Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-K

 

(Mark One)

 

x      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

for the fiscal year ended September 30, 2009

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

for the transition period from               to              

 

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.)

 

 

 

1521 Westbranch Drive, Suite 200
McLean, Virginia

 

22102

(Address of principal executive offices)

 

(Zip Code)

 

(703) 287-5800

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.001 par value per share

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES  o  NO x.

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o NO x.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES  x  NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act). See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12 b-2 of the Exchange Act.

 

Large Accelerated filer  o

 

Accelerated filer  x

 

 

 

Non-Accelerated filer  o

 

Smaller reporting company o.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act). YES o NO x.

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant on March 31, 2009, based on the closing price on that date of $6.26 on the Nasdaq Global Select Market, was $123,940,569. For the purposes of calculating this amount only, all directors and executive officers of the Registrant have been treated as affiliates.

 

There were 21,087,574 shares of the Registrant’s Common Stock, $0.001 par value, outstanding as of November 23, 2009.

 

Documents Incorporated by Reference. Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

 

 

 



Table of Contents

 

GLADSTONE CAPITAL CORPORATION
FORM 10-K FOR THE FISCAL YEAR ENDED
SEPTEMBER 30, 2009

 

TABLE OF CONTENTS

 

PART I

 

Item 1

Business

2

 

 

Item 1A

Risk Factors

18

 

 

Item 1B

Unresolved Staff Comments

31

 

 

Item 2

Properties

31

 

 

Item 3

Legal Proceedings

31

 

 

Item 4

Submission of Matters to a Vote of Security Holders

31

PART II

 

Item 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

31

 

 

Item 6

Selected Financial Data

32

 

 

Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

 

 

Item 7A

Quantitative and Qualitative Disclosures about Market Risk

60

 

 

Item 8

Financial Statements and Supplementary Data

62

 

 

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

99

 

 

Item 9A

Controls and Procedures

99

 

 

Item 9B

Other Information

99

PART III

 

Item 10

Directors, Executive Officers and Corporate Governance

99

 

 

Item 11

Executive Compensation

99

 

 

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

99

 

 

Item 13

Certain Relationships and Related Transactions, and Director Independence

100

 

 

Item 14

Principal Accountant Fees and Services

100

PART IV

 

Item 15

Exhibits and Financial Statement Schedule

100

SIGNATURES

 

 

 

102

 

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Table of Contents

 

FORWARD-LOOKING STATEMENTS

 

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 (the “Securities Act”), and Section 21 of the Securities Act of 1934, as amended (the “Exchange Act”). These statements may relate to, among other things, future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others: (1) further adverse changes in the economy and the capital markets; (2) risks associated with negotiation and consummation of pending and future transactions; (3) the loss of one or more of our executive officers, in particular David Gladstone, Terry Lee Brubaker, or George Stelljes III; (4) changes in our business strategy; (5) availability, terms and deployment of capital; (6) changes in our industry, interest rates, exchange rates or the general economy; (7) the degree and nature of our competition; and (8) those factors described in the “Risk Factors” section of this Form 10-K. We caution readers not to place undue reliance on any such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Form 10-K.

 

PART I

(Dollar amounts in thousands, unless otherwise indicated)

 

In this Annual Report on Form 10-K, or Annual Report, the “Company,” “we,” “us,” and “our” refer to Gladstone Capital Corporation and its wholly-owned subsidiaries unless the context otherwise indicates.

 

Item 1. Business

 

Overview

 

We were incorporated under the General Corporation Laws of the State of Maryland on May 30, 2001 and completed our initial public offering on August 24, 2001. We operate as a closed-end, non-diversified management investment company, and we have elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended ( the “1940 Act”).  In addition, for tax purposes we have elected to be treated as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”).

 

We seek 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 substantially owned by leveraged buyout funds, or individual investors or are family-owned businesses, with a particular focus on senior notes. In addition, we may acquire from others existing loans that meet this profile.  We also seek to provide our stockholders with long-term capital growth through appreciation in the value of warrants or other equity instruments that we may receive when we make loans.

 

We seek to invest in small and medium-sized private U.S. businesses that meet certain criteria, including some but not necessarily all of the following: the potential for growth in cash flow, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, profitable operations based on the borrower’s cash flow, reasonable capitalization of the borrower (usually by leveraged buyout funds or venture capital funds) and the potential to realize appreciation and gain liquidity in our equity positions, if any.  We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the borrower, a public offering of the borrower’s stock or by exercising our right to require the borrower to repurchase our warrants, though there can be no assurance that we will always have these rights.  We seek to lend to borrowers that need funds to finance growth, restructure their balance sheets or effect a change of control.

 

We seek to invest primarily in three categories of debt of private companies:

 

·                  Senior Notes.  We seek to invest a portion of our assets in senior notes of borrowers.  Using its assets and cash flow as collateral, the borrower typically uses senior notes to cover a substantial portion of the funding needed to operate.  Senior

 

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lenders are exposed to the least risk of all providers of debt because they command a senior position with respect to scheduled interest and principal payments.  However, unlike senior subordinated and junior subordinated lenders, these senior lenders typically do not receive any stock, warrants to purchase stock of the borrowers or other yield enhancements.  As such, they generally do not participate in the equity appreciation of the value of the business. Senior notes may include revolving lines of credit, senior term loans, senior syndicated loans and senior last-out tranche loans.

 

·                  Senior Subordinated Notes.  We seek to invest a portion of our assets in senior subordinated notes, which include second lien notes.  Holders of senior subordinated notes are subordinated to the rights of holders of senior debt in their right to receive principal and interest payments or, in the case of last out tranches of senior debt, liquidation proceeds from the borrower.  As a result, senior subordinated notes are riskier than senior notes.  Although such loans are sometimes secured by significant collateral, the lender is largely dependent on the borrower’s cash flow for repayment.  Additionally, lenders may receive warrants to acquire shares of stock in borrowers or other yield enhancements in connection with these loans.  Senior subordinated notes include second lien loans and syndicated second lien loans.

 

·                  Junior Subordinated Notes.  We also seek to invest a small portion of our assets in junior subordinated notes, which include mezzanine notes.  Holders of junior subordinated notes are subordinated to the rights of the holders of senior debt and senior subordinated debt in their rights to receive principal and interest payments from the borrower.  The risk profile of junior subordinated notes is high, which permits the junior subordinated lender to obtain higher interest rates and more equity and equity-like compensation.

 

Investment Concentrations

 

At September 30, 2009, we had aggregate investments in 48 portfolio companies, and approximately 66.1% of the aggregate fair value of such investments was senior term debt, approximately 33.0% was senior subordinated term debt, no investments were in junior subordinated debt and approximately 0.9% was in equity securities.  The following table outlines our investments by type at September 30, 2009 and 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Senior Notes

 

$

 240,172

 

$

 212,290

 

$

 297,910

 

$

 265,297

 

Senior Subordinated Notes

 

118,743

 

105,794

 

157,927

 

140,676

 

Junior Subordinated Notes

 

 

 

 

 

Preferred Equity Securities

 

2,028

 

 

1,584

 

 

Common Equity Securities

 

3,450

 

2,885

 

3,449

 

1,960

 

 

 

 

 

 

 

 

 

 

 

Total Investments

 

$

 364,393

 

$

 320,969

 

$

 460,870

 

$

 407,933

 

 

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Investments at fair value consisted of the following industry classifications as of September 30, 2009 and 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

 

 

Percentage

 

 

 

Percentage

 

Industry Classification

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Aerospace & Defense

 

$

 1,857

 

0.6

%

0.7

%

$

 4,192

 

1.0

%

1.6

%

Automobile

 

7,999

 

2.5

%

3.2

%

5,055

 

1.2

%

1.9

%

Broadcast (TV & Radio)

 

43,403

 

13.5

%

17.4

%

52,336

 

12.8

%

19.2

%

Buildings & Real Estate

 

12,882

 

4.0

%

5.2

%

13,519

 

3.3

%

5.0

%

Cargo Transport

 

5,427

 

1.7

%

2.2

%

15,805

 

3.9

%

5.8

%

Chemicals, Plastics & Rubber

 

15,884

 

4.9

%

6.4

%

16,375

 

4.0

%

6.0

%

Diversified/Conglomerate Manufacturing

 

1,236

 

0.4

%

0.5

%

3,195

 

0.8

%

1.2

%

Diversified Natural Resources, Precious Metals & Minerals

 

13,589

 

4.2

%

5.5

%

12,936

 

3.2

%

4.8

%

Electronics

 

27,899

 

8.7

%

11.2

%

35,208

 

8.6

%

13.0

%

Farming & Agriculture

 

9,309

 

2.9

%

3.7

%

10,031

 

2.5

%

3.7

%

Finance

 

 

 

 

1,812

 

0.4

%

0.7

%

Healthcare, Education & Childcare

 

58,054

 

18.1

%

23.3

%

76,642

 

18.8

%

28.2

%

Home & Office Furnishings

 

16,744

 

5.2

%

6.7

%

15,379

 

3.8

%

5.7

%

Leisure, Amusement, Movies & Entertainment

 

5,091

 

1.6

%

2.0

%

8,097

 

2.0

%

3.0

%

Machinery

 

9,202

 

2.9

%

3.7

%

9,834

 

2.4

%

3.6

%

Mining, Steel, Iron & Non-Precious Metals

 

21,926

 

6.8

%

8.8

%

25,095

 

6.2

%

9.2

%

Personal & Non-durable Consumer Products

 

8,714

 

2.7

%

3.5

%

9,703

 

2.4

%

3.6

%

Printing & Publishing

 

37,864

 

11.8

%

15.2

%

60,440

 

14.8

%

22.2

%

Retail Stores

 

23,669

 

7.4

%

9.5

%

22,800

 

5.6

%

8.4

%

Textiles & Leather

 

220

 

0.1

%

0.1

%

9,479

 

2.3

%

3.5

%

Total

 

$

320,969

 

100.0

%

 

 

$

407,933

 

100.0

%

 

 

 

The investments at fair value were included in the following geographic regions of the United States at September 30, 2009 and 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

 

 

Percentage

 

 

 

Percentage

 

Geographic
Region

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Midwest

 

$

172,263

 

53.7

%

69.2

%

$

206,271

 

50.6

%

75.9

%

West

 

65,678

 

20.4

%

26.4

%

85,294

 

20.9

%

31.4

%

Southeast

 

34,708

 

10.8

%

13.9

%

49,374

 

12.1

%

18.2

%

Mid-Atlantic

 

28,437

 

8.9

%

11.4

%

50,807

 

12.4

%

18.7

%

Northeast

 

14,170

 

4.4

%

5.7

%

10,617

 

2.6

%

3.9

%

U.S. Territory

 

5,713

 

1.8

%

2.3

%

5,570

 

1.4

%

2.0

%

 

 

$

320,969

 

100.0

%

 

 

$

407,933

 

100.0

%

 

 

 

The geographic region indicates the location of the headquarters for our portfolio companies.  A portfolio company may have a number of other business locations in other geographic regions.

 

Our loans typically range from $5 million to $20 million, generally mature in no more than seven years and accrue interest at a fixed or variable rate that exceeds the prime rate.  Because the majority of the loans in our portfolio consist of term debt of private companies that typically cannot or will not expend the resources to have their debt securities rated by a credit rating agency, we expect that most, if not all, of the debt securities we acquire will be unrated.  Accordingly, we cannot accurately

 

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predict what ratings these loans might receive if they were in fact rated, and thus cannot determine whether or not they could be considered “investment grade” quality.

 

We hold our loan investment portfolio through our wholly-owned subsidiary, Gladstone Business Loan, LLC (“Business Loan”).

 

Our Investment Adviser and Administrator

 

Gladstone Management Corporation (our “Adviser”) is led by a management team which has extensive experience in our lines of business.  Our Adviser also has a wholly-owned subsidiary, Gladstone Administration, LLC (the “Administrator”) which employs our chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.  Excluding our chief financial officer, all of our executive officers are officers or directors, or both, of our Adviser and our Administrator.

 

Our Adviser and Administrator also provide investment advisory and administrative services, respectively, to our affiliates Gladstone Commercial Corporation (“Gladstone Commercial”), a publicly traded real estate investment trust; Gladstone Investment Corporation (“Gladstone Investment”), a publicly traded business development company; and Gladstone Land Corporation, a private agricultural real estate company owned by Mr. David Gladstone, our chairman and chief executive officer. All of our directors and executive officers, with the exception of our chief financial officer, serve as either directors or executive officers, or both, of Gladstone Commercial and Gladstone Investment.  Our Adviser’s investment committee is composed of Mr. David Gladstone, Mr. Terry Brubaker, our vice chairman, chief operating officer and secretary, and Mr. George Stelljes III, our president and chief investment officer.  In the future, our Adviser may provide investment advisory and administrative services to other funds, both public and private, of which it is the sponsor.

 

We have been externally managed by our Adviser pursuant to a contractual investment advisory arrangement since October 1, 2004.  Our Adviser was organized as a corporation under the laws of the State of Delaware on July 2, 2002 and is a registered investment adviser under the Investment Advisers Act of 1940, as amended.  Our Adviser and Administrator are headquartered in McLean, Virginia, a suburb of Washington, D.C., and our Adviser also has offices in New York, New Jersey, Illinois, Texas and Georgia.

 

Our Investment Strategy

 

Our strategy is to make loans at favorable interest rates to small and medium-sized businesses. Our Adviser uses the loan referral networks of Messrs. Gladstone, Stelljes and Brubaker and of its managing directors to identify and make senior and subordinated loans to borrowers that need funds to finance growth, restructure their balance sheets or effect a change of control. We believe that our business strategy will enable us 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. In addition, from time to time we might acquire existing loans that meet this profile from leveraged buyout funds, venture capital funds and others. We also seek to provide our stockholders with long-term capital growth through the appreciation in the value of warrants or other equity instruments that we might receive when we make loans.

 

We target small and medium-sized private businesses that meet certain criteria, including some but not necessarily all of the following: the potential for growth in cash flow, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, profitable operations based on the borrower’s cash flow, reasonable capitalization of the borrower (usually by leveraged buyout funds or venture capital funds) and the potential to realize appreciation and gain liquidity in our equity position, if any. We may achieve liquidity in an equity position through a merger or acquisition of the borrower, a public offering of the borrower’s stock or by exercising our right to require the borrower to repurchase our warrants, although we cannot assure you that we will always have these rights.  We can also achieve a similar effect by requiring the borrower to pay us conditional interest, which we refer to as a success fee, upon the occurrence of certain events.  Success fees are dependent upon the success of the borrower and the occurrence of a triggering event, and are paid in lieu of warrants to purchase common stock of the borrower.

 

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Table of Contents

 

Investment Process

 

Overview of Loan Origination and Approval Process

 

To originate loans, our Adviser’s investment professionals use an extensive referral network comprised primarily of venture capitalists, leveraged buyout fund managers, investment bankers, attorneys, accountants, commercial bankers and business brokers.  Our Adviser’s investment professionals review informational packages from these and other sources in search of potential financing opportunities.  If a potential opportunity matches our investment objectives, the investment professionals will seek an initial screening of the opportunity from our Adviser’s investment committee which is composed of Mr. Gladstone, Mr. Brubaker and Mr. Stelljes.  If the prospective portfolio company passes this initial screening, the investment professionals conduct a due diligence investigation and create a detailed profile summarizing the prospective portfolio company’s historical financial statements, industry and management team and analyzing its conformity to our general investment criteria. The investment professionals then present this profile to our Adviser’s investment committee, which must approve each investment.  Further, each financing is reviewed and approved by the members of our Board of Directors, a majority of whom are not “interested directors” as defined in Section 2(a)(19) of the 1940 Act.

 

Prospective Portfolio Company Characteristics

 

We have identified certain characteristics that we believe are important in identifying and investing in prospective portfolio companies.  The criteria listed below provide general guideposts for our lending and investment decisions, although not all of these criteria may be met by each portfolio company.

 

·                  Value-and-Income Orientation and Positive Cash Flow.    Our investment philosophy places a premium on fundamental analysis from an investor’s perspective and has a distinct value-and-income orientation. In seeking value, we focus on companies in which we can invest at relatively low multiples of earnings before interest, taxes, depreciation and amortization (“EBITDA”), and that have positive operating cash flow at the time of investment. In seeking income, we seek to invest in companies that generate relatively high and stable cash flow to provide some assurance that they will be able to service their debt and pay any required dividends on preferred stock. Typically, we do not expect to invest in start-up companies or companies with speculative business plans.

 

·                  Experienced Management.   We generally require that our portfolio companies have an experienced  management team.  We also require the portfolio companies to have in place proper incentives to induce management to succeed and act in concert with our interests as investors, including having significant equity or other interests in the financial performance of their companies.

 

·                  Strong Competitive Position in an Industry.    We seek to invest in target companies that have developed strong market positions within their respective markets and that we believe are well-positioned to capitalize on growth opportunities. We seek companies that demonstrate significant competitive advantages versus their competitors, which we believe will help to protect their market positions and profitability.

 

·                  Exit Strategy. We seek to invest in companies that we believe will provide a stable stream of cash flow that is sufficient to repay the loans we make to them and to reinvest in their respective businesses. We expect that such internally generated cash flow, which will allow our portfolio companies to pay interest on, and repay the principal of, our investments, will be a key means by which we exit from our investments over time. In addition, we also seek to invest in companies whose business models and expected future cash flows offer attractive possibilities for capital appreciation on any equity interests we may obtain or retain. These capital appreciation possibilities include strategic acquisitions by other industry participants or financial buyers, initial public offerings of common stock, or other capital market transactions.

 

·                  Liquidation Value of Assets. The prospective liquidation value of the assets, if any, collateralizing loans in which we invest is an important factor in our investment analysis.  We emphasize both tangible and intangible assets, such as accounts receivable, inventory, equipment, and real estate and intangible assets, such as intellectual property, customer lists, networks, databases, although the relative weight we place on these assets will vary by company and industry.

 

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Table of Contents

 

Extensive Due Diligence

 

Our Adviser conducts what we believe are extensive due diligence investigations of our prospective portfolio companies and investment opportunities.  Our due diligence investigation may begin with a review of publicly available information, and will generally include some or all of the following:

 

·                  a review of the prospective portfolio company’s borrower’s historical and projected financial information;

·                  visits to the prospective portfolio company’s business site(s);

·                  interviews with the prospective portfolio company’s management, employees, customers and vendors;

·                  review of all loan documents;

·                  background checks on the prospective portfolio company’s management team; and

·                  research on the prospective portfolio company’s products, services or particular industry.

 

Upon completion of a due diligence investigation and a decision to proceed with an investment, our Adviser’s lending professionals who have primary responsibility for the investment present the investment opportunity to our Adviser’s investment committee, which consists of Messrs. Gladstone, Brubaker and Stelljes. The investment committee determines whether to pursue the potential investment. Additional due diligence of a potential investment may be conducted on our behalf by attorneys and independent accountants prior to the closing of the investment, as well as other outside advisers, as appropriate.

 

We also rely on the long-term relationships that our Adviser’s professionals have with venture capitalists, leveraged buyout fund managers, investment bankers, commercial bankers and business brokers, and on the extensive direct experiences of our executive officers and managing directors in providing debt and equity capital to small and medium-sized private businesses.

 

Investment Structure

 

We typically invest in senior, senior subordinated and junior subordinated loans. Our loans typically range from $5 million to $20 million, although the size of our investments may vary as our capital base changes.  Our loans generally mature within seven years and accrue interest at a variable rate that exceeds the LIBOR and prime rates.  In the past, some of our loans have had a provision that calls for some portion of the interest payments to be deferred and added to the principal balance so that the interest is paid, together with the principal, at maturity. This form of deferred interest is often called “paid in kind” (“PIK”) interest, and, when earned, we record PIK interest as interest income and add the PIK interest to the principal balance of the loans.  As of September 30, 2009, two loans in our portfolio contained PIK provisions.

 

To the extent possible, our loans generally are collateralized by a security interest in the borrower’s assets.  In senior and subordinated loans, we do not usually have the first claim on these assets. Interest payments on loans we make will generally be made monthly or quarterly (except to the extent of any PIK interest) with amortization of principal generally being deferred for several years. The principal amount of the loans and any accrued but unpaid interest will generally become due at maturity at five to seven years. We seek to make loans that are accompanied by warrants to purchase stock in the borrowers or other yield enhancement features, such as success fees. Any warrants that we receive will typically have an exercise price equal to the fair value of the portfolio company’s common stock at the time of the loan and entitle us to purchase a modest percentage of the borrower’s stock.  Success fees are conditional interest that is paid if the borrower is successful. The success fee is calculated as additional interest on the loan and is paid upon the occurrence of certain triggering events, such as the sale of the borrower.  If the event or events do not occur, no success fee will be paid.

 

From time to time, a portfolio company may request additional financing, providing us with additional lending opportunities. We will consider such requests for additional financing under the criteria we have established for initial investments and we anticipate that any debt securities we acquire in a follow-on financing will have characteristics comparable to those issued in the original financing. In some situations, our failure, inability or decision not to make a follow-on investment may be detrimental to the operations or survival of a portfolio company, and thus may jeopardize our investment in that borrower.

 

As noted above, we expect to receive yield enhancements in connection with many of our loans, which may include warrants to purchase stock or success fees. If a financing is successful, not only will our debt securities have been repaid with interest, but we will be in a position to realize a gain on the accompanying equity interests or other yield enhancements. The opportunity to realize such gain may occur if the borrower is sold to new owners or if it makes a public offering of its stock. In most cases, we will not have the right to require that a borrower undergo an initial public offering by registering securities under the Securities Act of 1933, as amended, (the “Securities Act”), but we generally will have the right to sell our equity

 

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interests in any subsequent public offering by the borrower. Even when we have the right to participate in a borrower’s public offering, the underwriters might insist, particularly if we own a large amount of equity securities, that we retain all or a substantial portion of our shares for a specified period of time. Moreover, we may decide not to sell an equity position even when we have the right and the opportunity to do so. Thus, although we expect to dispose of an equity interest after a certain time, situations may arise in which we hold equity securities for a longer period.

 

Risk Management

 

We seek to limit the downside risk of our investments by:

 

·                  making investments with an expected total return (including both interest and potential equity appreciation) that we believe compensates us for the credit risk of the investment;

 

·                  seeking collateral or superior positions in the portfolio company’s capital structure where possible;

 

·                  incorporating put rights and call protection into the investment structure where possible; and

 

·                  negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility as possible in managing their businesses, consistent with the preservation of our capital.

 

Temporary Investments

 

Pending investment in private companies, we invest our otherwise uninvested cash primarily in cash, cash items, government securities or high-quality debt securities maturing in one year or less from the time of investment, to which we refer collectively as temporary investments, so that 70% of our assets are “qualifying assets” for purposes of the business development company provisions of the 1940 Act. For information regarding regulations to which we are subject and the definition of “qualifying assets,” see “ — Regulation as a Business Development Company — Qualifying Assets.”

 

Hedging Strategies

 

Although it has not yet happened, nor do we expect this to happen in the near future, when one of our portfolio companies goes public, we may undertake hedging strategies with regard to any equity interests that we may have in that company. We may mitigate risks associated with the volatility of publicly traded securities by, for instance, selling securities short or writing or buying call or put options. Hedging against a decline in the value of such investments in public companies would not eliminate fluctuations in the values of such investments or prevent losses if the values of such investments decline, but would establish other investments designed to gain from those same developments. Therefore, by engaging in hedging transactions, we can moderate the decline in the value of our hedged investments in public companies. However, such hedging transactions would also limit our opportunity to gain from an increase in the value of our investment in the public company.  Hedging strategies can pose risks to us and our stockholders, however we believe that such activities are manageable because they will be limited to only a portion of our portfolio.

 

Section 12(a)(3) of the 1940 Act prohibits us from effecting a short sale of any security “in contravention of such rules and regulations or orders as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors . . .” However, to date, the SEC has not promulgated regulations under this statute. It is possible that such regulations could be promulgated in the future in a way that would require us to change any hedging strategies that we may adopt.  In addition, our ability to engage in short sales may be limited by the 1940 Act’s leverage limitations.  We will only engage in hedging activities in compliance with applicable laws and regulations.

 

Competitive Advantages

 

A large number of entities compete with us and make the types of investments that we seek to make in small and medium-sized privately-owned businesses. Such competitors include private equity funds, leveraged buyout funds, venture capital funds, investment banks and other equity and non-equity based investment funds, and other financing sources, including traditional financial services companies such as commercial banks. Many of our competitors are substantially larger than we are and have considerably greater funding sources that are not available to us. In addition, certain of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments, establish more relationships and build their market shares. Furthermore, many of these competitors are not subject to the

 

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regulatory restrictions that the 1940 Act imposes on us as a business development company.  However, we believe that we have the following competitive advantages over other providers of financing to small and mid-sized businesses.

 

Management Expertise

 

David Gladstone, our chairman and chief executive officer, is also the chairman and chief executive officer of our Adviser and its affiliated companies, which we refer to as the Gladstone Companies, and has been involved in all aspects of the Gladstone Companies’ investment activities, including serving as a member of our Adviser’s investment committee. Terry Lee Brubaker is our vice chairman, chief operating officer and secretary, and has substantial experience in acquisitions and operations of companies. George Stelljes III is our president and chief investment officer and has extensive experience in leveraged finance. Messrs. Gladstone, Brubaker and Stelljes have principal management responsibility for our Adviser as its senior executive officers. These individuals dedicate a significant portion of their time to managing our investment portfolio. Our senior management has extensive experience providing capital to small and mid-sized companies and has worked together for more than 10 years. In addition, we have access to the resources and expertise of our Adviser’s investment professionals and supporting staff who possess a broad range of transactional, financial, managerial and investment skills.

 

Increased Access to Investment Opportunities Developed Through Proprietary Research Capability and an Extensive Network of Contacts

 

Our Adviser seeks to identify potential investments both through active origination and due diligence and through its dialogue with numerous management teams, members of the financial community and potential corporate partners with whom our Adviser’s investment professionals have long-term relationships. We believe that our Adviser’s investment professionals have developed a broad network of contacts within the investment, commercial banking, private equity and investment management communities, and that their reputation in investment management enables us to identify well-positioned prospective portfolio companies which provide attractive investment opportunities. Additionally, our Adviser expects to generate information from its professionals’ network of accountants, consultants, lawyers and management teams of portfolio companies and other companies.

 

Disciplined, Value and Income-Oriented Investment Philosophy with a Focus on Preservation of Capital

 

In making its investment decisions, our Adviser focuses on the risk and reward profile of each prospective portfolio company, seeking to minimize the risk of capital loss without foregoing the potential for capital appreciation. We expect our Adviser to use the same value and income-oriented investment philosophy that its professionals use in the management of the other Gladstone Companies and to commit resources to management of downside exposure. Our Adviser’s approach seeks to reduce our risk in investments by using some or all of the following approaches:

 

·                  focusing on companies with good market positions, established management teams and good cash flow;

·                  investing in businesses with experienced management teams;

·                  engaging in extensive due diligence from the perspective of a long-term investor;

·                  investing at low price-to-cash flow multiples; or

·                  adopting flexible transaction structures by drawing on the experience of the investment professionals of our Adviser and its affiliates.

