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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED DECEMBER 31, 2001.
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 814-00237
GLADSTONE CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
MARYLAND 54-2040781
- -------------------------------------------------------------- ------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1616 ANDERSON ROAD, SUITE 208
MCLEAN, VIRGINIA 22102
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(Address of principal executive office)
(703) 286-7000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. The number of shares
of the issuer's Common Stock, $0.001 par value, outstanding as of January 31,
2002 was 10,060,178.
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GLADSTONE CAPITAL CORPORATION
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION........................................................................................3
Item 1. Financial Statements.........................................................................................3
Consolidated Balance Sheets as of December 31, 2001 (unaudited)and September 30, 2001........................4
Schedule of Investments as of December 31, 2001 (unaudited)..................................................5
Consolidated Statement of Operations for the three months ended December 31, 2001 (unaudited)................6
Consolidated Statements of Stockholders' Equity for the three months ended December 31, 2001 (unaudited).....7
Consolidated Statement of Cash Flows for the three months ended December 31, 2001 (unaudited)................8
Notes to Financial Statements (unaudited)....................................................................9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................11
Overview....................................................................................................11
Results of Operations.......................................................................................13
Financial Condition, Liquidity and Capital Resources........................................................14
Item 3. Quantitative and Qualitative Disclosure About Market Risk...................................................15
PART II. OTHER INFORMATION...........................................................................................16
Item 1. Legal Proceedings...........................................................................................16
Item 6. Exhibits and Reports on Form 8-K............................................................................16
SIGNATURES
2
PART I--FINANCIAL INFORMATION
Gladstone Capital Corporation
Consolidated Financial Statements
December 31, 2001
CONTENTS
Consolidated Balance Sheets...................................................................................4
Schedule of Investments.......................................................................................5
Consolidated Statements of Operations.........................................................................6
Consolidated Statements of Stockholders' Equity...............................................................7
Consolidated Statement of Cash Flows..........................................................................8
Notes to Consolidated Financial Statements....................................................................9
3
GLADSTONE CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)
December 31, September 30,
2001 2001
------------- -------------
ASSETS
Investments at fair value (Cost 12/31/2001: $42,017,863; 9/30/2001: $0) $ 42,017,863 $ -
Cash and cash equivalents 90,378,659 131,824,080
Interest receivable - debt securities 79,407 -
Interest receivable 3,737 34,544
Interest receivable - officers - 45,355
Prepaid assets 140,574 166,250
Other assets 249,762 135,257
------------- -------------
TOTAL ASSETS $ 132,870,002 $ 132,205,486
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Dividends Payable $ 1,810,832 $ -
Accounts Payable 250,538 -
Accrued offering costs - 590,382
Accrued expenses and deferred liabilities 223,380 365,960
------------- -------------
Total Liabilities $ 2,284,750 $ 956,342
------------- -------------
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value, 50,000,000 shares authorized
and 10,060,178 shares issued and outstanding $ 10,060 $ 10,060
Capital in excess of par value 140,080,807 140,131,778
Notes receivable - officers (8,799,119) (8,800,050)
Net realized loss - (92,644)
Distributions in excess of undistributed net realized earnings (706,496) -
------------- -------------
Total Stockholders' Equity 130,585,252 131,249,144
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 132,870,002 $ 132,205,486
============= =============
SEE ACCOMPANYING NOTES.
