April 22, 2011
|
April 29, 2011 | $ | 0.045 | |||
|
May 20, 2011
|
May 31, 2011 | 0.045 | ||||
|
June 20, 2011
|
June 30, 2011 | 0.045 | ||||
90
Table of Contents
Not applicable.
| a) | Disclosure Controls and Procedures |
As of March 31, 2011 (the end of the period covered by this report), we, including our chief
executive officer and chief financial officer, evaluated the effectiveness and design and operation
of our disclosure controls and procedures. Based on that evaluation, our management, including the
chief executive officer and chief financial officer, concluded that our disclosure controls and
procedures were effective in timely alerting management, including the chief executive officer and
chief financial officer, of material information about us required to be included in periodic SEC
filings. However, in evaluation of the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
| b) | Management’s Annual Report on Internal Control over Financial Reporting | |
| Refer to Management’s Report on Internal Control over Financial Reporting located in Item 8 of this Form 10-K. | ||
| c) | Attestation Report of the Independent Registered Public Accounting Firm | |
| Refer to the Report of Independent Registered Public Accounting Firm located in Item 8 of this Form 10-K. | ||
| d) | Change in Internal Control over Financial Reporting |
There were no changes in internal controls for the period ended March 31, 2011 that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
Not applicable.
We will file a definitive Proxy Statement for our 2011 Annual Meeting of Stockholders (the “2011
Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than 120 days after the end
of our fiscal year. Accordingly, certain information required by Part III has been omitted under
General Instruction G(3) to Form 10-K. Only those sections of the 2011 Proxy Statement that
specifically address the items set forth herein are incorporated by reference.
The information required by Item 10 is hereby incorporated by reference from our 2011 Proxy
Statement under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership
Reporting Compliance.”
The information required by Item 11 is hereby incorporated by reference from our 2011 Proxy
Statement under the captions “Compensation Discussion and Analysis—Executive Compensation” and
“Director Compensation.”
The information required by Item 12 is hereby incorporated by reference from our 2011 Proxy
Statement under the caption “Security Ownership of Certain Beneficial Owners and Management.”
The information required by Item 13 is hereby incorporated by reference from our 2011 Proxy
Statement under the captions “Certain Transactions” and “Information Regarding the Board Of
Directors and Corporate Governance—Director Independence.”
The information required by Item 14 is hereby incorporated by reference from our 2011 Proxy
Statement under the caption “Independent Registered Public Accounting Firm Fees.”
91
Table of Contents
| a. | DOCUMENTS FILED AS PART OF THIS REPORT | |
| 1. | The following financial statements are filed herewith: |
|
Report of Independent Registered Public Accounting Firm
|
63 | |||
|
Consolidated Statements of Assets and Liabilities as of March 31, 2011 and March 31, 2010
|
64 | |||
|
Consolidated Statements of Operations for the years ended March 31, 2011, March 31, 2010 and March 31, 2009
|
65 | |||
|
Consolidated Statements of Changes in Net Assets for the years ended March 31, 2011, March 31, 2010 and
March 31, 2009
|
66 | |||
|
Consolidated Statements of Cash Flows for the years ended March 31, 2011, March 31, 2010 and March 31, 2009
|
67 | |||
|
Consolidated Schedules of Investments as of March 31, 2011 and March 31, 2010
|
68 | |||