 

Longer Investment Horizon with Attractive Publicly Traded Model

 

Unlike private equity and venture capital funds that are typically organized as finite-life partnerships, we are not subject to standard periodic capital return requirements. The partnership agreements of most private equity and venture capital funds typically provide that these funds may only invest investors’ capital once and must return all capital and realized gains to investors within a finite time period, often seven to ten years. These provisions often force private equity and venture capital funds to seek returns on their investments by causing their portfolio companies to pursue mergers, public equity offerings, or other liquidity events more quickly than might otherwise be optimal or desirable, potentially resulting in both a lower overall return to investors and an adverse impact on their portfolio companies. We believe that our flexibility to make investments with a long-term view and without the capital return requirements of traditional private investment vehicles provides us with the opportunity to achieve greater long-term returns on invested capital.

 

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Flexible Transaction Structuring

 

We believe our management team’s broad expertise and its ability to draw upon many years of combined experience enables our Adviser to identify, assess, and structure investments successfully across all levels of a company’s capital structure and manage potential risk and return at all stages of the economic cycle. We are not subject to many of the regulatory limitations that govern traditional lending institutions such as banks. As a result, we are flexible in selecting and structuring investments, adjusting investment criteria and transaction structures, and, in some cases, the types of securities in which we invest. We believe that this approach enables our Adviser to identify attractive investment opportunities that will continue to generate current income and capital gain potential throughout the economic cycle, including during turbulent periods in the capital markets. One example of our flexibility is our ability to exchange our publicly-traded stock for the stock of an acquisition target in a tax-free reorganization under the Code. After completing an acquisition in such an exchange, we can restructure the capital of the small company to include senior and subordinated debt.

 

Leverage

 

For the purpose of making investments other than temporary investments and to take advantage of favorable interest rates, we intend to issue senior debt securities (including borrowings under our current line of credit) up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us to issue senior debt securities and preferred stock, to which we refer collectively as senior securities, in amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of senior securities. We may also incur such indebtedness to repurchase our common stock. As a result of issuing senior securities, we are exposed to the risks of leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we receive on the investments we make with such borrowed funds. In addition, our ability to pay dividends or incur additional indebtedness would be restricted if asset coverage is less than twice our indebtedness. If the value of our assets declines, we might be unable to satisfy that test. If this happens, we may be required to liquidate a portion of our loan portfolio and repay a portion of our indebtedness at a time when a sale may be disadvantageous. Furthermore, any amounts that we use to service our indebtedness will not be available for distributions to our stockholders. Our Board of Directors is authorized to provide for the issuance of preferred stock with such preferences, powers, rights and privileges as it deems appropriate, provided that such an issuance adheres to the requirements of the 1940 Act.  See “Regulation as a Business Development Company—Asset Coverage” for a discussion of our leveraging constraints.

 

Ongoing Relationships with and Monitoring of Portfolio Companies

 

Monitoring

 

Our Adviser’s investment professionals, led by Terry Lee Brubaker, our chief operating officer, monitor the financial trends of each portfolio company on an ongoing basis to determine if each is meeting its respective business plans and to assess the appropriate course of action for each company.  We monitor the status and performance of each portfolio company and use it to evaluate the overall performance of our portfolio.

 

Our Adviser employs various methods of evaluating and monitoring the performance of each of our portfolio companies, which include some or all of following:

 

·                  assessment of success in the portfolio company’s overall adherence to its business plan and compliance with covenants;

·                  attendance at and participation in meetings of the portfolio company’s board of directors;

·                  periodic contact, including formal update interviews with portfolio company management, and, if appropriate, the financial or strategic sponsor;

·                  comparison with other companies in the portfolio company’s industry; and

·                  review of monthly and quarterly financial statements and financial projections for portfolio companies.

 

Managerial Assistance and Services

 

As a business development company, we make available significant managerial assistance to our portfolio companies and provide other services to such portfolio companies. Neither we nor our Adviser currently receives fees in connection with managerial assistance. Our Adviser provides other services to our portfolio companies and receives fees for these other services, certain of which are credited by 50% against the investment advisory fees that we pay our Adviser.

 

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Valuation Process

 

The following is a general description of the steps we take each quarter to determine the value of our investment portfolio. We value our investments in accordance with the requirements of the 1940 Act. We value securities for which market quotations are readily available at their market value. We value all other securities and assets at fair value as determined in good faith by our Board of Directors. In determining the value of our investments, our Adviser has established an investment valuation policy (the “Policy”). The Policy has been approved by our Board of Directors and each quarter the Board of Directors reviews whether our Adviser has applied the Policy consistently and votes whether or not to accept the recommended valuation of our investment portfolio. Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been obtained had a ready market for the securities existed. Investments for which market quotations are readily available are recorded in our financial statements at such market quotations. With respect to any investments for which market quotations are not readily available, we perform the following valuation process each quarter:

 

·                  Our quarterly valuation process begins with each portfolio company or investment being initially assessed by our Adviser’s investment professionals responsible for the investment, using the Policy.

 

·                  Preliminary valuation conclusions are then discussed with our management, and documented, along with any independent opinions of value provided by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”), for review by our Board of Directors.

 

·                  Our Board of Directors reviews this documentation and discusses the input of our Adviser, management, and the opinions of value of SPSE to arrive at a determination for the aggregate fair value of our portfolio of investments.

 

Our valuation policies, procedures and processes are more fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Investment Valuation.”

 

Investment Advisory and Management Agreements

 

We are externally managed pursuant to contractual arrangements with our Adviser and Administrator, under which our Adviser and Administrator employ all of our personnel and pay our payroll, benefits, and general expenses directly.  On October 1, 2006, we entered into an amended and restated investment advisory agreement with our Adviser (the “Advisory Agreement”) and an administration agreement with our Administrator (the “Administration Agreement”).  On July 8, 2009, our Board of Directors renewed the Advisory Agreement and the Administration Agreement through August 31, 2010.  The management services and fees in effect under the Advisory Agreement are described below.  In addition to the fees described below, certain fees received by our Adviser from our portfolio companies were 100% credited, prior to April 1, 2007, or 50% credited effective April 1, 2007, against the investment advisory fee.  In addition, we pay our direct expenses including, but not limited to, directors’ fees, legal and accounting fees and stockholder related expenses under the Advisory Agreement.

 

Management services and fees under the Advisory Agreement

 

Under the Advisory Agreement, we pay our Adviser an annual base management fee of 2% of our average gross assets, which is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the two most recently completed calendar quarters, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.

 

We also pay our Adviser a two-part incentive fee under the Advisory Agreement.  The first part of the incentive fee is an income-based incentive fee which rewards our Adviser if our quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of our net assets (the “hurdle rate”). We pay our Adviser an income-based incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:

 

·             no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle rate (7% annualized);

 

·             100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in any calendar quarter (8.75% annualized); and

 

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·             20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized).

 

Quarterly Incentive Fee Based on Net Investment Income

 

Pre-incentive fee net investment income
(expressed as a percentage of the value of net assets)

 

GRAPHIC

 

Percentage of pre-incentive fee net investment income
allocated to income-related portion of incentive fee

 

The second part of the incentive fee is a capital gains-based incentive fee that is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), equals 20% of our realized capital gains as of the end of the fiscal year.  In determining the capital gains-based incentive fee payable to our Adviser, we calculate the cumulative aggregate realized capital gains and cumulative aggregate realized capital losses since our inception, and the aggregate unrealized capital depreciation as of the date of the calculation, as applicable, with respect to each of the investments in our portfolio. For this purpose, cumulative aggregate realized capital gains, if any, equals the sum of the differences between the net sales price of each investment, when sold, and the original cost of such investment since our inception. Cumulative aggregate realized capital losses equals the sum of the amounts by which the net sales price of each investment, when sold, is less than the original cost of such investment since our inception. Aggregate unrealized capital depreciation equals the sum of the difference, if negative, between the valuation of each investment as of the applicable calculation date and the original cost of such investment. At the end of the applicable year, the amount of capital gains that serves as the basis for our calculation of the capital gains-based incentive fee equals the cumulative aggregate realized capital gains less cumulative aggregate realized capital losses, less aggregate unrealized capital depreciation, with respect to our portfolio of investments. If this number is positive at the end of such year, then the capital gains-based incentive fee for such year equals 20% of such amount, less the aggregate amount of any capital gains-based incentive fees paid in respect of our portfolio in all prior years.

 

Beginning in April 2006, our Board of Directors has accepted from the Adviser unconditional and irrevocable voluntary waivers on a quarterly basis to reduce the annual 2% base management fee on senior syndicated loan participations to 0.5%, to the extent that proceeds resulting from borrowings were used to purchase such syndicated loan participations. These waivers were applied through September 30, 2009, and any waived fees may not be recouped by our Adviser in the future.

 

When our Adviser receives fees from our portfolio companies, such as investment banking fees, structuring fees or executive recruiting services fees, 50% of certain of these fees are credited against the base management fee that we would otherwise be required to pay to our Adviser.

 

In addition, our Adviser services the loans held by Business Loan in return for which our Adviser receives a 1.5% annual fee based on the monthly aggregate outstanding loan balance of the loans pledged under our credit facility.  This fee directly reduces the amount of the fee payable under the Advisory Agreement. Loan servicing fees of $5,620 were incurred for the fiscal year ended September 30, 2009, all of which were directly credited against the amount of the base management fee due to our Adviser under the Advisory Agreement.

 

We pay our direct expenses including, but not limited to, directors’ fees, legal and accounting fees, stockholder-related expenses, and directors and officers insurance under the Advisory Agreement.

 

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Administration Agreement

 

Under the Administration Agreement, we pay separately for administrative services. The Administration Agreement provides for payments equal to our allocable portion of the Administrator’s overhead expenses in performing its obligations under the Administration Agreement including, but not limited to, rent for employees of the Administrator and our allocable portion of the salaries and benefits expenses of our chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.  Our allocable portion of expenses is derived by multiplying our Administrator’s total expenses by the percentage of our average total assets (the total assets at the beginning and end of each quarter) in comparison to the average total assets of all companies managed by our Adviser under similar agreements.

 

Material U.S. Federal Income Tax Considerations

 

Regulated Investment Company Status

 

In order to maintain the qualification for treatment as a RIC under Subchapter M of the Code, we must distribute to our stockholders, for each taxable year, at least 90% of our investment company taxable income, which is generally our ordinary income plus short-term capital gains. We refer to this as the annual distribution requirement. We must also meet several additional requirements, including:

 

·                                          Income source requirements. At least 90% of our gross income for each taxable year must be from dividends, interest, payments with respect to securities loans, gains from sales or other dispositions of securities or other income derived with respect to our business of investing in securities, and net income derived from an interest in a qualified publicly traded partnership.

 

·                                          Asset diversification requirements. As of the close of each quarter of our taxable year: (1) at least 50% of the value of our assets must consist of cash, cash items, U.S. government securities, the securities of other regulated investment companies and other securities to the extent that (a) we do not hold more than 10% of the outstanding voting securities of an issuer of such other securities and (b) such other securities of any one issuer do not represent more than 5% of our total assets, and (2) no more than 25% of the value of our total assets may be invested in the securities of one issuer (other than U.S. government securities or the securities of other regulated investment companies), or of two or more issuers that are controlled by us and are engaged in the same or similar or related trades or businesses or in the securities of one or more qualified publicly traded partnerships.

 

Failure to Qualify as a RIC.  If we are unable to qualify for treatment as a RIC, we will be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to stockholders, nor would we be required to make such distributions. Distributions would be taxable to our stockholders as ordinary dividend income to the extent of our current and accumulated earnings and profits. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and then as a gain realized from the sale or exchange of property. If we fail to meet the RIC requirements for more than two consecutive years and then seek to requalify as a RIC, we would be required to recognize a gain to the extent of any unrealized appreciation on our assets unless we make a special election to pay corporate-level tax on any such unrealized appreciation recognized during the succeeding 10-year period. Absent such special election, any gain we recognized would be deemed distributed to our stockholders as a taxable distribution.

 

Qualification as a RIC.  If we qualify as a RIC and distribute to stockholders each year in a timely manner at least 90% of our investment company taxable income, we will not be subject to federal income tax on the portion of our taxable income and gains we distribute to stockholders. We would, however, be subject to a 4% nondeductible federal excise tax if we do not distribute, actually or on a deemed basis, 98% of our income, including both ordinary income and capital gains. The excise tax would apply only to the amount by which 98% of our income exceeds the amount of income we distribute, actually or on a deemed basis, to stockholders.  We will be subject to regular corporate income tax, currently at rates up to 35%, on any undistributed income, including both ordinary income and capital gains. We intend to retain some or all of our capital gains, but to designate the retained amount as a deemed distribution. In that case, among other consequences, we will pay tax on the retained amount, each stockholder will be required to include its share of the deemed distribution in income as if it had been actually distributed to the stockholder and the stockholder will be entitled to claim a credit or refund equal to its allocable share of the tax we pay on the retained capital gain. The amount of the deemed distribution net of such tax will be added to the stockholder’s cost basis for its common stock. Since we expect to pay tax on any retained capital gains at our regular

 

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corporate capital gain tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual stockholders will be treated as having paid will exceed the tax they owe on the capital gain dividend and such excess may be claimed as a credit or refund against the stockholder’s other tax obligations. A stockholder that is not subject to U.S. federal income tax or tax on long-term capital gains would be required to file a U.S. federal income tax return on the appropriate form in order to claim a refund for the taxes we paid. In order to utilize the deemed distribution approach, we must provide written notice to the stockholders prior to the expiration of 60 days after the close of the relevant tax year. We will also be subject to alternative minimum tax, but any tax preference items would be apportioned between us and our stockholders in the same proportion that dividends, other than capital gain dividends, paid to each stockholder bear to our taxable income determined without regard to the dividends paid deduction.

 

If we acquire debt obligations that were originally issued at a discount, which would generally include loans we make that are accompanied by warrants, that bear interest at rates that are not either fixed rates or certain qualified variable rates or that are not unconditionally payable at least annually over the life of the obligation, we will be required to include in taxable income each year a portion of the original issue discount (“OID”) that accrues over the life of the obligation. Such OID will be included in our investment company taxable income even though we receive no cash corresponding to such discount amount. As a result, we may be required to make additional distributions corresponding to such OID amounts in order to satisfy the annual distribution requirement and to continue to qualify as a RIC or to avoid the 4% excise tax. In this event, we may be required to sell temporary investments or other assets to meet the RIC distribution requirements.  Through September 30, 2009, we incurred no OID income.

 

Taxation of Our U.S. Stockholders

 

Distributions.  For any period during which we qualify for treatment as a RIC for federal income tax purposes, distributions to our stockholders attributable to our investment company taxable income generally will be taxable as ordinary income to stockholders to the extent of our current or accumulated earnings and profits. Any distributions in excess of our earnings and profits will first be treated as a return of capital to the extent of the stockholder’s adjusted basis in his or her shares of common stock and thereafter as gain from the sale of shares of our common stock. Distributions of our long-term capital gains, designated by us as such, will be taxable to stockholders as long-term capital gains regardless of the stockholder’s holding period for its common stock and whether the distributions are paid in cash or invested in additional common stock. Corporate stockholders are generally eligible for the 70% dividends received deduction with respect to ordinary income, but not to capital gains dividends to the extent such amount designated by us does not exceed the dividends received by us from domestic corporations. Any dividend declared by us in October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following year, will be treated as if it were paid by us and received by the stockholders on December 31 of the previous year. In addition, we may elect to relate a dividend back to the prior taxable year if we (1) declare such dividend prior to the due date for filing our return for that taxable year, (2) make the election in that return, and (3) distribute the amount in the 12-month period following the close of the taxable year but not later than the first regular dividend payment following the declaration. Any such election will not alter the general rule that a stockholder will be treated as receiving a dividend in the taxable year in which the distribution is made, subject to the October, November, December rule described above.

 

In general, the tax rates applicable to our dividends other than dividends designated as capital gain dividends will be the standard ordinary income tax rates, and not the lower federal income tax rate applicable to “qualified dividend income.” If we distribute dividends that are attributable to actual dividend income received by us that is eligible to be, and is, designated by us as qualified dividend income, such dividends would be eligible for such lower federal income tax rate. For this purpose, “qualified dividend income” means dividends received by us from United States corporations and qualifying foreign corporations, provided that both we and the stockholder recipient of our dividend satisfy certain holding period and other requirements in respect of our shares (in the case of our stockholder) and the stock of such corporations (in our case). However, we do not anticipate receiving or distributing a significant amount of qualified dividend income.

 

If a stockholder participates in our dividend reinvestment plan, any distributions reinvested under the plan will be taxable to the stockholder to the same extent, and with the same character, as if the stockholder had received the distribution in cash. The stockholder will have an adjusted basis in the additional common shares purchased through the plan equal to the amount of the reinvested distribution. The additional shares will have a new holding period commencing on the day following the day on which the shares are credited to the stockholder’s account.

 

Sale of Our Shares.   A U.S. stockholder generally will recognize taxable gain or loss if the U.S. stockholder sells or otherwise disposes of his, her or its shares of our common stock. Any gain arising from such sale or disposition generally will

 

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be treated as long-term capital gain or loss if the U.S. stockholder has held his, her or its shares for more than one year. Otherwise, it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares.  Under the tax laws in effect as of the date of this filing, individual U.S. stockholders are subject to a maximum federal income tax rate of 15% on their net capital gain ( i.e. the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year) including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Corporate U.S. stockholders currently are subject to federal income tax on net capital gain at the same rates applied to their ordinary income (currently up to a maximum of 35%). Capital losses are subject to limitations on use for both corporate and non-corporate stockholders.

 

Backup Withholding.   We may be required to withhold federal income tax, or backup withholding, currently at a rate of 28%, from all taxable distributions to any non-corporate U.S. stockholder (1) who fails to furnish us with a correct taxpayer identification number or a certificate that such stockholder is exempt from backup withholding, or (2) with respect to whom the Internal Revenue Service (“IRS”) notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individual’s taxpayer identification number is generally his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the U.S. stockholder’s federal income tax liability, provided that proper information is provided to the IRS.

 

Regulation as a Business Development Company

 

We are a closed-end, non-diversified management investment company that has elected to be regulated as a business development company under Section 54 of the 1940 Act. As such, we are subject to regulation under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates, principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a business development company unless approved by a majority of our outstanding voting securities.

 

We intend to conduct our business so as to retain our status as a business development company. A business development  company may use capital provided by public stockholders and from other sources to invest in long-term private investments in businesses.  A business development company provides stockholders the ability to retain the liquidity of a publicly traded stock while sharing in the possible benefits, if any, of investing in primarily privately owned companies.  In general, a business development company must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in assets described in Section 55(a) (1) — (3) of the 1940 Act.

 

Qualifying Assets

 

Under the 1940 Act, a business development company may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets, other than certain interests in furniture, equipment, real estate, or leasehold improvements (“operating assets”) represent at least 70% of the company’s total assets, exclusive of operating assets. The types of qualifying assets in which we may invest under the 1940 Act include, but are not limited to, the following:

 

(1)                                  Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer is an eligible portfolio company. An eligible portfolio company is generally defined in the 1940 Act as any issuer which:

 

(a)  is organized under the laws of, and has its principal place of business in, any State or States in the United States;

 

(b)  is not an investment company (other than a small business investment company wholly owned by the business development company); and

 

(c)  satisfies one of the following:

 

(i)  it does not have any class of securities with respect to which a broker or dealer may extend margin credit;

 

(ii) it is controlled by the business development company and for which an affiliate of the business development company serves as a director;

 

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(iii)  it has total assets of not more than $4 million and capital and surplus of not less than $2 million;

 

(iv)  it does not have any class of securities listed on a national securities exchange; or

 

(v)   it has a class of securities listed on a national securities exchange, with an aggregate market value of outstanding voting and non-voting equity of less than $250 million.

 

(2)                                  Securities received in exchange for or distributed on or with respect to securities described in (1) above, or pursuant to the exercise of options, warrants or rights relating to such securities.

 

(3)                                  Cash, cash items, government securities or high quality debt securities maturing in one year or less from the time of investment.

 

Asset Coverage

 

We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least 200% immediately after each such issuance. In addition, while senior securities are outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes. The 1940 Act requires, among other things, that (1) immediately after issuance and before any dividend or distribution is made with respect to our common stock or before any purchase of our common stock is made, the preferred stock, together with all other senior securities, must not exceed an amount equal to 50% of our total assets after deducting the amount of such dividend, distribution or purchase price, as the case may be, and (2) the holders of shares of preferred stock, if any are issued, must be entitled as a class to elect two directors at all times and to elect a majority of the directors if dividends on the preferred stock are in arrears by two years or more.

 

Significant Managerial Assistance

 

A business development company generally must make available significant managerial assistance to issuers of certain of its portfolio securities that the business development company counts as a qualifying asset for the 70% test described above. Making available significant managerial assistance means, among other things, any arrangement whereby the business development company, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. Significant managerial assistance also includes the exercise of a controlling influence over the management and policies of the portfolio company. However, with respect to certain, but not all such securities, where the business development company purchases such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance, or the business development company may exercise such control jointly.

 

Investment Policies

 

We seek to achieve a high level of current income and capital gains through investments in debt securities and preferred and common stock that we acquired in connection with buyout and other recapitalizations. The following investment policies, along with these investment objectives, may not be changed without the approval of our Board of Directors:

 

·                  We will at all times conduct our business so as to retain our status as a business development company. In order to be deemed to be a business development company, we must be operated for the purpose of investing in certain categories of qualifying assets.  In addition, we may not acquire any assets (other than non-investment assets necessary and appropriate to our operations as a business development company or qualifying assets) if, after giving effect to such acquisition, the value of our “qualifying assets” is less than 70% of the value of our total assets. We anticipate that the securities we seek to acquire, as well as temporary investments, will generally be qualifying assets.

 

·                  We will at all times endeavor to conduct our business so as to retain our status as a RIC under the Code. In order to do so, we must meet income source, asset diversification and annual distribution requirements. We may issue senior securities, such as debt or preferred stock, to the extent permitted by the 1940 Act for the purpose of making investments, to fund share repurchases, or for temporary emergency or other purposes.

 

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With the exception of our policy to conduct our business as a business development company, these policies are not fundamental and may be changed without stockholder approval.

 

Code of Ethics

 

We and our Adviser have each adopted a code of ethics and business conduct applicable to our officers, directors and all employees of our Adviser and our Administrator that complies with the guidelines set forth in Item 406 of Regulation S-K of the Securities Act.  As required by the 1940 Act, this code establishes procedures for personal investments, restricts certain transactions by our personnel and requires the reporting of certain transactions and holdings by our personnel.  A copy of this code is available for review, free of charge, at our website at www.GladstoneCapital.com.  We intend to provide any required disclosure of any amendments to or waivers of the provisions of this code by posting information regarding any such amendment or waiver to our website within four days of its effectiveness.

 

Compliance Policies and Procedures

 

We and our Adviser have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws, and our Board of Directors is required to review these compliance policies and procedures annually to assess their adequacy and the effectiveness of their implementation.  We have designated a chief compliance officer, John Dellafiora, Jr., who also serves as chief compliance officer for our Adviser.

 

Staffing

 

We do not currently have any employees and do not expect to have any employees in the foreseeable future.  Currently, services necessary for our business are provided by individuals who are employees of our Adviser and our Administrator pursuant to the terms of the Advisory Agreement and the Administration Agreement, respectively.  Excluding our chief financial officer, each of our executive officers is an employee or officer, or both, of our Adviser and our Administrator.  No employee of our Adviser or our Administrator will dedicate all of his or her time to us.  However, we expect that 25-30 full time employees of our Adviser and our Administrator will spend substantial time on our matters during the remainder of calendar year 2009 and all of calendar year 2010.  To the extent we acquire more investments, we anticipate that the number of employees of our Adviser and our Administrator who devote time to our matters will increase.

 

As of November 13, 2009, our Adviser and our Administrator collectively had 54 full-time employees. A breakdown of these employees is summarized by functional area in the table below:

 

Number of Individuals

 

Functional Area

 

12

 

Executive Management

 

 

 

 

 

34

 

Investment Management, Portfolio Management and Due Diligence

 

 

 

 

 

8

 

Administration, Accounting, Compliance, Human Resources, Legal and Treasury

 

 

Available Information

 

Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments, if any, to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website at www.GladstoneCapital.com.  A request for any of these reports may also be submitted to us by sending a written request addressed to Corporate Secretary, Gladstone Capital Corporation, 1521 Westbranch Drive, Suite 200, McLean, VA 22102, or by calling our toll-free investor relations line at 1-866-366-5745.  The public may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.  The SEC also maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

 

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Item 1A. Risk Factors

 

An investment in our securities involves a number of significant risks and other factors relating to our structure and investment objectives. As a result, we cannot assure you that we will achieve our investment objectives. You should consider carefully the following information before making an investment in our securities.

 

Risks Related to the Economy

 

The current state of the economy and the capital markets increases the possibility of adverse effects on our financial position and results of operations. Continued economic adversity could impair our portfolio companies’ financial positions and operating results and affect the industries in which we invest, which could, in turn, harm our operating results.  Continued adversity in the capital markets could impact our ability to raise capital and reduce our volume of new investments.

 

The United States is in a recession. The recession generally, and the disruptions in the capital markets in particular, have decreased liquidity and increased our cost of debt and equity capital, where available. The longer these conditions persist, the greater the probability that these factors could continue to increase our costs of, and significantly limit our access to, debt and equity capital and, thus, have an adverse effect on our operations and financial results. Many of the companies in which we have made or will make investments are also susceptible to the recession, which may affect the ability of one or more of our portfolio companies to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial public offering. The recession could also disproportionately impact some of the industries in which we invest, causing us to be more vulnerable to losses in our portfolio, which could cause the number of our non-performing assets to increase and the fair market value of our portfolio to decrease. The recession may also decrease the value of collateral securing some of our loans as well as the value of our equity investments which would decrease our ability to borrow under our credit facility or raise equity capital, thereby further reducing our ability to make new investments.
 

The recession has affected the availability of credit generally and we have seen the withdrawal of Deutsche Bank AG as a committed lender and a reduction in committed funding under our credit facility from $162.0 million to $107.0 million, which will be further reduced to $102.0 million at January 1, 2010.  Our current credit facility limits our distributions to stockholders and as a result we recently decreased our monthly cash distribution rate by 50% starting with the April 2009 distributions in an effort to more closely align our distributions to our net investment income. We do not know when market conditions will stabilize, if adverse conditions will intensify or the full extent to which the disruptions will continue to affect us. Also, it is possible that persistent instability of the financial markets could have other unforeseen material effects on our business.

