10-Q 1 w42027e10-q.txt ALLIED CAPITAL CORPORATION FORM 10-Q 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------------ FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 COMMISSION FILE NUMBER: 0-22832 ALLIED CAPITAL CORPORATION (Exact Name of Registrant as Specified in its Charter) MARYLAND (State or Jurisdiction of Incorporation or Organization) 52-1081052 (IRS Employer Identification No.) 1919 PENNSYLVANIA AVENUE, N.W. WASHINGTON, DC 20006 (Address of Principal Executive Offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 331-1112 ------------------ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 12 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] On November 3, 2000 there were 81,014,451 shares outstanding of the Registrant's common stock, $0.0001 par value. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 (This page has been left blank intentionally) 3 ALLIED CAPITAL CORPORATION FORM 10-Q INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheet as of September 30, 2000 (unaudited) and December 31, 1999............. 1 Consolidated Statement of Operations -- For the Three and Nine Months Ended September 30, 2000 and 1999 (unaudited)................................... 2 Consolidated Statement of Changes in Net Assets -- For the Nine Months Ended September 30, 2000 and 1999 (unaudited).......................... 3 Consolidated Statement of Cash Flows -- For the Nine Months Ended September 30, 2000 and 1999 (unaudited)........................................ 4 Consolidated Statement of Investments as of September 30, 2000 (unaudited) and December 31, 1999............................................... 5 Notes to Consolidated Financial Statements........ 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 29 Item 3. Quantitative and Qualitative Disclosures about Market Risk........................................... 46 PART II. OTHER INFORMATION Item 1. Legal Proceedings.............................. 47 Item 2. Changes in Securities and Use of Proceeds...... 47 Item 3. Defaults Upon Senior Securities................ 47 Item 4. Submission of Matters to a Vote of Security Holders............................................... 47 Item 5. Other Information.............................. 47 Item 6. Exhibits and Reports on Form 8-K............... 47 Signatures............................................. 51
4 (This page has been left blank intentionally) 5 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, DECEMBER 31, 2000 1999 ------------- ------------ (IN THOUSANDS, EXCEPT NUMBER OF SHARE AMOUNTS) (UNAUDITED) ASSETS Portfolio at value: Private finance (cost: 2000-$963,648; 1999-$639,171)....................................... $ 967,521 $ 647,040 Commercial real estate finance (cost: 2000-$597,358; 1999-$522,022)....................................... 600,030 520,029 Small business finance (cost: 2000-$71,591; 1999-$61,708)........................................ 70,656 61,428 ---------- ---------- Total portfolio at value.......................... 1,638,207 1,228,497 ---------- ---------- Cash and cash equivalents................................... 26,194 18,155 Other assets................................................ 67,372 43,386 ---------- ---------- Total assets...................................... $1,731,773 $1,290,038 ========== ========== Liabilities: Notes payable and debentures.......................... $ 577,150 $ 487,350 Revolving credit facilities........................... 185,000 105,500 Accounts payable and other liabilities................ 29,294 22,675 ---------- ---------- Total liabilities................................. 791,444 615,525 ---------- ---------- Commitments and Contingencies Preferred stock............................................. 7,000 7,000 Shareholders' equity: Common stock, $0.0001 par value, 100,000,000 shares authorized; 81,014,284 and 65,930,360 issued and outstanding at September 30, 2000 and December 31, 1999, respectively................................... 8 6 Additional paid-in capital............................ 954,576 699,149 Common stock held in deferred compensation trust (259,983 shares and 516,779 shares at September 30, 2000 and December 31, 1999, respectively)............ (1,404) (6,218) Notes receivable from sale of common stock............ (25,926) (29,461) Net unrealized appreciation on portfolio.............. 4,250 4,517 Distributions in excess of earnings................... 1,825 (480) ---------- ---------- Total shareholders' equity........................ 933,329 667,513 ---------- ---------- Total liabilities and shareholders' equity........ $1,731,773 $1,290,038 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 1 6 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- 2000 1999 2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- -------- -------- (UNAUDITED) (UNAUDITED) Interest and related portfolio income: Interest........................................ $48,054 $31,577 $129,768 $84,419 Premiums from loan dispositions................. 2,909 4,700 10,752 9,032 Investment advisory fees and other income....... 5,029 1,721 9,334 5,411 ------- ------- -------- ------- Total interest and related portfolio income................................... 55,992 37,998 149,854 98,862 ------- ------- -------- ------- Expenses: Interest........................................ 15,054 9,766 41,645 24,173 Employee........................................ 4,949 4,192 14,709 11,303 Administrative.................................. 3,876 3,200 10,711 8,476 ------- ------- -------- ------- Total operating expenses.................... 23,879 17,158 67,065 43,952 ------- ------- -------- ------- Formula and cut-off awards...................... 1,394 1,567 4,797 5,188 ------- ------- -------- ------- Portfolio income before net realized and unrealized gains............................................... 30,719 19,273 77,992 49,722 ------- ------- -------- ------- Net realized and unrealized gains: Net realized gains.............................. 8,054 4,886 23,095 16,448 Net unrealized gains (losses)................... (2,324) 2,785 (267) 1,475 ------- ------- -------- ------- Total net realized and unrealized gains..... 5,730 7,671 22,828 17,923 ------- ------- -------- ------- Net increase in net assets resulting from operations.......................................... $36,449 $26,944 $100,820 $67,645 ======= ======= ======== ======= Basic earnings per common share....................... $ 0.48 $ 0.44 $ 1.43 $ 1.14 ======= ======= ======== ======= Diluted earnings per common share..................... $ 0.48 $ 0.44 $ 1.42 $ 1.14 ======= ======= ======== ======= Weighted average common shares outstanding -- basic... 75,502 61,042 70,604 59,077 ======= ======= ======== ======= Weighted average common shares outstanding -- diluted.............................. 76,133 61,458 70,777 59,239 ======= ======= ======== =======
The accompanying notes are an integral part of these consolidated financial statements. 2 7 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------- 2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- (UNAUDITED) Operations: Portfolio income before realized and unrealized gains................................................. $ 77,992 $ 49,722 Net realized gains..................................... 23,095 16,448 Net unrealized gains (losses).......................... (267) 1,475 -------- -------- Net increase in net assets resulting from operations..................................... 100,820 67,645 -------- -------- Shareholder distributions: Common stock dividends................................. (98,617) (71,800) Preferred stock dividends.............................. (165) (165) -------- -------- Net decrease in net assets resulting from shareholder distributions...................... (98,782) (71,965) -------- -------- Capital share transactions: Sale of common stock................................... 250,911 103,022 Net decrease (increase) in notes receivable from sale of common stock....................................... 3,535 (3,540) Issuance of common stock upon the exercise of stock options............................................... 1,467 3,753 Issuance of common stock in lieu of cash distributions......................................... 3,613 3,498 Net decrease in common stock held in deferred compensation trust.................................... 4,814 6,303 Other.................................................. (562) -- -------- -------- Net increase in net assets resulting from capital share transactions............................. 263,778 113,036 -------- -------- Total increase in net assets...................... $265,816 $108,716 -------- -------- Net assets at beginning of period........................... $667,513 $485,117 -------- -------- Net assets at end of period................................. $933,329 $593,833 ======== ======== Net asset value per common share............................ $ 11.56 $ 9.58 ======== ======== Common shares outstanding at end of period.................. 80,754 61,972 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 3 8 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ----------- ----------- (UNAUDITED) Cash flows from operating activities: Net increase in net assets resulting from operations...... $ 100,820 $ 67,645 Adjustments Net unrealized (gains) losses.......................... 267 (1,475) Depreciation and amortization.......................... 659 599 Amortization of loan discounts and fees................ (9,767) (6,195) Changes in other assets and liabilities................ (8,712) (11,518) --------- --------- Net cash provided by operating activities............ 83,267 49,056 --------- --------- Cash flows from investing activities: Portfolio investments..................................... (675,379) (534,017) Repayments of investment principal........................ 117,940 120,563 Proceeds from loan sales.................................. 151,834 120,871 Collections of notes receivable from sale of common stock.................................................. 4,617 212 Other investing activities................................ 3,657 (2,738) --------- --------- Net cash used in investing activities................ (397,331) (295,109) --------- --------- Cash flows from financing activities: Sale of common stock...................................... 250,911 103,079 Common dividends and distributions paid................... (95,004) (70,003) Preferred stock dividends paid............................ (165) (165) Net borrowings under notes payable and debentures......... 89,800 165,500 Net borrowings under revolving lines of credit............ 79,500 38,000 Other financing activities................................ (2,939) (57) --------- --------- Net cash provided by financing activities............ 322,103 236,354 --------- --------- Net increase (decrease) in cash and cash equivalents........ $ 8,039 $ (9,699) --------- --------- Cash and cash equivalents at beginning of period............ $ 18,155 $ 25,075 --------- --------- Cash and cash equivalents at end of period.................. $ 26,194 $ 15,376 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 4 9 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INVESTMENTS
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Ability One Loans $ 9,951 $ 9,951 ----------------------------------------------------------------------------------------------------------- ACE Products, Inc. Loans 14,047 14,047 ----------------------------------------------------------------------------------------------------------- Acme Paging, L.P. Debt Securities 6,961 6,961 Limited Partnership Interest 1,456 -- ----------------------------------------------------------------------------------------------------------- Allied Office Products Debt Securities 9,343 9,343 Warrants 629 629 ----------------------------------------------------------------------------------------------------------- American Barbecue & Grill, Inc. Warrants 125 125 ----------------------------------------------------------------------------------------------------------- ASW Holding Corporation Warrants 25 25 ----------------------------------------------------------------------------------------------------------- Aurora Communications, LLC Loans 14,405 14,405 Equity Interest 1,500 3,347 ----------------------------------------------------------------------------------------------------------- Avborne, Inc. Debt Securities 12,227 12,227 Warrants 1,180 1,180 ----------------------------------------------------------------------------------------------------------- Bakery Chef, Inc. Loans 15,630 15,630 ----------------------------------------------------------------------------------------------------------- Border Foods, Inc. Debt Securities 9,901 9,901 Series A Convertible Preferred Stock (50,919 shares) 2,000 2,000 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Cahill-Warnock Strategic Partners Fund Limited Partnership Interest 420 420 II, L.P. ----------------------------------------------------------------------------------------------------------- CampGroup, LLC Debt Securities 2,550 2,550 Warrants 220 220 ----------------------------------------------------------------------------------------------------------- Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250 ----------------------------------------------------------------------------------------------------------- Celebrities, Inc. Loan 285 285 Warrants 12 312 ----------------------------------------------------------------------------------------------------------- Colibri Holding Corporation Loans 3,722 3,722 Common Stock (3,362 shares) 1,250 1,250 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Component Hardware Group Debt Securities 10,188 10,188 Class A Preferred Stock (18,000 shares) 1,800 1,800 Common Stock (2,000 shares) 200 200 ----------------------------------------------------------------------------------------------------------- Convenience Corporation of America Debt Securities 8,355 2,738 Series A Preferred Stock (31,521 shares) 334 -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Cooper Natural Resources, Inc. Debt Securities 3,424 3,424 Warrants -- -- ----------------------------------------------------------------------------------------------------------- CorrFlex Graphics, LLC Loan 6,945 6,945 Debt Securities 4,951 4,951 Warrants -- -- Options -- -- -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 5 10
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Cosmetic Manufacturing Loan $ 870 $ 870 Resources, LLC Debt Securities 5,840 5,840 Options 87 87 ----------------------------------------------------------------------------------------------------------- Coverall North America Loan 9,690 9,690 Debt Securities 4,964 4,964 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 -- ----------------------------------------------------------------------------------------------------------- CTT Holdings Loan 1,186 1,186 ----------------------------------------------------------------------------------------------------------- CyberRep.com Loan 1,014 1,014 Debt Securities 10,458 10,458 Warrants 360 1,010 ----------------------------------------------------------------------------------------------------------- DeVlieg-Bullard, Inc. (1) Warrants 350 1 ----------------------------------------------------------------------------------------------------------- Directory Investment Corporation Common Stock (470 shares) 80 -- ----------------------------------------------------------------------------------------------------------- Directory Lending Corporation Series A Common Stock (34 shares) -- -- Series B Common Stock (6 shares) 8 -- Series C Common Stock (10 shares) 22 -- ----------------------------------------------------------------------------------------------------------- Drilltec Patents & Technologies Loan 10,918 8,762 Company, Inc. Debt Securities 1,500 1,500 Warrants -- -- ----------------------------------------------------------------------------------------------------------- eCentury Capital Partners, L.P. Limited Partnership Interest 1,287 1,287 ----------------------------------------------------------------------------------------------------------- EDM Consulting, LLC Debt Securities 1,875 343 Common Stock (100 shares) 250 -- ----------------------------------------------------------------------------------------------------------- El Dorado Communications, Inc. Loans 306 306 ----------------------------------------------------------------------------------------------------------- Eparfin S.A. Loan 29 29 ----------------------------------------------------------------------------------------------------------- Esquire Communications Ltd. (1) Warrants 6 -- ----------------------------------------------------------------------------------------------------------- E-Talk Corporation Debt Securities 8,768 8,768 Warrants 1,157 1,157 ----------------------------------------------------------------------------------------------------------- Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) 500 500 Common Stock (2,500 shares) -- -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Executive Greetings, Inc. Debt Securities 15,866 15,866 Warrants 360 360 ----------------------------------------------------------------------------------------------------------- Fairchild Industrial Products Company Debt Securities 5,795 5,795 Warrants 280 3,628 ----------------------------------------------------------------------------------------------------------- FTI Consulting, Inc. (1) Debt Securities 14,864 14,864 Warrants 970 2,554 ----------------------------------------------------------------------------------------------------------- Galaxy American Debt Securities 31,857 31,857 Communications, LLC Warrants 500 1,250 ----------------------------------------------------------------------------------------------------------- Garden Ridge Corporation Debt Securities 26,537 26,537 Preferred Stock (1,130 shares) 1,130 1,130 Common Stock (471 shares) 613 613 ----------------------------------------------------------------------------------------------------------- Genesis Worldwide, Inc. (1) Loan 1,078 1,078 ----------------------------------------------------------------------------------------------------------- (1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 6 11