4
GLADSTONE CAPITAL CORPORATION
SCHEDULE OF INVESTMENTS
AS OF DECEMBER 31, 2001
(UNAUDITED)
COMPANY INDUSTRY INVESTMENT COST FAIR VALUE
- ----------------------------- --------------------------- --------------------------- ---------------- ---------------
ARI Holdings, Inc. Manufacturing--auto parts Sr. Subordinated Debt $ 7,980,863 $ 7,980,863
- ----------------------------- --------------------------- --------------------------- ---------------- ---------------
Finn Corporation Manufacturing--landscape Sr. Subordinated Debt 10,500,000 10,500,000
equipment Common Stock Warrants 37,000 37,000
for 2% ownership
- ----------------------------- --------------------------- --------------------------- ---------------- ---------------
Marcal Paper Mills, Inc. Manufacturing--paper Sr. Subordinated Debt 7,500,000 7,500,000
products First Mortgage Facility 9,000,000 9,000,000
- ----------------------------- --------------------------- --------------------------- ---------------- ---------------
Nextira, LLC(1) Service--network-related Term Loan 7,000,000 7,000,000
services
- ----------------------------- --------------------------- --------------------------- ---------------- ---------------
Totals $42,017,863 $42,017,863
---------------- ---------------
---------------- ---------------
- ----------
(1) We also have an $8 million credit facility with Nextira, LLC of which $0
was outstanding at December 31, 2001.
SEE ACCOMPANYING NOTES.
5
GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months
Ended December 31, 2001
-----------------------
OPERATING INCOME
Interest income - debt $ 329,657
Interest income - cash and cash equivalents 640,515
Interest income - officer loans 107,418
Loan and managerial assistance fees 611,809
-----------
Total Operating Income $ 1,689,399
-----------
OPERATING EXPENSES
Salaries and benefits $ 277,184
Rent 11,053
Professional fees 101,421
Directors fees 2,000
General and administrative 100,761
-----------
Total Operating Expenses $ 492,419
-----------
NET OPERATING INCOME(LOSS) $ 1,196,980
===========
NET INCREASE(DECREASE) IN STOCKHOLDERS' EQUITY
RESULTING FROM OPERATIONS $ 1,196,980
===========
- -----------------------------------------------------------------------------------------------------
NET OPERATING INCOME PER COMMON SHARE:
Basic $ 0.12
Diluted 0.12
WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:
Basic 10,060,178
Diluted 10,146,030
SEE ACCOMPANYING NOTES.
6
GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Notes (Distributions
Receivable in Excess of)
Common Stock Capital in From Sale of Undistributed Total
------------------------- Excess of Common Net Realized Stockholders'
Shares Amount Par Value Stock Earnings Equity
----------- ------------- ------------- ------------- -------------- -------------
Balance at September 30, 2001 10,060,178 $ 10,060 $ 140,131,778 $ (8,800,050) $ (92,644) $ 131,249,144
Offering Costs (50,971)
(50,971)
Repayment of Principal
on Notes Receivable 931 931
Net Increase in Stockholders'
Equity Resulting from
Operations 1,196,980 1,196,980
Distributions - - - - (1,810,832) (1,810,832)
------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 2001 10,060,178 $ 10,060 $ 140,080,807 $ (8,799,119) $ (706,496) $ 130,585,252
============= ============= ============= ============= ============= =============
SEE ACCOMPANYING NOTES.
7
GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS AND CASH EQUIVALENTS
(UNAUDITED)
Three Months Ended
December 31, 2001
------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in stockholders' equity resulting from operations $ 1,196,980
Adjustments to reconcile net decrease in stockholders' equity
resulting from operations to net cash provided by operating
activities:
Increase in interest receivable (3,245)
Increase in other assets (114,505)
Decrease in accrued expenses and deferred liabilities (142,580)
Decrease in prepaid assets 25,676
Increase in accounts payable 250,538
-------------
Net Cash Provided by Operating Activities $ 1,212,864
-------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments $ (42,017,863)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES
Offering costs $ (50,971)
Decrease in accrued offering costs (590,382)
Repayment of principal on notes receivable--officers 931
-------------
Net Cash Used in Financing Activities $ (640,422)
-------------
NET DECREASE IN CASH AND CASH EQUIVALENTS $ (41,445,421)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 131,824,080
-------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 90,378,659
=============
SEE ACCOMPANYING NOTES.