|
Notes to Consolidated Financial Statements
|
72 |
| 2. | The following financial statement schedule is filed herewith: |
|
Schedule 12-14 Investments in and Advances to Affiliates
|
94 |
| No other financial statement schedules are filed herewith because (1) such schedules are not required or (2) the information has been presented in the aforementioned financial statements. |
| 3. | Exhibits |
| The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC: |
| 3.1 | Amended and Restated Certificate of Incorporation, incorporated by reference to Exhibit a.2 to Pre-Effective Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-123699), filed May 13, 2005. | |
| 3.2 | Amended and Restated Bylaws, incorporated by reference to Exhibit b.2 to the Pre-effective Amendment No. 3 to the Registration Statement on Form N-2 (File No. 333-123699), filed June 21, 2005. | |
| 3.3 | First Amendment to Amended and Restated Bylaws of Gladstone Investment Corporation, incorporated by reference to Exhibit 99.1 to Current Report on Form 8-K (File No. 814-00704) filed July 10, 2007. | |
| 4.1 | Specimen Stock Certificate, incorporated by reference to Exhibit 99.d to Form N-2/A (File No. 333-123699), filed June 21, 2005. | |
| 4.2 | Dividend Reinvestment Plan, incorporated by reference to Exhibit 99.e to Pre-Effective Amendment No. 3 to the Registration Statement on Form N-2 (File No. 333-123699), filed June 21, 2005. | |
| 10.1* | Investment Advisory and Management Agreement between the Company and Gladstone Management Corporation, dated June 22, 2005, incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K filed June 14, 2006. | |
| 10.2* | Administration Agreement between the Registrant and Gladstone Administration, LLC, dated June 22, 2005, incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K filed June 14, 2006. | |
| 10.3 | Stock Transfer Agency Agreement between the Registrant and The Bank of New York, incorporated by reference to Exhibit k.1 to Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-123699), filed May 13, 2005. | |
| 10.4 | Custody Agreement between the Registrant and The Bank of New York, incorporated by reference to Exhibit 99.j to Pre-Effective Amendment No. 3 to the Registration Statement on Form N-2 (File No. 333-123699), filed June 21, 2005. | |
| 10.5 | Third Amended and Restated Credit Agreement dated as of April 13, 2010 by and among Gladstone Business Investment, LLC as Borrower, Gladstone Management Corporation as Servicer, the Committed Lenders named therein, the Managing Agents named therein, and Branch Banking and Trust Company as Administrative Agent, incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K (File No. 814-00704) filed on April 14, 2010. | |
| 11 | Computation of Per Share Earnings (included in the notes to the audited financial statements contained in this report). | |
| 21 | Subsidiaries of the Registrant. | |
| 31.1 | Certification of Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley Act of 2002. |
| * | Denotes management contract or compensatory plan or arrangement. |
92
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
|
GLADSTONE INVESTMENT CORPORATION
|
||||
| Date: May 23, 2011 | By: | /s/ DAVID WATSON | ||
| David Watson | ||||
| Chief Financial Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacity and on the
dates indicated.
| Date: May 23, 2011 | By: | /s/ DAVID GLADSTONE | ||
| David Gladstone | ||||
| Chief Executive Officer and Chairman of the Board of Directors (principal executive officer) | ||||
| Date: May 23, 2011 | By: | /s/ TERRY LEE BRUBAKER | ||
| Terry Lee Brubaker | ||||
| Co-Vice Chairman, Chief Operating Officer and Secretary | ||||
| Date: May 23, 2011 | By: | /s/ GEORGE STELLJES III | ||