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Genoa Mine Acquisition Corporation Loan $ 110 $ 110 ----------------------------------------------------------------------------------------------------------- Gibson Guitar Corporation Debt Securities 16,262 16,262 Warrants 525 1,000 ----------------------------------------------------------------------------------------------------------- Ginsey Industries, Inc. Loans 5,000 5,000 Convertible Debentures 500 500 Warrants -- 154 ----------------------------------------------------------------------------------------------------------- Global Communications, LLC Loans 8,513 8,513 Debt Securities 3,839 3,839 Equity Interest 10,467 10,467 Options 1,639 1,639 ----------------------------------------------------------------------------------------------------------- Grant Broadcasting Systems II Warrants 87 5,226 ----------------------------------------------------------------------------------------------------------- Grant Television, Inc. Equity Interest 660 660 ----------------------------------------------------------------------------------------------------------- HealthASPex, Inc. Series A Convertible Preferred Stock (189,568 shares) 640 640 Series A Preferred Stock (225,112 shares) 760 760 Common Stock (1,036,700 shares) -- -- ----------------------------------------------------------------------------------------------------------- HMT, Inc. Debt Securities 9,954 9,954 Common Stock (300,000 shares) 3,000 3,000 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Hotelevision, Inc. Preferred Stock (310,000 shares) 310 310 ----------------------------------------------------------------------------------------------------------- Icon International, Inc. Series A Preferred Stock (13,720 shares) 1,334 1,334 Series B Preferred Stock (11,987 shares) 1,166 1,166 ----------------------------------------------------------------------------------------------------------- Impact Innovations Group Debt Securities 6,314 6,314 Warrants 1,674 1,674 ----------------------------------------------------------------------------------------------------------- Intellirisk Management Corporation Loans 19,951 19,951 ----------------------------------------------------------------------------------------------------------- International Filler Corporation Debt Securities 21,636 21,636 Common Stock (1,029,068 shares) 5,483 5,483 Warrants 420 420 ----------------------------------------------------------------------------------------------------------- iSolve Incorporated Series A Preferred Stock (14,853 shares) 874 874 Common Stock (13,306 shares) 14 14 ----------------------------------------------------------------------------------------------------------- Jakel, Inc. Loan 18,904 18,904 ----------------------------------------------------------------------------------------------------------- JRI Industries, Inc. Debt Securities 1,948 1,948 Warrants 74 74 ----------------------------------------------------------------------------------------------------------- Julius Koch USA, Inc. Debt Securities 2,598 2,598 Warrants 259 6,500 ----------------------------------------------------------------------------------------------------------- Kirker Enterprises, Inc. Warrants 348 4,493 Equity Interest 4 11 ----------------------------------------------------------------------------------------------------------- Kirkland's, Inc. Debt Securities 6,342 6,342 Preferred Stock (917 shares) 412 412 Warrants 96 96 ----------------------------------------------------------------------------------------------------------- Kyrus Corporation Debt Securities 7,716 7,716 Warrants 348 348 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 7 12
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Liberty-Pittsburgh Systems, Inc. Debt Securities $ 3,467 $ 3,467 Common Stock (64,535 shares) 142 142 ----------------------------------------------------------------------------------------------------------- The Loewen Group, Inc. (1) High-Yield Senior Secured Debt 15,150 14,150 ----------------------------------------------------------------------------------------------------------- Logic Bay Corporation Preferred Stock (1,131,222 shares) 5,000 5,000 ----------------------------------------------------------------------------------------------------------- Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213 ----------------------------------------------------------------------------------------------------------- Master Plan, Inc. Loan 2,000 2,000 Common Stock (156 shares) 42 3,042 ----------------------------------------------------------------------------------------------------------- MedAssets.com, Inc. Debt Securities -- -- Series B Convertible Preferred Stock (227,665 shares) 2,049 2,049 Warrants 136 136 ----------------------------------------------------------------------------------------------------------- Mid-Atlantic Venture Fund IV, L.P. Limited Partnership Interest 1,801 1,801 ----------------------------------------------------------------------------------------------------------- Midview Associates, L.P. Warrants -- -- ----------------------------------------------------------------------------------------------------------- Monitoring Solutions, Inc. Debt Securities 1,823 243 Common Stock (33,333 shares) -- -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Morton Grove Pharmaceuticals, Inc. Loan 15,192 15,192 Redeemable Convertible Preferred Stock (106,947 shares) 5,000 5,000 ----------------------------------------------------------------------------------------------------------- Morton Industrial Group (1) Common Stock (5,835 shares) 241 20 ----------------------------------------------------------------------------------------------------------- MVL Group Debt Securities 14,088 14,088 Warrants 651 1,920 ----------------------------------------------------------------------------------------------------------- NETtel Communications, Inc. Debt Securities 13,455 13,455 Series A Convertible Preferred Stock (400 shares) 20 -- Series B Convertible Preferred Stock (647 shares) 5,000 -- Series C Convertible Preferred Stock (340,523 shares) 3,000 -- Series D Convertible Preferred Stock (2,270 shares) -- -- Warrants 500 -- ----------------------------------------------------------------------------------------------------------- Nobel Learning Communities, Debt Securities 9,551 9,551 Inc. (1) Series D Convertible Preferred Stock (265,957 shares) 2,000 2,000 Warrants 575 500 ----------------------------------------------------------------------------------------------------------- North American Loans 1,390 811 Archery, LLC Convertible Debentures 2,056 1,804 ----------------------------------------------------------------------------------------------------------- Northeast Broadcasting Group, L.P. Debt Securities 359 359 ----------------------------------------------------------------------------------------------------------- Nursefinders, Inc. Debt Securities 10,984 10,984 Warrants 900 900 ----------------------------------------------------------------------------------------------------------- Old Mill Holdings, Inc. Debt Securities 140 -- -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 8 13
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Onyx Television GmbH Common Stock (600,000 shares) $ 200 $ 200 ----------------------------------------------------------------------------------------------------------- Opinion Research Corporation (1) Debt Securities 13,996 13,996 Warrants 996 996 ----------------------------------------------------------------------------------------------------------- Oriental Trading Company, Inc. Debt Securities 12,452 12,452 Preferred Equity Interest 1,483 1,483 Common Equity Interest 17 17 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Outsource Partners, Inc. Debt Securities 23,840 23,840 Warrants 826 826 ----------------------------------------------------------------------------------------------------------- Packaging Advantage Corporation Debt Securities 11,476 11,476 Common Stock (200,000 shares) 2,000 2,000 Warrants 963 963 ----------------------------------------------------------------------------------------------------------- PF.Net Communications, Inc. Debt Securities 11,500 11,500 Warrants 3,540 3,540 ----------------------------------------------------------------------------------------------------------- Physician Specialty Corporation Debt Securities 14,792 14,792 Redeemable Preferred Stock (850 shares) 850 850 Convertible Preferred Stock (97,411 shares) 150 150 Warrants 476 476 ----------------------------------------------------------------------------------------------------------- Pico Products, Inc. (1) Loan 1,300 1,300 Debt Securities 4,591 1,591 Common Stock (208,000 shares) 59 -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Polaris Pool Systems, Inc. Debt Securities 6,460 6,460 Warrants 1,050 1,050 ----------------------------------------------------------------------------------------------------------- Powell Plant Farms, Inc. Loan 15,502 15,502 ----------------------------------------------------------------------------------------------------------- Proeducation GmbH Loan 40 40 ----------------------------------------------------------------------------------------------------------- Professional Paint, Inc. Debt Securities 20,000 20,000 Preferred Stock (15,000 shares) 15,000 15,000 Common Stock (110,000 shares) 69 69 ----------------------------------------------------------------------------------------------------------- Progressive International Corporation Debt Securities 3,947 3,947 Preferred Stock (500 shares) 500 500 Common Stock (197 shares) 13 13 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Schwinn/GT Debt Securities 10,268 10,268 Warrants 395 395 ----------------------------------------------------------------------------------------------------------- Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 -- ----------------------------------------------------------------------------------------------------------- Soff-Cut Holdings, Inc. Debt Securities 8,432 8,432 Preferred Stock (300 shares) 300 300 Common Stock (2,000 shares) 200 200 Warrants 446 446 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 9 14
PRIVATE FINANCE SEPTEMBER 30, 2000 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- (UNAUDITED) Southwest PCS, LLC Loan $ 7,500 $ 7,500 ----------------------------------------------------------------------------------------------------------- Southwest PCS, L.P. Debt Securities 6,461 7,378 ----------------------------------------------------------------------------------------------------------- Spa Lending Corporation Preferred Stock (28,625 shares) 545 436 Common Stock (6,208 shares) 25 18 ----------------------------------------------------------------------------------------------------------- Startec Global Communications, Inc. Debt Securities 19,807 19,807 Common Stock (258,064 shares) 3,000 3,000 Warrants -- -- ----------------------------------------------------------------------------------------------------------- SunStates Refrigerated Services, Inc. Loans 6,130 4,641 Debt Securities 2,445 1,316 ----------------------------------------------------------------------------------------------------------- Sure-Tel, Inc. Loan 207 207 Preferred Stock (1,116,902 shares) 4,536 4,536 Warrants 662 662 ----------------------------------------------------------------------------------------------------------- Sydran Food Services II, L.P. Debt Securities 12,973 12,973 ----------------------------------------------------------------------------------------------------------- Total Foam, Inc. Debt Securities 1,503 118 Common Stock (910 shares) 57 -- ----------------------------------------------------------------------------------------------------------- Tubbs Snowshoe Company, LLC Debt Securities 3,896 3,896 Warrants 54 54 Equity Interests 500 500 ----------------------------------------------------------------------------------------------------------- United Pet Group Debt Securities 4,957 4,957 Warrants 15 15 ----------------------------------------------------------------------------------------------------------- Venturehouse Group, LLC Common Equity Interest 333 333 ----------------------------------------------------------------------------------------------------------- Walker Investment Fund, II, L.P. Limited Partnership Interest 600 600 ----------------------------------------------------------------------------------------------------------- Warn Industries Debt Securities 18,972 18,972 Warrants 1,429 1,429 ----------------------------------------------------------------------------------------------------------- Williams Brothers Lumber Company Warrants 24 322 ----------------------------------------------------------------------------------------------------------- Wilmar Industries, Inc. Debt Securities 33,666 33,666 Warrants 1,181 1,181 ----------------------------------------------------------------------------------------------------------- Wilshire Restaurant Group, Inc. Debt Securities 15,000 15,000 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Wilton Industries, Inc. Loan 12,836 12,836 ----------------------------------------------------------------------------------------------------------- Woodstream Corporation Debt Securities 7,581 7,581 Equity Interests 1,700 1,700 Warrants 450 450 ----------------------------------------------------------------------------------------------------------- Wyo-Tech Acquisition Corporation Debt Securities 15,068 15,068 Preferred Stock (100 shares) 3,700 3,700 Common Stock (99 shares) 100 7,100 ----------------------------------------------------------------------------------------------------------- Total private finance (114 investments) $963,648 $967,521 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 10 15
SEPTEMBER 30, 2000 INTEREST NUMBER OF ----------------------- (IN THOUSANDS, EXCEPT NUMBER OF LOANS) RATE RANGES LOANS COST VALUE ---------------------------------------- ---------------- --------- ---------- ---------- COMMERCIAL REAL ESTATE FINANCE (UNAUDITED) Commercial Mortgage Loans Up to 6.99% 4 $ 977 $ 2,675 7.00%- 8.99% 10 29,751 31,851 9.00%-10.99% 19 21,985 21,873 11.00%-12.99% 47 34,174 34,306 13.00%-14.99% 14 14,134 14,135 15.00% and above 3 1,037 1,013 ------------------------------------------------------------------------------------------------ Total commercial mortgage loans 97 $ 102,058 $ 105,853 ------------------------------------------------------------------------------------------------
STATED INTEREST FACE -------- ---- Purchased CMBS Mortgage Capital Funding, Series 1998-MC3 5.5% $ 61,302 $ 29,953 $ 29,953 Morgan Stanley Capital I, Series 1999-RM1 6.4% 71,640 35,920 35,972 COMM 1999-1 5.7% 105,010 55,250 55,189 Morgan Stanley Capital I, Series 1999-FNV1 6.1% 49,486 24,797 24,800 DLJ Commercial Mortgage Trust 1999-CG2 6.1% 96,622 44,439 44,439 Commercial Mortgage Acceptance Corp., Series 1999-C1 6.8% 50,449 28,251 28,176 LB Commercial Mortgage Trust, Series 1999-C2 6.7% 42,391 20,429 20,579 Chase Commercial Mortgage Securities Corp., Series 1999-2 6.5% 43,046 20,429 20,429 FUNB CMT, Series 1999-C4 6.5% 49,288 22,326 22,524 Heller Financial, HFCMC Series 2000 PH-1 6.8% 55,026 24,943 24,943 SBMS VII, Inc., Series 2000-NL1 7.2% 40,940 26,324 26,796 DLJ Commercial Mortgage Trust, Series 2000-CF1 7.0% 49,364 25,700 25,920 Deutsche Bank Alex. Brown, Series Comm 2000-C1 6.9% 51,452 24,593 24,385 LB-UBS Commercial Mortgage Trust, Series 2000-C4 6.9% 47,818 24,157 25,149 -------------------------------------------------------------------------------------------------- Total purchased CMBS $813,834 $ 407,511 $ 409,254 -------------------------------------------------------------------------------------------------- Residual CMBS $ 77,205 $ 77,205 Residual Interest Spread 4,213 2,713 Real Estate Owned 6,371 5,005 -------------------------------------------------------------------------------------------------- Total commercial real estate finance $ 597,358 $ 600,030 -------------------------------------------------------------------------------------------------- Small business finance $ 71,591 $ 70,656 -------------------------------------------------------------------------------------------------- Total portfolio $1,632,597 $1,638,207 --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 11 16 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INVESTMENTS
PRIVATE FINANCE DECEMBER 31, 1999 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- ACE Products, Inc. Debt Securities $ 13,386 $ 13,386 ----------------------------------------------------------------------------------------------------------- Acme Paging, L.P. Debt Securities 6,618 6,618 Partnership Interest 1,456 2,100 ----------------------------------------------------------------------------------------------------------- Allied Office Products Debt Securities 9,905 9,905 Warrants -- -- ----------------------------------------------------------------------------------------------------------- American Barbecue & Grill, Inc. Warrants 125 125 ----------------------------------------------------------------------------------------------------------- ASW Holding Corporation Warrants 25 25 ----------------------------------------------------------------------------------------------------------- Aurora Communications, LLC Loans 13,370 13,370 Equity Interest 1,500 1,500 ----------------------------------------------------------------------------------------------------------- Avborne, Inc. Debt Securities 11,959 11,959 Warrants 1,180 1,180 ----------------------------------------------------------------------------------------------------------- Bakery Chef, Inc. Loans 10,967 10,967 ----------------------------------------------------------------------------------------------------------- CampGroup, LLC Debt Securities 2,491 2,491 Warrants 220 220 ----------------------------------------------------------------------------------------------------------- Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250 ----------------------------------------------------------------------------------------------------------- Celebrities, Inc. Loan 310 310 Warrants 12 212 ----------------------------------------------------------------------------------------------------------- Convenience Corporation of America Debt Securities 8,355 2,738 Series A Preferred Stock (31,521 shares) 334 -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Cooper Natural Resources, Inc. Debt Securities 3,460 3,460 Warrants -- 538 ----------------------------------------------------------------------------------------------------------- CorrFlex Graphics, LLC Loan 6,957 6,957 Debt Securities 4,942 4,942 Warrants -- -- Options -- -- ----------------------------------------------------------------------------------------------------------- Cosmetic Manufacturing Debt Securities 5,817 5,817 Resources, LLC Options 87 87 ----------------------------------------------------------------------------------------------------------- Coverall North America Loan 9,298 9,298 ----------------------------------------------------------------------------------------------------------- Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 -- ----------------------------------------------------------------------------------------------------------- CyberRep.com Debt Securities 3,694 3,694 Warrants 360 1,010 ----------------------------------------------------------------------------------------------------------- DEH Printed Circuits, Inc. Warrants 250 -- ----------------------------------------------------------------------------------------------------------- DeVlieg-Bullard, Inc. (1) Warrants 350 29 ----------------------------------------------------------------------------------------------------------- Directory Investment Corporation Common Stock (470 shares) -- -- ----------------------------------------------------------------------------------------------------------- Directory Lending Corporation Series A Common Stock (34 shares) -- -- Series B Common Stock (6 shares) 8 -- Series C Common Stock (10 shares) 22 -- -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 12 17