8
GLADSTONE CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
DECEMBER 31, 2001
NOTE 1. UNAUDITED INTERIM FINANCIAL STATEMENTS
Interim financial statements of Gladstone Capital Corporation (the
"Company") are prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and pursuant to the
requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain disclosures accompanying annual financial statements
prepared in accordance with GAAP are omitted. In the opinion of management, all
adjustments, consisting solely of normal recurring accruals, necessary for the
fair presentation of financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results that ultimately may be achieved for the year. The interim
financial statements and notes thereto should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K for
the fiscal year ended September 30, 2001, as filed with the Securities and
Exchange Commission.
NOTE 2. ORGANIZATION
The Company was incorporated under the General Corporation Laws of the
State of Maryland on May 30, 2001 as a closed-end investment company. The
Company has elected to be treated as a business development company under the
Investment Company Act of 1940, as amended (the "1940 Act"). In addition, the
Company has elected to be treated for tax purposes as a regulated investment
company, or RIC, under the Internal Revenue Code of 1986, as amended (the
"Code"). The Company's investment objectives are to achieve a high level of
current income by investing in debt and equity securities of established private
businesses.
Gladstone Advisers, Inc., a wholly-owned subsidiary, conducts the
daily administrative operations of the Company.
On August 29, 2001, the Company closed its initial public offering and
sold 9,430,000 shares of its common stock at $15.00 per share, less an
underwriting discount of $1.05 per share and offering expenses of $859,343, for
total net proceeds to the Company of $130,689,157.
NOTE 3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share.
Numerator for basic and diluted earnings per share $ 1,196,980
Denominator for basic weighted average shares 10,060,178
Employee stock options 663,330
Dilutive potential shares 85,852
Denominator for diluted weighted average shares 10,146,030
Basic earnings per common share $0.12
Diluted earnings per common share $0.12
9
NOTE 4. NET ASSET VALUE PER SHARE
The Company's net asset value per share at December 31, 2001 was $12.98
and at September 30, 2001 was $13.05.
NOTE 5. DIVIDENDS
The Company is required to pay out as a dividend 90% of its ordinary
income and short-term capital gains for each taxable year in order to maintain
its status as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. It
is the policy of the Company to pay out as a dividend up to 100% of those
amounts. The amount to be paid out as a dividend is determined by the Board of
Directors each quarter and is based on the annual earnings estimated by the
management of the Company. Based on that estimate, a dividend is declared each
quarter. At year-end the Company may pay a bonus dividend, in addition to the
quarterly dividends, to ensure that it has paid out at least 90% of its ordinary
income and short-term capital gains for the year. The Company has a policy of
retaining long-term capital gains and not paying them out as dividends.
On January 15, 2002, the Company paid a dividend of $0.18 per share on
its common stock to its stockholders of record as of December 31, 2001.
NOTE 6. INVESTMENT VALUATION
The Company carries its investments at fair value, as determined by the
Board of Directors. Securities that are publicly traded are valued at the
closing price on the valuation date. Debt and equity securities that are not
publicly traded are valued at fair value as determined in good faith by the
Board of Directors. In making such determination, the Board of Directors values
non-convertible debt securities at cost plus amortized original issue discount,
if any, unless adverse factors lead to a determination of a lesser valuation. In
valuing convertible debt, equity or other securities, the Board of Directors
determines the fair value based on the collateral, the issuer's ability to make
payments, the earnings of the issuer, sales to third parties of similar
securities, the comparison to publicly traded securities and other pertinent
factors. Due to the uncertainty inherent in the valuation process, such
estimates of fair value may differ significantly from the values that would have
resulted had a ready market for the securities existed, and the differences
could be material. Additionally, changes in the market environment and other
events that may occur over the life of the investments may cause the gains
ultimately realized on these investments to be different than the valuation
currently assigned.