 

We may experience fluctuations in our quarterly and annual results based on the impact of inflation in the United States.

 

The majority of our portfolio companies are in industries that are directly impacted by inflation, such as consumer goods and services and manufacturing.  Our portfolio companies may not be able to pass on to customers increases in their costs of operations which could greatly affect their operating results, impacting their ability to repay our loans.  In addition, any projected future decreases in our portfolio companies’ operating results due to inflation could adversely impact the fair value of those investments.  Any decreases in the fair value of our investments could result in future unrealized losses and therefore reduce our net assets resulting from operations.

 

Risks Related to Our External Management

 

We are dependent upon our key management personnel and the key management personnel of our Adviser, particularly David Gladstone, George Stelljes III and Terry Lee Brubaker, and on the continued operations of our Adviser, for our future success.

 

We have no employees. Our chief executive officer, president and chief investment officer, chief operating officer and chief financial officer, and the employees of our Adviser, do not spend all of their time managing our activities and our investment portfolio. We are particularly dependent upon David Gladstone, George Stelljes III and Terry Lee Brubaker in this regard. Our executive officers and the employees of our Adviser allocate some, and in some cases a material portion, of their time to businesses and activities that are not related to our business. We have no separate facilities and are completely reliant on our Adviser, which has significant discretion as to the implementation and execution of our business strategies and risk management practices. We are subject to the risk of discontinuation of our Adviser’s operations or termination of the Advisory Agreement and the risk that, upon such event, no suitable replacement will be found. We believe that our success

 

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depends to a significant extent upon our Adviser and that discontinuation of its operations could have a material adverse effect on our ability to achieve our investment objectives.

 

Our incentive fee may induce our Adviser to make certain investments, including speculative investments.

 

The management compensation structure that has been implemented under the Advisory Agreement may cause our Adviser to invest in high-risk investments or take other risks.  In addition to its management fee, our Adviser is entitled under the Advisory Agreement to receive incentive compensation based in part upon our achievement of specified levels of income.  In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net income may lead our Adviser to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity, or management of credit risk or market risk, in order to achieve higher incentive compensation.  Investments with higher yield potential are generally riskier or more speculative.  This could result in increased risk to the value of our investment portfolio.

 

We may be obligated to pay our Adviser incentive compensation even if we incur a loss.

 

The Advisory Agreement entitles our Adviser to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation, net operating losses and certain other items) above a threshold return for that quarter. When calculating our incentive compensation, our pre-incentive fee net investment income excludes realized and unrealized capital losses that we may incur in the fiscal quarter, even if such capital losses result in a net loss on our statement of operations for that quarter. Thus, we may be required to pay our Adviser incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter. For additional information on incentive compensation under the Advisory Agreement with our Adviser, see “Business — Investment Advisory and Management Agreements — Management services and fees under the Advisory Agreement.”

 

Our Adviser’s failure to identify and invest in securities that meet our investment criteria or perform its responsibilities under the Advisory Agreement may adversely affect our ability for future growth.

 

Our ability to achieve our investment objectives will depend on our ability to grow, which in turn will depend on our Adviser’s ability to identify and invest in securities that meet our investment criteria.  Accomplishing this result on a cost-effective basis will be largely a function of our Adviser’s structuring of the investment process, its ability to provide competent and efficient services to us, and our access to financing on acceptable terms.  The senior management team of our Adviser has substantial responsibilities under the Advisory Agreement.  In order to grow, our Adviser will need to hire, train, supervise, and manage new employees successfully.  Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition, and results of operations.

 

There are significant potential conflicts of interest which could impact our investment returns.

 

Our executive officers and directors, and the officers and directors of our Adviser, serve or may serve as officers, directors, or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders. For example, Mr. Gladstone, our chairman and chief executive officer, is the chairman of the board and chief executive officer of our Adviser, Gladstone Investment and Gladstone Commercial. In addition, Mr. Brubaker, our vice chairman, chief operating officer and secretary is the vice chairman, chief operating officer and secretary of our Adviser, Gladstone Investment and Gladstone Commercial. Mr. Stelljes, our president and chief investment officer, is also the president and chief investment officer of our Adviser and Gladstone Commercial and vice chairman and chief investment officer of Gladstone Investment. Moreover, our Adviser may establish or sponsor other investment vehicles which from time to time may have potentially overlapping investment objectives with those of ours and accordingly may invest in, whether principally or secondarily, asset classes similar to those we target. While our Adviser generally has broad authority to make investments on behalf of the investment vehicles that it advises, our Adviser has adopted investment allocation procedures to address these potential conflicts and intends to direct investment opportunities to the Gladstone affiliate with the investment strategy that most closely fits the investment opportunity. Nevertheless, the management of our Adviser may face conflicts in the allocation of investment opportunities to other entities managed by our Adviser. As a result, it is possible that we may not be given the opportunity to participate in certain investments made by other members of the Gladstone Companies or investment funds managed by investment managers affiliated with our Adviser.

 

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In certain circumstances, we may make investments in a portfolio company in which one of our affiliates has or will have an investment, subject to satisfaction of any regulatory restrictions and, where required, to the prior approval of our Board of Directors. As of September 30, 2009, our Board of Directors has approved the following types of co-investment transactions:

 

·      Our affiliate, Gladstone Commercial, may lease property to portfolio companies that we do not control under certain circumstances. We may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria of Gladstone Commercial, and (iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial. We expect that any such negotiations between Gladstone Commercial and our portfolio companies would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours.

 

·      We may invest simultaneously with our affiliate Gladstone Investment in senior syndicated loans whereby neither we nor any affiliate has the ability to dictate the terms of the loans.

 

Certain of our officers, who are also officers of our Adviser, may from time to time serve as directors of certain of our portfolio companies. If an officer serves in such capacity with one of our portfolio companies, such officer will owe fiduciary duties to all shareholders of the portfolio company, which duties may from time to time conflict with the interests of our stockholders.

 

In the course of our investing activities, we will pay management and incentive fees to our Adviser and will reimburse our Administrator for certain expenses it incurs. As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in, among other things, a lower rate of return than one might achieve through our investors themselves making direct investments. As a result of this arrangement, there may be times when the management team of our Adviser has interests that differ from those of our stockholders, giving rise to a conflict.

 

Our Adviser is not obligated to provide a waiver of the base management fee, which could negatively impact our earnings and our ability to maintain our current level of distributions to our stockholders.

 

The Advisory Agreement provides for a base management fee based on our gross assets. Since our 2008 fiscal year, our Board of Directors has accepted on a quarterly basis voluntary, unconditional and irrevocable waivers to reduce the annual 2.0% base management fee on senior syndicated loan participations to 0.5% to the extent that proceeds resulting from borrowings were used to purchase such syndicated loan participations, and any waived fees may not be recouped by our Adviser in the future. However, our Adviser is not required to issue these or other waivers of fees under the Advisory Agreement, and to the extent our investment portfolio grows in the future, we expect these fees will increase. If our Adviser does not issue these waivers in future quarters, it could negatively impact our earnings and may compromise our ability to maintain our current level of distributions to our stockholders, which could have a material adverse impact on our stock price.

 

Our business model is dependent upon developing and sustaining strong referral relationships with investment bankers, business brokers and other intermediaries.

 

We are dependent upon informal relationships with investment bankers, business brokers and traditional lending institutions to provide us with deal flow.  If we fail to maintain our relationship with such funds or institutions, or if we fail to establish strong referral relationships with other funds, we will not be able to grow our portfolio of loans and fully execute our business plan.

 

Risks Related to Our External Financing

 

Committed funding has been reduced from $162 million under our prior facility to $107 million under the new facility. Any inability to expand the credit facility could adversely impact our liquidity and ability to find new investments or maintain distributions to our stockholders.

 

On May 15, 2009 we, through our wholly-owned subsidiary Gladstone Business Loan, LLC, entered into a third amended and restated credit agreement providing for a $127.0 million revolving line of credit (the “KEF Facility”), arranged by Key Equipment Finance Inc. (“KEF”) as administrative agent.  Branch Banking and Trust Company (“BB&T”) also joined the KEF Facility as a committed lender.   Committed funding under the KEF Facility was reduced from $162.0 million under our prior credit facility and Deutsche Bank AG, who was a committed lender under the prior facility, elected not to participate in

 

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the new facility and withdrew its commitment.  The KEF Facility may be expanded up to $200.0 million through the addition of other committed lenders to the facility. However, if additional lenders are unwilling to join the facility on its terms, we will be unable to expand the facility and thus will continue to have limited availability to finance new investments under our line of credit. Furthermore, without the addition of other committed lenders, the KEF Facility provides a total commitment of $102.0 million from January 1, 2010 to May 11, 2010 and $77.0 million thereafter.  As of September 30, 2009, we had $44.0 million of availability to draw down borrowings under the KEF Facility.

 

In October and November of 2009, we reduced the size of the KEF Facility by $15.0 million and $5 million, respectively, from $127.0 million to $107.0 million. Under the KEF Facility the first $50.0 million of commitment reductions are applied against KEF’s commitment.  Therefore, the entire $20.0 million was subtracted from KEF’s commitment, reducing it from $100.0 million to $80.0 million and leaving BB&T’s commitment unchanged at $27.0 million.  As a result of the manner in which our borrowing base is calculated under the KEF Facility, the reductions did not affect our availability under the KEF Facility.  The KEF Facility matures on May 14, 2010, and if the facility is not renewed or extended by this date, all principal and interest will be due and payable within one year of maturity. In addition, if the facility is not renewed, our lenders have the right to apply all principal and interest collections to amounts outstanding under the KEF Facility.

 

There can be no guarantee that we will be able to renew, extend or replace the KEF Facility upon its maturity on terms that are favorable to us, if at all. Our ability to expand the KEF Facility, and to obtain replacement financing at the time of maturity, will be constrained by then-current economic conditions affecting the credit markets. In the event that we are not able to expand the KEF Facility, or to renew, extend or refinance the KEF Facility at the time of its maturity, this could have a material adverse effect on our liquidity and ability to fund new investments, our ability to make distributions to our stockholders and our ability to qualify as a RIC under the Code.

 

Our business plan is dependent upon external financing, which is constrained by the limitations of the 1940 Act.

 

Our business requires a substantial amount of cash to operate and grow. We may acquire such additional capital from the following sources:

 

·      Senior Securities.  We may issue debt securities, other evidences of indebtedness (including borrowings under our line of credit) and possibly senior common stock and preferred stock, up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us, as a business development company, to issue debt securities, senior common stock and preferred stock, which we refer to collectively as senior securities, in amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of senior securities. As a result of issuing senior securities, we will be exposed to the risks associated with leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we receive on the investments we make with such borrowed funds. In addition, our ability to pay distributions or incur additional indebtedness would be restricted if asset coverage is not at least twice our indebtedness. If the value of our assets declines, we might be unable to satisfy that test. If this happens, we may be required to liquidate a portion of our loan portfolio and repay a portion of our indebtedness at a time when a sale, to the extent possible given the limited market for many of our investments, may be disadvantageous. Furthermore, any amounts that we use to service our indebtedness will not be available for distributions to our stockholders.

 

·      Common Stock.  Because we are constrained in our ability to issue debt for the reasons given above, we are dependent on the issuance of equity as a financing source. If we raise additional funds by issuing more common stock or senior securities convertible into or exchangeable for our common stock, the percentage ownership of our stockholders at the time of the issuance would decrease and our common stock may experience dilution. In addition, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. In addition, under the 1940 Act, we will generally not be able to issue additional shares of our common stock at a price below net asset value per share to purchasers, other than to our existing stockholders, through a rights offering without first obtaining the approval of our stockholders and our independent directors. If we were to sell shares of our common stock below our then current net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. For example, if we sell an additional 10% of our common stock at a 5% discount from net asset value, a stockholder who

 

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does not participate in that offering for its proportionate interest will suffer net asset value dilution of up to 0.5% or $5 per $1,000 of net asset value.  This imposes constraints on our ability to raise capital when our common stock is trading at below net asset value, as it has for the last year.

 

A change in interest rates may adversely affect our profitability.

 

We anticipate using a combination of equity and long-term and short-term borrowings to finance our investment activities. As a result, a portion of our income will depend upon the difference between the rate at which we borrow funds and the rate at which we loan these funds. Higher interest rates on our borrowings will decrease the overall return on our portfolio.

 

Ultimately, we expect approximately 80% of the loans in our portfolio to be at variable rates determined on the basis of a London Interbank Offer Rate (“LIBOR”), and approximately 20% to be at fixed rates. As of September 30, 2009, our portfolio had approximately 11% of the total of the loan cost value at variable rates without a floor or ceiling, approximately 83% of the total loan cost value at variable rates with floors, approximately 2% at variable rates with a floor and ceiling and approximately 4% of the total loan portfolio cost basis at fixed rates.

 

In addition to regulatory limitations on our ability to raise capital, our credit facility contains various covenants which, if not complied with, could accelerate our repayment obligations under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions.

 

We will have a continuing need for capital to finance our loans. In order to maintain RIC status, we are required to distribute to our stockholders at least 90% of our ordinary income and short-term capital gains on an annual basis. Accordingly, such earnings will not be available to fund additional loans. Therefore, we are party to the KEF Facility, which provides us with a revolving credit line facility of $127.0 million, of which $44.0 million was available for borrowings as of September 30, 2009. In October and November of 2009, we reduced the size of the KEF Facility by $15.0 million and $5 million, respectively, from $127.0 million to $107.0 million. The KEF Facility permits us to fund additional loans and investments as long as we are within the conditions set out in the credit agreement. Current market conditions have forced us to write down the value of a portion of our assets as required by the 1940 Act and fair value accounting rules. These are not realized losses, but constitute adjustment in asset values for purposes of financial reporting and for collateral value for the KEF Facility. As assets are marked down in value, the amount we can borrow on the KEF Facility decreases.

 

As a result of the KEF Facility, we are subject to certain limitations on the type of loan investments we make, including restrictions on geographic concentrations, sector concentrations, loan size, dividend payout, payment frequency and status, and average life. The credit agreement also requires us to comply with other financial and operational covenants, which require us to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum net worth. As of September 30, 2009, we were in compliance with these covenants, however, our continued compliance with these covenants depends on many factors, some of which are beyond our control. In particular, depreciation in the valuation of our assets, which valuation is subject to changing market conditions that remain very volatile, affects our ability to comply with these covenants. During the year ended September 30, 2009, net unrealized appreciation on our investments was approximately $9.5 million, compared to $47.0 million unrealized depreciation during the prior fiscal year. Given the continued deterioration in the capital markets, the cumulative unrealized depreciation in our portfolio may increase in future periods and threaten our ability to comply with the covenants under the KEF Facility. Accordingly, there are no assurances that we will continue to comply with these covenants. Under the KEF Facility, we are also required to maintain our status as a BDC under the 1940 Act and as a RIC under the Code. Our failure to satisfy these covenants could result in foreclosure by our lenders, which would accelerate our repayment obligations under the facility and thereby have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders.

 

Risks Related to Our Investments

 

We operate in a highly competitive market for investment opportunities.

 

A large number of entities compete with us and make the types of investments that we seek to make in small and mid-sized companies. We compete with public and private buyout funds, commercial and investment banks, commercial financing companies, and, to the extent they provide an alternative form of financing, hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which would allow them to consider a wider

 

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variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company. The competitive pressures we face could have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.  We do not seek to compete based on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that will be comparable to or lower than the rates we offer.  We may lose investment opportunities if we do not match our competitors’ pricing, terms, and structure.  However, if we match our competitors’ pricing, terms, and structure, we may experience decreased net interest income and increased risk of credit loss.

 

Our investments in small and medium-sized portfolio companies are extremely risky and could cause you to lose all or a part of your investment.

 

Investments in small and medium-sized portfolio companies are subject to a number of significant risks including the following:

 

·     Small and medium-sized businesses are likely to have greater exposure to economic downturns than larger businesses. Our portfolio companies may have fewer resources than larger businesses, and thus the current recession, and any further economic downturns or recessions are more likely to have a material adverse effect on them. If one of our portfolio companies is adversely impacted by a recession, its ability to repay our loan or engage in a liquidity event, such as a sale, recapitalization or initial public offering would be diminished. Moreover, in light of our current near-term strategy of preserving capital, our inability to make additional investments in our portfolio companies at a time when they need capital may increase their exposure to the risks of the current recession and future economic downturns.

 

·     Small and medium-sized businesses may have limited financial resources and may not be able to repay the loans we make to them. Our strategy includes providing financing to portfolio companies that typically is not readily available to them. While we believe that this provides an attractive opportunity for us to generate profits, this may make it difficult for the portfolio companies to repay their loans to us upon maturity. A borrower’s ability to repay its loan may be adversely affected by numerous factors, including the failure to meet its business plan, a downturn in its industry, or negative economic conditions. A deterioration in a borrower’s financial condition and prospects usually will be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing on any guarantees we may have obtained from the borrower’s management. Although we will sometimes seek to be the senior, secured lender to a borrower, in most of our loans we expect to be subordinated to a senior lender, and our interest in any collateral would, accordingly, likely be subordinate to another lender’s security interest.  During the fiscal year ended September 30, 2009, we converted three non-performing Non-Control/Non-Affiliate investments to Control investments (Clinton, Defiance and Lindmark) and as of September 30, 2009, five investments were on non-accrual.  While we are working with the portfolio companies to improve their profitability and cash flows there can be no assurance that our efforts will prove successful.

 

·     Small and medium-sized businesses typically have narrower product lines and smaller market shares than large businesses. Because our target portfolio companies are smaller businesses, they will tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, our portfolio companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing, and other capabilities and a larger number of qualified managerial, and technical personnel.

 

·     There is generally little or no publicly available information about these businesses. Because we seek to invest in privately owned businesses, there is generally little or no publicly available operating and financial information about our potential portfolio companies. As a result, we rely on our officers, our Adviser, and its employees and consultants to perform due diligence investigations of these portfolio companies, their operations, and their prospects. We may not learn all of the material information we need to know regarding these businesses through our investigations.

 

·     Small and medium-sized businesses generally have less predictable operating results. We expect that our portfolio companies may have significant variations in their operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position, or may be adversely affected by changes in the business cycle. Our

 

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portfolio companies may not meet net income, cash flow, and other coverage tests typically imposed by their senior lenders. A borrower’s failure to satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially, foreclosure on its senior credit facility, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the borrower’s ability to repay our loan would be jeopardized.

 

·     Small and medium-sized businesses are more likely to be dependent on one or two persons. Typically, the success of a small or medium-sized business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability, or resignation of one or more of these persons could have a material adverse impact on our borrower and, in turn, on us.

 

·     Small and medium-sized businesses may have limited operating histories. While we intend to target stable companies with proven track records, we may make loans to new companies that meet our other investment criteria. Portfolio companies with limited operating histories will be exposed to all of the operating risks that new businesses face and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers.

 

Because a large percentage of the loans we make and equity securities we receive when we make loans are not publicly traded, there is uncertainty regarding the value of our privately held securities that could adversely affect our determination of our net asset value.

 

A large percentage of our portfolio investments are, and we expect will continue to be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. Our Board of Directors has established an investment valuation policy and consistently applied valuation procedures used to determine the fair value of these securities quarterly. These procedures for the determination of value of many of our debt securities rely on the opinions of value submitted to us by SPSE, the use of internally developed discounted cash flow, or DCF, methodologies, or internal methodologies based on the total enterprise value, or TEV, of the issuer used for certain of our equity investments. SPSE will only evaluate the debt portion of our investments for which we specifically request evaluation, and SPSE may decline to make requested evaluations for any reason in its sole discretion. However, to date, SPSE has accepted each of our requests for evaluation.

 

Our use of these fair value methods is inherently subjective and is based on estimates and assumptions of each security.  In the event that we are required to sell a security, we may ultimately sell for an amount materially less than the estimated fair value calculated by SPSE, TEV or the DCF methodology.  We sold 13 of the 24 syndicated loans that were held in our portfolio of investments at March 31, 2009 to various investors in the syndicated loan market for an aggregate of $22.5 million in net proceeds.  The loans had an aggregate cost value of approximately $30.4 million, or 7% of the cost value of our total investments, and an aggregate fair value of approximately $22.5 million, or 6% of the fair value of our total investments, at March 31, 2009.

 

Our procedures also include provisions whereby our Adviser will establish the fair value of any equity securities we may hold where SPSE or third-party agent banks are unable to provide evaluations. The types of factors that may be considered in determining the fair value of our debt and equity securities include some or all of the following:

 

·      the nature and realizable value of any collateral;

·      the portfolio company’s earnings and cash flows and its ability to make payments on its obligations;

·      the markets in which the portfolio company does business;

·      the comparison to publicly traded companies; and

·      discounted cash flow and other relevant factors.

 

Because such valuations, particularly valuations of private securities and private companies, are not susceptible to precise determination, may fluctuate over short periods of time, and may be based on estimates, our determinations of fair value may differ from the values that might have actually resulted had a readily available market for these securities been available.

 

A portion of our assets are, and will continue to be, comprised of equity securities that are valued based on internal assessment using our own valuation methods approved by our Board of Directors, without the input of SPSE or any other third-party evaluator. We believe that our equity valuation methods reflect those regularly used as standards by other professionals in our industry who value equity securities. However, determination of fair value for securities that are not publicly traded, whether or not we use the recommendations of an independent third-party evaluator, necessarily involves the

 

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exercise of subjective judgment. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.

 

The lack of liquidity of our privately held investments may adversely affect our business.

 

We will generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments we presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to quickly obtain cash equal to the value at which we record our investments if the need arises. This could cause us to miss important investment opportunities. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may record substantial realized losses upon liquidation.  For example, as a result of the economic downturn, the availability of credit in the market became scarce, and we were forced to sell 13 of the 24 syndicated loans that were held in our portfolio of investments at March 31, 2009 in order to repay amounts outstanding under our prior credit facility. These loans, in aggregate, had a cost value of approximately $30.4 million, or 7% of the cost value of our total investments, and an aggregate fair market value of approximately $22.5 million, or 6% of the fair market value of our total investments, at March 31, 2009.  Since then, we have sold additional syndicated loans and incurred a net realized loss of $26.4 million for the fiscal year ended September 30, 2009.  In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, our Adviser, or our respective officers, employees or affiliates have material non-public information regarding such portfolio company.

 

Due to the uncertainty inherent in valuing these securities, our determinations of fair value may differ materially from the values that could be obtained if a ready market for these securities existed. Our net asset value could be materially affected if our determinations regarding the fair value of our investments are materially different from the values that we ultimately realize upon our disposal of such securities.

 

Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected.

 

Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies.

 

When we are a debt or minority equity investor in a portfolio company, which we expect will generally be the case, we may not be in a position to control the entity, and its management may make decisions that could decrease the value of our investment.

 

We anticipate that most of our investments will continue to be either debt or minority equity investments in our portfolio companies.  Therefore, we are and will remain subject to risk that a portfolio company may make business decisions with which we disagree, and the shareholders and management of such company may take risks or otherwise act in ways that do not serve our best interests.  As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.  In addition, we will generally not be in a position to control any portfolio company by investing in its debt securities.

 

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

 

We invest primarily in debt securities issued by our portfolio companies.  In some cases portfolio companies will be permitted to have other debt that ranks equally with, or senior to, the debt securities in which we invest.  By their terms, such debt instruments may provide that the holders thereof are entitled to receive payment of interest and principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest.  Also, in the event of insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment.  After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us.  In the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company.

 

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Prepayments of our investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.

 

In addition to risks associated with delays in investing our capital, we are also subject to the risk that investments that we make in our portfolio companies may be repaid prior to maturity. For the year ended September 30, 2009, we received principal payments prior to maturity of $25.2 million.  We will first use any proceeds from prepayments to repay any borrowings outstanding on our credit facility. In the event that funds remain after repayment of our outstanding borrowings, then we will generally reinvest these proceeds in government securities, pending their future investment in new debt and/or equity securities. These government securities will typically have substantially lower yields than the debt securities being prepaid and we could experience significant delays in reinvesting these amounts. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.

 

Higher taxation of our portfolio companies may impact our quarterly and annual operating results.

 

The recession’s adverse effect on federal, state, and municipality revenues may induce these government entities to raise various taxes to make up for lost revenues. Additional taxation may have an adverse affect on our portfolio companies’ earnings and reduce their ability to repay our loans to them, thus affecting our quarterly and annual operating results.

 

Our portfolio is concentrated in a limited number of companies and industries, which subjects us to an increased risk of significant loss if any one of these companies does not repay us or if the industries experience downturns.

 

As of September 30, 2009 we had loans outstanding to 48 portfolio companies.  A consequence of a limited number of investments is that the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such loans or a substantial write-down of any one investment. Beyond our regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration and our investments could potentially be concentrated in relatively few industries. In addition, while we do not intend to invest 25.0% or more of our total assets in a particular industry or group of industries at the time of investment, it is possible that as the values of our portfolio companies change, one industry or a group of industries may comprise in excess of 25.0% of the value of our total assets. As of September 30, 2009, 18.1% of our total assets were invested in healthcare, education and childcare companies, 13.5% were invested in broadcast companies and 11.8% were invested in printing and publishing companies. As a result, a downturn in an industry in which we have invested a significant portion of our total assets could have a materially adverse effect on us.

 

Our investments are typically long term and will require several years to realize liquidation events.

 

Since we generally make five to seven year term loans and hold our loans and related warrants or other equity positions until the loans mature, you should not expect realization events, if any, to occur over the near term. In addition, we expect that any warrants or other equity positions that we receive when we make loans may require several years to appreciate in value and we cannot give any assurance that such appreciation will occur.

 

We may not realize gains from our equity investments and other yield enhancements.

 

When we make a subordinated loan, we may receive warrants to purchase stock issued by the borrower or other yield enhancements, such as success fees (conditional interest). Our goal is to ultimately dispose of these equity interests and realize gains upon our disposition of such interests. We expect that, over time, the gains we realize on these warrants and other yield enhancements will offset any losses we experience on loan defaults. However, any warrants we receive may not appreciate in value and, in fact, may decline in value and any other yield enhancements, such as success fees, may not be realized. Accordingly, we may not be able to realize gains from our equity interests or other yield enhancements and any gains we do recognize may not be sufficient to offset losses we experience on our loan portfolio.

 

Any unrealized depreciation we experience on our investment portfolio may be an indication of future realized losses, which could reduce our income available for distribution.

 

As a business development company we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our Board of Directors. Decreases in the

 

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market values or fair values of our investments will be recorded as unrealized depreciation. Since our inception, we have, at times, incurred a cumulative net unrealized depreciation of our portfolio. Any unrealized depreciation in our investment portfolio could result in realized losses in the future and ultimately in reductions of our income available for distribution to stockholders in future periods.