PRIVATE FINANCE DECEMBER 31, 1999 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- Drilltec Patents & Technologies Loan $ 10,911 $ 8,755 Company, Inc. Debt Securities 786 786 Warrants -- -- ----------------------------------------------------------------------------------------------------------- EDM Consulting, LLC Debt Securities 1,875 343 Common Stock (100 shares) 250 -- ----------------------------------------------------------------------------------------------------------- El Dorado Communications, Inc. Loans 306 306 ----------------------------------------------------------------------------------------------------------- Eparfin S.A. Loan 29 29 ----------------------------------------------------------------------------------------------------------- Esquire Communications Ltd. (1) Warrants 6 -- ----------------------------------------------------------------------------------------------------------- Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) 500 500 Common Stock (2,500 shares) -- -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Executive Greetings, Inc. Debt Securities 15,825 15,825 Warrants 360 360 ----------------------------------------------------------------------------------------------------------- Fairchild Industrial Products Company Debt Securities 5,753 5,753 Warrants 280 3,628 ----------------------------------------------------------------------------------------------------------- FTI Consulting, Inc. (1) Debt Securities 12,053 12,053 Warrants 970 970 ----------------------------------------------------------------------------------------------------------- Galaxy American Debt Securities 30,740 30,740 Communications, LLC Options -- 750 ----------------------------------------------------------------------------------------------------------- Garden Ridge Corporation Debt Securities 26,537 26,537 Preferred Stock (1,130 shares) 1,130 1,130 Common Stock (471 shares) 613 613 ----------------------------------------------------------------------------------------------------------- Genesis Worldwide, Inc. (1) Loan 1,328 1,328 Common Stock (41,644 shares) 214 81 ----------------------------------------------------------------------------------------------------------- Genoa Mine Acquisition Corporation Loan 108 108 ----------------------------------------------------------------------------------------------------------- Gibson Guitar Corporation Debt Securities 15,742 15,742 Warrants 525 1,000 ----------------------------------------------------------------------------------------------------------- Ginsey Industries, Inc. Loans 5,000 5,000 Convertible Debentures 500 500 Warrants -- 154 ----------------------------------------------------------------------------------------------------------- Global Communications, LLC Loans 2,526 2,526 Debt Securities 1,733 1,733 Equity Interest 6,867 6,867 Options 1,639 1,639 ----------------------------------------------------------------------------------------------------------- Golden Eagle/Satellite Loans 1,390 840 Archery, LLC Convertible Debentures 2,248 2,008 ----------------------------------------------------------------------------------------------------------- Grant Broadcasting Systems II Debt Securities 5,200 5,200 Warrants 87 5,226 ----------------------------------------------------------------------------------------------------------- Grant Television, Inc. Debt Securities 9,177 9,177 Warrants -- 2,500 ----------------------------------------------------------------------------------------------------------- Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000 ----------------------------------------------------------------------------------------------------------- Icon International, Inc. Series A Preferred Stock (13,720 shares) 1,334 1,334 Series B Preferred Stock (11,987 shares) 1,166 1,166 ----------------------------------------------------------------------------------------------------------- Impact Innovations Group Debt Securities 7,841 7,841 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Jakel, Inc. Loan 18,174 18,174 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 13 18
PRIVATE FINANCE DECEMBER 31, 1999 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- JRI Industries, Inc. Debt Securities $ 2,134 $ 2,134 Warrants 74 74 ----------------------------------------------------------------------------------------------------------- Julius Koch USA, Inc. Debt Securities 3,502 3,502 Warrants 324 4,100 ----------------------------------------------------------------------------------------------------------- Kirker Enterprises, Inc. Warrants 348 3,495 Equity Interest 4 9 ----------------------------------------------------------------------------------------------------------- Kirkland's, Inc. Debt Securities 6,318 6,318 Warrants 96 600 ----------------------------------------------------------------------------------------------------------- Kyrus Corporation Debt Securities 7,665 7,665 Warrants 348 348 ----------------------------------------------------------------------------------------------------------- Liberty-Pittsburgh Systems, Inc. Debt Securities 3,439 3,439 Common Stock (64,535 shares) 142 142 ----------------------------------------------------------------------------------------------------------- The Loewen Group, Inc. (1) High-Yield Senior Secured Debt 15,150 14,150 ----------------------------------------------------------------------------------------------------------- Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213 ----------------------------------------------------------------------------------------------------------- Master Plan, Inc. Common Stock (156 shares) 42 3,042 ----------------------------------------------------------------------------------------------------------- MedAssets.com, Inc. Debt Securities 3,793 3,793 Series B Convertible Preferred Stock (227,665 shares) 2,049 2,049 Warrants 136 136 ----------------------------------------------------------------------------------------------------------- Meigher Communications, L.P. Loan 2,938 2,938 ----------------------------------------------------------------------------------------------------------- Mid Atlantic Telecom Plus, LLC Loan 11,109 11,109 ----------------------------------------------------------------------------------------------------------- Midview Associates, L.P. Warrants -- -- ----------------------------------------------------------------------------------------------------------- Monitoring Solutions, Inc. Loans 7 7 Debt Securities 1,823 243 Common Stock (33,333 shares) -- -- Warrants -- -- ----------------------------------------------------------------------------------------------------------- Morton Industrial Group (1) Common Stock (5,835 shares) 241 20 ----------------------------------------------------------------------------------------------------------- MVL Group Debt Securities 13,989 13,989 Warrants 651 651 ----------------------------------------------------------------------------------------------------------- Net-Tel Communications, Inc. Debt Securities 9,426 9,426 Series B Convertible Preferred Stock (647 shares) 5,000 5,000 Warrants 500 500 ----------------------------------------------------------------------------------------------------------- Nobel Learning Communities, Debt Securities 9,492 9,492 Inc. (1) Series D Convertible Preferred Stock (265,957 shares) 2,000 2,000 Warrants 575 575 ----------------------------------------------------------------------------------------------------------- Northeast Broadcasting Group, L.P. Debt Securities 384 384 ----------------------------------------------------------------------------------------------------------- Nursefinders, Inc. Debt Securities 10,922 10,922 Warrants 900 900 ----------------------------------------------------------------------------------------------------------- Old Mill Holdings, Inc. Debt Securities 140 -- ----------------------------------------------------------------------------------------------------------- Opinion Research Corporation (1) Debt Securities 13,896 13,896 Warrants 996 996 ----------------------------------------------------------------------------------------------------------- Outsource Partners, Inc. Debt Securities 23,802 23,802 Warrants 826 826 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 14 19
PRIVATE FINANCE DECEMBER 31, 1999 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- Panera Bread Company (1) Warrants $ 227 $ 271 ----------------------------------------------------------------------------------------------------------- Physician Specialty Corporation Debt Securities 14,388 14,388 Redeemable Preferred Stock (850 shares) 850 850 Convertible Preferred Stock (97,411 shares) 150 150 Warrants 476 476 ----------------------------------------------------------------------------------------------------------- Pico Products, Inc. (1) Loan 1,300 1,300 Debt Securities 4,591 2,591 Common Stock (208,000 shares) 59 3 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Polaris Pool Systems, Inc. Debt Securities 6,395 6,395 Warrants 1,050 1,050 ----------------------------------------------------------------------------------------------------------- Powell Plant Farms, Inc. Loan 15,031 15,031 ----------------------------------------------------------------------------------------------------------- Progressive International Corporation Debt Securities 3,940 3,940 Preferred Stock (500 shares) 500 500 Common Stock (197 shares) 13 13 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Schwinn/GT Debt Securities 9,978 9,978 Warrants 395 395 ----------------------------------------------------------------------------------------------------------- Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 136 ----------------------------------------------------------------------------------------------------------- Soff-Cut Holdings, Inc. Debt Securities 8,140 8,140 Warrants 446 446 Preferred Stock (300 shares) 300 300 Common Stock (2,000 shares) 200 200 ----------------------------------------------------------------------------------------------------------- Southwest PCS, L.P. Debt Securities 6,364 6,364 Options 1,000 2,000 ----------------------------------------------------------------------------------------------------------- Spa Lending Corporation Preferred Stock (28,625 shares) 469 360 Common Stock (6,208 shares) 25 18 ----------------------------------------------------------------------------------------------------------- SunStates Refrigerated Services, Inc. Loans 6,130 4,641 Debt Securities 2,445 1,316 ----------------------------------------------------------------------------------------------------------- Sure-Tel, Inc. Preferred Stock (1,116,902 shares) 3,108 3,108 Warrants 662 662 Options -- -- ----------------------------------------------------------------------------------------------------------- Sydran Food Services II, L.P. Debt Securities 11,674 11,674 Options 266 266 ----------------------------------------------------------------------------------------------------------- Teknekron Infoswitch Corporation Debt Securities 13,863 13,863 Warrants 900 900 ----------------------------------------------------------------------------------------------------------- Total Foam, Inc. Debt Securities 1,528 135 Common Stock (910 shares) 57 -- ----------------------------------------------------------------------------------------------------------- Tubbs Snowshoe Company, LLC Debt Securities 3,886 3,886 Warrants 54 54 Equity Interests 500 500 ----------------------------------------------------------------------------------------------------------- United Pet Group Debt Securities 4,938 4,938 Warrants 15 15 ----------------------------------------------------------------------------------------------------------- Wildwood Designs, Inc. Loan 1,167 1,167 ----------------------------------------------------------------------------------------------------------- Williams Brothers Lumber Company Warrants 24 322 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 15 20
PRIVATE FINANCE DECEMBER 31, 1999 PORTFOLIO COMPANY ------------------- (IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE --------------------------------------- --------------------------------------------- -------- -------- Wilton Industries, Inc. Loan $ 12,390 $ 12,390 ----------------------------------------------------------------------------------------------------------- Woodstream Corporation Debt Securities 8,000 8,000 Equity Interests 1,700 1,700 Warrants -- -- ----------------------------------------------------------------------------------------------------------- Wyo-Tech Acquisition Corporation Debt Securities 15,113 15,113 Preferred Stock (100 shares) 3,700 3,700 Common Stock (99 shares) 100 4,100 ----------------------------------------------------------------------------------------------------------- Total private finance (91 investments) $639,171 $647,040 -----------------------------------------------------------------------------------------------------------
(1) Public company. (2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial statements. 16 21
DECEMBER 31, 1999 INTEREST NUMBER OF ----------------------- (IN THOUSANDS, EXCEPT NUMBER OF LOANS) RATE RANGES LOANS COST VALUE ---------------------------------------- ---------------- --------- ---------- ---------- COMMERCIAL REAL ESTATE FINANCE Commercial Mortgage Loans Up to 6.99% 5 $ 1,422 $ 1,422 7.00%- 8.99% 15 71,619 71,595 9.00%-10.99% 41 39,415 39,623 11.00%-12.99% 30 25,016 25,175 13.00%-14.99% 12 15,207 15,230 15.00% and above 3 1,088 1,064 ------------------------------------------------------------------------------------------------ Total commercial mortgage loans 106 $ 153,767 $ 154,109 ------------------------------------------------------------------------------------------------
STATED INTEREST FACE -------- ---- Purchased CMBS Mortgage Capital Funding, Series 1998-MC3 5.5% $ 61,302 $ 29,141 $ 29,141 Morgan Stanley Capital I, Series 1999-RM1 6.4% 71,640 35,453 35,453 COMM 1999-1 5.7% 105,010 54,166 54,166 Morgan Stanley Capital I, Series 1999-FNV1 6.1% 49,486 24,505 24,505 DLJ Commercial Mortgage Trust 1999-CG2 6.1% 96,622 44,288 44,288 Commercial Mortgage Acceptance Corp., Series 1999-C1 6.8% 50,449 28,115 28,115 LB Commercial Mortgage Trust, Series 1999-C2 6.7% 42,391 20,054 20,054 Chase Commercial Mortgage Securities Corp., Series 1999-2 6.5% 43,046 20,121 20,121 FUNB CMT, Series 1999-C4 6.5% 49,288 21,851 21,851 -------------------------------------------------------------------------------------------------- Total purchased CMBS $569,234 $ 277,694 $ 277,694 -------------------------------------------------------------------------------------------------- Residual CMBS $ 76,374 $ 76,374 Residual Interest Spread 6,882 5,382 Real Estate Owned 7,305 6,470 -------------------------------------------------------------------------------------------------- Total commercial real estate finance $ 522,022 $ 520,029 -------------------------------------------------------------------------------------------------- Small business finance $ 61,708 $ 61,428 -------------------------------------------------------------------------------------------------- Total portfolio $1,222,901 $1,228,497 -------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 17 22 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION Allied Capital Corporation, a Maryland corporation, is a closed-end management investment company that has elected to be regulated as a business development company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). Allied Capital Corporation has two wholly owned subsidiaries that have also elected to be regulated as BDCs. Allied Investment Corporation ("Allied Investment") is licensed under the Small Business Investment Act of 1958 as a Small Business Investment Company ("SBIC"). Allied Capital SBLC Corporation ("Allied SBLC") is licensed by the Small Business Administration ("SBA") as a Small Business Lending Company and is a participant in the SBA Section 7(a) Guaranteed Loan Program. In addition, the Company has a real estate investment trust subsidiary, Allied Capital REIT, Inc. ("Allied REIT") and several single- member limited liability companies established primarily to hold real estate properties. Allied Capital Corporation and its subsidiaries, collectively, are hereinafter referred to as the "Company." The investment objective of the Company is to achieve current income and capital gains. In order to achieve this objective, the Company invests primarily in private, small and middle-market companies in a variety of industries and in diverse geographic locations in the United States. NOTE 2. BASIS OF PRESENTATION In the opinion of management, the unaudited consolidated financial results of the Company included herein contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position of the Company as of September 30, 2000 and December 31, 1999 and for the nine months ended September 30, 2000 and 1999 and the results of operations, changes in net assets, and cash flows for these periods. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 1999 Annual Report. The results of operations for the nine months ended September 30, 2000 are not necessarily indicative of the operating results to be expected for the full year. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 1999 balances to conform with the 2000 financial statement presentation. In October 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a Replacement of FASB Statement No. 125", which requires new disclosures about securitizations and retained interests in securitized financial assets and revises the criteria involving qualifying special purpose entities. These new disclosure requirements are to be provided for fiscal years ending after December 15, 2000. The revisions related to special purpose entities are to be applied prospectively to transfers of financial assets and extinguishments of liabilities occurring after March 31, 2001. 18 23 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO The Company's investment operations are conducted in three primary areas: private finance, commercial real estate finance, and small business finance. PRIVATE FINANCE At September 30, 2000 and December 31, 1999, the private finance portfolio consisted of the following:
2000 1999 --------------------------- --------------------------- COST VALUE YIELD COST VALUE YIELD (IN THOUSANDS) -------- -------- ----- -------- -------- ----- Loans and debt securities......... $833,286 $814,346 14.6% $578,570 $559,746 14.2% Equity interests.................. 130,362 153,175 60,601 87,294 -------- -------- -------- -------- Total................... $963,648 $967,521 $639,171 $647,040 ======== ======== ======== ========
Private finance investments are generally structured as loans and debt securities that carry a relatively high fixed rate of interest, which may be combined with equity features, such as conversion privileges, or warrants or options to purchase a portion of the portfolio company's equity at a nominal price. Debt securities would typically have a maturity of five to ten years, with interest-only payments in the early years and payments of both principal and interest in the later years, although debt maturities and principal amortization schedules vary. Equity interests consist primarily of securities issued by privately owned companies and may be subject to restrictions on their resale or otherwise illiquid. Equity securities generally do not produce a current return, but are held for investment appreciation and ultimate gain on sale. At September 30, 2000 and December 31, 1999, approximately 98% of the Company's private finance loan portfolio was composed of fixed interest rate loans. At September 30, 2000 and December 31, 1999, loans and debt securities with a value of $51,982,000 and $34,560,000, respectively, were not accruing interest. The geographic and industry compositions of the private finance portfolio at September 30, 2000 and December 31, 1999 were as follows:
2000 1999 ---- ---- GEOGRAPHIC REGION Midwest..................................................... 27% 26% Mid-Atlantic................................................ 25 23 West........................................................ 23 11 Southeast................................................... 16 27 Northeast................................................... 7 9 International............................................... 2 4 --- --- Total............................................. 100% 100% === ===
19 24 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO, CONTINUED
2000 1999 ---- ---- INDUSTRY Business Services........................................... 32% 32% Consumer Products........................................... 25 19 Industrial Products......................................... 12 12 Telecommunications.......................................... 7 5 Retail...................................................... 7 8 Broadcasting/Cable.......................................... 6 11 Education................................................... 4 5 Other....................................................... 7 8 --- --- Total............................................. 100% 100% === ===
COMMERCIAL REAL ESTATE FINANCE At September 30, 2000 and December 31, 1999, the commercial real estate finance portfolio consisted of the following:
2000 1999 --------------------------- --------------------------- COST VALUE YIELD COST VALUE YIELD (IN THOUSANDS) -------- -------- ----- -------- -------- ----- Loans..................... $102,058 $105,853 9.7% $153,767 $154,109 9.4% CMBS...................... 488,929 489,172 13.9% 360,950 359,450 13.5% REO....................... 6,371 5,005 7,305 6,470 -------- -------- -------- -------- Total.............. $597,358 $600,030 $522,022 $520,029 ======== ======== ======== ========
LOANS The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers. At September 30, 2000 and December 31, 1999, approximately 71% and 29% and 81% and 19%, of the Company's commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. As of September 30, 2000 and December 31, 1999, loans with a value of $11,472,000 and $8,334,000, respectively, were not accruing interest. The geographic composition and the property types securing the commercial mortgage loan portfolio at September 30, 2000 and December 31, 1999 were as follows:
2000 1999 ---- ---- GEOGRAPHIC REGION Southeast................................................... 36% 31% Mid-Atlantic................................................ 23 32 West........................................................ 20 25 Midwest..................................................... 15 9 Northeast................................................... 6 3 --- --- Total............................................. 100% 100% === ===
20 25 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO, CONTINUED
2000 1999 ---- ---- PROPERTY TYPE Hospitality................................................. 33% 42% Office...................................................... 29 24 Retail...................................................... 18 11 Recreation.................................................. 9 8 Other....................................................... 11 15 --- --- Total............................................. 100% 100% === ===
CMBS At September 30, 2000 and December 31,1999, the CMBS portfolio consisted of the following:
2000 1999 ------------------- ------------------- COST VALUE COST VALUE (IN THOUSANDS) -------- -------- -------- -------- Purchased CMBS.......................... $407,511 $409,254 $277,694 $277,694 Residual CMBS........................... 77,205 77,205 76,374 76,374 Residual interest spread................ 4,213 2,713 6,882 5,382 -------- -------- -------- -------- Total......................... $488,929 $489,172 $360,950 $359,450 ======== ======== ======== ========
PURCHASED CMBS. The Company has Purchased CMBS bonds with a face amount of $813,834,000 and a cost of $407,511,000, with the difference representing original issue discount. As of September 30, 2000 and December 31, 1999, the estimated yield to maturity on the Purchased CMBS was approximately 14.7% and 14.6%, respectively. The Company's yield on its Purchased CMBS is based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples include the timing and magnitude of credit losses on the mortgage loans underlying the Purchased CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality) and changes in market rental rates. At September 30, 2000 and December 31, 1999, the yield on the Purchased CMBS portfolio was computed assuming a 1% loss estimate for its entire underlying collateral mortgage pool. As these uncertainties and contingencies are difficult to predict and are subject to future events which may alter these assumptions, no assurance can be given that the anticipated yields to maturity will be achieved. The non-investment grade and unrated tranches of the Purchased CMBS bonds are junior in priority for payment of principal to the more senior tranches of the related commercial securitization. Cash flow from the underlying mortgages generally is allocated first to the senior tranches, with the most senior tranches having a priority right to the cash flow. Then, any remaining cash flow is allocated, generally, among the other tranches in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages resulting in reduced cash flows, the subordinate tranche will bear this loss first. 21 26 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO, CONTINUED The underlying rating classes of the Purchased CMBS is as follows:
SEPTEMBER 30, 2000 DECEMBER 31, 1999 -------------------------------- -------------------------------- PERCENTAGE PERCENTAGE COST VALUE OF TOTAL COST VALUE OF TOTAL (IN THOUSANDS) -------- -------- ---------- -------- -------- ---------- BB+................... $ 8,608 $ 8,968 2.2% $ -- $ -- -- % BB.................... 66,850 68,233 16.7 41,091 41,091 14.8 BB-................... 66,594 66,594 16.3 46,692 46,692 16.8 B+.................... 59,396 59,396 14.5 41,765 41,765 15.0 B..................... 89,230 89,230 21.8 64,830 64,830 23.4 B-.................... 56,156 56,156 13.7 40,995 40,995 14.8 CCC................... 7,812 7,812 1.9 6,506 6,506 2.3 Unrated............... 52,865 52,865 12.9 35,815 35,815 12.9 -------- -------- ----- -------- -------- ----- Total....... $407,511 $409,254 100.0% $277,694 $277,694 100.0% ======== ======== ===== ======== ======== =====
As of September 30, 2000, the BB+ and BB rated classes of the Purchased CMBS were classified by the Company as held for sale, and therefore, have been valued at the market price at which the Company would expect to sell these securities. All other classes of Purchased CMBS were classified as held for investment at September 30, 2000. RESIDUAL CMBS AND RESIDUAL INTEREST SPREAD. The Residual CMBS primarily consists of a retained interest from a post-Merger asset securitization whereby bonds were sold in three classes rated "AAA," "AA" and "A." The Company sold $295 million of loans, and received cash proceeds, net of costs, of approximately $223 million. The Company retained a trust certificate for its residual interest in the loan pool sold, and will receive interest income from this Residual CMBS as well as the Residual Interest Spread from the interest earned on the loans sold less the interest paid on the bonds over the life of the bonds. As of September 30, 2000 and December 31, 1999, the mortgage loan pool had an approximate weighted average stated interest rate of 9.3%. The three bond classes sold had an aggregate weighted average interest rate of 6.5% as of September 30, 2000 and December 31, 1999. The value of the Residual CMBS was determined using a discount rate equal to the average interest rate of the underlying mortgage loans. The value of the residual interest spread was determined based on a constant prepayment rate of 7% and a discount rate of 14%. 22 27 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO, CONTINUED The geographic composition and the property types of the underlying mortgage loan pools securing the CMBS at September 30, 2000 and December 31, 1999 were as follows:
2000 1999 ---- ---- GEOGRAPHIC REGION West........................................................ 31% 32% Mid-Atlantic................................................ 23 23 Midwest..................................................... 22 21 Southeast................................................... 19 20 Northeast................................................... 5 4 --- --- Total............................................. 100% 100% === === PROPERTY TYPE Retail...................................................... 32% 33% Housing..................................................... 30 29 Office...................................................... 21 20 Hospitality................................................. 8 9 Other....................................................... 9 9 --- --- Total............................................. 100% 100% === ===
SMALL BUSINESS FINANCE At September 30, 2000 and December 31, 1999, the small business finance portfolio consisted of the following:
2000 1999 ----------------- ----------------- COST VALUE COST VALUE ------- ------- ------- ------- (IN THOUSANDS) 7(a) loans.................................. $45,590 $44,689 $43,246 $43,000 Residual interest in loans sold............. 8,050 8,050 4,036 4,036 Residual interest spread.................... 16,729 16,729 14,046 14,046 REO......................................... 1,222 1,188 380 346 ------- ------- ------- ------- Total............................. $71,591 $70,656 $61,708 $61,428 ======= ======= ======= =======
The Company, through its wholly owned subsidiary, Allied SBLC, participates in the SBA's Section 7(a) Guaranteed Loan Program ("7(a) loans"). Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA will guarantee 80% of any qualified loan up to $100,000 regardless of maturity, and 75% of any such loan over $100,000 regardless of maturity, to a maximum guarantee of $750,000 for any one borrower. SBA regulations define qualified small businesses generally as businesses with no more than $5 million in annual sales or no more than 500 employees. The Company charges interest on the 7(a) loans at a variable rate, typically 1.75% to 2.75% above the prime rate, as published in The Wall Street Journal or other financial newspaper, adjusted monthly. All loans are payable in equal monthly installments of principal and interest from the date on which the loan was made to its maturity. 23 28 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. PORTFOLIO, CONTINUED As permitted by SBA regulations, the Company sells to investors, without recourse, 100% of the guaranteed portion of its 7(a) loans while retaining the right to service 100% of such loans. Additionally, the Company sells up to a 90% interest in the unguaranteed portion of its 7(a) loans through a structured finance agreement with a commercial paper conduit. In 1999, the Company sold $36,387,000 of the unguaranteed portion of 7(a) loans into the facility. The Company received $35,500,000 in proceeds and retained a subordinated interest valued at $4,036,000. The Company recognized a premium from the loan sale of $4,106,000, which includes the value of the retained residual interest spread. As of September 30, 2000 and December 31, 1999, 7(a) loans with a value of $6,556,000 and $5,562,000, respectively, were not accruing interest. As of September 30, 2000 and December 31, 1999, 7(a) loans include a balance of $9,327,000 and $7,667,000, respectively, that is guaranteed by the SBA. NOTE 4. DEBT At September 30, 2000 and December 31, 1999, the Company had the following debt:
2000 1999 --------------------- ------------------- FACILITY AMOUNT FACILITY AMOUNT AMOUNT DRAWN AMOUNT DRAWN ---------- -------- -------- -------- (IN THOUSANDS) Notes payable and debentures: Unsecured long-term notes payable............ $ 419,000 $419,000 $419,000 $419,000 SBA debentures............................... 98,450 77,450 74,650 62,650 Auction rate reset note...................... 75,000 75,000 -- -- OPIC loan.................................... 5,700 5,700 5,700 5,700 ---------- -------- -------- -------- Total notes payable and debentures... 598,150 577,150 499,350 487,350 ---------- -------- -------- -------- Revolving credit facilities: Revolving line of credit..................... 417,500 185,000 340,000 82,000 Master loan and security agreement........... 100,000 -- 100,000 23,500 ---------- -------- -------- -------- Total revolving credit facilities.... 517,500 185,000 440,000 105,500 ---------- -------- -------- -------- Total........................................ $1,115,650 $762,150 $939,350 $592,850 ========== ======== ======== ========
NOTES PAYABLE AND DEBENTURES UNSECURED LONG-TERM NOTES PAYABLE. In June 1998, May 1999 and November 1999, the Company issued unsecured long-term notes to private institutional investors. The notes require semi-annual interest payments until maturity and have terms of five or seven years. The weighted average interest rate on the notes was 7.6% at September 30, 2000 and December 31, 1999. The notes may be prepaid in whole or in part together with an interest premium, as stipulated in the note agreement. SBA DEBENTURES. At September 30, 2000 and December 31, 1999, the Company had debentures payable to the SBA with terms of ten years and at interest rates ranging from 6.9% to 9.6%. The debentures require semi-annual interest-only payments with all principal due upon maturity. The SBA debentures are subject to prepayment penalties if paid prior to maturity. 24 29 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4. DEBT, CONTINUED AUCTION RATE RESET NOTE. On August 31, 2000, the Company completed a private placement of a $75 million Auction Rate Reset Senior Note Series A. The note matures on December 2, 2002 and bears interest at the London Interbank Offer Rate ("LIBOR") plus 175 basis points which adjusts quarterly. Interest is due quarterly and the Company, at its option, may pay or defer such interest payments. As a means to repay the note, the Company has entered into an agreement to issue $75 million of debt, equity or other securities in one or more public or private transactions, or prepay the note, on or before August 31, 2002. If the note is prepaid, the Company will pay a fee equal to 0.5% of the aggregate amount of the note outstanding. SCHEDULED MATURITIES. Scheduled future maturities of notes payable and debentures at September 30, 2000 are as follows:
YEAR AMOUNT MATURING ---- --------------- (IN THOUSANDS) 2000........................................................ $ 11,100 2001........................................................ 9,350 2002........................................................ 75,000 2003........................................................ 140,000 2004........................................................ 221,000 Thereafter.................................................. 120,700 -------- Total............................................. $577,150 ========