| George Stelljes III | ||||
| Co-Vice Chairman and Chief Investment Officer | ||||
| Date: May 23, 2011 | By: | /s/ DAVID A. R. DULLUM | ||
| David A. R. Dullum | ||||
| President and Director | ||||
| Date: May 23, 2011 | By: | /s/ DAVID WATSON | ||
| David Watson | ||||
| Chief Financial Officer (principal financial and accounting officer) | ||||
| Date: May 23, 2011 | By: | /s/ ANTHONY W. PARKER | ||
| Anthony W. Parker | ||||
| Director | ||||
| Date: May 23, 2011 | By: | /s/ MICHELA A. ENGLISH | ||
| Michela A. English | ||||
| Director | ||||
| Date: May 23, 2011 | By: | /s/ PAUL ADELGREN | ||
| Paul Adelgren | ||||
| Director | ||||
| Date: May 23, 2011 | By: | /s/ JACK REILLY | ||
| Jack Reilly | ||||
| Director | ||||
| Date: May 23, 2011 | By: | /s/ JOHN OUTLAND | ||
| John Outland | ||||
| Director | ||||
| Date: May 23, 2011 | By: | /s/ GERARD MEAD | ||
| Gerard Mead | ||||
| Director | ||||
93
Table of Contents
SCHEDULE 12-14
GLADSTONE INVESTMENT CORPORATION
INVESTMENTS IN AND ADVANCES TO AFFILIATES
(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND WARRANTS)
INVESTMENTS IN AND ADVANCES TO AFFILIATES
(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND WARRANTS)
| Number of Shares | ||||||||||||||||||
| or Warrants or | Amount of | |||||||||||||||||
| Principal Amount | Equity in Net | |||||||||||||||||
| of Indebtedness | Profit (Loss) for | Income Earned for | ||||||||||||||||
| Title of Issue or Nature of | Held at March 31, | the Year Ended | the Year Ended | Value at | ||||||||||||||
| Name of Issuer (1) | Indebtedness | 2011 | March 31, 2011 (2) | March 31, 2011 | March 31, 2011 | |||||||||||||
|
CONTROL INVESTMENTS
|
||||||||||||||||||
|
A. Stucki Holding Corp.
(4)
|
Senior Term Debt | $ | — | $ | — | |||||||||||||
|
|
Senior Term Debt | $ | — | — | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | — | — | ||||||||||||||
|
|
Preferred Stock | — | — | |||||||||||||||
|
|
Common Stock | — | — | |||||||||||||||
|
|
$ | — | $ | 3,316 | — | |||||||||||||
|
|
||||||||||||||||||
|
Acme Cryogenics, Inc.
|
Senior Subordinated Term Debt | $ | 14,500 | 14,500 | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | 415 | 415 | ||||||||||||||
|
|
Preferred Stock (3) | 898,814 | 4,991 | |||||||||||||||
|
|
Common Stock (3) | 418,072 | — | |||||||||||||||
|
|
Common Stock Warrants (3) | 452,683 | — | |||||||||||||||
|
|
— | 1,737 | 19,906 | |||||||||||||||
|
|
||||||||||||||||||
|
ASH Holdings Corp.
|
Revolving Credit Facility | $ | 3,283 | — | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | 6,250 | — | ||||||||||||||
|
|
Preferred Stock (3) | 2,500 | — | |||||||||||||||
|
|
Common Stock (3) | 1 | — | |||||||||||||||
|
|
Common Stock Warrants (3) | 73,599 | — | |||||||||||||||
|
|
— | — | — | |||||||||||||||
|
|
||||||||||||||||||
|
Cavert II Holdings Corp
|
Senior Term Debt | $ | 2,650 | 2,650 | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | 4,671 | 4,671 | ||||||||||||||
|
|
Preferred Stock (3) | 41,102 | 5,354 | |||||||||||||||
|
|
Common Stock (3) | 69,126 | 5,577 | |||||||||||||||
|
|
— | 1,675 | 18,252 | |||||||||||||||
|
|
||||||||||||||||||
|
Chase II Holdings Corp.
(4)
|
Senior Term Debt | $ | — | — | ||||||||||||||
|
|
Senior Term Debt | $ | — | — | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | — | — | ||||||||||||||
|
|
Preferred Stock | — | — | |||||||||||||||
|
|
Common Stock | — | — | |||||||||||||||
|
|
— | 8,093 | — | |||||||||||||||
|
|
||||||||||||||||||
|
Country Club Enterprises, LLC
|
Senior Subordinated Term Debt | $ | 8,000 | 7,560 | ||||||||||||||
|
|
Preferred Stock (3) | 2,380,000 | — | |||||||||||||||
|
|
— | 1,291 | 7,560 | |||||||||||||||
|
|
||||||||||||||||||
|
Galaxy Tool Holding Corp.