 

Risks Related to Our Regulation and Structure

 

We will be subject to corporate-level tax if we are unable to satisfy Code requirements for RIC qualification.

 

To maintain our qualification as a RIC, we must meet income source, asset diversification, and annual distribution requirements. The annual distribution requirement is satisfied if we distribute at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual basis. Because we use leverage, we are subject to certain asset coverage ratio requirements under the 1940 Act and could, under certain circumstances, be restricted from making distributions necessary to qualify as a RIC. Warrants we receive with respect to debt investments will create “original issue discount,” which we must recognize as ordinary income, increasing the amounts we are required to distribute to maintain RIC status. Because such warrants will not produce distributable cash for us at the same time as we are required to make distributions in respect of the related original issue discount, we will need to use cash from other sources to satisfy such distribution requirements. The asset diversification requirements must be met at the end of each calendar quarter. If we fail to meet these tests, we may need to quickly dispose of certain investments to prevent the loss of RIC status. Since most of our investments will be illiquid, such dispositions, if even possible, may not be made at prices advantageous to us and, in fact, may result in substantial losses. If we fail to qualify as a RIC for any reason and become fully subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution, and the actual amount distributed. Such a failure would have a material adverse effect on us and our shares. For additional information regarding asset coverage ratio and RIC requirements, see “Business—Competitive Advantages—Leverage” and “Business—Material U.S. Federal Income Tax Considerations—Regulated Investment Company Status.”

 

Changes in laws or regulations governing our operations, or changes in the interpretation thereof, and any failure by us to comply with laws or regulations governing our operations may adversely affect our business.

 

We and our portfolio companies are subject to regulation by laws at the local, state and federal levels. These laws and regulations, as well as their interpretation, may be changed from time to time. Accordingly, any change in these laws or regulations, or their interpretation, or any failure by us or our portfolio companies to comply with these laws or regulations may adversely affect our business. For additional information regarding the regulations to which we are subject, see “Material U.S. Federal Income Tax Considerations—Regulated Investment Company Status” and “Regulation as a Business Development Company.”

 

We are subject to restrictions that may discourage a change of control. Certain provisions contained in our articles of incorporation and Maryland law may prohibit or restrict a change of control and adversely impact the price of our shares.

 

Our Board of Directors is divided into three classes, with the term of the directors in each class expiring every third year. At each annual meeting of stockholders, the successors to the class of directors whose term expires at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. After election, a director may only be removed by our stockholders for cause. Election of directors for staggered terms with limited rights to remove directors makes it more difficult for a hostile bidder to acquire control of us. The existence of this provision may negatively impact the price of our securities and may discourage third-party bids to acquire our securities. This provision may reduce any premiums paid to stockholders in a change in control transaction.

 

Certain provisions of Maryland law applicable to us prohibit business combinations with:

 

·      any person who beneficially owns 10% or more of the voting power of our common stock (an “interested stockholder”);

·      an affiliate of ours who at any time within the two-year period prior to the date in question was an interested stockholder; or

·      an affiliate of an interested stockholder.

 

These prohibitions last for five years after the most recent date on which the interested stockholder became an interested stockholder. Thereafter, any business combination with the interested stockholder must be recommended by our board of directors and approved by the affirmative vote of at least 80% of the votes entitled to be cast by holders of our outstanding

 

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shares of common stock and two-thirds of the votes entitled to be cast by holders of our common stock other than shares held by the interested stockholder. These requirements could have the effect of inhibiting a change in control even if a change in control were in our stockholders’ interest. These provisions of Maryland law do not apply, however, to business combinations that are approved or exempted by our Board of Directors prior to the time that someone becomes an interested stockholder.

 

Our articles of incorporation permit our Board of Directors to issue up to 50,000,000 shares of capital stock. In addition, our Board of Directors, without any action by our stockholders, may amend our articles of incorporation from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series of stock that we have authority to issue.  Our Board of Directors may classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of any such stock.  Thus, our Board of Directors could authorize the issuance of senior common stock or preferred stock with terms and conditions that could have a priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock.  Senior Common Stock or Preferred stock could also have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock.

 

Risks Related to an Investment in Our Common Stock

 

We may experience fluctuations in our quarterly and annual operating results.

 

We may experience fluctuations in our quarterly and annual operating results due to a number of factors, including, among others, variations in our investment income, the interest rates payable on the debt securities we acquire, the default rates on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the level of our expenses, the degree to which we encounter competition in our markets, and general economic conditions, including the impacts of inflation. The majority of our portfolio companies are in industries that are directly impacted by inflation, such as manufacturing and consumer goods and services. Our portfolio companies may not be able to pass on to customers increases in their costs of production which could greatly affect their operating results, impacting their ability to repay our loans. In addition, any projected future decreases in our portfolio companies’ operating results due to inflation could adversely impact the fair value of those investments. Any decreases in the fair value of our investments could result in future realized and unrealized losses and therefore reduce our net assets resulting from operations. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

 

There is a risk that you may not receive distributions.

 

Our current intention is to distribute at least 90% of our ordinary income and short-term capital gains to our stockholders on a quarterly basis by paying monthly distributions. We expect to retain net realized long-term capital gains to supplement our equity capital and support the growth of our portfolio, although our Board of Directors may determine in certain cases to distribute these gains. In addition, our credit facility restricts the amount of distributions we are permitted to make.  We cannot assure you that we will achieve investment results or maintain a tax status that will allow or require any specified level of cash distributions.

 

Distributions by us have and may in the future continue to include a return of capital.

 

Our Board of Directors declares monthly distributions based on estimates of net investment income for each fiscal year, which may differ, and in the past have differed, from actual results. Because our distributions are based on estimates of net investment income that may differ from actual results, future distributions payable to our stockholders may also include a return of capital. Moreover, to the extent that we distribute amounts that exceed our accumulated earnings and profits, these distributions constitute a return of capital. A return of capital represents a return of a stockholder’s original investment in shares of our stock and should not be confused with a distribution from earnings and profits. Although return of capital distributions may not be taxable, such distributions may increase an investor’s tax liability for capital gains upon the sale of our shares by reducing the investor’s tax basis for such shares. Such returns of capital reduce our asset base and also adversely impact our ability to raise debt capital as a result of the leverage restrictions under the 1940 Act, which could have a material adverse impact on our ability to make new investments.

 

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The market price of our shares may fluctuate significantly.

 

The trading price of our common stock may fluctuate substantially. The extreme volatility and disruption that have affected the capital and credit markets for over a year have reached unprecedented levels in recent months We have experienced greater than usual stock price volatility.

 

The market price and marketability of our shares may from time to time be significantly affected by numerous factors, including many over which we have no control and that may not be directly related to us. These factors include, but are not limited to, the following:

 

·

 

general economic trends and other external factors;

·

 

price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies;

·

 

significant volatility in the market price and trading volume of shares of RICs, business development companies or other companies in our sector, which is not necessarily related to the operating performance of these companies;

·

 

changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies;

·

 

loss of business development company status;

·

 

loss of RIC status;

·

 

changes in our earnings or variations in our operating results;

·

 

changes in the value of our portfolio of investments;

·

 

any shortfall in our revenue or net income or any increase in losses from levels expected by securities analysts;

·

 

departure of key personnel;

·

 

operating performance of companies comparable to us;

·

 

short-selling pressure with respect to our shares or business development companies generally;

·

 

the announcement of proposed, or completed, offerings of our securities, including a rights offering; and

·

 

loss of a major funding source.

 

Fluctuations in the trading prices of our shares may adversely affect the liquidity of the trading market for our shares and, if we seek to raise capital through future equity financings, our ability to raise such equity capital.

 

The issuance of subscription rights to our existing stockholders may dilute the ownership and voting powers by existing stockholders in our common stock, dilute the net asset value of their shares and have a material adverse effect on the trading price of our common stock.

 

There are significant capital raising constraints applicable to us under the 1940 Act when our stock is trading below its net asset value per share. In the event that we issue subscription rights to our existing stockholders, there is a significant possibility that the rights offering will dilute the ownership interest and voting power of stockholders who do not fully exercise their subscription rights. Stockholders who do not fully exercise their subscription rights should expect that they will, upon completion of the rights offering, own a smaller proportional interest in the Company than would otherwise be the case if they fully exercised their subscription rights. In addition, because the subscription price of the rights offering is likely to be less than the Company’s most recently determined net asset value per share, our stockholders are likely to experience an immediate dilution of the per share net asset value of their shares as a result of the offer. As a result of these factors, any future rights offerings of our common stock, or our announcement of our intention to conduct a rights offering, could have a material adverse impact on the trading price of our common stock.

 

Shares of closed-end investment companies frequently trade at a discount from net asset value.

 

Shares of closed-end investment companies frequently trade at a discount from net asset value.  Since our inception, our common stock has at times traded above net asset value, and at times traded below net asset value. During the past year, our common stock has traded consistently, and at times significantly, below net asset value. Subsequent to September 30, 2009, our stock has traded at discounts of up to 34% of our net asset value as of September 30, 2009.  This characteristic of shares of closed-end investment companies is separate and distinct from the risk that our net asset value per share will decline.  As with any stock, the price of our shares will fluctuate with market conditions and other factors.  If shares are sold, the price received may be more or less than the original investment.  Whether investors will realize gains or losses upon the sale of our shares will not depend directly upon our net asset value, but will depend upon the market price of the shares at the time of

 

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sale.  Since the market price of our shares will be affected by such factors as the relative demand for and supply of the shares in the market, general market and economic conditions and other factors beyond our control, we cannot predict whether the shares will trade at, below or above our net asset value.  Under the 1940 Act, we are generally not able to issue additional shares of our common stock at a price below net asset value per share to purchasers other than our existing stockholders through a rights offering without first obtaining the approval of our stockholders and our independent directors. Additionally, at times when our stock is trading below its net asset value per share, our dividend yield may exceed the weighted average returns that we would expect to realize on new investments that would be made with the proceeds from the sale of such stock, making it unlikely that we would determine to issue additional shares in such circumstances. Thus, for as long as our common stock trades below net asset value we will be subject to significant constraints on our ability to raise capital through the issuance of common stock. Additionally, an extended period of time in which we are unable to raise capital may restrict our ability to grow and adversely impact our ability to increase or maintain our distributions.

 

Stockholders may incur dilution if we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.

 

At our most recent annual meeting, our stockholders approved a proposal designed to allow us to access the capital markets in a way that we were previously unable to as a result of restrictions that, absent stockholder approval, apply to business development companies under the 1940 Act.  Specifically, our stockholders approved a proposal that authorizes us to sell shares of our common stock below the then current net asset value per share of our common stock in one or more offerings for a period of one year.  At the upcoming annual stockholders meeting scheduled for February 18, 2010, our stockholders will again be asked to vote in favor of renewing this proposal for another year.  During the past year, our common stock has traded consistently, and at times significantly, below net asset value. Any decision to sell shares of our common stock below the then current net asset value per share of our common stock would be subject to the determination by our Board of Directors that such issuance is in our and our stockholders’ best interests.

 

If we were to sell shares of our common stock below net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. The greater the difference between the sale price and the net asset value per share at the time of the offering, the more significant the dilutive impact would be. Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect, if any, cannot be currently predicted.  However, if for example, we sold an additional 10% of our common stock at a 5% discount from net asset value, a stockholder who did not participate in that offering for its proportionate interest would suffer net asset value dilution of up to 0.5% or $5 per $1,000 of net asset value.

 

Other Risks

 

We could face losses and potential liability if intrusion, viruses or similar disruptions to our technology jeopardize our confidential information, whether through breach of our network security or otherwise.

 

Maintaining our network security is of critical importance because our systems store highly confidential financial models and portfolio company information. Although we have implemented, and will continue to implement, security measures, our technology platform is and will continue to be vulnerable to intrusion, computer viruses or similar disruptive problems caused by transmission from unauthorized users. The misappropriation of proprietary information could expose us to a risk of loss or litigation.

 

Terrorist attacks, acts of war, or national disasters may affect any market for our common stock, impact the businesses in which we invest, and harm our business, operating results, and financial conditions.

 

Terrorist acts, acts of war, or national disasters have created, and continue to create, economic and political uncertainties and have contributed to global economic instability.  Future terrorist activities, military or security operations, or national disasters could further weaken the domestic/global economies and create additional uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results, and financial condition.  Losses from terrorist attacks and national disasters are generally uninsurable.

 

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Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

We do not own any real estate or other physical properties materially important to our operations.  Gladstone Management Corporation is the current leaseholder of all properties in which we operate.  We occupy these premises pursuant to our Advisory and Administration Agreements with our Adviser and Administrator, respectively.  Our Adviser and Administrator are headquartered in McLean, Virginia and our Adviser also has operations in New York, New Jersey, Illinois, Texas and Georgia.

 

Item 3. Legal Proceedings

 

We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2009.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is traded on the Nasdaq Global Select Market under the symbol “GLAD.” The following table reflects, by quarter, the high and low closing prices per share of our common stock on the Nasdaq Global Select Market, the closing sale price as a percentage of net asset value (“NAV”) and quarterly dividends declared per share for each fiscal quarter during the last two fiscal years.  Amounts presented for each fiscal quarter of 2009 and 2008 represent the cumulative amount of the dividends declared for the months composing such quarter.

 

 

 

Quarter

 

 

 

Closing Sales Price

 

Premium
(discount) of

 

Premium
(discount) of

 

Declared

 

 

 

Ended

 

NAV (1)

 

High

 

Low

 

High to NAV(1)

 

Low to NAV(2)

 

Dividends

 

FY 2009

 

09/30/09

 

$

11.81

 

$

10.40

 

$

7.17

 

(12

)%

(39

)%

$

0.210

 

 

 

06/30/09

 

11.86

 

7.80

 

5.49

 

(34

)%

(54

)%

0.210

 

 

 

03/31/09

 

12.10

 

10.28

 

5.01

 

(15

)%

(59

)%

0.420

 

 

 

12/31/08

 

12.04

 

15.38

 

5.50

 

28

%

(54

)%

0.420

 

FY 2008

 

09/30/08

 

$

12.89

 

$

18.65

 

$

12.91

 

45

%

0

%

$

0.420

 

 

 

06/30/08

 

13.97

 

19.31

 

15.24

 

38

%

9

%

0.420

 

 

 

03/31/08

 

14.27

 

19.22

 

16.25

 

35

%

14

%

0.420

 

 

 

12/31/07

 

15.08

 

20.62

 

17.01

 

37

%

13

%

0.420

 

 


(1)

 

NAV per share is determined as of the last day in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period.

 

 

 

(2)

 

The premiums (discounts) set forth in these columns represent the high or low, as applicable, closing price per share for the relevant quarter minus the net asset value per share as of the end of such quarter, and therefore may not reflect the premium (discount) to net asset value per share on the date of the high and low closing prices.

 

As of November 13, 2009, there were approximately 80 stockholders of record of our common stock.

 

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Distributions

 

We currently intend to distribute in the form of cash dividends a minimum of 90% of our ordinary income and short-term capital gains, if any, on a quarterly basis to our stockholders in the form of monthly dividends.

 

Recent Sales of Unregistered Securities

 

There were no unregistered sales of securities during the fiscal year ended September 30, 2009.

 

Item 6. Selected Financial Data

 

The following selected financial data for the fiscal years ended September 30, 2009, 2008, 2007, 2006 and 2005 are derived from our audited consolidated financial statements. The data should be read in conjunction with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

 

GLADSTONE CAPITAL CORPORATION
SELECTED FINANCIAL DATA

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)

 

 

 

Year Ended September 30,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Total Investment Income

 

$

42,618

 

$

45,725

 

$

36,687

 

$

26,900

 

$

23,950

 

Total Expenses

 

$

21,587

 

$

19,172

 

$

14,426

 

$

7,447

 

$

6,454

 

Net Investment Income

 

$

21,031

 

$

26,553

 

$

22,261

 

$

19,351

 

$

17,286

 

Net Realized (Loss) Gain on Investments

 

$

(26,411

)

$

(787

)

$

44

 

$

(904

)

$

30

 

Realized (Loss) Gain on Settlement of Derivative

 

$

(304

)

$

7

 

$

39

 

$

15

 

$

 

Unrealized Appreciation (Depreciation) on Derivative

 

$

304

 

$

(12

)

$

(38

)

$

 

$

(39

)

Net Unrealized Appreciation (Depreciation) on Investments

 

$

9,513

 

$

(47,023

)

$

(7,354

)

$

5,968

 

$

(1,786

)

Net Unrealized Appreciation on Borrowings under Line of Credit

 

$

(350

)

$

 

$

 

$

 

$

 

Net Increase (Decrease) in Net Assets Resulting from Operations

 

$

3,783

 

$

(21,262

)

$

14,952

 

$

24,430

 

$

15,491

 

Per Share Data (1):

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

$

0.18

 

$

(1.08

)

$

1.13

 

$

2.15

 

$

1.37

 

Diluted:

 

$

0.18

 

$

(1.08

)

$

1.13

 

$

2.10

 

$

1.33

 

Cash Distributions Declared per share

 

$

1.260

 

$

1.680

 

$

1.680

 

$

1.635

 

$

1.515

 

Statement of Assets and Liabilities Data:

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

335,910

 

$

425,698

 

$

367,729

 

$

225,783

 

$

205,793

 

Net Assets

 

$

249,076

 

$

271,748

 

$

220,959

 

$

172,570

 

$

151,611

 

Net Asset Value Per Share

 

$

11.81

 

$

12.89

 

$

14.97

 

$

14.02

 

$

13.41

 

Common Shares Outstanding

 

21,087,574

 

21,087,574

 

14,762,574

 

12,305,008

 

11,303,510

 

Senior Securities Data:

 

 

 

 

 

 

 

 

 

 

 

Borrowings under line of credit (2)

 

$

83,350

 

$

151,030

 

$

144,440

 

$

49,993

 

$

53,034

 

Asset coverage ratio (3) (4)

 

399

%

286

%

259

%

466

%

402

%

Asset coverage per unit (4)

 

$

3,988

 

$

2,860

 

$

2,594

 

$

4,657

 

$

4,024

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Number of Portfolio Companies at Year End

 

48

 

63

 

56

 

32

 

28

 

Principal Amount of Loan Originations

 

$

26,366

 

$

176,550

 

$

261,700

 

$

135,955

 

$

143,794

 

Principal Amount of Loan Repayments and Investments Sold

 

$

96,693

 

$

70,482

 

$

121,818

 

$

124,010

 

$

88,019

 

Weighted Average Yield on Investments (5):

 

9.91

%

10.23

%

11.98

%

12.74

%

12.23

%

Total Return (6)

 

(30.94

)%

(13.90

)%

(4.40

)%

5.21

%

5.93

%

 

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(1)

 

Per share data for net increase in net assets resulting from operations is based on the weighted common stock outstanding for both basic and diluted.

(2)

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our level of indebtedness.

(3)

 

As a business development company, we are generally required to maintain a ratio of 200% of total assets, less all liabilities and indebtedness not represented by senior securities, to total borrowings.

(4)

 

Asset coverage ratio is the ratio of the carrying value of our total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per $1,000 of indebtedness.

(5)

 

Weighted average yield on investments equals interest income on investments divided by the annualized weighted average investment balance throughout the year.

(6)

 

Total return equals the increase of the ending market value over the beginning market value plus monthly dividends divided by the monthly beginning market value.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in thousands, unless otherwise indicated)

 

The following analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the notes thereto contained elsewhere in this Form 10-K.

 

OVERVIEW

 

General

 

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 substantially owned by leveraged buyout funds, individual investors or are family-owned businesses, with a particular focus on senior notes. In addition, we may acquire from others existing loans that meet this profile. We also seek to provide our stockholders with long-term 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 (the “1940 Act”).  In addition, for tax purposes we have elected to be treated as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”).

 

We seek out small and medium-sized private U.S. businesses that meet certain criteria, including some but not all of the following: the potential for growth in cash flow, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, profitable operations based on the borrower’s cash flow, reasonable capitalization of the borrower (usually by leveraged buyout funds or venture capital funds) and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the borrower, a public offering of the borrower’s stock or by exercising our right to require the borrower to repurchase our warrants, though there can be no assurance that we will always have these rights. We lend to borrowers that need funds to finance growth, restructure their balance sheets or effect a change of control.

 

Business Environment

 

The current economic conditions generally and the disruptions in the capital markets in particular have decreased liquidity and increased our cost of debt and equity capital, where available. The longer these conditions persist, the greater the probability that these factors could continue to increase our cost and significantly limit our access to debt and equity capital, and thus have an adverse effect on our operations and financial results. Many of the companies in which we have made or will make investments are also susceptible to the adverse economic environment, which may affect the ability of one or more of our portfolio companies to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial public offering. The recession could also disproportionately impact some of the industries in which we invest, causing us to be more vulnerable to losses in our portfolio. Therefore, the fair market value of our portfolio could continue to decrease during the current economic situation, or future economic downturns.

 

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As a result of the economic downturn, the availability of credit in the market became scarce, and we were forced to sell 13 of the 24 syndicated loans that were held in our portfolio of investments at March 31, 2009 to various investors in the syndicated loan market in order to repay amounts outstanding under our prior credit facility, which matured in May 2009. These loans, in aggregate, had a cost value of approximately $30,427, or 7% of the cost value of our total investments, and an aggregate fair market value of approximately $22,467, or 6% of the fair market value of our total investments, at March 31, 2009.  Since then, we have sold additional syndicated loans and incurred a net realized loss of $26,411 for the fiscal year ended September 30, 2009.  We intend to sell the remaining syndicated loans in our portfolio as soon as practicable, which will likely result in further realized losses.

 

Challenges in the current market are intensified for us by certain regulatory limitations under the Code and the 1940 Act, as well as contractual restrictions under the agreement governing our credit facility that further constrain our ability to access the capital markets.  To maintain our qualification as a RIC, we must satisfy, among other requirements, an annual distribution requirement to pay out at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual basis.  Because we are required to distribute our income in this manner, and because the illiquidity of many of our investments makes it difficult for us to finance new investments through the sale of current investments, our ability to make new investments is highly dependent upon external financing.  Our external financing sources include the issuance of equity securities, debt securities or other leverage such as borrowings under our line of credit.  Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act, which require us to have at least a 200% asset coverage ratio, meaning generally that for every dollar of debt, we must have two dollars of assets.

 

Recent market conditions have also affected the trading price of our common stock and thus our ability to finance new investments through the issuance of equity.  On November 13, 2009, the closing market price of our common stock was $7.98, which price represented a 32% discount to our September 30, 2009 net asset value (“NAV”) per share.  When our stock is trading below NAV, as it has consistently traded for more than a year, our ability to issue equity is constrained by provisions of the 1940 Act which generally prohibit the issuance and sale of our common stock below NAV per share without stockholder approval other than through sales to our then-existing stockholders pursuant to a rights offering.  At our annual meeting of stockholders held on February 19, 2009, stockholders approved a proposal which authorizes us to sell shares of our common stock at a price below our then current NAV per share for a period of one year from the date of approval, provided that our Board of Directors makes certain determinations prior to any such sale.  At the upcoming annual stockholders meeting scheduled for February 18, 2010, our stockholders will again be asked to vote in favor of renewing this proposal for another year.

 

The recession may also continue to decrease the value of collateral securing some of our loans, as well as the value of our equity investments, which has impacted and may continue to impact our ability to borrow under our credit facility.  Additionally, our credit facility contains covenants regarding the maintenance of certain minimum net worth requirements which are affected by the decrease in value of our portfolio.  Failure to meet these requirements would result in a default which, if we are unable to obtain a waiver from our lenders, would result in the acceleration of our repayment obligations under our credit facility.  As of September 30, 2009, we were in compliance with all of the facility covenants.

 

We expect that, given these regulatory and contractual constraints in combination with current market conditions, debt and equity capital may be costly or difficult for us to access for some time.  For so long as this is the case, our near-term strategy will be focused primarily on retaining capital and building the value of our existing portfolio companies to increase the likelihood of maintaining potential future returns.  We will also, where prudent and possible, consider the sale of lower-yielding investments.  This has resulted, and may continue to result, in significantly reduced investment activity, as our ability to make new investments under these conditions is largely dependent on availability of proceeds from the sale or exit of existing portfolio investments, which events may be beyond our control.  As capital constraints improve, we intend to continue our strategy of making conservative investments in businesses that we believe will weather the economy and that are likely to produce attractive long-term returns for our stockholders.

 

Syndicated Loan Valuations

 

Due to the illiquidity in the market for syndicated loans during the three quarters prior to and including the quarter ended June 30, 2009, a discounted cash flow (“DCF”) methodology was used to value these investments during those periods, following guidance provided under Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures.”  However, in monitoring the market activity during the quarter ended September 30, 2009, we noted changing markets conditions indicating a return to liquidity and a better functioning secondary

 

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Table of Contents

 

market for syndicated loans.  Therefore, in accordance with ASC 820, and following our valuation procedures which specify the use of third-party indicative bid quotes for valuing syndicated loans where there is a liquid public market for those loans and market pricing quotes are readily available, a third-party bid quote was used to value the remaining syndicated loans not sold during the year ended September 30, 2009.  In November 2009, we settled sales of two syndicated loans(Kinetek and Wesco).  Those loans are included in our consolidated assets as of September 30, 2009 and were valued as of September 30, 2009 at the respective sale prices.  The Wesco loan was sold subsequent to September 30, 2009 and the sale price was deemed to be an accurate reflection of the fair value as of September 30, 2009.

 

Highlights

 

Registration Statement

 

On October 20, 2009, we filed a registration statement on Form N-2 with the SEC.  If and when it is declared effective, it will permit us to issue, through one or more transactions, up to an aggregate of $300,000 in securities, consisting of common stock, senior common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock, or a combination of these securities.

 

Portfolio Company Investment Activity

 

Purchases: During the year ended September 30, 2009, we extended $26,366 of investments to existing portfolio companies through revolver draws or the additions of new term notes.

 

Repayments: During the year ended September 30, 2009, we were repaid in full by three portfolio companies.  In addition, three portfolio companies refinanced their loans, one borrower made an unscheduled partial payoff, and we experienced contractual amortization, revolver repayments and some principal payments received ahead of schedule for total principal repayments of $47,490.

 

Sales/Exits: During the year ended September 30, 2009, we exited from 12 companies and received an aggregate of $49,203 in net proceeds.

 

Since our initial public offering in August 2001, we have made 261 different loans to, or investments in, 126 companies for a total of approximately $952,348, before giving effect to principal repayments on investments and divestitures.