REVOLVING CREDIT FACILITIES REVOLVING LINE OF CREDIT. The Company has an unsecured revolving line of credit for $417,500,000. The facility may be expanded up to $500,000,000. The facility bears interest at LIBOR plus 1.25% and adjusts at the beginning of each new interest period, usually every thirty days. The interest rates were 7.9% and 7.7% at September 30, 2000 and December 31, 1999, respectively, and the facility requires a commitment fee equal to 0.25% of the committed amount. The line expires in May 2002. The line of credit requires monthly interest payments and all principal is due upon its expiration. MASTER LOAN AND SECURITY AGREEMENT. The Company had a facility to borrow up to $100,000,000, using certain commercial mortgage loans as collateral. The Company pledged commercial mortgage loans as collateral for the facility such that the amount borrowed is approximately equal to 80% of the value of the collateral pledged. The agreement generally required interest-only payments with all principal due at maturity. The agreement charged interest at the one-month LIBOR plus 1.0%, adjusted daily, or 7.6% and 6.8% at September 30, 2000 and December 31, 1999, respectively. The agreement matured on October 27, 2000 and was not renewed. The average debt outstanding on the revolving credit facilities was $179,312,000 and $123,860,000 for the nine months ended September 30, 2000 and for the year ended December 31, 1999, respectively. The maximum amount borrowed under these facilities and the weighted average interest rate for the nine months ended September 30, 2000 and for the year ended December 31, 1999, were $257,000,000 and $199,392,000, and 7.6% and 6.5%, respectively. 25 30 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5. SHAREHOLDERS' EQUITY Sale of common stock for the nine months ended September 30, 2000 and the year ended December 31, 1999 was as follows:
2000 1999 (IN THOUSANDS) -------- -------- Number of common shares..................................... 14,812 8,659 Gross proceeds.............................................. $263,460 $172,539 Less costs including underwriting fees...................... (12,549) (8,270) -------- -------- Net proceeds.............................................. $250,911 $164,269 ======== ========
The Company has a dividend reinvestment plan, whereby the Company may buy shares of its common stock in the open market or issue new shares in order to satisfy dividend reinvestment requests. If the Company issues new shares, the issue price is equal to the average of the closing sale prices reported for the Company's common stock for the five consecutive days immediately prior to the dividend payment date. Dividend reinvestment plan activity for the nine months ended September 30, 2000 and for the year ended December 31, 1999 was as follows:
2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ------ ------ Shares issued............................................... 199 233 Average price per share..................................... $18.18 $19.43
NOTE 6. EARNINGS PER COMMON SHARE Earnings per common share for the nine months ended September 30, 2000 and 1999 were as follows:
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------ 2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- ------- Net increase in net assets resulting from operations........ $100,820 $67,645 Less preferred stock dividends.............................. (165) (165) -------- ------- Income available to common shareholders..................... $100,655 $67,480 ======== ======= Weighted average basic shares outstanding................... 70,604 59,077 Options outstanding to officers............................. 173 162 -------- ------- Weighted average diluted shares outstanding................. 70,777 59,239 ======== ======= BASIC EARNINGS PER COMMON SHARE............................. $ 1.43 $ 1.14 ======== ======= DILUTED EARNINGS PER COMMON SHARE........................... $ 1.42 $ 1.14 ======== =======
NOTE 7. CUT-OFF AWARD AND FORMULA AWARD The Predecessor Companies' existing stock option plans were canceled and the Company established a cut-off dollar amount for all existing, but unvested options as of the date of the Merger 26 31 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7. CUT-OFF AWARD AND FORMULA AWARD, CONTINUED (the "Cut-off Award"). The Cut-off Award was computed for each unvested option as of the Merger date. The Cut-off Award was equal to the difference between the market price on August 14, 1997 (the Merger announcement date) of the shares of stock underlying the option less the exercise price of the option. The Cut-off Award was payable for each unvested option upon the future vesting date of that option. The Cut-off Award was designed to cap the appreciated value in unvested options at the Merger announcement date, in order to set the foundation to balance option awards upon the Merger. The Cut-off Award approximated $2.9 million in the aggregate and has been expensed as the Cut-off Award vests. For the nine months ended September 30, 2000 and the year ended December 31, 1999, $535,000 and $532,000, respectively, of the Cut-off Award vested. The Formula Award was established to compensate employees from the point when their unvested options would cease to appreciate in value (the Merger announcement date), up until the time at which they would be able to receive option awards in ACC post-merger. In the aggregate, the Formula Award equaled 6% of the difference between an amount equal to the combined aggregated market capitalizations of the Predecessor Companies as of the close of the market on the day before the Merger date (December 30, 1997), less an amount equal to the combined aggregate market capitalizations of Allied Lending and the Predecessor Companies as of the close of the market on the Merger announcement date. Advisers' compensation committee allocated the Formula Award to individual officers on December 30, 1997. The amount of the Formula Award as computed at December 30, 1997 was $18,994,000. This amount was contributed to the Company's deferred compensation trust under the deferred compensation plan and was used to purchase shares of the Company's stock (included in common stock held in deferred compensation trust). The Formula Award vests equally in three installments on December 31, 1998, 1999 and 2000; provided, however, that such Formula Award vests immediately upon a change in control of the Company. The Formula Award has been expensed in each year in which it vests. For the nine months ended September 30, 2000 and for the year ended December 31, 1999, $4,262,000 and $6,221,000, respectively, was expensed as a result of the Formula Award. For the nine months ended September 30, 2000 and for the year ended December 31, 1999, the liability related to the Formula Award was $4,854,000 and $6,221,000, respectively, and has been included in common stock held in deferred compensation trust. Vested Formula Awards are distributable to recipients at the Company's discretion, however, sale of the Company's stock by the recipients is restricted. Unvested Formula Awards are forfeited upon a recipient's separation from service and the related Company stock is retired. For the nine months ended September 30, 2000 and for the year ended December 31, 1999, $563,000 and $61,000, respectively, of the Formula Award was forfeited. On January 3, 2000 and January 4, 1999, the Company distributed shares of the Company's common stock with a value of $4,274,000 and $4,062,000, respectively, representing the portion of the Formula Award that vested during the respective previous year. NOTE 8. DIVIDENDS AND DISTRIBUTIONS The Company's Board of Directors declared and the Company paid a $1.36 per common share dividend or $98,617,000 for the nine months ended September 30, 2000. NOTE 9. SUBSEQUENT EVENTS On October 24, 2000, the Company closed on $125 million of five-year unsecured long-term debt, financed primarily by insurance companies. The five-year notes were priced at 8.54% and have 27 32 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 9. SUBSEQUENT EVENTS, CONTINUED substantially the same terms as the Company's existing long-term debt. The proceeds from this debt were used to repay borrowings from the revolving line of credit. On October 31, 2000, the Company entered into a definitive merger agreement in order to acquire BLC Financial Services Inc. ("BLC") in a stock for stock exchange. The transaction will create an independently managed, private portfolio company. The Company also plans to merge its small business finance portfolio and Allied Capital Express operations into the new portfolio company. To effect the transaction, the Company will issue approximately 4.2 million shares of common stock, and BLC shareholders will receive a fixed exchange ratio of 0.180 shares of Company common stock for each share of BLC stock in a tax-free exchange. In addition, in a separate transaction, the Company intends to acquire a corporate shareholder of BLC for approximately $9.1 million in cash. The Company filed a registration statement on Form N-14 with the SEC on November 6, 2000 to register the shares to be issued in this transaction. The Company will own approximately 95% of the portfolio company upon completion of the transaction. Certain officers, directors and existing shareholders of BLC will retain approximately 5% ownership. The Company's investment is structured to provide a current return through interest, dividends and fee income, and the investment will include debt, preferred stock and common stock. In addition, the Company believes there is opportunity to add value to the new portfolio company and to position its investment for future capital gain. Necessary approvals to complete the transaction include an affirmative vote of BLC shareholders, as well as regulatory approval by the SBA. The transaction is expected to close by December 31, 2000. 28 33 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto included herein and in the Company's annual report on Form 10-K. This Management's Discussion and Analysis contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives, loan portfolio growth and availability of funds. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth below in the Investment Considerations section. Other factors that could cause actual results to differ materially include the uncertainties of economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements included herein are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Therefore, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. OVERVIEW The Company provides private investment capital to private and undervalued public companies in a variety of different industries and in diverse geographic locations. Our lending and investment activity is focused in three areas: - Private finance - Commercial real estate finance, and - Small business loans originated for sale under our Allied Capital Express brand name. The Company's portfolio composition at September 30, 2000 and December 31, 1999 was as follows:
AT AT SEPTEMBER 30, DECEMBER 31, 2000 1999 ------------- ------------ Private Finance............................................. 59% 53% Commercial Real Estate Finance.............................. 37% 42% Small Business Finance...................................... 4% 5%
The Company's earnings depend primarily on the level of interest and related portfolio income and net realized and unrealized gains earned on the Company's investment portfolio after deducting interest paid on borrowed capital and operating expenses. Interest income results from the stated interest rate earned on a loan and the amortization of loan origination points and discounts. The level of interest income is directly related to the balance of the investment portfolio multiplied by the weighted average yield on the portfolio. The Company's ability to generate interest income is dependent on economic, regulatory and competitive factors that influence interest rates and loan originations, and the Company's ability to secure financing for its investment activities. 29 34 PORTFOLIO AND INVESTMENT ACTIVITY Total portfolio investment activity and yields were as follows:
AT SEPTEMBER 30, AT DECEMBER 31, 2000 1999 ---------------- --------------- (IN MILLIONS) Portfolio at Value................................... $1,638.2 $1,228.5 Yield................................................ 13.9% 13.0%
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, FOR THE YEAR --------------- --------------- ENDED DECEMBER 31, 2000 1999 2000 1999 1999 ------ ------ ------ ------ ------------------ (IN MILLIONS) New Investments................. $237.8 $191.5 $640.2 $534.0 $751.9 Repayments...................... $ 59.1 $ 48.7 $117.9 $120.6 $145.7 Sales........................... $ 34.7 $ 52.9 $151.8 $120.9 $198.4
PRIVATE FINANCE Private finance investment activity and yields were as follows:
AT SEPTEMBER 30, AT DECEMBER 31, 2000 1999 ---------------- --------------- (IN MILLIONS) Portfolio at Value................................... $967.5 $647.0 Yield................................................ 14.6% 14.2%
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, FOR THE YEAR --------------- --------------- ENDED DECEMBER 31, 2000 1999 2000 1999 1999 ------ ------ ------ ------ ------------------ (IN MILLIONS) New Investments................. $148.5 $110.4 $387.6 $237.6 $346.7 Repayments...................... $ 49.6 $ 38.3 $ 88.8 $ 86.5 $ 87.5
The private finance portfolio increased 50% from December 31, 1999 to September 30, 2000 and 67% during the year ended December 31, 1999. The Company's increasing capital base has enabled it to make larger private finance investments, supporting the increase in originations for 2000 and 1999. During the three months ended September 30, 2000, the Company originated 10 investments with an average investment size of $14.0 million and a weighted average current yield on loans and debt securities of 15.7%. Investments during the third quarter of 2000 included an investment in Wilmar Industries, Inc. for $33.7 million. As a part of this transaction, Wilmar repaid in full the $30 million investment that the Company provided in May 2000. During the nine months ended September 30, 2000, the Company originated 26 investments with an average investment size of $14.0 million and a weighted average current yield on loans and debt securities of 15.3%. During 1999, the Company originated 27 investments with an average investment size of $12.4 million and a weighted average current yield on loans and debt securities of 13.6%. The current yield on the private finance portfolio will fluctuate over time depending on the equity "kicker" or warrants received with each financing. Private finance investments are generally structured such that equity kickers may provide an additional investment return of up to 10%. During the second quarter of 2000, the Company began an initiative to invest in and strategically partner with select private equity funds focused on investments in technology and the new economy. The strategy for these fund investments is to provide solid investment returns and build strategic 30 35 relationships with the fund managers and their portfolio companies. The Company believes that it will have opportunities to co-invest with the funds as well as finance their portfolio companies as they mature. The Company believes that the fund investment strategy is an excellent means of participating in technology investing through a diverse pooled investment portfolio. The fund concept allows the Company to participate in a pooled investment return without exposure to the risk of any single technology investment. During 2000, the Company committed a total of $41.2 million to seven private equity funds. The committed amount is expected to be invested over the next three years. The Company has funded $4.4 million of this commitment during the nine months ended September 30, 2000. COMMERCIAL REAL ESTATE FINANCE Commercial real estate finance investment activity and yields were as follows:
AT SEPTEMBER 30, AT DECEMBER 31, 2000 1999 ---------------- --------------- (IN MILLIONS) Portfolio at Value................................... $600.0 $520.0 Yield................................................ 13.2% 12.3%
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED FOR THE YEAR SEPTEMBER 30, SEPTEMBER 30, ENDED DECEMBER 31, ------------- --------------- ------------------ 2000 1999 2000 1999 1999 ----- ----- ------ ------ ------------------ (IN MILLIONS) New Investments................... $52.6 $46.4 $143.7 $216.2 $288.7 Repayments........................ $ 6.5 $ 9.2 $ 20.8 $ 20.0 $ 51.5 Sales............................. $ 1.6 $27.7 $ 53.1 $ 60.6 $ 86.1
The commercial real estate finance portfolio increased 15% from December 31, 1999 to September 30, 2000 and increased 46.5% for the year ended December 31, 1999. During 1999, the Company began to migrate its portfolio from investments in lower yielding commercial mortgage loans to higher yielding real estate investments. During 1998, the Company reduced its commercial mortgage loan origination activity for its own portfolio due to declining interest rates and began to sell its loans to other lenders. Then, beginning in the fourth quarter of 1998, the Company began to take advantage of a unique market opportunity to acquire non-investment grade commercial mortgage-backed securities ("CMBS") at significant discounts from the face amount of the bonds. Turmoil in the CMBS market created a lack of liquidity for the traditional buyers of non-investment grade bonds. As a result, yields on these collateralized bonds increased, thus providing an attractive investment opportunity. The Company believes that CMBS is an attractive asset class because of the yields that can be earned on a security that is fully secured by commercial mortgage loans. The Company opportunistically purchased CMBS throughout 1999, and has continued to do so during 2000. However, the Company has begun to curtail its CMBS investment activity to maintain a balanced portfolio and does not currently expect to purchase additional CMBS during the fourth quarter of 2000. In addition, during the third quarter of 2000, the Company decided to begin to liquidate its portfolio of BB+ and BB rated bonds. 31 36 The underlying pool of approximately 2,600 loans that are collateral for our CMBS had underwritten loan to value ("LTV") and debt service coverage ratios ("DSCR") as follows.