|
Senior Subordinated Term Debt | $ | 5,220 | 5,220 | ||||||||||||||
|
|
Preferred Stock (3) | 4,111,907 | 1,439 | |||||||||||||||
|
|
Common Stock (3) | 48,093 | — | |||||||||||||||
|
|
— | 1,129 | 6,659 | |||||||||||||||
|
|
||||||||||||||||||
|
Mathey Investments, Inc.
|
Revolving Credit Facility | $ | 1,032 | 1,022 | ||||||||||||||
|
|
Senior Term Debt | $ | 2,375 | 2,345 | ||||||||||||||
|
|
Senior Term Debt | $ | 3,727 | 3,643 | ||||||||||||||
|
|
Senior Term Debt | $ | 3,500 | 3,421 | ||||||||||||||
|
|
Common Stock (3) | 37 | — | |||||||||||||||
|
|
Common Stock Warrants (3) | 21 | — | |||||||||||||||
|
|
— | 1,332 | 10,431 | |||||||||||||||
|
|
||||||||||||||||||
|
Neville Limited
|
Common Stock (3) | 100 | 534 | |||||||||||||||
|
|
— | — | 534 | |||||||||||||||
|
|
||||||||||||||||||
|
Precision Southeast, Inc.
|
Revolving Credit Facility | $ | 749 | 749 | ||||||||||||||
|
|
Senior Term Debt | $ | 7,775 | 7,775 | ||||||||||||||
|
|
Preferred Stock (3) | 19,091 | 1,948 | |||||||||||||||
|
|
Common Stock (3) | 90,909 | 305 | |||||||||||||||
|
|
— | 294 | 10,777 | |||||||||||||||
94
Table of Contents
| Number of Shares | ||||||||||||||||||
| or Warrants or | Amount of | |||||||||||||||||
| Principal Amount | Equity in Net | |||||||||||||||||
| of Indebtedness | Profit (Loss) for | Income Earned for | ||||||||||||||||
| Title of Issue or Nature of | Held at March 31, | the Year Ended | the Year Ended | Value at | ||||||||||||||
| Name of Issuer (1) | Indebtedness | 2011 | March 31, 2011 (2) | March 31, 2011 | March 31, 2011 | |||||||||||||
|
Tread Corp.
|
Senior Subordinated Term Debt | $ | 5,000 | 4,931 | ||||||||||||||
|
|
Preferred Stock (3) | 832,765 | — | |||||||||||||||
|
|
Common Stock (3) | 129,067 | — | |||||||||||||||
|
|
Common Stock Warrants (3) | 1,022,727 | — | |||||||||||||||
|
|
— | 633 | 4,931 | |||||||||||||||
|
|
||||||||||||||||||
|
Venyu Solutions, Inc.
|
Senior Subordinated Term Debt | $ | 7,000 | 7,000 | ||||||||||||||
|
|
Senior Subordinated Term Debt | $ | 12,000 | 12,000 | ||||||||||||||
|
|
Preferred Stock (3) | 5,400 | 6,012 | |||||||||||||||
|
|
— | 1,056 | 25,012 | |||||||||||||||
|
|
||||||||||||||||||
|
Total Control Investments
|
$ | — | $ | 20,556 | $ | 104,062 | ||||||||||||
|
|
||||||||||||||||||
|
AFFILIATE INVESTMENTS
|
||||||||||||||||||
|
Danco Acquisition Corp.
|
Revolving Credit Facility | $ | 1,100 | $ | 1,084 | |||||||||||||
|
|
Senior Term Debt | $ | 2,925 | 2,881 | ||||||||||||||
|
|
Senior Term Debt | $ | 8,961 | 8,781 | ||||||||||||||
|
|
Preferred Stock (3) | 25 | — | |||||||||||||||
|
|
Common Stock Warrants (3) | 420 | — | |||||||||||||||
|
|
$ | — | $ | 1,599 | 12,746 | |||||||||||||
|
|
||||||||||||||||||
|
Noble Logistics, Inc.