 

Financing Activity

 

On May 15, 2009 we, through our wholly-owned subsidiary Gladstone Business Loan, LLC (“Business Loan”), entered into a third amended and restated credit agreement providing for a $127,000 revolving line of credit arranged by Key Equipment Finance Inc. (“KEF”) as administrative agent, replacing Deutsche Bank AG as administrative agent (the “KEF Facility”).  Branch Banking and Trust Company (“BB&T”) also joined the KEF Facility as a committed lender.  In connection with entering into the KEF Facility, we borrowed $35,881 under the KEF Facility to make a final payment to Deutsche Bank AG in satisfaction of all unpaid principal and interest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to $200,000 through the addition of other committed lenders to the facility.  Without the addition of other committed lenders, the KEF Facility provides a total commitment of $102,000 from January 1, 2010 to May 11, 2010, and $77,000 thereafter.

 

In October and November of 2009, we reduced the size of the KEF Facility by $15,000 and $5,000, respectively, from $127,000 to $107,000.  Under the KEF Facility the first $50,000 of commitment reductions are applied against KEF’s commitment.  Therefore, the entire $20,000 was subtracted from KEF’s commitment, reducing it from $100,000 to $80,000 and leaving BB&T’s commitment unchanged at $27,000.  As a result of the manner in which our borrowing base is calculated under the KEF Facility, the reductions did not affect our availability under the KEF Facility.  The KEF Facility matures on May 14, 2010, and if the facility is not renewed or extended by this date, all principal and interest will be due and payable within one year of maturity In addition, if the facility is not renewed, our lenders have the right to apply all principal and interest collections to amounts outstanding under the KEF Facility.  Advances under the KEF Facility will generally bear interest at the 30-day LIBOR or commercial paper rate (subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of 0.75% per annum on undrawn amounts.  As of September 30, 2009, there was a cost basis of approximately $83,000 of borrowings outstanding on the KEF Facility at an average rate of 7.36%, and the remaining borrowing capacity under the KEF Facility was $44,000.  Available borrowings are subject to various constraints imposed

 

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Table of Contents

 

under the KEF Facility, based on the aggregate loan balance pledged by Business Loan. Interest is payable monthly during the term of the KEF Facility.

 

During the year ended September 30, 2009, we elected to apply ASC 825, “Financial Instruments,” specifically for the KEF Facility, which requires us to apply a fair value methodology to the KEF Facility as of September 30, 2009.  The KEF Facility was fair valued at $83,350 as of September 30, 2009.

 

Investment Strategy

 

Our loans typically range from $5 million to $20 million, although this investment size may vary proportionately as the size of our capital base changes, generally mature in no more than seven years and accrue interest at fixed or variable rates.  Some of our loans may contain a provision that calls for some portion of the interest payments to be deferred and added to the principal balance so that the interest is paid, together with the principal, at maturity. This form of deferred interest is often called “paid in kind” (“PIK”) interest and, when earned, we record PIK interest as interest income and add the PIK interest to the principal balance of the loans. We seek to avoid PIK interest with all potential investments under review. As of September 30, 2009 one Control investment and one Non-Control/Non-Affiliate investment bore PIK interest.

 

Because the majority of our portfolio loans consist of term debt of private companies who typically cannot or will not expend the resources to have their debt securities rated by a credit rating agency, we expect that most, if not all, of the debt securities we acquire will be unrated. We cannot accurately predict what ratings these loans might receive if they were rated, and thus cannot determine whether or not they could be considered “investment grade” quality.

 

To the extent possible, our loans generally are collateralized by a security interest in the borrower’s assets. Interest payments are generally made monthly or quarterly (except to the extent of any PIK interest) 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. When we receive a warrant to purchase stock in a borrower in connection with a loan, the warrant will typically have an exercise price equal to the fair value of the portfolio company’s common stock at the time of the loan and entitle us to purchase a modest percentage of the borrower’s stock.

 

Original issue discount (“OID”) arises when we extend a loan and receive an equity interest in the borrower at the same time.  To the extent that the price paid for the equity is not at market value, we must allocate part of the price paid for the loan, to the value of the equity.  Then the amount allocated to the equity, the OID, must be amortized over the life of the loan.  As with PIK interest, the amortization of OID also produces income that must be recognized for purposes of satisfying the distribution requirements for a RIC under Subchapter M of the Code, whereas the cash is received, if at all, when the equity instrument is sold.  We seek to avoid OID with all potential investments under review and from inception through September 30, 2009, we did not hold any investments with OID income.

 

In addition, as a business development company under the 1940 Act, we are required to make available significant managerial assistance to our portfolio companies. Our investment adviser, Gladstone Management Corporation (the “Adviser”) provides these services on our behalf through its officers who are also our officers.  Currently, neither we nor our Adviser charges a fee for managerial assistance, however, if our Adviser does receive fees for managerial assistance, our Adviser will credit the managerial assistance fees to the base management fee due from us to our Adviser.

 

Our Adviser receives fees for the other services it provides to our portfolio companies. These other fees are typically non-recurring, are recognized as revenue when earned and are generally paid directly to our Adviser by the borrower or potential borrower upon the closing of the investment. The services our Adviser provides to our portfolio companies vary by investment, but generally include a broad array of services, such as investment banking services, arranging bank and equity financing, structuring financing from multiple lenders and investors, reviewing existing credit facilities, restructuring existing investments, raising equity and debt capital from other investors, turnaround management, merger and acquisition services and recruiting new management personnel. When our Adviser receives fees for these services, 50% of certain of those fees are credited against the base management fee that we pay to our Adviser.  Any services of this nature subsequent to closing would typically generate a separate fee at the time of completion.

 

Our Adviser also receives fees for monitoring and reviewing portfolio company investments. These fees are recurring and are generally paid annually or quarterly in advance to our Adviser throughout the life of the investment. Fees of this nature are recorded as revenue by our Adviser when earned and are not credited against the base management fee.

 

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Table of Contents

 

We may receive fees for the origination and closing services we provide to portfolio companies through our Adviser. These fees are paid directly to us and are recognized as revenue upon closing of the originated investment and are reported as fee income in the consolidated statements of operations.

 

Prior to making an investment, we ordinarily enter into a non-binding term sheet with the potential borrower. These non-binding term sheets are generally subject to a number of conditions, including, but not limited to, the satisfactory completion of our due diligence investigations of the potential borrower’s business, reaching agreement on the legal documentation for the loan, and the receipt of all necessary consents. Upon execution of the non-binding term sheet, the potential borrower generally pays the Adviser a non-refundable fee for services rendered by the Adviser through the date of the non-binding term sheet. These fees are received by the Adviser and are offset against the base management fee payable to the Adviser, which has the effect of reducing our expenses to the extent of any such fees received by the Adviser.

 

In the event that we expend significant effort in considering and negotiating a potential investment that ultimately is not consummated, we generally will seek reimbursement from the proposed borrower for our reasonable expenses incurred in connection with the transaction, including legal fees.  Any amounts collected for expenses incurred by the Adviser in connection with unconsummated investments will be reimbursed to the Adviser.  Amounts collected for these expenses incurred by us will be reimbursed to us and will be recognized in the period in which such reimbursement is received, however, there can be no guarantee that we will be successful in collecting any such reimbursements.

 

Our Adviser and Administrator

 

Our Adviser is led by a management team which has extensive experience in our lines of business. Our Adviser is controlled by David Gladstone, our chairman and chief executive officer. Mr. Gladstone is also the chairman and chief executive officer of our Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer, secretary and director, is a member of the board of directors of our Adviser and its vice chairman and chief operating officer, George Stelljes III, our president, chief investment officer and director, is a member of the board of directors of our Adviser and its president and chief investment officer. Our Adviser also has a wholly-owned subsidiary, Gladstone Administration, LLC (the “Administrator”), which employs our chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.

 

Our Adviser and Administrator also provide investment advisory and administrative services to our affiliates, Gladstone Commercial Corporation, a publicly traded real estate investment trust; Gladstone Investment Corporation, a publicly traded business development company; and Gladstone Land Corporation, a private agricultural real estate company. With the exception of our chief financial officer, all of our executive officers serve as either directors or executive officers, or both, of our Adviser, our Administrator, Gladstone Commercial Corporation and Gladstone Investment Corporation. In the future, our Adviser may provide investment advisory and administrative services to other funds, both public and private, of which it is the sponsor.

 

Investment Advisory and Management Agreement

 

Under the amended and restated investment advisory agreement (“Advisory Agreement”), we pay our Adviser an annual base management fee of 2% of our average gross assets, which is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the two most recently completed calendar quarters and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.

 

We also pay our Adviser a two-part incentive fee under the Advisory Agreement.  The first part of the incentive fee is an income-based incentive fee which rewards our Adviser if our quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of our net assets (the “hurdle rate”). The second part of the incentive fee is a capital gains-based incentive fee that is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), and equals 20% of our realized capital gains as of the end of the fiscal year. In determining the capital gains-based incentive fee payable to our Adviser, we will calculate the cumulative aggregate realized capital gains and cumulative aggregate realized capital losses since our inception, and the aggregate unrealized capital depreciation as of the date of the calculation, as applicable, with respect to each of the investments in our portfolio.  The Adviser did not earn the capital gains portion of the incentive fee for the fiscal year ended September 30, 2009.

 

We pay our direct expenses including, but not limited to, directors’ fees, legal and accounting fees, stockholder related expenses, and directors and officers insurance under the Advisory Agreement.

 

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Beginning in April 2006, our Board of Directors has accepted from the Adviser, unconditional and irrevocable voluntarily waivers on a quarterly basis to reduce the annual 2.0% base management fee on senior syndicated loans to 0.5% to the extent that proceeds resulting from borrowings were used to purchase such syndicated loan participations.  In addition to the base management and incentive fees under the Advisory Agreement, 50% of certain fees received by the Adviser from our portfolio companies are credited against the investment advisory fee and paid to the Adviser.

 

The Adviser services our loan portfolio pursuant to a loan servicing agreement with Gladstone Business Loan, LLC (“Business Loan”) in return for a 1.5% annual fee, based on the monthly aggregate outstanding loan balance of the loans pledged under our credit facility.

 

Administration Agreement

 

We have entered into an administration agreement with our Administrator (the “Administration Agreement”), whereby we pay separately for administrative services. The Administration Agreement provides for payments equal to our allocable portion of the Administrator’s overhead expenses in performing its obligations under the Administration Agreement including, but not limited to, rent for employees of the Administrator, and our allocable portion of the salaries and benefits expenses of our chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.  Our allocable portion of expenses is derived by multiplying our Administrator’s total expenses by the percentage of our average assets (the total assets at the beginning of each quarter) in comparison to the average total assets of all companies managed by our Adviser under similar agreements.  On July 8, 2009, our Board of Directors approved the renewal of this Administration Agreement with our Administrator through August 31, 2010. We expect that the Board of Directors will consider a further one year renewal in July 2010.

 

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RESULTS OF OPERATIONS

 

COMPARISON OF THE FISCAL YEARS ENDED SEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008

 

A comparison of our operating results for the fiscal years ended September 30, 2009 and 2008 is below:

 

 

 

For the year ended September 30,

 

 

 

2009

 

2008

 

$ Change

 

% Change

 

INVESTMENT INCOME

 

 

 

 

 

 

 

 

 

Interest income – non control/non affiliate investments

 

$

41,134

 

$

44,733

 

$

(3,599

)

(8.0

)%

Interest income – control investments

 

933

 

64

 

869

 

1,357.8

%

Interest income – cash

 

11

 

335

 

(324

)

(96.7

)%

Interest income – notes receivable from employees

 

468

 

471

 

(3

)

(0.6

)%

Prepayment fees and other income

 

72

 

122

 

(50

)

(41.0

)%

Total investment income

 

42,618

 

45,725

 

(3,107

)

(6.8

)%

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

Interest expense

 

7,949

 

8,284

 

(335

)

(4.0

)%

Loan servicing fee

 

5,620

 

6,117

 

(497

)

(8.1

)%

Base management fee

 

2,005

 

2,212

 

(207

)

(9.4

)%

Incentive fee

 

3,326

 

5,311

 

(1,985

)

(37.4

)%

Administration fee

 

872

 

985

 

(113

)

(11.5

)%

Professional fees

 

1,586

 

911

 

675

 

74.1

%

Amortization of deferred financing fees

 

2,778

 

1,534

 

1,244

 

81.1

%

Stockholder related costs

 

415

 

443

 

(28

)

(6.3

)%

Directors’ fees

 

197

 

220

 

(23

)

(10.5

)%

Insurance expense

 

241

 

227

 

14

 

6.2

%

Other expenses

 

278

 

325

 

(47

)

(14.5

)%

Expenses before credit from Adviser

 

25,267

 

26,569

 

(1,302

)

(4.9

)%

Credit to base management and incentive fees from Adviser

 

(3,680

)

(7,397

)

3,717

 

(50.3

)%

Total expenses net of credit to base management and incentive fees

 

21,587

 

19,172

 

2,415

 

12.6

%

 

 

 

 

 

 

 

 

 

 

NET INVESTMENT INCOME

 

21,031

 

26,553

 

(5,522

)

(20.8

)%

 

 

 

 

 

 

 

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT:

 

 

 

 

 

 

 

 

 

Net realized loss on investments

 

(26,411

)

(787

)

(25,624

)

3,255.9

%

Realized (loss) gain on settlement of derivative

 

(304

)

7

 

(311

)

(4,442.9

)%

Net unrealized appreciation (depreciation) on derivative

 

304

 

(12

)

316

 

(2,633.3

)%

Net unrealized appreciation (depreciation) on investments

 

9,513

 

(47,023

)

56,536

 

(120.2

)%

Net unrealized appreciation on borrowings under line of credit

 

(350

)

 

(350

)

 

Net loss on investments, derivative and borrowings under line of credit

 

(17,248

)

(47,815

)

30,567

 

(63.9

)%

 

 

 

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS

 

$

3,783

 

$

(21,262

)

25,045

 

(117.8

)%

 

Investment Income

 

Investment income for the year ended September 30, 2009 was $42,618 as compared to $45,725 for the year ended September 30, 2008.  Interest income from our aggregate investment portfolio decreased for the year ended September 30, 2009 as compared to the prior year.  The level of interest income from investments is directly related to the balance, at cost, of the interest-bearing investment portfolio outstanding during the year multiplied by the weighted average yield.  The weighted average yield varies from year to year based on the current stated interest rate on interest-bearing investments and the amounts of loans for which interest is not accruing.  Interest income from our investments decreased primarily due to the overall reduction in the cost basis of our investments, resulting primarily from the exit of 15 investments during the year ended September 30, 2009, as well as a slight decrease in the weighted average yield on our portfolio.  The annualized weighted average yield on our portfolio was 9.9% for the year ended September 30, 2009 as compared to 10.2% for the prior

 

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year.  During the year ended September 30, 2009, five investments were on non-accrual, for an aggregate of approximately $10,022 at cost, or 2.8% of the aggregate cost of our investment portfolio and during the prior year, three investments were on non-accrual for an aggregate of approximately $13,098 at cost, or 2.8% of the aggregate cost of our investment portfolio.

 

Interest income from Non-Control/Non-Affiliate investments decreased for the year ended September 30, 2009 as compared to the prior year, primarily from an overall decrease in the aggregate cost basis of our Non-Control/Non-Affiliate investments during the year.  In addition, the success fees earned during the year ended September 30, 2009 totaled $387, compared to $998 earned in the prior year.  Success fees earned during the year ended September 30, 2009 resulted from refinancings by ActivStyle and It’s Just Lunch and an amendment by Interfilm.  Success fees earned during the year ended September 30, 2008 resulted from refinancings by Defiance and Westlake Hardware and a full repayment from Express Courier.

 

Interest income from Control investments increased for the year ended September 30, 2009 as compared to the prior year.  The increase was attributable to four additional Control investments held during the year ended September 30, 2009, which were converted from Non-Control/Non-Affiliate investments.

 

The following table lists the interest income from investments for the five largest portfolio companies during the respective years:

 

Year ended September 30, 2009

 

Company

 

Interest
Income

 

% of
Total

 

Sunshine Media

 

$

3,352

 

8.0

%

Reliable Biopharma

 

3,073

 

7.3

%

Westlake Hardware

 

2,417

 

5.7

%

Clinton Holdings

 

1,888

 

4.5

%

VantaCore

 

1,696

 

4.0

%

Subtotal

 

$

12,426

 

29.5

%

Other companies

 

29,641

 

70.5

%

Total interest income

 

$

42,067

 

100.0

%

 

Year ended September 30, 2008

 

Company

 

Interest
Income

 

% of
Total

 

Sunshine Media

 

$

2,939

 

6.6

%

Reliable Biopharma

 

2,870

 

6.4

%

Westlake Hardware

 

2,852

 

6.4

%

Clinton Holdings

 

1,902

 

4.2

%

Winchester Electronics

 

1,399

 

3.1

%

Subtotal

 

$

11,962

 

26.7

%

Other companies

 

32,835

 

73.3

%

Total interest income

 

$

44,797

 

100.0

%

 

Interest income from invested cash decreased for the year ended September 30, 2009 as compared to the prior year.  Interest income came from the following sources:

 

 

 

Year ended

 

 

 

September 30,
2009

 

September 30,
2008

 

 

 

 

 

 

 

Interest earned on Gladstone Capital account (1)

 

$

 

$

50

 

Interest earned on Business Loan custodial account (2)

 

10

 

199

 

Interest earned on Gladstone Financial account (3)

 

1

 

86

 

Total interest income from invested cash

 

$

11

 

$

335

 

 


(1)          Interest earned on our Gladstone Capital account during the year ended September 30, 2008 resulted from proceeds received from the equity offerings completed during the fiscal year that were held in the account prior to being invested or used to pay down the line of credit.

(2)          Interest earned on our Business Loan custodial account during the year ended September 30, 2008 resulted from large cash amounts held in the account prior to disbursement.  During this fiscal year, we had $140,817 of originations to new portfolio companies.

(3)          Interest earned on our Gladstone Financial account during the year ended September 30, 2008 resulted from the U.S. Treasury bill that was held with an original maturity of six months.

 

Interest income from loans to our employees, in connection with the exercise of employee stock options, decreased slightly for the year ended September 30, 2009 as compared to the prior year due to principal payments on the employee loans during the current year.

 

Prepayment fees and other income decreased for the year ended September 30, 2009 as compared to the prior year.  The income for the prior year consisted of prepayment penalty fees received upon the full repayment of certain loan investments

 

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ahead of contractual maturity and prepayment fees received upon the early unscheduled principal repayments, which was based on a percentage of the outstanding principal amount of the loan at the date of prepayment.

 

Operating Expenses

 

Operating expenses, net of credits from the Adviser for fees earned and voluntary irrevocable and unconditional waivers to the base management and incentive fees, increased for the year ended September 30, 2009 as compared to the prior year primarily due to an increase in professional fees and amortization of deferred financing fees incurred in connection with our previous credit facility with Deutsche Bank AG (the “DB Facility”) and the new KEF Facility.

 

Interest expense decreased for the year ended September 30, 2009 as compared to the prior year due primarily to decreased borrowings under our line of credit during the year ended September 30, 2009, partially offset by a higher weighted average annual interest cost, which is determined by using the annual stated interest rate plus commitment and other fees, plus the amortization of deferred financing fees dividend by the weighted average debt outstanding.

 

Loan servicing fees decreased for the year ended September 30, 2009 as compared to the prior year.  These fees were incurred in connection with a loan servicing agreement between Business Loan and our Adviser, which is based on the size and mix of the portfolio.  The decrease was primarily due to the reduction in the size of our investment portfolio.  Due to voluntary, irrevocable and unconditional waivers in place during these years, senior syndicated loans incurred a 0.5% annual fee,  whereas proprietary loans incurred a 1.5% annual fee.  All of these fees were reduced against the amount of the base management fee due to our Adviser.

 

The base management fee decreased for the year ended September 30, 2009 as compared to the prior year, which is reflective of fewer total assets held during the year ended September 30, 2009.  Furthermore, due to the liquidation of the majority of our syndicated loans, the credit received against the gross base management fee for investments in syndicated loans has also been reduced. The base management fee is computed quarterly as described under “Investment Advisory and Management Agreement” in Note 4 to the accompanying consolidated financial statements, and is summarized in the table below:

 

 

 

Year ended

 

 

 

September
30, 2009

 

September
30, 2008

 

Base management fee (1)

 

$

2,005

 

$

2,212

 

Credit for fees received by Adviser from the portfolio companies

 

(89

)

(1,678

)

Fee reduction for the voluntary, irrevocable and unconditional waiver of 2% fee on senior syndicated loans to 0.5% (2)

 

(265

)

(408

)

Net base management fee

 

$

1,651

 

$

126

 

 


(1)          Base management fee is net of loan servicing fees per the terms of the Advisory Agreement.

(2)          The board of our Adviser voluntarily, irrevocably and unconditionally waived on a quarterly basis the annual 2.0% base management fee to 0.5% for senior syndicated loan participations for the years ended September 30, 2009 and 2008,.  Fees waived cannot be recouped by the Adviser in the future.

 

Incentive fee decreased for the year ended September 30, 2009 as compared to the prior year.  The board of our Adviser voluntarily, irrevocably and unconditionally waived on a quarterly basis the entire incentive fee for each quarter of the years ended September 30, 2009 and 2008.  The incentive fee and associated credits are summarized in the table below:

 

 

 

Year ended

 

 

 

September
30, 2009

 

September
30, 2008

 

Incentive fee

 

$

3,326

 

$

5,311

 

Credit from voluntary, irrevocable and unconditional waiver issued by Adviser’s board of directors

 

(3,326

)

(5,311

)

Net incentive fee

 

$

 

$

 

 

Administration fee decreased for the year ended September 30, 2009 as compared to the prior year, due to a decrease of administration staff and related expenses, as well as a decrease in our total assets in comparison to the total assets of all

 

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companies managed by our Adviser under similar agreements.  The calculation of the administrative fee is described in detail under “Investment Advisory and Management Agreement” in Note 4 of the notes to the accompanying consolidated financial statements.

 

Other operating expenses (including deferred financing fees, stockholder related costs, directors’ fees, insurance and other expenses) increased over the prior year driven by amortization of additional fees incurred with amending the DB Facility and entering into the new KEF Facility and legal fees incurred in connection with troubled loans in the current year.

 

Net Realized Loss on Investments

 

The realized loss for the year ended September 30, 2009 consisted of a $15,029 loss from the sale of several syndicated loans and one non-syndicated loan, a $9,409 write-off of the Badanco loan, and a $2,000 write-off of a portion of the Greatwide second lien syndicated loan, partially offset by a $27 gain from the Country Road payoff.  Net realized loss on investments during the year ended September 30, 2008 resulted from the partial sale of the senior subordinated term debt of Greatwide Logistics, as well as the unamortized investment acquisition costs related to the Anitox and Macfadden loans, which were repaid in full during the year.

 

Realized (Loss) Gain on Settlement of Derivative

 

The realized loss for the year ended September 30, 2009 was due to the expiration of our interest rate cap agreement in February 2009.  We did not receive any interest rate cap agreement payments during the period from October 2008 through February 2009 as a result of the one-month LIBOR having a downward trend.  During the year ended September 30, 2008, we received interest rate cap agreement payments of only $7 as a result of the one-month LIBOR having a downward trend.  We received payments when the one-month LIBOR was over 5%.

 

Net Unrealized Appreciation (Depreciation) on Derivative

 

Net unrealized appreciation (depreciation) on derivative is the net change in the fair value of our interest rate cap during the year, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.  The unrealized appreciation on derivative during the year ended September 30, 2009 resulted from the reversal of previously recorded unrealized depreciation when the loss was realized during the three months ended March 31, 2009.  For the year ended September 30, 2008, the unrealized depreciation was due to a decrease in the fair market value of our interest rate cap agreement.

 

Net Unrealized Appreciation (Depreciation) on Investments

 

Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio during the year, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.  The net unrealized appreciation on investments for the year ended September 30, 2009 consisted of the following:

 

·

 

Control investments

 

$

1,564

 

·

 

Non-Control/Non-Affiliate investments

 

(16,582

)

·

 

Reversal of previously unrealized depreciation upon realization of losses

 

24,531

 

 

 

Total

 

$

9,513

 

 

We believe that our investment portfolio was valued at a depreciated value due primarily to the general instability of the loan markets.  Although our investment portfolio has depreciated, our entire portfolio was fair valued at 88% of cost as of September 30, 2009.  The cumulative unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders; however, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution.

 

Net Unrealized Appreciation on Borrowings under Line of Credit

 

Unrealized appreciation on borrowings under line of credit is the net change in the fair value of our line of credit borrowings during the year, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.  During the year ended September 30, 2009, we elected to apply ASC 825, “Financial Instruments,” which

 

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requires that we apply a fair value methodology to the KEF Facility.  We estimated the fair value of the KEF Facility using estimates of value provided by an independent third party and our own assumptions in the absence of observable market data, including estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date.  The KEF Facility was fair valued at $83,350 as of September 30, 2009, and an unrealized appreciation of $350 was recorded for the year ended September 30, 2009.

 

Net Increase (Decrease) in Net Assets from Operations

 

For the year ended September 30, 2009, we realized a net increase in net assets resulting from operations of $3,783 as a result of the factors discussed above.  For the year ended September 30, 2008, we realized a net decrease in net assets resulting from operations of $21,262.  Our net increase (decrease) in net assets resulting from operations per basic and diluted weighted average common share for the years ended September 30, 2009 and 2008 were $0.18 and ($1.08), respectively.