NOTE 7. LOAN AND MANAGERIAL ASSISTANCE FEES
The 1940 Act requires that a business development company make
available managerial assistance to its portfolio companies. The company
provides managerial assistance to its portfolio companies through its
wholly-owned subsidiary, Gladstone Advisers, Inc. The Company receives fee
income for managerial assistance it renders to portfolio companies in
connection with its investments. Such fees are normally paid at the closing
of the Company's investments and are non-recurring. These managerial
assistance services vary by investment, but generally consist of reviewing
existing credit facilities, arranging bank financing, arranging equity
financing, structuring financing from multiple lenders, structuring financing
from equity investors, restructuring existing loans, raising equity and debt
capital and providing general financial advice. For the three months ended
December 31, 2001, these fees totaled $612,000.
From time to time, the Company will be invited to participate as a
co-lender in a transaction. Where the Company does not provide significant
managerial assistance services, loan fees paid to the Company in such
situations will be deferred and amortized over the life of the loan.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
ALL STATEMENTS CONTAINED HEREIN, OTHER THAN HISTORICAL FACTS, MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED. THESE STATEMENTS MAY RELATE TO, AMONG OTHER THINGS,
FUTURE EVENTS OR OUR FUTURE PERFORMANCE OR FINANCIAL CONDITION. IN SOME CASES,
YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS "MAY,"
"MIGHT," "BELIEVE," "WILL," "PROVIDED," "ANTICIPATE," "FUTURE," "COULD,"
"GROWTH," "PLAN," "INTEND," "EXPECT," "SHOULD," "WOULD," "IF," "SEEK,"
"POSSIBLE," "POTENTIAL" OR THE NEGATIVE OF SUCH TERMS OR COMPARABLE TERMINOLOGY.
THESE FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES
AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS, LEVELS OF ACTIVITY,
PERFORMANCE OR ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS,
LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, (1) ADVERSE
CHANGES IN INTEREST RATES; (2) OUR FAILURE OR INABILITY TO ESTABLISH OR MAINTAIN
REFERRAL ARRANGEMENTS WITH LEVERAGED BUYOUT FUNDS AND VENTURE CAPITAL FUNDS TO
GENERATE LOAN OPPORTUNITIES; (3) THE LOSS OF ONE OR MORE OF OUR EXECUTIVE
OFFICERS, IN PARTICULAR DAVID GLADSTONE OR TERRY LEE BRUBAKER; (4) OUR INABILITY
TO ESTABLISH OR MAINTAIN A CREDIT FACILITY ON TERMS REASONABLY ACCEPTABLE TO US,
IF AT ALL; (5) OUR INABILITY TO SUCCESSFULLY SECURITIZE OUR LOAN PORTFOLIO ON
TERMS REASONABLY ACCEPTABLE TO US, IF AT ALL; (6) THE DECISION OF OUR
COMPETITORS TO AGGRESSIVELY SEEK TO MAKE SENIOR AND SUBORDINATED LOANS TO SMALL
AND MEDIUM-SIZED BUSINESSES ON TERMS MORE FAVORABLE THAN WE INTEND TO PROVIDE;
(7) OUR INABILITY TO CONSUMMATE LOAN TRANSACTIONS WITH ONE OR MORE OF THE
ENTITIES IDENTIFIED UNDER THE CAPTION "PROSPECTIVE PORTFOLIO COMPANIES" OF OUR
PROSPECTUS DATED AUGUST 23, 2001, AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION (THE "SEC") ON AUGUST 27, 2001, ON TERMS ACCEPTABLE TO US, IF AT ALL;
AND (8) THOSE FACTORS LISTED UNDER THE CAPTION "RISK FACTORS" OF THE ANNUAL
REPORT ON FORM 10-K AS FILED WITH THE SEC ON DECEMBER 21, 2001. WE CAUTION
READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH FORWARD-LOOKING STATEMENTS,
WHICH ARE MADE PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT ON 1995
AND, AS SUCH, SPEAK ONLY AS OF THE DATE MADE. WE UNDERTAKE NO OBLIGATION TO
PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF
NEW INFORMATION, FUTURE EVENTS OR OTHERWISE AFTER THE DATE OF THIS FORM 10-Q.