|
Revolving Credit Facility | $ | 300 | 206 | ||||||||||||||
|
|
Senior Term Debt | $ | 7,227 | 4,951 | ||||||||||||||
|
|
Senior Term Debt | $ | 3,650 | 2,500 | ||||||||||||||
|
|
Senior Term Debt | $ | 3,650 | 2,500 | ||||||||||||||
|
|
Preferred Stock (3) | 1,075,000 | 3,026 | |||||||||||||||
|
|
Common Stock (3) | 1,682,456 | — | |||||||||||||||
|
|
— | 1,468 | 13,183 | |||||||||||||||
|
|
||||||||||||||||||
|
Quench Holdings Corp.
|
Senior Subordinated Term Debt | $ | 8,000 | 6,000 | ||||||||||||||
|
|
Preferred Stock (3) | 388 | 2,627 | |||||||||||||||
|
|
Common Stock (3) | 35,242 | — | |||||||||||||||
|
|
— | 830 | 8,627 | |||||||||||||||
|
|
||||||||||||||||||
|
Total Affiliate Investments
|
$ | — | $ | 3,897 | $ | 34,556 | ||||||||||||
| (1) | Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company. | |
| (2) | In accordance with Regulation S-X, Rule 6-03(c)(i), the Company does not consolidate its portfolio investments. Therefore, no equity in the net profit (loss) was recorded as of March 31, 2011. | |
| (3) | Security is non-income producing. | |
| (4) | Portfolio Company exited during the fiscal year ended March 31, 2011. |
95
Table of Contents
| Title of Issue or | Value as of | Gross | Gross | Value as of | ||||||||||||||
| Name of Issuer (1) | Nature of Indebtedness | March 31, 2010 | Additions | Reductions | March 31, 2011 | |||||||||||||
|
CONTROL INVESTMENTS:
|
||||||||||||||||||
|
A. Stucki Holding Corp.
(3)
|
Senior Term Debt | $ | 9,101 | $ | — | $ | (9,101 | ) | $ | — | ||||||||
|
|
Senior Term Debt | 9,900 | — | (9,900 | ) | — | ||||||||||||
|
|
Senior Subordinated Term Debt | 9,456 | — | (9,456 | ) | — | ||||||||||||
|
|
Preferred Stock | 4,529 | 118 | (4,647 | ) | — | ||||||||||||
|
|
Common Stock | 17,393 | — | (17,393 | ) | — | ||||||||||||
|
|
||||||||||||||||||
|
|
50,379 | 118 | (50,497 | ) | — | |||||||||||||
|
|
||||||||||||||||||
|
Acme Cryogenics, Inc.
(3)
|
Senior Subordinated Term Debt | 13,585 | 915 | — | 14,500 | |||||||||||||
|
|
Senior Subordinated Term Debt | — | 415 | — | 415 | |||||||||||||
|
|
Preferred Stock (2) | — | 4,991 | — | 4,991 | |||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock Warrants (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
13,585 | 6,321 | — | 19,906 | ||||||||||||||
|
|
||||||||||||||||||
|
ASH Holdings Corp.
|
Revolving Credit Facility | 421 | 1,778 | (2,199 | ) | — | ||||||||||||
|
|
Senior Subordinated Term Debt | 1,750 | — | (1,750 | ) | — | ||||||||||||
|
|
Preferred Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock Warrants (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
2,171 | 1,778 | (3,949 | ) | — | |||||||||||||
|
|
||||||||||||||||||
|
Cavert II Holding Corp.
(3)
|
Senior Term Debt | 2,875 | — | (2,875 | ) | — | ||||||||||||
|
|
Senior Term Debt | 2,700 | — | (50 | ) | 2,650 | ||||||||||||
|
|
Senior Subordinated Term Debt | 4,671 | — | — | 4,671 | |||||||||||||
|
|
Preferred Stock (2) | 4,959 | 395 | — | 5,354 | |||||||||||||
|
|
Common Stock (2) | 3,526 | 2,051 | — | 5,577 | |||||||||||||
|
|
||||||||||||||||||
|
|
18,731 | 2,446 | (2,925 | ) | 18,252 | |||||||||||||
|
|
||||||||||||||||||
|
Chase II Holdings Corp.