 

COMPARISON OF THE FISCAL YEARS ENDED SEPTEMBER 30, 2008 AND SEPTEMBER 30, 2007

 

A comparison of our operating results for the fiscal years ended September 30, 2008 and 2007 is below:

 

 

 

For the year ended September 30,

 

 

 

2008

 

2007

 

$ Change

 

% Change

 

INVESTMENT INCOME

 

 

 

 

 

 

 

 

 

Interest income – non control/non affiliate investments

 

$

44,733

 

$

35,413

 

$

9,320

 

26.3

%

Interest income – control investments

 

64

 

 

64

 

 

Interest income – cash

 

335

 

256

 

79

 

30.9

%

Interest income – notes receivable from employees

 

471

 

526

 

(55

)

(10.5

)%

Prepayment fees and other income

 

122

 

492

 

(370

)

(75.2

)%

Total investment income

 

45,725

 

36,687

 

9,038

 

24.6

%

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

Interest expense

 

8,284

 

7,226

 

1,058

 

14.6

%

Loan servicing fee

 

6,117

 

3,624

 

2,493

 

68.8

%

Base management fee

 

2,212

 

2,402

 

(190

)

(7.9

)%

Incentive fee

 

5,311

 

4,608

 

703

 

15.3

%

Administration fee

 

985

 

719

 

266

 

37.0

%

Professional fees

 

911

 

523

 

388

 

74.2

%

Amortization of deferred financing fees

 

1,534

 

267

 

1,267

 

474.5

%

Stockholder related costs

 

443

 

217

 

226

 

104.1

%

Directors’ fees

 

220

 

234

 

(14

)

(6.0

)%

Insurance expense

 

227

 

249

 

(22

)

(8.8

)%

Other expenses

 

325

 

328

 

(3

)

(0.9

)%

Expenses before credit from Adviser

 

26,569

 

20,397

 

6,172

 

30.3

%

Credit to base management and incentive fees from Adviser

 

(7,397

)

(5,971

)

(1,426

)

23.9

%

Total expenses net of credit to base management and incentive fees

 

19,172

 

14,426

 

4,746

 

32.9

%

 

 

 

 

 

 

 

 

 

 

NET INVESTMENT INCOME

 

26,553

 

22,261

 

4,292

 

19.3

%

 

 

 

 

 

 

 

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT:

 

 

 

 

 

 

 

 

 

Net realized (loss) gain on investments

 

(787

)

44

 

(831

)

(1,888.6

)%

Realized gain on settlement of derivative

 

7

 

39

 

(32

)

(82.1

)%

Net unrealized depreciation on derivative

 

(12

)

(38

)

26

 

(68.4

)%

Net unrealized depreciation on investments

 

(47,023

)

(7,354

)

(39,669

)

539.4

%

Net loss on investments and derivative

 

(47,815

)

(7,309

)

(40,506

)

554.2

%

 

 

 

 

 

 

 

 

 

 

NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

 

$

(21,262

)

$

14,952

 

(36,214

)

(242.2

)%

 

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Table of Contents

 

Investment Income

 

Interest income from our investments in debt securities of private companies increased for the year ended September 30, 2008 as compared to the prior year.  The level of interest income from investments is directly related to the balance, at cost, of the interest-bearing investment portfolio outstanding during the year multiplied by the weighted average yield.  The weighted average yield varies from year to year based on the current stated interest rate on interest-bearing investments and the amounts of loans for which interest is not accruing.  Interest income from our investments increased during the year ended September 30, 2008 based on the overall growth in the cost basis of our investments, offset by the decrease in the weighted average yield.  The success fees during the year ended September 30, 2008 and 2007 were $998 and $2,249 respectively.  The success fees for the year ended September 30, 2008 resulted from refinancings by Westlake Hardware, Inc. and Defiance Acquisition Corp., and a full repayment by Express Courier International, while the success fees for the year ended September 30, 2007 resulted from a refinancing by Badanco Acquisition Corp. and full repayments by Mistras Holdings Corp., SCPH Holdings and Allied Extruders LLC.

 

·                  The interest-bearing investment portfolio had an average cost basis of approximately $400,567 for the year ended September 30, 2008, as compared to an average cost basis of $284,305 for the year ended September 30, 2007.  The following table lists the interest income from investments for the five largest portfolio companies during the respective years:

 

Year ended September 30, 2008

 

Company

 

Interest
Income

 

% of
Total

 

Sunshine Media

 

$

2,939

 

6.6

%

Reliable Biopharma

 

2,870

 

6.4

%

Westlake Hardware

 

2,852

 

6.4

%

Clinton Holdings

 

1,902

 

4.2

%

Winchester Electronics

 

1,399

 

3.1

%

Subtotal

 

$

11,962

 

26.7

%

Other companies

 

32,835

 

73.3

%

Total interest income

 

$

44,797

 

100.0

%

 

Year ended September 30, 2007

 

Company

 

Interest
Income

 

% of
Total

 

Westlake Hardware

 

$

1,918

 

5.4

%

Badanco

 

1,905

 

5.4

%

Mistras Holdings

 

1,356

 

3.8

%

Clinton Holdings

 

1,321

 

3.7

%

Specialty Coatings

 

1,285

 

3.7

%

Subtotal

 

$

7,785

 

22.0

%

Other companies

 

27,628

 

78.0

%

Total interest income

 

$

35,413

 

100.0

%

 

·                  The weighted average yield on our portfolio, excluding cash and cash equivalents, for the year ended September 30, 2008 was 10.2%, compared to 12.0% for the year ended September 30, 2007.  The weighted average yields were not materially impacted by the PIK interest, which was $62 and $0 for the year ended September 30, 2008 and 2007, respectively.  The decrease in the annualized weighted average yield primarily resulted from a reduction in the average LIBOR, which was 3.8% for the year ended September 30, 2008, compared to 5.3% in the prior year, as well as four investments being on non-accrual during the year ended September 30, 2008 (LocalTel, West Cost Yellow Pages, Greatwide Logistics and U.S. Healthcare) and none in the prior year.  As of September 30, 2008, three investments were on non-accrual (Greatwide Logistics, LocalTel, and U.S. Healthcare).  West Coast Yellow Pages was restructured as a Control investment and was renamed Western Directories.

 

Interest income from invested cash increased for the year ended September 30, 2008 as compared to the prior year due to the amount of cash that was held in interest bearing accounts and the interest earned on our custodial account prior to disbursement.

 

Interest income from loans to our employees, in connection with the exercise of employee stock options, decreased for the year ended September 30, 2008 as compared to the prior year due to the cancellation in full of one employee loan during the fourth quarter of the prior fiscal year, and full repayment of another employee loan in the second quarter of the year ended September 30, 2008.

 

Prepayment fees and other income decreased for the year ended September 30, 2008 as compared to the prior year.  The income for the prior year consisted of prepayment penalty fees received upon the full repayment of certain loan investments ahead of contractual maturity and prepayment fees received upon the early unscheduled principal repayments, which was based on a percentage of the outstanding principal amount of the loan at the date of prepayment.

 

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Operating Expenses

 

Operating expenses, net of credits from the Adviser for fees earned and voluntary irrevocable and unconditional waivers to the base management and incentive fees, increased for the year ended September 30, 2008 as compared to the prior year due to a significant increase in interest expense, loan servicing fees and amortization of deferred financing fees incurred in connection with certain amendments to our credit facility.

 

Interest expense increased for the year ended September 30, 2008 as compared to the prior year due primarily to increased borrowings under our line of credit and an increase in the interest rates on our borrowings.  The borrowings were partially used to finance the increase in our investment activity during the fiscal year ended September 30, 2008.

 

Loan servicing fees increased for the year ended September 30, 2008 as compared to the prior year.  These fees were incurred in connection with a loan servicing agreement between Business Loan and our Adviser, which is based on the size and mix of the portfolio.  The average size of our investment portfolio, excluding equity investments and control investments, was approximately $375,563 for the year ended September 30, 2008 as compared to approximately $281,313 for the year ended September 30, 2007.  In terms of portfolio mix, senior syndicated loans comprised 7.3% and 10.7% of the portfolio during the year ended September 30, 2008 and 2007, respectively.  Due to voluntary, irrevocable and unconditional waivers in place during these years, senior syndicated loans incurred a 0.5% annual fee,  whereas proprietary loans incurred a 1.5% annual fee.  All of these fees were reduced against the amount of the base management fee due to our Adviser.

 

The base management fee decreased for the year ended September 30, 2008 as compared to the prior year.  The base management fee is computed quarterly as described under “Investment Advisory and Management Agreement” in Note 4 to the accompanying consolidated financial statements, and is summarized in the table below:

 

 

 

Year ended

 

 

 

September
30, 2008

 

September
30, 2007

 

Base management fee (1)

 

$

2,212

 

$

2,402

 

Credit for fees received by Adviser from the portfolio companies (2)

 

(1,678

)

(1,660

)

Fee reduction for the voluntary, irrevocable and unconditional waiver of 2% fee on senior syndicated loans to 0.5% (3)

 

(408

)

(481

)

Net base management fee

 

$

126

 

$

261

 

 


(1)          Base management fee is net of loan servicing fees per the terms of the Advisory Agreement.

(2)          Effective April 1, 2007, the board of directors of our Adviser reduced the amount of voluntary, irrevocable and unconditional credit for investment advisory fees received by our Adviser from 100% of the fees received to 50% of the fees received.  Therefore, the year ended September 30, 2008 and the last six months of the year ended September 30, 2007 reflect the reduced credit for fees received by our Adviser.

(3)          The board of our Adviser voluntarily, irrevocably and unconditionally waived, for the year ended September 30, 2008 and 2007, the annual 2.0% base management fee to 0.5% for senior syndicated loan participations.

 

Incentive fee increased for the year ended September 30, 2008 as compared to the prior year.  The board of our Adviser voluntarily, irrevocably and unconditionally waived on a quarterly basis the entire incentive fee for each quarter of the year ended September 30, 2008 and a portion of the incentive fee due for each quarter of the year ended September 30, 2007.  The incentive fee and associated credits are summarized in the table below:

 

 

 

Year ended

 

 

 

September
30, 2008

 

September
30, 2007

 

Incentive fee

 

$

5,311

 

$

4,608

 

Credit from voluntary, irrevocable and unconditional waiver issued by Adviser’s board of directors

 

(5,311

)

(3,830

)

Net incentive fee

 

$

 

$

778

 

 

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Table of Contents

 

Administration fee increased for the year ended September 30, 2008 as compared to the prior year, due to the addition of administration staff and related expenses.

 

Professional fees, consisting primarily of legal and audit fees, increased for the year ended September 30, 2008 as compared to the prior year due primarily to legal fees incurred in connection with converting troubled loans to control investments.

 

Amortization of deferred financing fees, in connection with our line of credit, increased for the year ended September 30, 2008 as compared to the prior year due to the amortization of additional fees incurred with certain amendments to our line of credit.  In February 2008, we increased the DB Facility from $220 million to $250 million, and in April 2008, increased the DB Facility to $300 million and added BB&T as a committed lender.  In June 2008, we renewed the DB Facility.  The fees incurred for the above amendments are recorded in deferred financing fees on our consolidated statements of assets and liabilities, and amortized over the life of the DB Facility.

 

Stockholder related costs increased for the year ended September 30, 2008 as compared to the prior year.  Stockholder related costs include such recurring items as transfer agent fees, NASDAQ listing fees, costs associated with SEC filings, and annual report printing and distribution costs.  These fees increased during the year ended September 30, 2008 due to the size and quantity of our annual report and additional expenses for the annual stockholder meeting and proxy costs compared to the prior year.

 

Directors’ fees decreased for the year ended September 30, 2008 as compared to the prior year.  The fees consisted of amortization of the directors’ annual stipend and meeting stipends.

 

Insurance expense decreased for the year ended September 30, 2008 as compared to the prior year, due to a decrease in the amortization of our directors and officers insurance policy premiums.

 

Other expenses decreased slightly for the year ended September 30, 2008 as compared to the prior year.  The expenses primarily represent direct expenses such as travel related specifically to our portfolio companies, loan evaluation services for our portfolio companies, press releases and backup servicer expenses.

 

Net Realized (Loss) Gain on Investments

 

Net realized loss on investments during the year ended September 30, 2008 resulted from the partial sale of the senior subordinated term debt of Greatwide Logistics, as well as the unamortized investment acquisition costs related to the Anitox and Macfadden loans, which were repaid in full during the year, as compared to the net realized gain on investments during the year ended September 30, 2007 from the sale or repayment of 27 syndicated loan investments.

 

Net Realized Gain on Settlement of Derivative

 

During the years ended September 30, 2008 and September 30, 2007, we received interest rate cap agreement payments of $7 and $39, respectively, as a result of the one month LIBOR exceeding 5%.

 

Net Unrealized Depreciation on Derivative

 

Net unrealized depreciation on derivative during the year ended September 30, 2008 was due to a decrease in the fair market value of our interest rate cap agreement.

 

Net Unrealized Depreciation on Investments

 

The net unrealized depreciation on investments during the year ended September 30, 2008 was mainly attributable to the decrease in fair value of our portfolio.  We believe that our investment portfolio was valued at a depreciated value due primarily to the general instability of the loan markets and, to a lesser extent, the use of a modified valuation procedure for our non-control/non-affiliate investments.  Previously, we valued the debt portion of bundled debt and equity investments in non-controlled companies in accordance with Board-approved valuation procedures, which valued the debt securities at the contractual principal balance, if it was determined total enterprise value was sufficient to cover the contractual principal balance.  Consistent with the Board’s ongoing review and analysis of appropriate valuation procedures, and in consideration of the fair value measurements of ASC 820, the Board of Directors modified our valuation procedure so that the debt portion of bundled investments in non-controlled companies is primarily based on opinions of value provided by

 

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Table of Contents

 

SPSE.  This change in valuation estimate accounted for $2,887, or 6.1%, of the net unrealized depreciation for the year.  Although our investment portfolio has depreciated, our entire portfolio was fair valued at 88.5% of cost as of September 30, 2008.  The unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders, however, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution.

 

Net (Decrease) Increase in Net Assets from Operations

 

For the year ended September 30, 2008, we realized a net decrease in net assets resulting from operations of $21,262 as a result of the factors discussed above.  For the year ended September 30, 2007, we realized a net increase in net assets resulting from operations of $14,952.  Our net (decrease) increase in net assets resulting from operations per basic and diluted weighted average common share for the years ended September 30, 2008 and 2007 were ($1.08) and $1.13, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Operating Activities

 

Net cash provided by operating activities for the year ended September 30, 2009 was $95,521 and consisted primarily of proceeds received from the syndicated loan sales and the net loss realized on those sales and principal payments received from existing investments.  In contrast,  net cash used in operating activities for the years ended September 30, 2008 and 2007 were $80,218 and $116,984, respectively, and consisted of the purchase of new investments, partially offset by principal loan repayments.

 

At September 30, 2009, we had investments in debt securities, or loans to or syndicated participations in 48 private companies with a cost basis totaling $364,393.  At September 30, 2008, we had investments in debt securities, or loans to or syndicated participations in 63 private companies with a cost basis totaling $460,870.  At September 30, 2007, we had investments in debt securities, or loans to or syndicated participations in 56 private companies with a cost basis totaling approximately $355,759.

 

During the fiscal years ended September 30, 2009, 2008 and 2007, the following investment activity occurred during each quarter of the respective fiscal year:

 

Quarter Ended

 

New
Investments (1)

 

Principal
Repayments (2)

 

Proceeds from
Sales/Exits (3)

 

Net Gain (Loss)
on Disposal

 

September 30, 2009

 

$

 1,652

 

$

 4,071

 

$

 7,241

 

$

(12,086

)

June 30, 2009

 

7,582

 

15,439

 

39,750

 

(10,594

)

March 31, 2009

 

8,430

 

13,053

 

 

(2,000

)

December 31, 2008

 

8,702

 

14,927

 

2,212

 

(1,731

)

Total fiscal year 2009

 

$

 26,366

 

$

 47,490

 

$

 49,203

 

$

(26,411

)

 

 

 

 

 

 

 

 

 

 

September 30, 2008

 

$

 39,048

 

$

 21,381

 

$

 1,299

 

$

 (701

)

June 30, 2008

 

43,678

 

40,755

 

 

(86

)

March 31, 2008

 

20,483

 

3,000

 

 

 

December 31, 2007

 

73,341

 

4,047

 

 

 

Total fiscal year 2008

 

$

 176,550

 

$

 69,183

 

$

 1 ,299

 

$

 (787

)

 

 

 

 

 

 

 

 

 

 

September 30, 2007

 

$

 7,972

 

$

 22,015

 

$

 —

 

$

 (37

)

June 30, 2007

 

126,087

 

20,913

 

16,660

 

(5

)

March 31, 2007

 

75,330

 

20,063

 

18,200

 

84

 

December 31, 2006

 

52,311

 

23,967

 

 

2

 

Total fiscal year 2007

 

$

 261,700

 

$

 86,958

 

$

 34,860

 

$

 44

 

 

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Table of Contents

 

(1)   New Investments:

 

 

 

New Investments

 

Disbursements to
Existing Portfolio

 

Total

 

Quarter Ended

 

Companies

 

Investments

 

Companies

 

Disbursements

 

September 30, 2009

 

 

$

 —

 

$

 1,652

 

$

 1,652

 

June 30, 2009

 

 

 

7,582

 

7,582

 

March 31, 2009

 

 

 

8,430

 

8,430

 

December 31, 2008

 

 

 

8,702

 

8,702

 

Total fiscal year 2009

 

 

$

 —

 

$

 26,366

 

$

 26,366

 

 

 

 

 

 

 

 

 

 

 

September 30, 2008

 

3

(a)

$

 33,375

 

$

 5,673

 

$

 39,048

 

June 30, 2008

 

3

(b)

35,750

 

7,928

 

43,678

 

March 31, 2008

 

1

(c)

13,700

 

6,783

 

20,483

 

December 31, 2007

 

5

(d)

57,992

 

15,349

 

73,341

 

Total fiscal year 2008

 

12

 

$

140,817

 

$

 35,733

 

$

 176,550

 

 

 

 

 

 

 

 

 

 

 

September 30, 2007

 

 

$

 —

 

$

 7,972

 

$

 7,972

 

June 30, 2007

 

20

(e)

112,709

 

13,378

 

126,087

 

March 31, 2007

 

12

(f)

53,138

 

22,192

 

75,330

 

December 31, 2006

 

20

(g)

48,827

 

3,484

 

52,311

 

Total fiscal year 2007

 

52

 

$

214,674

 

$

 47,026

 

$

 261,700

 

 


(a)          AKQA, VantaCore and Tulsa Welding School

(b)         Saunders, Legend and BAS Broadcasting

(c)          ACE Expediters

(d)         Interfilm, Reliable, Lindmark, GS Maritime and GFRC

(e)          Includes acquisition of loans in 16 companies from Wells Fargo Foothill in June 2007 (totaling $63,259)

(f)            Most notably Clinton Holdings and Greatwide Logistics

(g)         Most notably Precision and Pinnacle Treatment Centers

 

(2)         Principal Repayments:

 

Quarter Ended

 

Number of
Companies
Fully Exited

 

Unscheduled
Principal
Repayments (*)

 

Scheduled
Principal
Repayments

 

Total Principal
Repayments

 

September 30, 2009

 

 

$

 —

 

$

 4,071

 

$

 4,071

 

June 30, 2009

 

1

(a)

10,449

 

4,990

 

15,439

 

March 31, 2009

 

(b)

7,813

 

5,240

 

13,053

 

December 31, 2008

 

2

(c)

6,966

 

7,961

 

14,927

 

Total fiscal year 2009

 

3

 

$

25,228

 

$

22,262

 

$

 47,490

 

 

 

 

 

 

 

 

 

 

 

September 30, 2008

 

2

(d)

$

12,797

 

$

 8,584

 

$

 21,381

 

June 30, 2008

 

3

(e)

28,134

 

12,621

 

40,755

 

March 31, 2008

 

(f)

500

 

2,500

 

3,000

 

December 31, 2007

 

 

 

4,047

 

4,047

 

Total fiscal year 2008

 

5

 

$

41,431

 

$

27,752

 

$

 69,183

 

 

 

 

 

 

 

 

 

 

 

September 30, 2007

 

3

(g)

$

17,889

 

$

 4,126

 

$

 22,015

 

June 30, 2007

 

5

(h)

17,061

 

3,852

 

20,913

 

March 31, 2007

 

1

(i)

17,785

 

2,278

 

20,063

 

December 31, 2006

 

3

(j)

20,860

 

3,107

 

23,967

 

Total fiscal year 2007

 

12

 

$

73,595

 

$

13,363

 

$

 86,958

 

 

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Table of Contents

 


(*)         Includes principal payments due to excess cash flows, covenant violations, exits, refinancing, etc.

(a)          Full payoff from Multi-Ag Media ($1,687), partial payoff from Saunders line of credit ($2,500) and refinancing from ActivStyle ($6,262).

(b)         Refinancing from ACE Expediters and Sunburst media.

(c)          Full payoff from Community Media and Country Road.

(d)         Full payoff from Express Courier International and Meteor Holding.

(e)          Full payoff from Macfadden Performing Arts, Reading Broadcasting and SCS ($25,074) and partial payoff from Anitox Senior Real Estate Term Debt ($3,060).

(f)            Partial payoff from Risk Metrics Senior Subordinated Term Debt.

(g)         Full payoff from Advanced Homecare Management, Florida Cable and Ohmstede Acquisition.

(h)         Full payoff from Allied Extruders, Benetech, Consolidated Bedding SCPH Holdings and IPC.

(i)             Full payoff from Network Solutions ($4,455) and refinancing from Badanco Acquisition Corp. ($13,330).

(j)             Full payoff from Fresh Start Bakeries, Mistras Holdings and Xspedius.

 

(3)  Loan Sales / Exits:

 

Quarter Ended

 

Number of
Companies
Fully Exited

 

Proceeds
Received

 

Position
(Principal)
Exited

 

Unamortized
Loan Costs (*)

 

Net (Loss)
Gain on Exit

 

September 30, 2009

 

3

(a)

$

 7,241

 

$

 (19,321

)

$

 (6

)

$

(12,086

)

June 30, 2009

 

8

(b)

39,750

 

(52,295

)

1,951

 

(10,594

)

March 31, 2009

 

1

(c)

 

(2,000

)

 

(2,000

)

December 31, 2008

 

(d)

2,212

 

(3,950

)

7

 

(1,731

)

Total fiscal year 2009

 

12

 

$

49,203

 

$

(77,566

)

$

1,952

 

$

(26,411

)

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2008

 

(e)

$

 1,299

 

$

 (2,000

)

$

 —

 

$

 (701

)

June 30, 2008

 

 

 

 

(86

)

(86

)

March 31, 2008

 

 

 

 

 

 

December 31, 2007

 

 

 

 

 

 

Total fiscal year 2008

 

 

$

 1,299

 

$

 (2,000

)

$

 (86

)

$

 (787

)

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2007

 

 

$

 —

 

$

 —

 

$

 (37

)

$

 (37

)

June 30, 2007

 

9

(f)

16,660

 

(16,660

)

(5

)

(5

)

March 31, 2007

 

7

(g)

18,200

 

(18,200

)

84

 

84

 

December 31, 2006

 

 

 

 

2

 

2

 

Total fiscal year 2007

 

16

 

$

34,860

 

$

(34,860

)

$

 44

 

$

 44

 

 


(*)         Includes balance of premiums, discounts and acquisition cost at time of exit.

(a)          Full sale of CHG and John Henry syndicated loans, write-off of Badanco loan, and partial sale of Kinetek syndicated loan (senior subordinated debt).

(b)         Full sale of 8 loans (7 syndicated and 1 non-syndicated) and partial sale of CHG, GTM and Wesco syndicated loans (senior term debt).

(c)          Write-off of Greatwide syndicated loan (senior subordinated term debt).

(d)         Partial sale of Greatwide Logistics syndicated loan (senior term debt).

(e)          Partial sale of Greatwide Logistics syndicated loan (senior subordinated term debt).

(f)            Full sale of nine syndicated loans, most notably Generac and Hudson Products.

(g)         Full sale of seven syndicated loans, most notably ACS Media and West Corp.

 

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Table of Contents

 

The following table summarizes the contractual principal repayment and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments.

 

 

 

Amount

 

Fiscal Year Ending September 30,

 

 

 

2010

 

$

 50,033

 

2011

 

86,116

 

2012

 

72,836

 

2013

 

123,225

 

2014

 

19,347

 

Thereafter

 

6,851

 

Total Contractual Repayments

 

358,408

 

Investments in equity securities

 

5,478

 

Unamortized premiums, discounts and investment acquisition costs on debt securities

 

507

 

Total

 

$

 364,393

 

 

Investing Activities

 

Net cash provided by investing activities for the fiscal year ended September 30, 2008 was $2,484 for the redemption of a U.S. Treasury Bill with an original maturity of six months.  Net Cash used in investing activities for the fiscal year ended September 30, 2007 was $2,484 for the purchase of the U.S. Treasury Bill.  The U.S. Treasury Bill was purchased with proceeds from our initial stock purchase in our wholly owned subsidiary, Gladstone Financial Corporation (previously known as Gladstone SSBIC Corporation).

 

Financing Activities

 

Net cash used in financing activities for the fiscal year ended September 30, 2009 was $96,738 and mainly consisted of net payments on our line of credit of $68,030, distribution payments of $26,570 and financing fees of $2,103 associated with the KEF Facility which was entered into on May 15, 2009.

 

Net cash provided by financing activities for the fiscal year ended September 30, 2008 was $75,388 and mainly consisted of net borrowings on our line of credit of $6,590, proceeds of $105,374, net of offering costs, from the issuance of common stock and distribution payments of $33,379.

 

Net cash provided by financing activities for the fiscal year ended September 30, 2007 was $127,575 and mainly consisted of net borrowings on our line of credit of $94,447,  proceeds of $56,764, net of offering costs, from the issuance of common stock and distribution payments of $22,141.

 

Distributions

 

In order to qualify as a RIC and to avoid corporate level tax on the income we distribute to our stockholders, we are required, under Subchapter M of the Code, to distribute at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual basis. In accordance with these requirements, we declared and paid monthly cash dividends of $0.14 per common share for each month from October 2008 through March 2009 and $0.07 per common share for each month from April 2009 through September 2009.  We declared and paid monthly cash dividends of $0.14 per common share during each month of the fiscal years ended September 30, 2008 and September 30, 2007.

 

For the year ended September 30, 2009, our distribution payments of approximately $26,570 exceeded our net investment income by $5,539.  We declared these distributions based on our estimates of net investment income for the fiscal year.  Our investment pace was slower than expected and, consequently, our net investment income was lower than our original estimates.  A portion of the distributions declared during fiscal 2009 is expected to be treated as a return of capital to our stockholders.

 

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Table of Contents

 

Section 19(a) Disclosure – Unaudited

 

The Company’s Board of Directors estimates the source of the distributions at the time of their declaration as required by Section 19(a) of the 1940 Act.  On a monthly basis, if required under Section 19(a), the Company posts a Section 19(a) notice through the Depository Trust Company’s Legal Notice System (“LENS”) and also sends to its registered stockholders a written Section 19(a) notice along with the payment of dividends for any payment which includes a dividend estimated to be paid from any other source other than net investment income.  The estimates of the source of the distribution are interim estimates based on GAAP that are subject to revision, and the exact character of the distributions for tax purposes cannot be determined until the final books and records of the Company are finalized for the calendar year.  Following the calendar year end, after definitive information has been determined by the Company, if the Company has made distributions of taxable income (or return of capital), the Company will deliver a Form 1099-DIV to its stockholders specifying such amount and the tax characterization of such amount.  Therefore, these estimates are made solely in order to comply with the requirements of Section 19(a) of the 1940 Act and should not be relied upon for tax reporting or any other purposes and could differ significantly from the actual character of distributions for tax purposes.