THE FOLLOWING ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE
NOTES THERETO CONTAINED ELSEWHERE IN THIS REPORT.
OVERVIEW
We were incorporated under the General Corporation Laws of the State of
Maryland on May 30, 2001. Our investment objectives are to achieve a high level
of current income by investing in debt securities, consisting primarily of
senior notes, senior subordinated notes and junior subordinated notes, of
established private businesses that are backed by leveraged buyout funds,
venture capital funds or others, with a particular emphasis on senior
subordinated notes. In addition, we may acquire existing loans that meet this
profile from leveraged buyout funds, venture capital funds and others. We will
also seek to provide our stockholders with long-term
11
capital growth through the appreciation in the value of warrants or other equity
instruments that we may receive when we make loans. We operate as a closed-end,
non-diversified management investment company, and have elected to be treated as
a business development company under the Investment Company Act of 1940, as
amended (the "1940 Act").
We seek out small and medium-sized businesses that meet certain
criteria, including (1) the potential for growth in cash flow, (2) adequate
assets for loan collateral, (3) experienced management teams with significant
ownership interest in the borrower, (4) profitable operations based on the
borrower's cash flow, (5) reasonable capitalization of the borrower (usually by
leveraged buyout funds or venture capital funds) and (6) the potential to
realize appreciation and gain liquidity in our equity position. We anticipate
that this liquidity will be achieved through a merger or acquisition of the
borrower, a public offering by the borrower or by exercise of our right to
require the borrower to buy back its warrants. We lend to borrowers that need
funds to finance growth, restructure their balance sheets or effect a change of
control.
As a business development company, we make available significant
managerial assistance to our portfolio companies. Such assistance typically
involves closely monitoring the operations of each company, participating in its
board and management meetings, being available for consultation with its
officers and providing organizational and financial guidance.
Our loans typically range from $5 million to $15 million, mature in no
more than seven years and accrue interest at a fixed rate or an annualized
variable rate that exceeds the prime rate. Most, if not all, of the debt
securities we acquire are unrated by credit rating agencies. To the extent
possible, our loans generally are collateralized by a security interest in the
borrower's assets. Interest payments are generally made monthly or quarterly
with amortization of principal generally being deferred for several years. The
principal amount of the loans and any accrued but unpaid interest generally
become due at maturity at five to seven years. We focus on making loans
accompanied by warrants to purchase stock in the borrowers. These warrants
typically have a nominal exercise price and entitle us to purchase a modest
percentage of the borrower's stock.
To date, we have made four investments for a total of approximately $42
million with a commitment to lend up to an additional $8 million to one of our
portfolio companies under a revolving line of credit. In addition, we are
earnestly working toward the consummation of more investments. These prospective
loans are subject to, among other things, the satisfactory completion of our due
diligence investigation of each borrower, acceptance of terms and structure and
necessary consents. With respect to each prospective loan, we will only agree to
provide the loan if, among other things, the results of our due diligence
investigations are satisfactory, the terms and conditions of the loan are
acceptable and all necessary consents are received. Our management has initiated
its due diligence investigations of the potential borrowers, however we can not
assure you that we will not discover facts in the course of completing our due
diligence that would render a particular investment imprudent or that any of
these loans will actually be made.
We carry our investments on our balance sheet at fair value, as
determined by our board of directors. Securities that are publicly traded will
be valued at their respective closing price
12
prices on the valuation date. Debt and equity securities that are not publicly
traded are valued at fair value as determined in good faith by our board of
directors. In making such determination, our board of directors values
non-convertible debt securities at cost plus amortized original issue discount,
if any, unless adverse factors lead to a determination of a lesser valuation. In
valuing convertible debt, equity or other securities, our board of directors
determines the fair value based on the collateral, the issuer's ability to make
payments, the earnings of the issuer, sales to third parties of similar
securities, the comparison to publicly traded securities and other pertinent
factors. Due to the uncertainty inherent in the valuation process, such
estimates of fair value may differ significantly from the values that would have
resulted had a ready market for the securities existed, and the differences
could be material. Additionally, changes in the market environment and other
events that may occur over the life of the investments may cause the gains
ultimately realized on these investments to be different than the valuation
currently assigned.