(3)
|
Senior Term Debt | 7,700 | — | (7,700 | ) | — | ||||||||||||
|
|
Senior Term Debt | 7,520 | — | (7,520 | ) | — | ||||||||||||
|
|
Senior Subordinated Term Debt | 6,168 | — | (6,168 | ) | — | ||||||||||||
|
|
Preferred Stock | 7,713 | 3,282 | (10,995 | ) | — | ||||||||||||
|
|
Common Stock | — | 6,918 | (6,918 | ) | — | ||||||||||||
|
|
||||||||||||||||||
|
|
29,101 | 10,200 | (39,301 | ) | — | |||||||||||||
|
|
||||||||||||||||||
|
Country Club Enterprises, LLC
(3)
|
Senior Subordinated Term Debt | 6,869 | 1,000 | (309 | ) | 7,560 | ||||||||||||
|
|
Preferred Stock (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
6,869 | 1,000 | (309 | ) | 7,560 | |||||||||||||
|
|
||||||||||||||||||
|
Galaxy Tool Holdings Corp.
(3)
|
Senior Subordinated Term Debt | 17,099 | 421 | (12,300 | ) | 5,220 | ||||||||||||
|
|
Preferred Stock (2) | — | 15,546 | (14,107 | ) | 1,439 | ||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
17,099 | 15,967 | (26,407 | ) | 6,659 | |||||||||||||
|
|
||||||||||||||||||
|
Mathey Investments, Inc.
(3)
|
Revolving Credit Facility | 1,011 | 11 | — | 1,022 | |||||||||||||
|
|
Senior Term Debt | 2,328 | 17 | — | 2,345 | |||||||||||||
|
|
Senior Term Debt | 6,974 | 169 | (3,500 | ) | 3,643 | ||||||||||||
|
|
Senior Term Debt | — | 3,500 | (79 | ) | 3,421 | ||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock Warrants (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
10,313 | 3,697 | 3,579 | 10,431 | ||||||||||||||
|
|
||||||||||||||||||
|
Neville Limited
|
Common Stock (2) | — | 610 | (76 | ) | 534 | ||||||||||||
|
|
||||||||||||||||||
|
|
— | 610 | (76 | ) | 534 | |||||||||||||
|
|
||||||||||||||||||
|
Precision Southeast, Inc.
(3)
|
Revolving Credit Facility | — | 749 | — | 749 | |||||||||||||
|
|
Senior Term Debt | — | 7,775 | — | 7,775 | |||||||||||||
|
|
Preferred Stock (2) | — | 1,909 | 39 | 1,948 | |||||||||||||
|
|
Common Stock (2) | — | 91 | 214 | 305 | |||||||||||||
|
|
||||||||||||||||||
|
|
— | 10,524 | 253 | 10,777 | ||||||||||||||
|
|
||||||||||||||||||
|
Tread Corp.
(3)
|
Senior Subordinated Term Debt | 4,943 | — | (12 | ) | 4,931 | ||||||||||||
|
|
Preferred Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock (2) | — | 1 | (1 | ) | — | ||||||||||||
|
|
Common Stock Warrants (2) | — | 83 | (83 | ) | — | ||||||||||||
|
|
||||||||||||||||||
|
|
4,943 | 84 | (96 | ) | 4,931 | |||||||||||||
96
Table of Contents
| Title of Issue or | Value as of | Gross | Gross | Value as of | ||||||||||||||
| Name of Issuer (1) | Nature of Indebtedness | March 31, 2010 | Additions | Reductions | March 31, 2011 | |||||||||||||
|
Venyu Solutions, Inc.