 

The following GAAP estimates were made by the Board of Directors during the quarter ended September 30, 2009:

 

Month Ended

 

Ordinary Income

 

Return of Capital

 

Total Dividend

 

July 31, 2009

 

$

 0.089

 

$

 (0.019

)

$

 0.070

 

August 31, 2009

 

0.087

 

(0.017

)

0.070

 

September 30, 2009

 

0.086

 

(0.016

)

0.070

 

 

Because the Board of Directors declares dividends at the beginning of a quarter, it is difficult to estimate how much of the Company’s monthly dividends and distributions, based on GAAP, will come from ordinary income, capital gains and returns of capital.  Subsequent to the quarter ended September 30, 2009, the following corrections were made to the above listed estimates for that quarter:

 

Month Ended

 

Ordinary Income

 

Return of Capital

 

Total Dividend

 

July 31, 3009

 

$

 0.099

 

$

 (0.029

)

$

 0.070

 

August 31, 2009

 

0.057

 

0.013

 

0.070

 

September 30, 2009

 

0.041

 

0.029

 

0.070

 

 

For dividends declared subsequent to quarter end, the following estimates, based on GAAP, have been made pursuant to Section 19(a) of the 1940 Act:

 

Month Ended

 

Ordinary Income

 

Return of Capital

 

Total Dividend

 

October 31, 2009

 

$

 0.080

 

$

 (0.010

)

$

 0.070

 

November 30, 2009

 

0.079

 

(0.009

)

0.070

 

December 31, 2009

 

0.078

 

(0.008

)

0.070

 

 

Tax Information for the Year Ended September 30, 2009 – Unaudited

 

We are providing this information as required by the Internal Revenue Code. The amounts shown may differ from those elsewhere in this report because of differences between tax and financial reporting requirements

 

Our distributions to stockholders included $27 from long-term capital gains, subject to the 15% rate gains category.

 

For taxable non-corporate stockholders, none of our income represents qualified dividend income subject to the 15% rate category.

 

Issuance of Equity

 

On October 20, 2009, we filed a registration statement with the SEC (the “Registration Statement”) which, if and when declared effective will permit us to issue, through one or more transactions, up to an aggregate of $300,000 in securities, consisting of common stock, senior common stock, preferred stock, subscription rights, debt securities, warrants to purchase common stock, or a combination of these securities.

 

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We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. Additionally, when our common stock is trading below NAV, we will have regulatory constraints under the 1940 Act on our ability to obtain additional capital in this manner.  Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our NAV per share, other than to our then existing stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors.  As of September 30, 2009, our NAV per share was $11.81 and our closing market price was $8.93 per share.  However, subsequent to that date our stock has consistently traded at discounts of up to 34% of our September 30, 2009 NAV per share.  On November 13, 2009, our closing market price was $7.98 per share.  To the extent that our common stock trades at a market price below our NAV per share, we will generally be precluded from raising equity capital through public offerings of our common stock, other than pursuant to a rights offering.  The asset coverage requirement of a BDC under the 1940 Act effectively limits our ratio of debt to equity to 1:1.  To the extent that we are unable to raise capital through the issuance of equity, our ability to raise capital through the issuance of debt may also be inhibited to the extent of our regulatory debt to equity ratio limits.

 

At our Annual Meeting of Stockholders held on February 19, 2009, our stockholders approved a proposal which authorizes us to sell shares of our common stock at a price below our then current NAV per share for a period of one year, provided that our Board of Directors makes certain determinations prior to any such sale. At the upcoming annual stockholders meeting scheduled for February 18, 2010, our stockholders will again be asked to vote in favor of renewing this proposal for another year.

 

Revolving Credit Facility

 

On May 15, 2009 we, through our wholly-owned subsidiary Business Loan, entered into the KEF Facility.  BB&T also joined the KEF Facility as a committed lender.  In connection with entering into the KEF Facility, we borrowed $35,881 under the KEF Facility to make a final payment to Deutsche Bank AG in satisfaction of all unpaid principal and interest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to $200,000 through the addition of other committed lenders to the facility.  Without the addition of other committed lenders, the KEF Facility provides a total commitment of $102,000 from January 1, 2010 to May 11, 2010, and $77,000 thereafter.  The KEF Facility matures on May 14, 2010, and if the facility is not renewed or extended by this date, all principal and interest will be due and payable within one year of maturity. In addition, if the facility is not renewed, our lenders have the right to apply all principal and interest collections to amounts outstanding under the KEF Facility.

 

Advances under the KEF Facility will generally bear interest at the 30-day LIBOR or commercial paper rate (subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of 0.75% per annum on undrawn amounts.  As of September 30, 2009, there was a cost basis of approximately $83,000 of borrowings outstanding under the KEF Facility at an average rate of 7.36%, and the remaining borrowing capacity under the KEF Facility was $44,000.  Available borrowings are subject to various constraints imposed under the KEF Facility, based on the aggregate loan balance pledged by Business Loan. Interest is payable monthly during the term of the KEF Facility.

 

In October and November of 2009, we reduced the size of the KEF Facility by $15,000 and $5,000, respectively, from $127,000 to $107,000.  Under the KEF Facility the first $50,000 of commitment reductions are applied against KEF’s commitment.  Therefore, the entire $20,000 was subtracted from KEF’s commitment, reducing it from $100,000 to $80,000 and leaving BB&T’s commitment unchanged at $27,000.  As a result of the manner in which our borrowing base is calculated under the KEF Facility, the reductions did not affect our borrowing capacity under the KEF Facility at the time of the reductions.  As noted above, the size of the KEF Facility will be reduced by $5,000 effective January 1, 2010 to $102,000.

 

The KEF Facility contains covenants that require Business Loan to maintain its status as a separate entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions), and restrict material changes to our credit and collection policies.  The facility also limits payments of distributions. Further, the KEF Facility requires us to pay distributions only from estimated net investment income.  As of September 30, 2009, Business Loan was in compliance with all of the facility covenants.

 

We elected to apply ASC 825, “Financial Instruments,” specifically for the KEF Facility, which was consistent with its application of ASC 820 to its investments.  ASC 825 requires that we apply a fair value methodology to the KEF Facility. We estimated the fair value of the KEF Facility using estimates of value provided by an independent third party and our own assumptions in the absence of observable market data, including estimated remaining life, current market yield and interest

 

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rate spreads of similar securities as of the measurement date.  The following table presents the KEF Facility carried at fair value as of September 30, 2009, by caption on the accompanying consolidated statements of assets and liabilities for each of the three levels of hierarchy established by ASC 820-10:

 

 

 

As of September 30, 2009

 

 

 

 

 

 

 

 

 

Total Fair Value

 

 

 

 

 

 

 

 

 

Reported in

 

 

 

 

 

 

 

 

 

Consolidated
Statement of

 

 

 

Level 1

 

Level 2

 

Level 3

 

Assets and Liabilities

 

Borrowings under Line of Credit (a)

 

$

 

$

 

$

83,350

 

$

83,350

 

Total

 

$

 

$

 

$

83,350

 

$

83,350

 

 


(a)     Unrealized appreciation of $350 is reported on the accompanying consolidated statements of operations for the year ended September 30, 2009.

 

In conjunction with entering into the KEF Facility, we amended a performance guaranty, which remains substantially similar to the form under the previous facility.  The loan documents require us to maintain a minimum net worth of $200,000 plus 50% of all equity issuances after May 2009, to maintain “asset coverage” with respect to “senior securities representing indebtedness” of at least 200%, in accordance with Section 18 of the 1940 Act, and to maintain our status as a BDC under the 1940 Act and as a RIC under the Code.  As of September 30, 2009, we were in compliance with all covenants under the performance guaranty.

 

Our continued compliance with these covenants, however, depends on many factors, some of which are beyond our control.  In particular, depreciation in the valuation of our assets, which valuation is subject to changing market conditions that are presently very volatile, affects our ability to comply with these covenants.  Given the continued deterioration in the capital markets, net unrealized depreciation in our portfolio may occur in future periods and threaten our ability to comply with the covenants under our KEF Facility.  Accordingly, there are no assurances that we will continue to comply with these covenants.  Failure to comply with these covenants would result in a default which, if we are unable to obtain a waiver from the lenders, could accelerate our repayment obligations under the KEF Facility and thereby have a material adverse impact on our liquidity, financial condition, results of operations and ability to pay distributions.

 

There can be no guarantee that we will be able to renew, extend or replace the KEF Facility on terms that are favorable to us, or at all.  Our ability to obtain replacement financing will be constrained by current economic conditions affecting the credit markets.  Consequently, any renewal, extension or refinancing of the KEF Facility will likely result in significantly higher interest rates and related charges and may impose significant restrictions on the use of borrowed funds with regard to its ability to fund investments or maintain distributions.  For instance, in connection with the establishment of the KEF Facility in May 2009, the size of the line was reduced from $162,000 under our prior facility to $107,000 under the KEF Facility, and Deutsche Bank AG, who was a committed lender under our prior credit facility elected not to participate in the KEF Facility and withdrew its commitment.  If we are not able to renew, extend or refinance the KEF Facility, this would likely have a material adverse effect on our liquidity and ability to fund new investments or pay distributions to our stockholders.  Our inability to pay distributions could result in our failing to qualify as a RIC.  Consequently, any income or gains could become taxable at corporate rates.  If we are unable to secure replacement financing, we will be forced to sell certain assets on disadvantageous terms, which may result in realized losses such as those recently recorded in connection with the syndicated loan sales, which resulted in a realized loss of approximately $26,411 during the year ended September 30, 2009.  Such realized losses could materially exceed the amount of any unrealized depreciation on these assets as of our most recent balance sheet date, which would have a material adverse effect on its results of operations.  In addition to selling assets, or as an alternative, we may issue equity in order to repay amounts outstanding under the KEF Facility.  Based on the recent trading prices of our stock, such an equity offering may have a substantial dilutive impact on our existing stockholders’ interest in our earnings and assets and voting interest in it.

 

Contractual Obligations

 

As of September 30, 2009, we were not party to any signed term sheets.

 

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Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K as of September 30, 2009.

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported consolidated amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the years reported. Actual results could materially differ from those estimates. Our accounting policies are more fully described in the “Notes to Consolidated Financial Statements” contained elsewhere in this report. We have identified our investment valuation process as our most critical accounting policy.

 

Investment Valuation

 

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.

 

General Valuation Policy:  We value our investments in accordance with the requirements of the 1940 Act.  As discussed more fully below, we value securities for which market quotations are readily available and reliable at their market value.  We value all other securities and assets at fair value as determined in good faith by our Board of Directors.

 

We adopted guidance for fair value measurements on October 1, 2008. In part, this guidance defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. The guidance provides a consistent definition of fair value that focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. The guidance also establishes the following three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

 

·                  Level 1 —inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets;

 

·                  Level 2 —inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and

 

·                  Level 3 —inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect our own assumptions that market participants would use to price the asset or liability based upon the best available information.

 

See Note 3, “Investments” in the notes to the consolidated financial statements for additional information regarding fair value measurements.

 

We use generally accepted valuation techniques to value our portfolio unless we have specific information about the value of an investment to determine otherwise. From time to time we may accept an appraisal of a business in which we hold securities. These appraisals are expensive and occur infrequently but provide a third-party valuation opinion that may differ in results, techniques and scopes used to value our investments.  When these specific third-party appraisals are engaged or accepted, we would use estimates of value provided by such appraisals and our own assumptions including estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date to value the investment we have in that business.

 

In determining the value of our investments, our Adviser has established an investment valuation policy (the “Policy”).  The Policy has been approved by our Board of Directors, and each quarter the Board of Directors reviews whether our Adviser has applied the Policy consistently and votes whether or not to accept the recommended valuation of our investment portfolio.

 

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The Policy, which is summarized below, applies to the following categories of securities:

 

·                  Publicly-traded securities;

·                  Securities for which a limited market exists; and

·                  Securities for which no market exists.

 

Valuation Methods:

 

Publicly-traded securities: We determine the value of publicly-traded securities based on the closing price for the security on the exchange or securities market on which it is listed and primarily traded on the valuation date. To the extent that we own restricted securities that are not freely tradable, but for which a public market otherwise exists, we will use the market value of that security adjusted for any decrease in value resulting from the restrictive feature.

 

Securities for which a limited market exists: We value securities that are not traded on an established secondary securities market, but for which a limited market for the security exists, such as certain participations in, or assignments of, syndicated loans, at the quoted bid price.  In valuing these assets, we assess trading activity in an asset class, evaluate variances in prices and other market insights to determine if any available quote prices are reliable.  If we conclude that quotes based on active markets or trading activity may be relied upon, firm bid prices are requested; however, if a firm bid price is unavailable, we base the value of the security upon the indicative bid price offered by the respective originating syndication agent’s trading desk, or secondary desk, on or near the valuation date.  To the extent that we use the indicative bid price as a basis for valuing the security, our Adviser may take further steps to consider additional information to validate that price in accordance with the Policy.

 

In the event these limited markets become illiquid such that market prices are no longer readily available, we will value our syndicated loans using estimated net present values of the future cash flows or discounted cash flows. The use of a DCF methodology follows that prescribed by ASC 820, which provides guidance on the use of a reporting entity’s own assumptions about future cash flows and risk-adjusted discount rates when relevant observable inputs, such as quotes in active markets, are not available. When relevant observable market data does not exist, the alternative outlined in ASC 820 is the use of valuing investments based on DCF.  For the purposes of using DCF to provide fair value estimates, we considere multiple inputs such as a risk-adjusted discount rate that incorporates adjustments that market participants would make both for nonperformance and liquidity risks.  As such, we develop a modified discount rate approach that incorporates risk premiums including, among others, increased probability of default, or higher loss given default, or increased liquidity risk.  The DCF valuations applied to the syndicated loans provide an estimate of what we believe a market participant would pay to purchase a syndicated loan in an active market, thereby establishing a fair value.  We will continue to apply the DCF methodology in illiquid markets until quoted prices are available or are deemed reliable based on trading activity.

 

As of September 30, 2009, we assessed trading activity in syndicated loan assets and determined that there had been a return to market liquidity and a better functioning secondary market for these assets.  Thus, firm bid prices or indicative bids were used to fair value our remaining syndicated loans at September 30, 2009.   However, for those syndicated loans where sales were completed after September 30, 2009, we used the respective sales prices to value those syndicated loans.

 

Securities for which no market exists: The valuation methodology for securities for which no market exists falls into three categories: (1) portfolio investments comprised solely of debt securities; (2) portfolio investments in controlled companies comprised of a bundle of securities, which can include debt and equity securities; and (3) portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities.

 

(1)          Portfolio investments comprised solely of debt securities: Debt securities that are not publicly traded on an established securities market, or for which a limited market does not exist (“Non-Public Debt Securities”), and that are issued by portfolio companies where we have no equity or equity-like securities, are fair valued in accordance with the terms of the policy, which utilizes opinions of value submitted to us by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”). We may also submit PIK interest to SPSE for their evaluation when it is determined that PIK interest is likely to be received.

 

In the case of Non-Public Debt Securities, we have engaged SPSE to submit opinions of value for our debt securities that are issued by portfolio companies in which we own no equity, or equity-like securities.  SPSE’s opinions of value are based on the valuations prepared by our portfolio management team as described below.  We request that SPSE also evaluate and assign values to success fees (conditional interest included in some loan securities) when we determine that

 

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there is reasonable probability of receiving a success fee on a given loan. SPSE will only evaluate the debt portion of our investments for which we specifically request evaluation, and may decline to make requested evaluations for any reason at its sole discretion. Upon completing our collection of data with respect to the investments (which may include the information described below under “---Credit Information,” the risk ratings of the loans described below under “---Loan Grading and Risk Rating” and the factors described hereunder), this valuation data is forwarded to SPSE for review and analysis. SPSE makes its independent assessment of the data that we have assembled and assesses its independent data to form an opinion as to what they consider to be the market values for the securities. With regard to its work, SPSE has issued the following paragraph:

 

SPSE provides evaluated price opinions which are reflective of what SPSE believes the bid side of the market would be for each loan after careful review and analysis of descriptive, market and credit information. Each price reflects SPSE’s best judgment based upon careful examination of a variety of market factors. Because of fluctuation in the market and in other factors beyond its control, SPSE cannot guarantee these evaluations. The evaluations reflect the market prices, or estimates thereof, on the date specified. The prices are based on comparable market prices for similar securities. Market information has been obtained from reputable secondary market sources. Although these sources are considered reliable, SPSE cannot guarantee their accuracy.

 

SPSE opinions of value of our debt securities that are issued by portfolio companies where we have no equity or equity-like securities are submitted to our Board of Directors along with our Adviser’s supplemental assessment and recommendation regarding valuation of each of these investments. Our Adviser generally accepts the opinion of value given by SPSE, however, in certain limited circumstances, such as when our Adviser may learn new information regarding an investment between the time of submission to SPSE and the date of the Board assessment our Adviser’s conclusions as to value may differ from the opinion of value delivered by SPSE. Our Board of Directors then reviews whether our Adviser has followed its established procedures for determinations of fair value, and votes to accept or reject the recommended valuation of our investment portfolio. Our Adviser and our management recommended, and the Board of Directors voted to accept, the opinions of value delivered by SPSE on the loans in our portfolio as denoted on the Schedule of Investments included in our accompanying consolidated financial statements.

 

Because there is a delay between when we close an investment and when the investment can be evaluated by SPSE, new loans are not valued immediately by SPSE; rather, management makes its own determination about the value of these investments in accordance with our valuation policy using the methods described herein.

 

(2)          Portfolio investments in controlled companies comprised of a bundle of investments, which can include debt and equity securities: The fair value of these investments is determined based on the total enterprise value of the portfolio company, or issuer, utilizing a liquidity waterfall approach.  For Non-Public Debt Securities and equity or equity-like securities (e.g. preferred equity, equity, or other equity-like securities) that are purchased together as part of a package, where we have control or could gain control through an option or warrant security, both the debt and equity securities of the portfolio investment would exit in the mergers and acquisitions market as the principal market, generally through a sale or recapitalization of the portfolio company. In accordance with ASC 820-10, we apply the in-use premise of value which assumes the debt and equity securities are sold together. Under this liquidity waterfall approach, we continue to use the enterprise value methodology utilizing a liquidity waterfall approach to determine the fair value of these investments under ASC 820-10 if we have the ability to initiate a sale of a portfolio company as of the measurement date. Under this approach, we first calculate the total enterprise value of the issuer by incorporating some or all of the following factors:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  discounted cash flow or other pertinent factors.

 

In gathering the sales to third parties of similar securities, we may reference industry statistics and use outside experts. Once we have estimated the total enterprise value of the issuer, we subtract the value of all the debt securities of the issuer; which are valued at the contractual principal balance. Fair values of these debt securities are discounted for any shortfall of total enterprise value over the total debt outstanding for the issuer. Once the values for all outstanding senior securities (which include the debt securities) have been subtracted from the total enterprise value of the issuer, the remaining amount, if any, is used to determine the value of the issuer’s equity or equity-like securities.  If, in our

 

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Adviser’s judgment, the liquidity waterfall approach does not accurately reflect the value of the debt component, our Adviser may recommend that we use a valuation by SPSE or, if that is unavailable, a DCF valuation technique.

 

(3)          Portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities: We value Non-Public Debt Securities that are purchased together with equity or equity-like securities from the same portfolio company, or issuer, for which we do not control or cannot gain control as of the measurement date, using a hypothetical secondary market as our principal market. In accordance with ASC 820-10, we determine the fair value of these debt securities of non-control investments assuming the sale of an individual debt security using the in-exchange premise of value. As such, we estimate the fair value of the debt component using estimates of value provided by SPSE and our own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. Subsequent to June 30, 2009, for equity or equity-like securities of investments for which we do not control or cannot gain control as of the measurement date, we estimate the fair value of the equity using the in-exchange premise of value based on factors such as the overall value of the issuer, the relative fair value of other units of account including debt, or other relative value approaches. Consideration also is given to capital structure and other contractual obligations that may impact the fair value of the equity. Further, we may utilize comparable values of similar companies, recent investments and indices with similar structures and risk characteristics or our own assumptions in the absence of other observable market data and may also employ DCF valuation techniques.

 

Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been obtained had a ready market for the securities existed, and the differences could be material. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned. There is no single standard for determining fair value in good faith, as fair value depends upon circumstances of each individual case. In general, fair value is the amount that we might reasonably expect to receive upon the current sale of the security in an arms-length transaction in the security’s principal market.

 

Valuation Considerations:  From time to time, depending on certain circumstances, the Adviser may use the following valuation considerations, including but not limited to:

 

·      the nature and realizable value of the collateral;

·      the portfolio company’s earnings and cash flows and its ability to make payments on its obligations;

·      the markets in which the portfolio company does business;

·      the comparison to publicly traded companies; and

·      DCF and other relevant factors.

 

Because such valuations, particularly valuations of private securities and private companies, are not susceptible to precise determination, may fluctuate over short periods of time, and may be based on estimates, our determinations of fair value may differ from the values that might have actually resulted had a readily available market for these securities been available.

 

Credit Information:  Our Adviser monitors a wide variety of key credit statistics that provide information regarding our portfolio companies to help us assess credit quality and portfolio performance. We and our Adviser participate in the periodic board meetings of our portfolio companies in which we hold Control and Affiliate investments and also require them to provide annual audited and monthly unaudited financial statements. Using these statements or comparable information and board discussions, our Adviser calculates and evaluates the credit statistics.

 

Loan Grading and Risk Rating:  As part of our valuation procedures above, we risk rate all of our investments in debt securities. For syndicated loans that have been rated by an NRSRO (as defined in Rule 2a-7 under the 1940 Act), we use the NRSRO’s risk rating for such security. For all other debt securities, we use a proprietary risk rating system. Our risk rating system uses a scale of 0 to 10, with 10 being the lowest probability of default. This system is used to estimate the probability of default on debt securities and the probability of loss if there is a default. These types of systems are referred to as risk rating systems and are used by banks and rating agencies. The risk rating system covers both qualitative and quantitative aspects of the business and the securities we hold.

 

For the debt securities for which we do not use a third-party NRSRO risk rating, we seek to have our risk rating system mirror the risk rating systems of major risk rating organizations, such as those provided by an NRSRO. While we seek to mirror the NRSRO systems, we cannot provide any assurance that our risk rating system will provide the same risk rating as

 

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an NRSRO for these securities. The following chart is an estimate of the relationship of our risk rating system to the designations used by two NRSROs as they risk rate debt securities of major companies. Because our system rates debt securities of companies that are unrated by any NRSRO, there can be no assurance that the correlation to the NRSRO set out below is accurate. We believe our risk rating would be significantly higher than a typical NRSRO risk rating because the risk rating of the typical NRSRO is designed for larger businesses. However, our risk rating has been designed to risk rate the securities of smaller businesses that are not rated by a typical NRSRO. Therefore, when we use our risk rating on larger business securities, the risk rating is higher than a typical NRSRO rating. The primary difference between our risk rating and the rating of a typical NRSRO is that our risk rating uses more quantitative determinants and includes qualitative determinants that we believe are not used in the NRSRO rating. It is our understanding that most debt securities of medium-sized companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in the middle market that would meet the definition of AAA, AA or A. Therefore, our scale begins with the designation 10 as the best risk rating which may be equivalent to a BBB from an NRSRO, however, no assurance can be given that a 10 on our scale is equal to a BBB on an NRSRO scale.

 

Company’s System

 

First
NRSRO

 

Second
NRSRO

 

Gladstone Capital’s Description(a)

>10

 

Baa2

 

BBB

 

Probability of Default (PD) during the next ten years is 4% and the Expected Loss (EL) is 1% or less

10

 

Baa3

 

BBB-

 

PD is 5% and the EL is 1% to 2%

9

 

Ba1

 

BB+

 

PD is 10% and the EL is 2% to 3%

8

 

Ba2

 

BB

 

PD is 16% and the EL is 3% to 4%

7

 

Ba3

 

BB-

 

PD is 17.8% and the EL is 4% to 5%

6

 

B1

 

B+

 

PD is 22% and the EL is 5% to 6.5%

5

 

B2

 

B

 

PD is 25% and the EL is 6.5% to 8%

4

 

B3

 

B-

 

PD is 27% and the EL is 8% to 10%

3

 

Caa1

 

CCC+

 

PD is 30% and the EL is 10% to 13.3%

2

 

Caa2

 

CCC

 

PD is 35% and the EL is 13.3% to 16.7%

1

 

Caa3

 

CC

 

PD is 65% and the EL is 16.7% to 20%

0

 

N/a

 

D

 

PD is 85% or there is a payment default and the EL is greater than 20%

 


(a)                                  The default rates set forth are for a ten year term debt security. If a debt security is less than ten years, then the probability of default is adjusted to a lower percentage for the shorter period, which may move the security higher on our risk rating scale.

 

The above scale gives an indication of the probability of default and the magnitude of the loss if there is a default. Our policy is to stop accruing interest on an investment if we determine that interest is no longer collectible. At September 30, 2009, one Non-Control/Non-Affiliate investments and four Control investments were on non-accrual.  At September 30, 2008 one Non-Control/Non-Affiliate investment and two Control investments were on non-accrual.  Additionally, we do not risk rate our equity securities.

 

The following table lists the risk ratings for all non-syndicated loans in our portfolio at September 30, 2009 and September 30, 2008, representing approximately 96% and 83%, respectively, of all loans in our portfolio at the end of each year:

 

Rating

 

Sept. 30, 2009

 

Sept. 30, 2008

 

Average

 

7.1

 

7.3

 

Weighted Average

 

7.2

 

7.0

 

Highest

 

9.0

 

9.0

 

Lowest

 

3.0

 

5.0

 

 

The following table lists the risk ratings for all syndicated loans in our portfolio that were not rated by an NRSRO at September 30, 2009 and September 30, 2008, representing approximately 2% and 6%, respectively, of all loans in our portfolio at the end of each year:

 

Rating

 

Sept. 30, 2009

 

Sept. 30, 2008

 

Average

 

7.0

 

6.6

 

Weighted Average

 

7.0

 

6.7

 

Highest

 

7.0

 

7.0

 

Lowest

 

7.0

 

6.0

 

 

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For syndicated loans that are currently rated by an NRSRO, we risk rate such loans in accordance with the risk rating systems of major risk rating organizations, such as those provided by an NRSRO. The following table lists the risk ratings for all syndicated loans in our portfolio that were rated by an NRSRO at September 30, 2009 and September 30, 2008, representing approximately 2% and 11%, respectively, of all loans in our portfolio at the end of each year:

 

Rating

 

Sept. 30, 2009

 

Sept. 30, 2008

 

Average

 

CCC+/Caa1

 

CCC+/Caa1

 

Weighted Average

 

CCC+/Caa1

 

CCC+/Caa1

 

Highest

 

B-/B3

 

BB/Ba3

 

Lowest

 

D/C

 

CC/C

 

 

Tax Status

 

We intend to continue to qualify for treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. As a RIC, we are not subject to federal income tax on the portion of our taxable income and gains distributed to stockholders. To qualify as a RIC, we must meet certain source-of-income, asset diversification, and annual distribution requirements.  Under the annual distribution requirement, we are required to distribute to stockholders at least 90% of our investment company taxable income, as defined by the Code.  We have a policy to pay out as a distribution up to 100% of that amount.