LOAN TO VALUE RANGES $ % -------------------- ------------- --- (IN MILLIONS) Less than 60%............................................... $ 1,544.5 12% 60 - 65%.................................................... 961.9 8% 65 - 70%.................................................... 2,051.8 16% 70 - 75%.................................................... 4,247.2 33% 75 - 80%.................................................... 3,727.8 29% Greater than 80%............................................ 214.2 2% --------- --- $12,747.4 100% ========= === Weighted average LTV........................................ 70.1%
DEBT SERVICE COVERAGE RATIO RANGES $ % --------------------- ------------- --- (IN MILLIONS) 1.00 - 1.25................................................. $ 3,178.3 25% 1.26 - 1.50................................................. 7,174.7 56% 1.51 - 1.75................................................. 1,487.9 12% 1.76 - 2.00................................................. 440.6 3% Greater than 2.00........................................... 465.9 4% --------- --- $12,747.4 100% ========= === Weighted average DSCR....................................... 1.40
The increase in the commercial real estate portfolio during 2000 and 1999 was primarily due to the purchase of CMBS. The Company purchases CMBS at significant discounts from the face amount of the bonds. During the third quarter of 2000, the Company purchased $48.8 million in CMBS with a face value of $101.3 million and a weighted average yield to maturity of 15.0% after assuming a 1% loss rate on the underlying collateral mortgage pool. During the nine months ended September 30, 2000 the Company purchased $124.3 million in CMBS with a face value of $244.6 million and a weighted average yield to maturity of 14.7% after assuming a 1% loss rate on the underlying collateral mortgage pool. In 1999, the Company purchased $245.9 million in CMBS with a face value of $507.9 million and a weighted average yield to maturity of 14.6% after assuming a 1% loss rate on the underlying collateral mortgage pool. At September 30, 2000, the face value of the entire purchased CMBS portfolio was $813.8 million, our cost of acquiring the securities was $405.4 million and our unamortized discount was $406.3 million. The yield on the purchased CMBS portfolio was 14.7% as of September 30, 2000. The Company has been liquidating much of its whole commercial mortgage loan portfolio so that it can redeploy the proceeds into higher yielding assets and for the three months ended September 30, 2000, the Company sold $1.6 million of commercial mortgage loans. For the nine months ended September 30, 2000, the Company sold $53.1 million of commercial mortgage loans. At September 30, 2000, the Company's whole commercial loan portfolio had been reduced to $105.9 million from $154.1 million at December 31, 1999. During 1999, the Company sold $86.1 million of commercial mortgage loans. SMALL BUSINESS FINANCE During the second quarter of 1999, the Company combined its whole commercial real estate loan origination activity with its SBA 7(a) lending activity in order to increase its loans originated for sale 32 37 business under the Allied Capital Express brand name. Through Allied Capital Express, the Company provides small business and commercial real estate loans up to $3 million. The majority of the loans originated in this area are originated for sale, generally at premiums of up to 10% of the loan amount. Allied Capital Express loan activity and yields were as follows:
AT SEPTEMBER 30, AT DECEMBER 31, 2000 1999 ---------------- --------------- (IN MILLIONS) Portfolio at Value................................... $70.7 $61.4 Yield................................................ 12.3% 11.5%
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED FOR THE YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, ------------- -------------- ------------------ 2000 1999 2000 1999 1999 ----- ----- ------ ----- ------------------ (IN MILLIONS) New Investments..................... $36.7 $34.7 $109.0 $80.2 $116.5 Repayments.......................... $ 3.0 $ 1.2 $ 8.3 $ 9.9 $ 6.7 Sales............................... $33.1 $25.2 $ 98.8 $60.3 $112.3
Allied Capital Express loan origination activity for 2000 and 1999 increased due to the opening of new regional office locations and from opportunities created by our Internet site launched in the fall of 1999. Loans in the Allied Capital Express program are originated for sale; therefore, the increase in loan sales is the result of the increase in originations. In addition, beginning in 1999, the Company began to sell 90% of the unguaranteed portion of SBA 7(a) loans through a structured finance agreement with a commercial paper conduit. Allied Capital Express targets small commercial real estate loans that are, in many cases, originated in conjunction with SBA 7(a) loans. SBA 7(a) loans are originated with variable interest rates priced at spreads ranging from 1.75% to 2.75% over the prime lending rate. On October 31, 2000, the Company entered into a definitive merger agreement in order to acquire BLC Financial Services Inc. ("BLC") in a stock for stock exchange. The transaction will create an independently managed, private portfolio company. The Company also plans to merge its small business finance portfolio and Allied Capital Express operations into the new portfolio company. To effect the transaction, the Company will issue approximately 4.2 million shares of common stock, and BLC shareholders will receive a fixed exchange ratio of 0.18 shares of Company common stock for each share of BLC stock in a tax-free exchange. In addition, in a separate transaction, the Company intends to acquire a corporate shareholder of BLC for approximately $9.1 million in cash. The Company filed a registration statement on Form N-14 with the SEC on November 6, 2000 to register the shares to be issued in this transaction. The Company will own approximately 95% of the portfolio company upon completion of the transaction. Management will retain approximately 5% ownership. The Company's investment is structured to provide a current return through interest, dividends and fee income, and the investment will include debt, preferred stock and common stock. In addition, the Company believes there is opportunity to add value to the new portfolio company and to position its investment for future capital gain. Necessary approvals to complete the transaction include an affirmative vote of BLC shareholders, as well as regulatory approval by the SBA. The transaction is expected to close by December 31, 2000. 33 38 RESULTS OF OPERATIONS COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 The following table summarizes Allied Capital's operating results for the nine months ended September 30, 2000 and 1999:
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------- PERCENT 2000 1999 CHANGE CHANGE -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INTEREST AND RELATED PORTFOLIO INCOME Interest............................................... $129,768 $84,419 $45,349 54% Premiums from loan dispositions........................ 10,752 9,032 1,720 19% Investment advisory fees and other income.............. 9,334 5,411 3,923 73% -------- ------- ------- ----- Total interest and related portfolio income.... 149,854 98,862 50,992 52% -------- ------- ------- ----- EXPENSES Interest............................................... 41,645 24,173 17,472 72% Employee............................................... 14,709 11,303 3,406 30% Administrative......................................... 10,711 8,476 2,235 26% -------- ------- ------- ----- Total operating expenses....................... 67,065 43,952 23,113 53% -------- ------- ------- ----- Formula and cut-off awards............................. 4,797 5,188 (391) (8%) -------- ------- ------- ----- Portfolio income before net realized and unrealized gains............................ 77,992 49,722 28,270 57% -------- ------- ------- ----- NET REALIZED AND UNREALIZED GAINS Net realized gains..................................... 23,095 16,448 6,647 40% Net unrealized gains (losses).......................... (267) 1,475 (1,742) (118%) -------- ------- ------- ----- Total net realized and unrealized gains........ 22,828 17,923 4,905 27% -------- ------- ------- ----- Net increase in net assets resulting from operations..... $100,820 $67,645 $33,175 49% ======== ======= ======= ===== Diluted earnings per share............................... $ 1.42 $ 1.14 $ 0.28 25% ======== ======= ======= ===== Weighted average shares outstanding - diluted............ 70,777 59,239 11,538 19%
Net increase in net assets resulting from operations (NIA) results from total interest and related portfolio income earned, less total expenses incurred in the operations of the Company, plus net realized and unrealized gains or losses. Total interest and related portfolio income increased for the nine months ended September 30, 2000 by 52% as compared to the nine months ended September 30, 1999. Total interest and related portfolio income is primarily a function of the level of interest income earned and the balance of portfolio assets. In addition, total interest and related portfolio income includes premiums from loan dispositions, prepayment premiums, and investment advisory fees and other income.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2000 1999 --------- -------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Total Interest and Related Portfolio Income................. $149.9 $98.9 Per share................................................... $ 2.11 $1.67
34 39 The increase in interest income earned results primarily from continued growth of the Company's investment portfolio and the Company's focus on increasing its overall portfolio yield. The Company's investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 44% to $1,485.0 million at September 30, 2000 from $1,033.6 million at September 30, 1999. The weighted average yield on the interest bearing investments in the portfolio at September 30, 2000 and 1999 was as follows:
AT SEPTEMBER 30, -------------- 2000 1999 ----- ----- Private Finance............................................. 14.6% 14.0% Commercial Real Estate Finance.............................. 13.2% 11.8% Small Business Finance...................................... 12.3% 10.9% Total Portfolio............................................. 13.9% 12.6%
Included in net premiums from loan dispositions are premiums from loan sales and premiums received on the early repayment of loans. Premiums from loan sales were $8.7 million and $5.2 million for the nine months ended September 30, 2000 and 1999, respectively. This premium income results primarily from the premium paid by purchasers of loans originated through Allied Capital Express, less the origination commissions associated with the loans sold. The Company sold $98.8 million and $60.3 million of loans originated through Allied Capital Express during the nine months ended September 30, 2000 and 1999, respectively. The Company also sold commercial mortgage loans totaling $53.1 million and $60.6 million for the nine months ended September 30, 2000 and 1999, respectively. Prepayment premiums were $2.1 million, and $3.8 million for the nine months ended September 30, 2000 and 1999, respectively. While the scheduled maturities of private finance and commercial real estate loans range from five to ten years, it is not unusual for the Company's borrowers to refinance or pay off their debts to the Company ahead of schedule. Because the Company seeks to finance primarily seasoned, performing companies, such companies at times can secure lower cost financing as their balance sheets strengthen, or as more favorable interest rates become available. Therefore, the Company generally structures its loans to require a prepayment premium for the first three to five years of the loan. Our operating expenses include interest, employee and administrative expenses. The Company's largest expense is interest on indebtedness. The fluctuations in interest expense during the nine months ended September 30, 2000 and 1999 are attributable to changes in the level of borrowings by the Company and its subsidiaries under various notes payable and debentures and revolving credit facilities. The Company's borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:
AT AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------- 2000 1999 ------ ------ (IN MILLIONS) Total Outstanding Debt...................................... $762.2 $537.9 Average Outstanding Debt.................................... $684.3 $414.1 Weighted Average Cost....................................... 8.1% 7.4% BDC Asset Coverage*......................................... 236% 223%
------------------------- * As a BDC, the Company is generally required to maintain a ratio of 200% of total assets to total borrowings. 35 40 Employee expenses include salaries and employee benefits. The increase in salaries and employee benefits for the periods presented reflects the increase in total employees, combined with wage increases and the experience level of employees hired. Total employees were 136 and 124 at September 30, 2000 and 1999, respectively. The Company has been an active recruiter for experienced investment and operational personnel, and the Company will continue to actively recruit and hire new professionals throughout 2000 to support anticipated portfolio growth. Administrative expenses include the leases for the Company's headquarters in Washington, DC, and its regional offices. Administrative expenses also include travel costs, stock record expenses, directors' fees, legal and accounting fees and various other expenses. The increase in administrative expenses for the nine months ended September 30, 2000 as compared to the nine months ended September 30, 1999 was primarily the result of increases in costs associated with the growth of the Company and new regional offices. Net realized gains resulted from the sale of equity securities associated with certain private finance investments and the realization of unamortized discount resulting from the sale and early repayment of private finance and commercial mortgage loans, offset by losses on investments.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------- 2000 1999 ----- ----- (IN MILLIONS) Realized Gains.............................................. $24.7 $21.6 Realized Losses............................................. (1.6) (5.2) ----- ----- Net Realized Gains.......................................... $23.1 $16.4 ===== ===== Net Unrealized Gains (Losses)............................... $(0.3) $ 1.5 ===== =====
Realized gains of $24.7 million for the nine months ended September 30, 2000, resulted primarily from transactions involving seven portfolio companies, Southwest PCS, L.P. ($11.5 million), Grant Television, Inc. ($5.4 million), Julius Koch USA, Inc. ($1.7 million), Wilmar Industries, Inc. ($1.2 million), Hotelevision ($1.0 million), FTI Consulting, Inc. ($0.7 million) and Panera Bread Co. ($0.7 million). During the second quarter of 2000, the Company had the opportunity to sell its equity interest in Southwest PCS, L.P. ("SWPCS") to SWPCS's parent company. The Company sold its equity interest in exchange for two notes totaling $12.5 million. The first note was a short-term full recourse note for $5.0 million, bearing interest at a rate of 15% per annum. This first note was repaid on September 30, 2000. The second note was a two-year full recourse note for $7.5 million, bearing interest at 15% per annum. The second note is secured by the equity interest sold by the Company. The Company reversed previously recorded unrealized appreciation of $6.2 million when these gains were realized. Realized gains for the nine months ended September 30, 1999 of $21.6 million resulted primarily from transactions involving three portfolio companies. The Company reversed previously recorded unrealized appreciation of $8.3 million when these 1999 gains were realized. Realized losses of $1.6 million and $5.2 million for the nine months ended September 30, 2000 and 1999, respectively, resulted from the liquidation of certain portfolio investments. Losses realized for the nine months ended September 30, 2000 and 1999 had been recognized in NIA over time as unrealized depreciation when the Company determined that the respective portfolio security's value had become impaired. Thus, the Company reversed previously recorded unrealized depreciation totaling $1.3 million and $4.7 million when the related losses were realized for the nine months ended September 30, 2000 and 1999, respectively. 36 41 Net unrealized losses of $0.3 million and net unrealized gains of $1.5 million for the nine months ended September 30, 2000 and 1999, respectively, consisted of valuation changes resulting from the Board of Directors' valuation of the Company's assets and the effect of reversals of unrealized appreciation or depreciation resulting from realized gains or losses. During the third quarter of 2000, a portfolio company, NETtel Communications, Inc. ("NETtel") filed for bankruptcy protection. The Company has a $22 million senior debt and preferred stock investment in NETtel. Due to the portfolio company's current situation, in the third quarter the Company decreased the value of its principal investment in NETtel by recording unrealized depreciation of $8.5 million, reversed previously recorded unrealized appreciation of $1.4 million and placed the senior debt on non-accrual status. At September 30, 2000, net unrealized appreciation in the portfolio totaled $4.3 million and was composed of unrealized appreciation of $44.0 million, resulting primarily from appreciated equity interests in portfolio companies, and unrealized depreciation of $39.7 million, resulting primarily from underperforming loan and equity interests in the portfolio. At September 30, 1999, net unrealized appreciation in the portfolio totaled $3.9 million and was composed of unrealized appreciation of $31.8 million and unrealized depreciation of $27.9 million. Net realized and unrealized gains can vary substantially on a quarterly basis. Therefore, quarterly net realized and unrealized gains should not be annualized to predict expected annual results. The Company employs a standard grading system for the entire portfolio. Grade 1 is used for those investments from which a capital gain is expected. Grade 2 is used for investments performing in accordance with plan. Grade 3 is used for investments that require closer monitoring; however, no loss of interest or principal is expected. Grade 4 is used for investments for which some loss of contractually due interest is expected, but no loss of principal is expected. Grade 5 is used for investments for which some loss of principal is expected and the investment is written down to net realizable value. At September 30, 2000, the Company's portfolio was graded as follows:
PORTFOLIO PERCENTAGE OF GRADE AT VALUE TOTAL PORTFOLIO ----- ------------- --------------- (IN MILLIONS) 1...................................................... $ 156.0 9.5% 2...................................................... 1,362.6 83.2% 3...................................................... 40.0 2.4% 4...................................................... 54.2 3.3% 5...................................................... 25.4 1.6% -------- ------ $1,638.2 100.0% ======== ======