We initially expected that it would take approximately one year to
substantially fully invest the proceeds from our initial public offering.
However, the terrorist attacks on the United States on September 11, 2001 and
the ensuing economic uncertainty have resulted in a delay in the rate at which
we have been able to enter into loans. We anticipate that we are approximately
ninety days behind our original schedule for closing loans.
RESULTS OF OPERATIONS
OPERATING INCOME
Operating income for the quarter ended December 31, 2001 was
approximately $1.2 million. This amount consisted of approximately $640,000 in
interest income from our invested cash and cash equivalents, approximately
$330,000 in interest income from our investments in debt securities of private
companies, approximately $612,000 in non-recurring fee income and approximately
$107,000 in interest income from loans to our employees in connection with the
exercise of employee stock options.
The interest on invested cash and cash equivalents primarily reflects
the interest we received on the investment of the proceeds of our initial public
offering in short-term investment grade securities during the quarter. As we
acquire debt securities, we expect that income from invested cash and cash
equivalents will decline as a percentage of total revenue and that interest
income from debt securities will increase and become our predominant source of
revenue.
Income from investments in debt securities of private companies was
modest since we did not close our first investment until November 6, 2001 and
the remaining three investments did not close until late December 2001. As we
continue to invest the proceeds of our initial public offering in debt
securities of private companies, we expect that we will generate additional
income from these debt securities, which we anticipate will be at interest rates
significantly greater than the rates that we are currently receiving on our
deposited cash and cash equivalents.
13
As a business development company under the 1940 Act, we are required
to provide significant managerial assistance to our portfolio companies. We
provide these services, for which we receive fees, through our wholly-owned
subsidiary, Gladstone Advisers, Inc. Such fees are only paid to us at the
closing of the investments and are non-recurring. The specific services we
provide vary by portfolio company, but generally consist of reviewing existing
credit facilities, arranging bank financing, arranging equity financing,
structuring financing from multiple lenders, structuring financing from equity
investors, restructuring existing loans, raising equity and debt capital and
providing general financial advice.
The only continuing revenue associated with our investments is interest
paid on the loans we make and, potentially, capital gains received in connection
with the liquidation of any associated equity interest (e.g., warrants).
OPERATING EXPENSES
Operating expenses for the quarter ended December 31, 2001 were
approximately $492,000. This amount consisted primarily of salaries and
benefits, professional fees, rent and general and administrative expenses.
Salaries and benefits consisted of approximately $277,000 for the
quarter ended December 31, 2001; we expect this expense to increase as we hire
additional loan officers. The remainder of the operating expenses incurred for
the quarter ended December 31, 2001 consisted of approximately $101,000 in
professional fees, $11,000 in rent and $101,000 in general and administrative
expenses.
We believe that this level of operating expenses is not necessarily
indicative of our future operating expenses. We estimate that over time, as we
begin to more fully deploy the proceeds of our initial public offering, our
operating expenses will be approximately two percent of our net assets.
NET OPERATING INCOME
As a result of the operating income and operating expenses described
above, we had net operating income of approximately $1.2 million for the quarter
ended December 31, 2001. Based on a weighted-average of 10,060,178 (actual) and
10,146,030 (fully diluted) shares outstanding, our net operating income per
common share for the quarter ended December 31, 2001 was $0.12, basic and fully
diluted, respectively.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2001, we had investments in debt securities of four
private companies, approximately $42 million of total investment assets and a
commitment to lend up to an additional $8 million to one of our portfolio
companies under a revolving line of credit.