(3)
|
Senior Subordinated Term Debt | — | 7,000 | — | 7,000 | |||||||||||||
|
|
Senior Subordinated Term Debt | — | 12,000 | — | 12,000 | |||||||||||||
|
|
Preferred Stock (2) | — | 6,012 | — | 6,012 | |||||||||||||
|
|
||||||||||||||||||
|
|
— | 25,012 | — | 25,012 | ||||||||||||||
|
|
||||||||||||||||||
|
|
||||||||||||||||||
|
Total Control Investments
|
$ | 153,191 | $ | 77,757 | $ | (126,886 | ) | $ | 104,062 | |||||||||
|
|
||||||||||||||||||
|
|
||||||||||||||||||
|
AFFILIATE INVESTMENTS:
|
||||||||||||||||||
|
Danco Acquisition Corp.
(3)
|
Revolving Credit Facility | $ | 893 | $ | 200 | $ | (9 | ) | $ | 1,084 | ||||||||
|
|
Senior Term Debt | 4,131 | — | (1,250 | ) | 2,881 | ||||||||||||
|
|
Senior Term Debt | 8,929 | — | (148 | ) | 8,781 | ||||||||||||
|
|
Preferred Stock (2) | — | — | — | — | |||||||||||||
|
|
Common Stock Warrants (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
13,953 | 200 | (1,407 | ) | 12,746 | |||||||||||||
|
|
||||||||||||||||||
|
Noble Logistics, Inc.
(3)
|
Revolving Credit Facility | 1,210 | 696 | (1,700 | ) | 206 | ||||||||||||
|
|
Senior Term Debt | 3,767 | 1,184 | — | 4,951 | |||||||||||||
|
|
Senior Term Debt | 4,417 | 1,733 | (3,650 | ) | 2,500 | ||||||||||||
|
|
Senior Term Debt | — | 3,650 | (1,150 | ) | 2,500 | ||||||||||||
|
|
Preferred Stock (2) | — | 3,026 | — | 3,026 | |||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
9,394 | 10,289 | (6,500 | ) | 13,183 | |||||||||||||
|
|
||||||||||||||||||
|
Quench Holdings Corp.
(3)
|
Senior Subordinated Term Debt | 6,150 | — | (150 | ) | 6,000 | ||||||||||||
|
|
Preferred Stock (2) | 3,224 | — | (597 | ) | 2,627 | ||||||||||||
|
|
Common Stock (2) | — | — | — | — | |||||||||||||
|
|
||||||||||||||||||
|
|
9,374 | — | (747 | ) | 8,627 | |||||||||||||
|
|
||||||||||||||||||
|
|
||||||||||||||||||
|
Total Affiliate Investments
|
$ | 32,721 | $ | 10,489 | $ | (8,654 | ) | $ | 34,556 | |||||||||
|
|
||||||||||||||||||
| (1) | Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company. | |
| (2) | Security is non-income producing. | |
| (3) | Some or all of the securities of this portfolio company are pledged as collateral to the Company’s Credit Facility. | |
| (4) | Portfolio Company was exited during the fiscal year ended March 31, 2011. |
97
TABLE OF CONTENTS
Part IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsPart IIItem 5. Market For Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 6. Selected Financial DataItem 7. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataNote 1. OrganizationNote 2. Summary Of Significant Accounting PoliciesNote 3. InvestmentsNote 4. Related Party TransactionsNote 5. BorrowingsNote 6. Interest Rate Cap AgreementsNote 7. Common StockNote 8. Net Increase (decrease) in Net Assets Resulting From Operations Per ShareNote 9. DistributionsNote 10. Federal and State Income TaxesNote 11. Commitments and ContingenciesNote 12. Financial HighlightsNote 13. Selected Quarterly Data (unaudited)Note 14. Subsequent EventsItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceItem 11. Executive CompensationItem 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related Transactions and Director IndependenceItem 14. Principal Accountant Fees and ServicesPart IVItem 15. Exhibits and Financial Statement Schedules