Included in the Grade 5 portfolio at September 30, 2000 are private finance investments totaling $18.1 million at value, or 1.1% of the Company's total portfolio based on the valuation of the Board of Directors. The value of these Grade 5 private finance investments has been reduced from an aggregate cost of $48.0 million in order to reflect the Company's estimate of the net realizable value of these investments upon disposition. This reduction in value has been recorded as unrealized depreciation over several years in the Company's earnings. The Company continues to follow its historical practices of working with a troubled portfolio company in order to recover the maximum amount of the Company's investment, but records unrealized depreciation for the expected full amount of the potential loss when such exposure is identified. Grade 5 private finance investments at December 31, 1999, 1998 and 1997 totaled $12.6 million, $6.4 million and $12.9 million at value, or 1.0%, 0.8% and 1.8% of the Company's total portfolio, respectively. 37 42 At September 30, 2000, the credit quality of the Company's CMBS portfolio remained strong, with less than 0.2% in delinquencies. The yield used to accrue interest on this portfolio assumes a 1% loss rate on the entire underlying collateral mortgage pool. For the total investment portfolio, loans greater than 120 days delinquent were $51.7 million at value at September 30, 2000, or 3.2% of the total portfolio. Included in this category are loans valued at $13.5 million that are fully secured by real estate. Loans greater than 120 days delinquent generally do not accrue interest. Loans greater than 120 days delinquent at December 31, 1999 were $18.6 million at value, or 1.5% of the total portfolio, which included $11.7 million that were fully secured by real estate. Because we are a provider of long-term privately negotiated investment capital, it is not atypical for us to defer payment of principal or interest from time to time. As a result, the amount of our portfolio that is greater than 120 days delinquent may vary from quarter to quarter. The terms of our private finance agreements frequently provide an opportunity for our portfolio companies to restructure their debt and equity capital. During such restructuring, we may not receive or accrue interest or dividend payments. We price our investment portfolio to provide adequate current returns for our shareholders assuming that a portion of the portfolio at any time may not be accruing interest currently. We also price our investments for a total return including current interest or dividends plus capital gains from the sale of equity securities. Therefore, the amount of loans greater than 120 days delinquent is not necessarily an indication of future principal loss or loss of anticipated investment return. The Company's portfolio grading system is used as a means to assess loss of investment return (Grade 4 assets) or loss of investment principal (Grade 5 assets). The Company has elected to be taxed as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended ("Code"). As long as the Company qualifies as a RIC, the Company is not taxed on its investment company taxable income or realized capital gains, to the extent that such income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis. Annual tax distributions may differ from NIA for the fiscal year due to timing differences in the recognition of income and expenses, returns of capital and net unrealized appreciation or depreciation, which are not included in taxable income. In order to maintain its RIC status, the Company must, in general, (1) derive at least 90% of its gross income from dividends, interest, gains from the sale of securities and other specified types of income; (2) meet investment diversification requirements as defined in the Code; and (3) distribute annually to shareholders at least 90% of its investment company taxable ordinary income. The Company intends to take all steps necessary to continue to meet the RIC qualifications. However, there can be no assurance that the Company will continue to elect or qualify for such treatment in future years. The weighted average common shares outstanding used to compute basic earnings per share were 70.6 million and 59.1 million for the nine months ended September 30, 2000 and 1999, respectively. The increases in the weighted average shares reflect the issuance of new shares and the issuance of shares pursuant to a dividend reinvestment plan. All per share amounts included in management's discussion and analysis have been computed using the weighted average shares used to compute diluted earnings per share, which were 70.8 million and 59.2 million for the nine months ended September 30, 2000 and 1999, respectively. 38 43 RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 The following table summarizes Allied Capital's operating results for the three months ended September 30, 2000 and 1999:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, ------------------- PERCENT 2000 1999 CHANGE CHANGE -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INTEREST AND RELATED PORTFOLIO INCOME Interest............................................... $ 48,054 $31,577 $16,477 52% Premiums from loan dispositions........................ 2,909 4,700 (1,791) (38%) Investment advisory fees and other income.............. 5,029 1,721 3,308 192% -------- ------- ------- ----- Total interest and related portfolio income.... 55,992 37,998 17,994 47% -------- ------- ------- ----- EXPENSES Interest............................................... 15,054 9,766 5,288 54% Employee............................................... 4,949 4,192 757 18% Administrative......................................... 3,876 3,200 676 21% -------- ------- ------- ----- Total operating expenses....................... 23,879 17,158 6,721 39% -------- ------- ------- ----- Formula and cut-off awards............................. 1,394 1,567 (173) (11%) -------- ------- ------- ----- Portfolio income before net realized and unrealized gains............................ 30,719 19,273 11,446 59% -------- ------- ------- ----- NET REALIZED AND UNREALIZED GAINS Net realized gains..................................... 8,054 4,886 3,168 65% Net unrealized gains (losses).......................... (2,324) 2,785 (5,109) (183%) -------- ------- ------- ----- Total net realized and unrealized gains........ 5,730 7,671 (1,941) (25%) -------- ------- ------- ----- Net increase in net assets resulting from operations..... $ 36,449 $26,944 $ 9,505 35% ======== ======= ======= ===== Diluted earnings per share............................... $ 0.48 $ 0.44 $ 0.04 9% ======== ======= ======= ===== Weighted average shares outstanding - diluted............ 76,133 61,458 14,675 24%
Net increase in net assets resulting from operations (NIA) results from total interest and related portfolio income earned, less total expenses incurred in the operations of the Company, plus net realized and unrealized gains or losses. In addition to the discussion of the comparison of the three months ended September 30, 2000 to the three months ended September 30, 1999 that follows, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Comparison of Nine Months Ended September 30, 2000 and 1999" above for additional discussion regarding the nature of and reasons for fluctuation in income and expense items in the Company's operating results. Total interest and related portfolio income increased for the three months ended September 30, 2000 by 47% as compared to the three months ended September 30, 1999. Total interest and related portfolio income is primarily a function of the level of interest income earned and the balance of 39 44 portfolio assets. In addition, total interest and related portfolio income includes premiums from loan dispositions, prepayment premiums, and investment advisory fees and other income.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, -------------------- 2000 1999 -------- -------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Total Interest and Related Portfolio Income................. $56.0 $38.0 Per share................................................... $0.73 $0.62
The increase in interest income earned results primarily from continued growth of the Company's investment portfolio and the Company's focus on increasing its overall portfolio yield. The Company's investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 44% to $1,485.0 million at September 30, 2000 from $1,033.6 million at September 30, 1999. Included in net premiums from loan dispositions are premiums from loan sales and premiums received on the early repayment of loans. Premiums from loan sales were $2.9 million and $1.5 million for the three months ended September 30, 2000 and 1999, respectively. This premium income results primarily from the premium paid by purchasers of loans originated through Allied Capital Express, less the origination commissions associated with the loans sold. The Company sold $33.1 million and $25.2 million of loans originated through Allied Capital Express during the three months ended September 30, 2000 and 1999, respectively. The Company also sold commercial mortgage loans totaling $1.6 million and $27.7 million for the three months ended September 30, 2000 and 1999, respectively. There were no prepayment premiums for the three months ended September 30, 2000 and $3.2 million for the three months ended September 30, 1999. Our operating expenses include interest, employee and administrative expenses. The Company's largest expense is interest on indebtedness. The fluctuations in interest expense during the three months ended September 30, 2000 and 1999 are attributable to changes in the level of borrowings by the Company and its subsidiaries under various notes payable and debentures and revolving credit facilities. The Company's borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:
AT AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, --------------- 2000 1999 ------ ------ (IN MILLIONS) Total Outstanding Debt...................................... $762.2 $537.9 Average Outstanding Debt.................................... $734.3 $517.0 Weighted Average Cost....................................... 8.1% 7.4% BDC Asset Coverage*......................................... 236% 223%
------------------------- * As a BDC, the Company is generally required to maintain a ratio of 200% of total assets to total borrowings. Employee expenses include salaries and employee benefits. The increase in salaries and employee benefits for the periods presented reflects the increase in total employees, combined with wage increases and the experience level of employees hired. Total employees were 136 and 124 at September 30, 2000 and 1999, respectively. The Company has been an active recruiter for experienced investment and operational personnel, and the Company will continue to actively recruit and hire new professionals throughout 2000 to support anticipated portfolio growth. 40 45 Administrative expenses include the leases for the Company's headquarters in Washington, DC, and its regional offices. Administrative expenses also include travel costs, stock record expenses, directors' fees, legal and accounting fees and various other expenses. The increase in administrative expenses for the three months ended September 30, 2000 as compared to the three months ended September 30, 1999 was primarily the result of increases in costs associated with the growth of the Company and new regional offices. Net realized gains resulted from the sale of equity securities associated with certain private finance investments and the realization of unamortized discount resulting from the sale and early repayment of private finance and commercial mortgage loans, offset by losses on investments. For further discussion of net realized and unrealized gains and losses, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Comparison of Nine Months Ended September 30, 2000 and 1999" above.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, ------------- 2000 1999 ----- ----- (IN MILLIONS) Realized Gains.............................................. $ 8.7 $ 6.7 Realized Losses............................................. $(0.7) $(1.8) ----- ----- Net Realized Gains.......................................... $ 8.0 $ 4.9 ===== ===== Net Unrealized Gains (Losses)............................... $(2.3) $ 2.8 ===== =====
The weighted average common shares outstanding used to compute basic earnings per share were 75.5 million and 61.0 million for the three months ended September 30, 2000 and 1999, respectively. The increases in the weighted average shares reflect the issuance of new shares and the issuance of shares pursuant to a dividend reinvestment plan. All per share amounts included in management's discussion and analysis have been computed using the weighted average shares used to compute diluted earnings per share, which were 76.1 million and 61.5 million for the three months ended September 30, 2000 and 1999, respectively. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES CASH AND CASH EQUIVALENTS At September 30, 2000, the Company had $26.2 million in cash and cash equivalents. The Company invests otherwise uninvested cash in U.S. government or agency-issued or guaranteed securities that are backed by the full faith and credit of the United States, or in high quality, short-term repurchase agreements fully collateralized by such securities. The Company's objective is to manage to a low cash balance and fund new originations with its credit facilities. 41 46 'DEBT The Company had outstanding debt at September 30, 2000 as follows:
ANNUAL AMOUNT INTEREST OUTSTANDING COST(1) ------------- -------- (IN MILLIONS) Notes payable and debentures: Unsecured long-term notes payable......................... $419.0 7.7% SBA debentures............................................ 77.5 8.5% Auction rate reset note................................... 75.0 8.6% OPIC loan................................................. 5.7 6.6% ------ ---- Total notes payable and debentures................ $577.2 7.9% ------ ---- Revolving credit facilities: Revolving line of credit.................................. $185.0 8.7% ------ ---- Total debt........................................ $762.2 8.1% ====== ====
------------------------- (1) The annual interest cost includes the cost of commitment fees and other facility fees. UNSECURED LONG-TERM NOTES PAYABLE. The Company has issued long-term debt to institutional lenders, primarily insurance companies. The notes have five- or seven-year maturities. The notes require payment of interest only semi-annually, and all principal is due upon maturity. On October 24, 2000, the Company closed on $125 million of five-year unsecured long-term debt, financed primarily by insurance companies. The five-year notes were priced at 8.54% and have substantially the same terms as the Company's existing long-term debt. The proceeds from this debt were used to repay borrowings from the revolving line of credit. SBA DEBENTURES. The Company, through its SBIC subsidiary, has debentures payable to the SBA with terms of ten years. The notes require payment of interest only semi-annually, and all principal is due upon maturity. The Company may borrow up to $105 million from the SBA under the SBIC program. At September 30, 2000, the Company has a commitment to borrow up to an additional $21 million from the SBA. The commitment expires on September 30, 2004. AUCTION RATE RESET NOTE. On August 31, 2000, the Company completed a private placement of a $75 million Auction Rate Reset Senior Note Series A. The note matures on December 2, 2002 and bears interest at the London Inter-Bank Offer Rate ("LIBOR") plus 175 basis points which adjusts quarterly. Interest is due quarterly and the Company, at its option, may pay or defer such interest payments. REVOLVING LINE OF CREDIT. The Company has a two-year, $417.5 million unsecured revolving line of credit that expires in May 2002. This facility may be expanded up to $500 million. At the Company's option, the credit facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The credit facility requires monthly payments of interest, and all principal is due upon maturity. 42 47 EQUITY CAPITAL AND DIVIDENDS The Company raises debt and equity capital for continued investment in growing businesses. Because the Company is a RIC, it distributes its income and requires external capital for growth. Because the Company is a BDC, it is limited in the amount of debt capital it may use to fund its growth, since it is generally required to maintain a ratio of 200% of total assets to total borrowings, or approximately 1 to 1 debt to equity capital ratio. To support its growth during the nine months ended September 30, 2000, the Company raised $250.9 million in new equity capital, of which $108.9 million was raised during the three months ended September 30, 2000, primarily through the sale of shares from its shelf registration statement. At September 30, 2000, total shareholders' equity had increased to $933.3 million. The Company issues equity from time to time using a shelf registration statement. The Company issues new equity when it has a clear use of proceeds for attractive investment opportunities. Historically, this process has enabled the Company to raise equity on an accretive basis for existing shareholders. The Company's Board has established a dividend policy for 2000 to review the dividend rate quarterly, and to adjust the quarterly dividend rate throughout the year as the Company's earnings momentum builds. In 1999, the Board had established a dividend policy of level quarterly dividends of $0.40 per common share, for an annual total distribution of $1.60 per common share to approximate annual taxable income. The Board changed its dividend policy for 2000 because of the Company's significant portfolio growth and continued growth in ordinary taxable income. For the first and second quarter of 2000, the Board declared a $0.45 per common share dividend. For the third and fourth quarters of 2000, the Board declared a dividend of $0.46 per common share. As a result of growth in ordinary taxable income combined with the increased size and diversity of the Company's portfolio and its projected future capital gains, the Company's Board of Directors will continue to evaluate whether to retain or distribute capital gains as they occur. The new policy will allow the Company to continue to distribute some capital gains, but will also allow the Company to retain gains that exceed a normal capital gains distribution level, and therefore avoid any unusual spike in dividends in any one year. The new policy also enables the Board to selectively retain gains to support future growth. The Company plans to maintain a strategy of financing its operations, dividend requirements and future investments with cash from operations, through borrowings under short- or long-term credit facilities or other debt securities, through asset sales, or through the sale or issuance of new equity capital. The Company will utilize its short-term credit facilities only as a means to bridge to long-term financing. The Company evaluates its interest rate exposure on an ongoing basis. The Company maintains a matched-funding philosophy that focuses on matching the estimated maturities of its loan and investment portfolio to the estimated maturities of its borrowings. The Company also manages its interest rate risk by financing floating-rate assets with similar term floating-rate liabilities and fixed-rate assets with similar term fixed-rate liabilities. To the extent deemed necessary, the Company may hedge variable and short-term interest rate exposure through interest rate swaps or other techniques. At September 30, 2000, the Company's debt to equity ratio was less than 1 to 1. The Company's weighted average cost of funds was 8.1% at September 30, 2000. There are no significant maturities of long-term debt until 2002. The Company believes that it has access to capital sufficient to fund its ongoing investment and operating activities, and from which to pay dividends. 