Cash used by operating activities for the quarter ended December 31,
2001, consisting primarily of the items described in "Results of Operations,"
was approximately $1.2 million. Net
14
cash used in investing activities was approximately $42 million and primarily
consisted of the amounts used to make investments in our four portfolio
companies. Net cash used in financing activities was approximately $640,000 for
the quarter ended December 31, 2001 and consisted primarily of the repayment of
accrued costs associated with our initial public offering.
During the quarter ended December 31, 2001, cash and cash equivalents
decreased from approximately $131.8 million at the beginning of the quarter to
approximately $90.4 million at the end of the quarter. This decrease of
approximately $41.4 million was largely the result of our investing activities,
described above.
In order to qualify as a regulated investment company and to avoid
corporate level tax on the income we distribute to our stockholders, we are
required, under Subchapter M of the Internal Revenue Code, to distribute at
least 90% of our ordinary income and short-term capital gains to our
stockholders on an annual basis. In accordance with these requirements, on
December 10, 2001, we declared a quarterly cash dividend of $0.18 per share on
our common stock which was paid on January 15, 2002 to stockholders of record as
of December 31, 2001. This dividend was paid from ordinary income.
We anticipate borrowing funds to obtain additional capital once the
proceeds of our initial public offering have been fully invested. We also intend
to pursue a strategy of securitizing our loan portfolio in approximately two
years. We would use the cash we receive upon the sale of interests in our loans
to repay bank borrowings and make additional loans. We can not assure you that
this securitization strategy will be successful.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are subject to financial market risks, including changes in interest
rates. We expect that approximately 50% of the loans in our portfolio will be
made at fixed rates, with approximately 50% made at variable rates. To date, we
have made only four investments and substantially all of the remainder of our
assets are invested in money market instruments.
We also expect to borrow funds to finance future lending activities
after we have substantially fully invested the proceeds of our initial public
offering. These future borrowings may be at fixed rates or variable rates. To
date, we have not yet borrowed any funds.
We expect to hedge against interest rate fluctuations in the future by
using standard hedging instruments such as futures, options and forward
contracts. While hedging activities may insulate us against adverse fluctuations
in interest rates, they may also limit our ability to participate in the
benefits of lower interest rates with respect to our portfolio of investments.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Neither the Company nor its subsidiary is currently subject to any
material legal proceeding, nor, to the Company's knowledge, is any material
legal proceeding threatened against the Company or its subsidiary.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.1 Articles of Amendment and Restatement of the Articles of Incorporation,
incorporated by reference to Exhibit a.2 to Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 (File No. 333-63700),
filed July 27, 2001.
3.2 By-laws, incorporated by reference to Exhibit b to Pre-Effective
Amendment No. 1 to the Registration Statement on Form N-2 (File
No. 333-63700), filed July 27, 2001.
4.1 Form of Direct Registration Transaction Advice for the Company's common
stock, par value $0.001 per share, the rights of holders of which are
defined in exhibits 3.1 and 3.2, incorporated by reference to Exhibit d
to Pre-Effective Amendment No. 1 to the Registration Statement on Form
N-2 (File No. 333-63700), filed July 27, 2001.
4.2 Specimen Stock Certificate, incorporated by reference to Exhibit d.2 to
Pre-Effective Amendment No. 3 to the Registration Statement on Form N-2
(File No. 333-63700), filed August 23, 2001.
10.1 Facility Service License, dated November 1, 2001, between the Company
and Teqcorner, LLC, incorporated by reference to Exhibit 10.8 to the
Company's Annual Report on Form 10-K for the period ended September 30,
2001 (File No. 814-00237), filed December 21, 2001.
11 Computation of Per Share Earnings (included in the notes to the
unaudited financial statements contained in this report).
All other exhibits for which provision is made in the applicable
regulations of the Securities and Exchange Commission are not required under the
related instruction or are inapplicable and therefore have been omitted.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the period for
which this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GLADSTONE CAPITAL CORPORATION
By: /s/ Harry Brill
----------------------------------
Harry Brill
Chief Financial Officer and Treasurer
Date: February 14, 2002
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