43 48 INVESTMENT CONSIDERATIONS Investing in the Company involves a number of significant risks and other factors relating to the structure and investment objective of the Company. As a result, there can be no assurance that the Company will achieve its investment objective. INVESTING IN PRIVATE COMPANIES INVOLVES A HIGH DEGREE OF RISK. Our portfolio consists primarily of long-term loans to and investments in private companies. There is generally no publicly available information about these companies, and we rely significantly on the diligence of our employees and agents to obtain information in connection with the Company's investment decisions. In addition, some smaller businesses have narrower product lines and market shares than their competition, and may be more vulnerable to customer preferences, market conditions or economic downturns, which may adversely affect the return on, or the recovery of, our investment in such businesses. Investments in private businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS. We primarily invest in and lend to companies that may have limited financial resources and that may be unable to obtain financing from traditional sources. Numerous factors may affect a borrower's ability to repay its loan, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. Deterioration in a borrower's financial condition and prospects may be accompanied by deterioration in the collateral for the loan. We make unsecured, subordinated loans and invest in equity securities, which may involve a higher degree of repayment risk. OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID. We acquire most of our investments directly from private companies. The majority of the investments in our portfolio will be subject to restrictions on resale or otherwise have no established trading market. The illiquidity of most of our portfolio may adversely affect our ability to dispose of loans and securities at times when it may be advantageous for us to liquidate such investments. WE INVEST IN NON-INVESTMENT GRADE CMBS. The commercial mortgage-backed securities ("CMBS") in which we invest are non-investment grade, which means that nationally recognized statistical rating organizations rate them below the top four investment-grade rating categories (i.e., "AAA" through "BBB"). Non-investment grade securities usually provide a higher yield than do investment-grade bonds, but with the higher return comes greater risk. Non-investment grade securities are considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not ensured. Therefore, the non-investment grade CMBS tend to be less liquid, may have a higher risk of default and may be more difficult to value. OUR PORTFOLIO IS RECORDED AT FAIR VALUE AS DETERMINED BY THE BOARD OF DIRECTORS. Pursuant to the requirements of the Investment Company Act of 1940 ("1940 Act"), the Board of Directors is required to value each asset quarterly, and we are required to carry our portfolio at fair value as determined by the Board of Directors. Since there is typically no public market for the loans and equity securities of the companies in which we make investments, our Board of Directors estimates the fair value of these loans and equity securities pursuant to a written valuation policy and a consistently applied valuation process. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses; we are instead required by the 1940 Act to specifically value each individual investment and record an unrealized loss for an asset that we believe has become impaired. We adjust quarterly the valuation of our portfolio to reflect the Board of Directors' estimate of the current realizable value of each investment in our portfolio. Without a readily ascertainable market value, the estimated value of our portfolio of loans and equity securities may differ significantly from the values that would be placed on the portfolio if there existed a ready market for the loans and 44 49 equity securities. Any changes in estimated value are recorded in the Company's statement of operations as "Net unrealized gains (losses)." WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY. We borrow from, and issue senior debt securities to, banks, insurance companies and other lenders. Lenders of these senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common shareholders. Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to the Company's common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our consolidated income in excess of consolidated interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our consolidated income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock dividend payments, and, if asset coverage for a class of senior security representing indebtedness declines to less than 200%, we may be required to sell a portion of our investments when it is disadvantageous to do so. Leverage is generally considered a speculative investment technique. As of September 30, 2000, the Company's asset coverage for indebtedness was 236%. Our ability to achieve our investment objective may depend in part on our continued ability to maintain a leveraged capital structure by borrowing from banks or other lenders on favorable terms. There can be no assurance that we will be able to maintain such leverage. At September 30, 2000, the Company had $762.2 million of outstanding indebtedness, bearing a weighted annual interest cost of 8.1%. In order for us to cover these annual interest payments on indebtedness, we must achieve annual returns on our September 30, 2000 portfolio of at least 3.6%. CHANGES IN INTEREST RATES MAY AFFECT OUR COST OF CAPITAL. Because we borrow money to make investments, our income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our portfolio income before net realized and unrealized gains. However, there would be no effect on the return, if any, that could be generated from our equity interests. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. Investments originated for sale generally carry variable rates and are financed with short-term variable rate debt. Our long-term fixed-rate investments are financed with long-term fixed-rate debt and equity. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. There can be no assurance that a significant change in market interest rates will not have a material adverse effect on our portfolio income. BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL. We will continue to need capital to fund incremental growth in our investments. Historically, we have borrowed from financial institutions and have issued equity securities. A reduction in the availability of funds from financial institutions could limit our ability to grow. We must distribute at least 90% of our taxable net operating income excluding net realized long-term capital gains to our stockholders to maintain our regulated investment company ("RIC") status. As a result such earnings will not be available to fund investment originations. We expect to continue to borrow from financial institutions and sell additional equity securities. If we fail to obtain funds from such sources or from other sources to fund our investments, it could limit our ability to grow, which could have a material adverse effect on the value of the Company's common stock. In addition, as a business development 45 50 company ("BDC"), we are generally required to maintain a ratio of at least 200% of total assets to total borrowings, which may restrict our ability to borrow in certain circumstances. OUR PORTFOLIO MAY NOT PRODUCE CAPITAL GAINS. Private finance investments are typically structured as debt securities with a relatively high fixed rate of interest and with an equity feature such as conversion rights, warrants or options. As a result, private finance investments generate interest income from the time they are made, and may also produce a realized gain from an accompanying equity feature. We cannot be sure that our portfolio will generate a current return or capital gains. LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS AND INCOME AVAILABLE FOR DIVIDENDS. We have operated the Company so as to qualify to be taxed as a RIC under Subchapter M of the Internal Revenue Code of 1986, as amended ("Code"). If we meet certain source of income, diversification and distribution requirements, the Company qualifies for pass-through tax treatment. The Company would cease to qualify for pass-through tax treatment if it were unable to comply with these requirements, or if it ceased to qualify as a BDC under the 1940 Act. We also could be subject to a 4% excise tax (and, in certain cases, corporate level income tax) if we fail to make certain distributions. If the Company fails to qualify as a RIC, the Company would become subject to federal income tax as if it were an ordinary corporation, which would substantially reduce our net assets and the amount of income available for distribution to our shareholders. WE OPERATE IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES. We compete for investments with many other companies and individuals, some of whom have greater resources than we do. Increased competition would make it more difficult for us to purchase or originate investments at attractive prices. As a result of this competition, sometimes we may be precluded from making otherwise attractive investments. WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT. We are regulated by the Commission and the SBA. In addition, changes in the laws or regulations that govern BDCs, RICs, real estate investment trusts ("REITs"), SBICs and SBLCs may significantly affect our business. Laws and regulations may be changed from time to time, and the interpretations of the relevant laws and regulations also are subject to change. Any change in the law or regulations that govern our business could have a material impact on the Company or its operations. QUARTERLY RESULTS MAY FLUCTUATE. The Company's quarterly operating results could fluctuate due to a number of factors. These factors include, among others, variations in the investment origination volume, variation in timing of prepayments, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, you should not rely on quarterly results to be indicative of the Company's performance in future quarters. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change in the quantitative or qualitative disclosures about market risk since December 31, 1999. 46 51 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is party to certain lawsuits in the normal course of business. While the outcome of these legal proceedings cannot at this time be predicted with certainty, the Company does not expect that these proceedings will have a material effect upon the Company's financial condition or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS During the three months ended September 30, 2000 ACC issued a total of 58,715 shares pursuant to a dividend reinvestment plan. This plan is not registered and relies on an exemption from registration in the Securities Act of 1933. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) List of Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1(18) Agreement and Plan of Merger, dated as of October 31, 2000, by and among Allied Capital Corporation, Allied Capital B Sub Corporation, and BLC Financial Services, Inc. 2.2(18) Voting and Support Agreement with key shareholders of BLC Financial Services, Inc. dated October 31, 2000. 2.3(18) Lockup Agreement with key shareholders of BLC Financial Services, Inc. dated October 31, 2000. 2.4(18) Agreement and Plan of Merger, dated as of October 31, 2000, by and among the Company, Allied Capital F Sub Corporation and Futuronics Corporation. 2.5(18) Voting and Support Agreement with key shareholders of Futuronics Corporation dated October 31, 2000. 2.6(18) Lockup Agreement with key shareholders of Futuronics Corporation dated October 31, 2000. 3(i)(1) Articles of Amendment and Restatement of the Articles of Incorporation. 3(ii)(2) Articles of Merger. 3(iii)(15) Bylaws. 4.1(6) Specimen certificate of the Company's Common stock, par value $0.0001 per share. See exhibits 3(i), 3(ii) and 3(iii) for other instruments defining the rights of security holders.
47 52
EXHIBIT NUMBER DESCRIPTION ------- ----------- 4.2(4) Form of debenture between certain subsidiaries of the Company and the U.S. Small Business Administration. 5 Not applicable. 9 Not applicable. 10.1(11) Credit Agreement dated as of March 9, 1999 between the Company, as borrower, each of the financial institutions initially a signatory thereto, as Lenders, and Nationsbank, N.A., as administrative agent, Nationsbanc Montgomery Securities LLC, as sole lead arranger and sole book manager, First Union National Bank, as syndication agent, BankBoston, N.A., as documentation agent, Riggs Bank, N.A., as managing agent, and Chevy Chase Bank, F.S.B. and Credit Lyonnais New York Branch, as co-agents. 10.1a(12) First Amendment to Credit Agreement dated May 7, 1999. 10.1b(15) Second Amendment to Credit Agreement dated January 18, 2000. 10.1c(15) Third Amendment to Credit Agreement dated March 17, 2000. 10.1d(16) Amended and Restated Credit Agreement dated May 17, 2000. 10.2(8) Note Agreement dated as of April 30, 1998. 10.3(5) Loan Agreement between Allied I and Overseas Private Investment Corporation, dated April 10, 1995. Letter dated December 11, 1997 evidencing assignment of Loan Agreement from Allied I to the Company. 10.4(12) Note Agreement dated as of May 1, 1999. 10.4a(15) Note Agreement dated as of November 15, 1999. 10.4b* Note Agreement dated as of October 15, 2000. 10.5(14) Second Amended and Restated Master Loan & Security Agreement dated October 28, 1999 between the Company and Morgan Stanley Mortgage Capital, Inc. 10.6(6) Sale and Servicing Agreement dated as of January 1, 1998 among Allied Capital CMT, Inc., Allied Capital Commercial Mortgage Trust 1998-1 and the Company and LaSalle National Bank Inc. and ABN AMRO Bank N.V. 10.7(6) Indenture dated as of January 1, 1998 between Allied Capital Commercial Mortgage Trust 1998-1 and LaSalle National Bank. 10.8(6) Amended and Restated Trust Agreement dated January 1, 1998 between Allied Capital CMT, Inc., LaSalle National Bank Inc. and Wilmington Trust Company. 10.9(6) Guaranty dated as of January 1, 1998 by the Company. 10.10(3) Employee Stock Ownership Plan, as amended on December 31, 1997. 10.10a(7) First Amendment to the Company's Employee Stock Ownership Plan dated April 30, 1998. 10.10b(14) Termination Amendment to the Allied Capital Employee Stock Ownership Plan effective December 31, 1999. 10.10c(16) Employment Agreement dated June 15, 2000 between the Company and William L. Walton. 10.10d(16) Employment Agreement dated June 15, 2000 between the Company and Joan M. Sweeney. 10.10e(16) Employment agreement dated June 15, 2000 between the Company and G. Cabell Williams III. 10.11(10) Amended and Restated Deferred Compensation Plan dated December 30, 1998.
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.12(9) Amended Stock Option Plan. 10.12a(13) Allied Capital 401(k) Plan dated September 1, 1999. 10.13a(6) Form of Custody Agreement with Riggs Bank N.A. with respect to safekeeping. 10.13b(6) Form of Custody Agreement with La Salle National Bank. 10.14(17) Auction Rate Reset Note Agreement, dated as of August 31, 2000 between the Company and Intrepid Funding Master Trust, a Delaware business trust administered by Banc of America Securities LLC; Forward Issuance Agreement, dated as of August 31, 2000, between the Company and Banc of America Securities LLC; Remarketing and Contingency Purchase Agreement, dated as of August 31, 2000 between the Company and Banc of America Securities LLC. 10.18(3) Dividend Reinvestment Plan. 11 Statement regarding computation of per share earnings is incorporated by reference to Note 6 to the Company's Notes to the Consolidated Financial Statements contained herein. 21 Subsidiaries of the Company and jurisdiction of incorporation/organization: Allied Investment Corporation Maryland Allied Capital SBLC Corporation Maryland Allied Capital REIT, Inc. Maryland Allied Capital Holdings LLC Delaware Allied Capital Beteiligungsberatung GmbH Germany 27* Financial Data Schedule
-------------------- * Filed herewith. (1) Incorporated by reference to exhibit 3(i) with Allied Lending's Annual Report on Form 10-K for the year ended December 31, 1996. (2) Incorporated by reference from Appendix B to the Company's registration statement on Form N-14 filed on the Company's behalf with the Commission on September 26, 1997 (File No. 333-36459). (3) Incorporated by reference to the exhibit of the same name filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1997. (4) Incorporated by reference to the exhibit of the same name filed with Allied I's Annual Report on Form 10-K for the year ended December 31, 1996. (5) Incorporated by reference to Exhibit f.7 of Allied I's Pre-Effective Amendment No. 2 filed with the registration statement on Form N-2 on January 24, 1996 (File No. 33-64629). Assignment to Company is incorporated by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 1997. (6) Incorporated by reference to the exhibit of the same name to the Company's registration statement on Form N-2 filed on the Company's behalf with the Commission on May 5, 1998 (File No. 333-51899). (7) Incorporated by reference to the exhibit of the same name filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1998. (8) Incorporated by reference to the exhibit of the same name filed with the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998. 49 54 (9) Incorporated by reference to Exhibit A of the Company's definitive proxy materials for the Company's 2000 Annual Meeting of Stockholders filed with the Commission on March 29, 2000. (10) Incorporated by reference to the exhibit of the same name filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1998. (11) Incorporated by reference to Exhibit f.2.a with the Company's registration statement on Form N-2 (File No. 333-75161) filed on March 26, 1999. (12) Incorporated by reference to the exhibit of the same name filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1999. (13) Incorporated by reference to Exhibit 4.4 of the Allied Capital 401(k) Plan registration statement on Form S-8, filed on behalf of such Plan on October 8, 1999 (File No. 333-88681). (14) Incorporated by reference to the exhibit of the same name filed with the Company's Post-Effective Amendment No. 1 to Form N-2 (File No. 333-84973) on November 10, 1999. (15) Incorporated by reference to the exhibit of the same name filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1999. (16) Incorporated by reference to the exhibit of the same name to the Company's registration statement on Form N-2 filed on the Company's behalf with the Commission on August 11, 2000. (File No. 333-43534) (17) Incorporated by reference to the exhibit of the same name to Allied Capital's registration statement on Pre-Effective Amendment No. 1 to Form N-2 filed on Allied Capital's behalf with the Commission on September 12, 2000 (File No. 333-43534). (18) Incorporated by reference to the exhibit of the same name to the Company's registration statement on Form N-14 filed on the Company's behalf with the Commission on November 6, 2000. (b) Reports on Form 8-K. The Company filed no reports on Form 8-K during the quarter ended September 30, 2000. 50 55 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized. ALLIED CAPITAL CORPORATION (Registrant) Dated: November 6, 2000 /s/ PENNI F. ROLL ---------------------------------------------- Executive Vice President and Chief Financial Officer
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