 

In an effort to avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year, an amount at least equal to the sum of (1) 98% of our ordinary income for the calendar year, (2) 98% of our capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year and (3) any ordinary income and net capital gains for preceding years that were not distributed during such years.

 

Revenue Recognition

 

Interest Income Recognition

 

Interest income, adjusted for amortization of premiums and acquisition costs and for the accretion of discounts, is recorded on the accrual basis to the extent that such amounts are expected to be collected.  Generally, when a loan becomes 90 days or more past due or if our qualitative assessment indicates that the debtor is unable to service its debt or other obligations, we will place the loan on non-accrual status and cease recognizing interest income on that loan until the borrower has demonstrated the ability and intent to pay contractual amounts due.  However, we remain contractually entitled to this interest.  At September 30, 2009, one Non-Control/Non-Affiliate investments and four Control investment were on non-accrual with an aggregate cost basis of approximately $10,022 or 2.8% of the cost basis of all investments in our portfolio.  At September 30, 2008, one Non-Control/Non-Affiliate investment and two Control investments were on non-accrual with an aggregate cost basis of approximately $13,098 at September 30, 2008, or 2.8% of the cost basis of all investments in our portfolio.  Conditional interest, or a success fee, is recorded when earned or upon full repayment of a loan investment.

 

Paid in Kind Interest

 

We may hold loans in our portfolio which contain a PIK interest provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain our status as a RIC, this non-cash source of income must be paid out to stockholders in the form of distributions, even though we have not yet collected the cash.  As of September 30, 2009, two loans in our portfolio bore PIK interest.

 

Services Provided to Portfolio Companies

 

As a business development company under the 1940 Act, we are required to make available significant managerial assistance to our portfolio companies. We provide these services through our Adviser, who provides these services on our behalf through its officers who are also our officers.  Currently, neither we nor our Adviser charges a fee for managerial assistance, however, if our Adviser does receive fees for such managerial assistance, our Adviser will credit the managerial assistance fees to the base management fee due from us to our Adviser.

 

Our Adviser receives fees for the other services it provides to our portfolio companies.  These other fees are typically non-recurring, are recognized as revenue when earned and are generally paid directly to our Adviser by the borrower or potential

 

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borrower upon the closing of the investment. The services our Adviser provides to our portfolio companies vary by investment, but generally include a broad array of services such as investment banking services, arranging bank and equity financing, structuring financing from multiple lenders and investors, reviewing existing credit facilities, restructuring existing investments, raising equity and debt capital, consulting, turnaround management, merger and acquisition services and recruiting new management personnel.  When our Adviser receives fees for these services, 50% of certain of those fees are voluntarily and irrevocably credited against the base management fee that we pay to our Adviser, while others are reimbursements for costs associated with the engagement.  Any services of this nature subsequent to the closing would typically generate a separate fee at the time of completion.

 

Our Adviser also receives fees for monitoring and reviewing portfolio company investments.  These fees are recurring and are generally paid annually or quarterly in advance to our Adviser throughout the life of the investment.  Fees of this nature are recorded as revenue by our Adviser when earned and are not credited against the base management fee.

 

We may receive fees for the origination and closing services we provide to portfolio companies through our Adviser.  These fees are paid directly to us and are recognized as revenue upon closing of the originated investment and are reported as fee income in the accompanying consolidated statements of operations.

 

Recent Accounting Pronouncements

 

Refer to Note 2 Summary of Significant Accounting Policies in the notes to our consolidated financial statements included elsewhere in this report.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk (dollar amounts in thousands, unless otherwise indicated)

 

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments.  The prices of securities held by the us may decline in response to certain events, including those directly involving the companies whose securities are owned by us; conditions affecting the general economy; overall market changes; local, regional or global political, social or economic instability; and interest rate fluctuations.

 

The primary risk we believe we are exposed to is interest rate risk.  Because we borrow money to make investments, our net investment is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest those funds.  As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income.  We use a combination of debt and equity capital to finance our investing activities.  We may use interest rate risk management techniques 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.  We have analyzed the potential impact of changes in interest rates on interest income net of interest expense.

 

While we expect that ultimately approximately 20% of the loans in our portfolio will be made at fixed rates, with approximately 80% made at variable rates, currently substantially all of our investment portfolio is at variable rates.  At September 30, 2009, our portfolio consisted of the following:

 

83

%

variable rates with a floor

 

2

%

variable rates with a floor and ceiling

 

11

%

variable rates without a floor or ceiling

 

4

%

fixed rate

 

100

%

total

 

 

All of our variable-rate loans have rates associated with either the current LIBOR or prime rate.

 

To illustrate the potential impact of changes in interest rates on our net increase in net assets resulting from operations, we have performed the following analysis, which assumes that our balance sheet remains constant and no further actions are taken to alter our existing interest rate sensitivity.

 

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Basis Point Change

 

Increase
(Decrease) in
Interest Income

 

Increase
(Decrease) in
Interest Expense

 

Net Increase (Decrease) in
Net Assets Resulting from
Operations

 

Up 200 basis points

 

$

668

 

$

1,660

 

$

(992

)

Up 100 basis points

 

275

 

830

 

(555

)

Down 100 basis points

 

(156

)

(830

)

674

 

Down 200 basis points

 

(263

)

(1,660

)

1,397

 

 

Although management believes that this analysis is indicative of our existing interest rate sensitivity, it does not adjust for potential changes in credit quality, size and composition of our loan portfolio on the balance sheet and other business developments that could affect net increase in net assets resulting from operations.  Accordingly, no assurances can be given that actual results would not differ materially from the results under this hypothetical analysis.

 

We may also experience risk associated with investing in securities of companies with foreign operations. We currently do not anticipate investing in debt or equity of foreign companies, however, some potential portfolio companies may have operations located outside the United States. These risks include, but are not limited to, fluctuations in foreign currency exchange rates, imposition of foreign taxes, changes in exportation regulations and political and social instability.

 

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Item 8. Financial Statements and Supplementary Data

 

Index to Consolidated Financial Statements

 

Report of Management on Internal Controls

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Statements of Assets and Liabilities as of September 30, 2009 and September 30, 2008

 

Consolidated Schedules of Investments as of September 30, 2009 and September 30, 2008

 

Consolidated Statements of Operations for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

 

Consolidated Statements of Changes in Net Assets for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

 

Consolidated Statements of Cash Flows for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

 

Financial Highlights for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

 

Notes to Consolidated Financial Statements

 

 

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Report of Management on Internal Controls

 

To the Stockholders and Board of Directors of Gladstone Capital Corporation:

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and include those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

Under the supervision and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 30, 2009, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on its assessment, management has concluded that our internal control over financial reporting was effective as of September 30, 2009.

 

Our management’s assessment of the effectiveness of our internal control over financial reporting as of September 30, 2009 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

 

November 23, 2009

 

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Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Gladstone Capital Corporation:

 

In our opinion, the accompanying consolidated statements of assets and liabilities, including the schedules of investments, and the related statements of operations, changes in net assets and cash flows and the financial highlights present fairly, in all material respects, the financial position of Gladstone Capital Corporation and its subsidiaries at September 30, 2009 and  2008, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2009 in conformity with accounting principles generally accepted in the United States of America.  In addition, in our opinion, the financial statement schedule listed in the accompanying index under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

PricewaterhouseCoopers LLP

McLean, VA

November 23, 2009

 

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GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Non-Control/Non-Affiliate investments (Cost 9/30/09: $312,043; 9/30/08: $448,356)

 

$

286,997

 

$

407,153

 

Control investments (Cost 9/30/09: $52,350; 9/30/08: $12,514)

 

33,972

 

780

 

Total investments at fair value (Cost 9/30/09: $364,393; 9/30/08 $460,870)

 

320,969

 

407,933

 

Cash

 

5,276

 

6,493

 

Interest receivable – investments in debt securities

 

3,048

 

3,588

 

Interest receivable – employees (Refer to Note 4)

 

85

 

91

 

Due from custodian

 

3,059

 

4,544

 

Due from Adviser (Refer to Note 4)

 

69

 

 

Deferred financing fees

 

1,230

 

1,905

 

Prepaid assets

 

341

 

306

 

Other assets

 

1,833

 

838

 

TOTAL ASSETS

 

$

335,910

 

$

425,698

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Accounts payable

 

$

67

 

$

8

 

Interest payable

 

378

 

646

 

Fee due to Administrator (Refer to Note 4)

 

216

 

247

 

Due to Adviser (Refer to Note 4)

 

834

 

457

 

Borrowings under line of credit (Cost 9/30/09: $83,000; 9/30/08: $151,030)

 

83,350

 

151,030

 

Accrued expenses and deferred liabilities

 

1,800

 

1,328

 

Funds held in escrow

 

189

 

234

 

TOTAL LIABILITIES

 

86,834

 

153,950

 

NET ASSETS

 

$

249,076

 

$

271,748

 

 

 

 

 

 

 

ANALYSIS OF NET ASSETS

 

 

 

 

 

Common stock, $0.001 par value, 50,000,000 shares authorized and 21,087,574 shares issued and outstanding at September 30, 2009 and September 30, 2008, respectively

 

$

21

 

$

21

 

Capital in excess of par value

 

328,203

 

334,143

 

Notes receivable – employees (Refer to Note 4)

 

(9,019

)

(9,175

)

Net unrealized depreciation on investments

 

(43,425

)

(52,937

)

Net unrealized depreciation on derivative

 

 

(304

)

Net unrealized appreciation on borrowings under line of credit

 

(350

)

 

Accumulated Net Realized Losses

 

(26,354

)

 

TOTAL NET ASSETS

 

$

249,076

 

$

271,748

 

NET ASSETS PER SHARE

 

$

11.81

 

$

12.89

 

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

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Table of Contents

 

GLADSTONE CAPITAL CORPORATION
CONSOLIDATED SCHEDULE OF INVESTMENTS

SEPTEMBER 30, 2009

(DOLLAR AMOUNTS IN THOUSANDS)

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

NON-CONTROL/NON-AFFILIATE INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-syndicated Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Access Television Network, Inc.

 

Service-cable airtime (infomercials)

 

Senior Term Debt (14.5%, Due 12/2009) (5) (9)

 

$

963

 

$

868

 

 

 

 

 

 

 

 

 

 

 

ACE Expediters, Inc

 

Service-over-the-ground logistics

 

Senior Term Debt (13.5%, Due 9/2014) (5) (13)

 

5,106

 

4,864

 

 

 

 

 

Common Stock Warrants (8)

 

200

 

564

 

 

 

 

 

 

 

 

 

 

 

ActivStyle Acquisition Co.

 

Service-medical products distribution

 

Senior Term Debt (13.0%, Due 4/2014) (3) (5)

 

4,000

 

3,940

 

 

 

 

 

 

 

 

 

 

 

Allison Publications, LLC

 

Service-publisher of consumer oriented magazines

 

Senior Term Debt (10.0%, Due 9/2012) (5)

 

9,709

 

8,746

 

 

Senior Term Debt (13.0%, Due 12/2010) (5)

 

260

 

246

 

 

 

 

 

 

 

 

 

 

 

Anitox Acquisition Company

 

Manufacturing-preservatives for animal feed

 

Line of Credit, $3,000 available (4.5%, Due 1/2010) (5)

 

1,700

 

1,681

 

 

Senior Term Debt (8.5%, Due 1/2012) (5)

 

2,877

 

2,823

 

 

Senior Term Debt (10.5%, Due 1/2012) (3) (5)

 

3,688

 

3,582

 

 

 

 

 

 

 

 

 

 

 

BAS Broadcasting

 

Service-radio station operator

 

Senior Term Debt (11.5%, Due 7/2013) (5)

 

7,300

 

5,840

 

 

 

 

 

Senior Term Debt (12.0%, Due 7/2009) (3) (5) (12)

 

950

 

475

 

 

 

 

 

 

 

 

 

 

 

CCS, LLC

 

Service-cable TV franchise owner

 

Senior Term Debt (non-accrual, Due 8/2008) (5) (10) (12)

 

631

 

126

 

 

 

 

 

 

 

 

 

 

 

Chinese Yellow Pages Company

 

Service-publisher of Chinese language directories

 

Line of Credit, $700 available (7.3%, Due 9/2010) (5)

 

450

 

427

 

 

Senior Term Debt (7.3%, Due 9/2010) (5)

 

518

 

488

 

 

 

 

 

 

 

 

 

 

 

CMI Acquisition, LLC

 

Service-recycling

 

Senior Subordinated Term Debt (10.3%, Due 11/2012) (5)

 

6,233

 

5,890

 

 

 

 

 

 

 

 

 

 

 

Doe & Ingalls Management LLC

 

Distributor-specialty chemicals

 

Senior Term Debt (6.8%, Due 11/2010) (5)

 

2,300

 

2,266

 

 

 

 

 

Senior Term Debt (7.8%, Due 11/2010) (3) (5)

 

4,365

 

4,267

 

 

 

 

 

 

 

 

 

 

 

Finn Corporation

 

Manufacturing-landscape equipment

 

Common Stock Warrants (8)

 

37

 

1,223

 

 

 

 

 

 

 

 

 

 

 

GFRC Holdings LLC

 

Manufacturing-glass-fiber reinforced concrete

 

Line of Credit, $2,000 available (4.5%, Due 12/2010)

 

 

 

 

Senior Term Debt (9.0%, Due 12/2012) (5)

 

6,599

 

6,450

 

 

Senior Subordinated Term Debt (11.5%, Due 12/2012) (3) (5)

 

6,665

 

6,432

 

 

 

 

 

 

 

 

 

 

 

Global Materials Technologies, Inc.

 

Manufacturing-steel wool products and metal fibers

 

Senior Term Debt (13.0%, Due 6/2010) (3) (5)

 

4,410

 

3,528

 

 

 

 

 

 

 

 

 

 

 

Heartland Communications Group

 

Service-radio station operator

 

Senior Term Debt (10.0%, Due 5/2011) (5)

 

4,567

 

2,726

 

 

 

 

 

 

 

 

 

 

 

Interfilm Holdings, Inc.

 

Service-slitter and distributor of plastic films

 

Senior Term Debt (12.3%, Due 10/2012) (5)

 

4,950

 

4,715

 

 

 

 

 

 

 

 

 

 

 

International Junior Golf Training Acquisition Company

 

Service-golf training

 

Line of Credit, $1,500 available (9.0%, Due 5/2010) (5)

 

700

 

690

 

 

Senior Term Debt (8.5%, Due 5/2012) (5)

 

2,120

 

2,036

 

 

Senior Term Debt (10.5%, Due 5/2012) (3) (5)

 

2,500

 

2,366

 

 

 

 

 

 

 

 

 

 

 

KMBQ Corporation

 

Service-AM/FM radio broadcaster

 

Line of Credit, $200 available (11.0%, Due 3/2010) (5)

 

153

 

69

 

 

 

 

 

Senior Term Debt (11.0%, Due 3/2010) (5)

 

1,785

 

801

 

 

 

 

 

 

 

 

 

 

 

Legend Communications of Wyoming LLC

 

Service-operator of radio stations

 

Line of Credit, $500 available (12.0%, Due 6/2011) (5)

 

497

 

450

 

 

Senior Term Debt (12.0%, Due 6/2013) (5)

 

9,373

 

8,482

 

 

 

 

 

 

 

 

 

 

 

Newhall Holdings, Inc.

 

Service-distributor of personal care products and supplements

 

Line of Credit, $3,000 available (11.3%, Due 5/2010) (5)

 

1,000

 

945

 

 

Senior Term Debt (5) (11.3%, Due 5/2012) (5)

 

3,870

 

3,657

 

 

Senior Term Debt (14.3%, Due 5/2012) (3) (5)

 

4,410

 

4,112

 

 

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Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Northern Contours, Inc.

 

Manufacturing-veneer and laminate components

 

Senior Subordinated Term Debt (10.0%, Due 5/2010) (5)

 

$

6,562

 

$

5,414

 

 

 

 

 

 

 

 

 

 

 

Pinnacle Treatment Centers, Inc.

 

Service-Addiction treatment centers

 

Line of Credit, $500 available (4.5%, Due 12/2009)

 

 

 

 

 

 

 

Senior Term Debt (10.5%, Due 12/2011) (5)

 

2,750

 

2,633

 

 

 

 

 

Senior Term Debt (10.5%, Due 12/2011) (3) (5)

 

7,500

 

7,059

 

 

 

 

 

 

 

 

 

 

 

Precision Acquisition Group Holdings, Inc.

 

Manufacturing-consumable components for the aluminum industry

 

Equipment Note (8.5%, Due 10/2011) (5)

 

1,000

 

988

 

 

Senior Term Debt (8.5%, Due 10/2010) (5)

 

4,250

 

4,192

 

 

Senior Term Debt (11.5%, Due 10/2010) (3) (5)

 

4,074

 

4,023

 

 

 

 

 

 

 

 

 

 

 

PROFITSystems Acquisition Co.

 

Service-design and develop ERP software

 

Line of Credit, $350 available (4.5%, Due 7/2010)

 

 

 

 

Senior Term Debt (8.5%, Due 7/2011) (5)

 

1,600

 

1,468

 

 

Senior Term Debt (10.5%, Due 7/2011) (3) (5)

 

2,900

 

2,632

 

 

 

 

 

 

 

 

 

 

 

RCS Management Holding Co.

 

Service-healthcare supplies

 

Senior Term Debt (8.5%, Due 1/2011) (3) (5)

 

2,437

 

2,383

 

 

 

 

 

Senior Term Debt (10.5%, Due 1/2011) (4) (5)

 

3,060

 

2,949

 

 

 

 

 

 

 

 

 

 

 

Reliable Biopharmaceutical Holdings, Inc.

 

Manufacturing-pharmaceutical and biochemical intermediates

 

Line of Credit, $5,000 available (9.0%, Due 10/2010) (5)

 

800

 

788

 

 

Mortgage Note (9.5%, Due 10/2014) (5)

 

7,335

 

7,261

 

 

Senior Term Debt (9.0%, Due 10/2012) (5)

 

1,530

 

1,507

 

 

Senior Term Debt (11.0%, Due 10/2012) (3) (5)

 

11,813

 

11,518

 

 

Senior Subordinated Term Debt (12.0%, Due 10/2013) (5)

 

6,000

 

5,640

 

 

Common Stock Warrants (8)

 

209

 

282

 

 

 

 

 

 

 

 

 

 

 

Saunders & Associates

 

Manufacturing-equipment provider for frequency control devices

 

Senior Term Debt (9.8%, Due 5/2013) (5)

 

10,780

 

10,618

 

 

 

 

 

 

 

 

 

 

 

SCI Cable, Inc.

 

Service-cable, internet, voice provider

 

Senior Term Debt (9.3%, Due 10/2008) (5) (12)

 

2,881

 

576

 

 

 

 

 

 

 

 

 

 

 

Sunburst Media - Louisiana, LLC

 

Service-radio station operator

 

Senior Term Debt (10.5%, Due 6/2011) (5)

 

6,411

 

5,817

 

 

 

 

 

 

 

 

 

 

 

Sunshine Media Holdings

 

Service-publisher regional B2B trade magazines

 

Senior Term Debt (11.0%, Due 5/2012) (5)

 

16,948

 

15,973

 

 

Senior Term Debt (13.5%, Due 5/2012) (3) (5)

 

10,700

 

9,978

 

 

 

 

 

 

 

 

 

 

 

Thibaut Acquisition Co.

 

Service-design and disbribute wall covering

 

Line of Credit, $1,000 available (9.0%, Due 1/2011) (5)

 

1,000

 

933

 

 

Senior Term Debt (8.5%, Due 1/2011) (5)

 

1,487

 

1,387

 

 

Senior Term Debt (12.0%, Due 1/2011) (3) (5)

 

3,000

 

2,745

 

 

 

 

 

 

 

 

 

 

 

Tulsa Welding School

 

Service-private welding school

 

Line of credit, $750 available (9.5%, Due 9/2011)

 

 

 

 

 

 

 

Senior Term Debt (9.5%, Due 9/2013) (5)

 

4,144

 

4,144

 

 

 

 

 

Senior Term Debt (12.8%, Due 9/2013) (5)

 

7,960

 

7,950

 

 

 

 

 

 

 

 

 

 

 

VantaCore

 

Service-acquisition of aggregate quarries

 

Senior Subordinated Term Debt (12.0%, Due 8/2013) (5)

 

13,726

 

13,589

 

 

 

 

 

 

 

 

 

 

 

Viapack, Inc.

 

Manufacturing-polyethylene film

 

Senior Real Estate Term Debt (10.0%, Due 3/2011) (5)

 

775

 

743

 

 

 

 

 

Senior Term Debt (13.0%, Due 3/2011) (3) (5)

 

4,061

 

3,893

 

 

 

 

 

 

 

 

 

 

 

Visual Edge Technology, Inc.

 

Service-office equipment distribution

 

Line of credit, $3,000 available (10.8%, Due 9/2011) (5)

 

2,981

 

2,340

 

 

Senior Subordinated Term Debt (15.5%, Due 8/2011) (5)

 

5,000

 

3,925

 

 

 

 

 

 

 

 

 

 

 

Westlake Hardware, Inc.

 

Retail-hardware and variety

 

Senior Subordinated Term Debt (9.0%, Due 1/2011) (5)

 

15,000

 

14,269

 

 

 

 

 

Senior Subordinated Term Debt (10.3%, Due 1/2011) (5)

 

10,000

 

9,400

 

 

 

 

 

 

 

 

 

 

 

Winchester Electronics

 

Manufacturing-high bandwidth connectors and cables

 

Senior Term Debt (5.3%, Due 5/2013) (5)

 

1,147

 

1,136

 

 

Senior Term Debt (5.7%, Due 5/2013) (5)

 

1,690

 

1,642

 

 

Senior Subordinated Term Debt (14.0%, Due 6/2013) (5)

 

9,925

 

9,478

 

 

 

 

 

 

 

 

 

 

 

Subtotal - Non-syndicated loans

 

 

 

 

 

298,322

 

277,048

 

 

67



Table of Contents

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Syndicated Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GTM Holdings, Inc.

 

Manufacturing-socks

 

Senior Subordinated Term Debt (11.8%, Due 4/2014) (6)

 

$

500

 

$

220

 

 

 

 

 

 

 

 

 

 

 

Kinetek Acquisition Corp.

 

Manufacturing-custom engineered motors & controls

 

Senior Term Debt (3.6%, Due 11/2013) (7)

 

1,438

 

925

 

 

 

 

 

 

 

 

 

 

 

Puerto Rico Cable Acquisition Company, Inc.

 

Service-telecommunications

 

Senior Subordinated Term Debt (7.8%, Due 1/2012) (6)

 

7,174

 

5,713

 

 

 

 

 

 

 

 

 

 

 

Wesco Holdings, Inc.

 

Service-aerospace parts and distribution

 

Senior Subordinated Term Debt (6.0%, Due 3/2014) (7)

 

2,264

 

1,856

 

 

 

 

 

 

 

 

 

 

 

WP Evenflo Group Holdings Inc.

 

Manufacturing-infant and juvenile products

 

Senior Term Debt (8.0%, Due 2/2013) (6)

 

1,901

 

1,235

 

 

Senior Preferred Equity (8)

 

333

 

 

 

Junior Preferred Equity (8)

 

111

 

 

 

Common Stock (8)

 

 

 

 

 

 

 

 

 

 

 

 

 

Subtotal - Syndicated loans

 

 

 

 

 

13,721

 

9,949

 

 

 

 

 

 

 

 

 

 

 

Total Non-Control/Non-Affiliate Investments

 

 

 

 

 

$

312,043

 

$

286,997

 

 

 

 

 

 

 

 

 

 

 

CONTROL INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BERTL, Inc.

 

Service-web-based evaluator of digital imaging products

 

Line of Credit, $842 available (non-accrual, Due 10/2009) (10)(13)(15)

 

$

930

 

$

 

 

Common Stock (8) (15)

 

424

 

 

 

 

 

 

 

 

 

 

 

 

Clinton Holdings, LLC

 

Distribution-aluminum sheets and stainless steel

 

Senior Subordinated Term Debt (12.0%, Due 1/2013) (5) (14)

 

15,500

 

12,013

 

 

Escrow Funding Note (12.0%, Due 1/2013) (5) (14)

 

640

 

496

 

 

Common Stock Warrants (8) (15)

 

109

 

 

 

 

 

 

 

 

 

 

 

 

Defiance Integrated Technologies, Inc.

 

Manufacturing-trucking parts

 

Senior Term Debt (11.0%, Due 4/2010) (3) (11)

 

6,005

 

6,005

 

 

Senior Term Debt (11.0%, Due 4/2010) (3) (11)

 

1,178

 

1,178

 

 

Common Stock (8) (15)

 

1

 

816

 

 

 

 

 

 

 

 

 

 

 

Lindmark Acquisition, LLC

 

Service-advertising

 

Senior Subordinated Term Debt (11.3%, Due 10/2012) (15) (16)

 

12,000

 

10,410

 

 

 

 

 

Senior Subordinated Term Debt (13.0%, Due Upon Demand) (15) (16)

 

1,553

 

1,049

 

 

 

 

 

Common Stock (8) (15)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

LYP Holdings Corp.

 

Service-yellow pages publishing

 

Line of credit, $1,250 available (10.0%, Due 7/2010) (15)

 

1,168

 

1,168

 

 

 

 

 

Senior Term Debt (12.5%, Due 2/2012) (15)

 

325

 

325

 

 

 

 

 

Line of Credit, $3,000 available (non-accrual, Due 6/2010) (10) (15)

 

1,170

 

421

 

 

 

 

 

Senior Term Debt (non-accrual, Due 6/2011) (10) (15)

 

2,688

 

 

 

 

 

 

Senior Term Debt (non-accrual, Due 6/2011) (3) (10) (15)

 

2,750

 

 

 

 

 

 

Common Stock Warrants (8) (15)

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Healthcare Communications, Inc.

 

Service-magazine publisher/operator

 

Line of credit, $200 available (non-accrual, Due 3/2010) (10) (15)

 

169

 

91

 

 

Line of credit, $450 available (non-accrual, Due 3/2010) (10) (15)

 

450

 

 

 

Common Stock (8) (15)

 

2,470

 

 

 

 

 

 

 

 

 

 

 

 

Western Directories, Inc.

 

Service-directory publisher

 

Line of credit, $1,250 available (non-accrual, Due 12/2009) (10) (15)

 

1,234

 

 

 

 

 

 

Preferred Stock (8) (15)

 

1,584

 

 

 

 

 

 

Common Stock (8) (15)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

Total Control Investments

 

 

 

 

 

$

52,350

 

$

33,972

 

 

 

 

 

 

 

 

 

 

 

Total Investments (17)

 

 

 

 

 

$

364,393

 

$

320,969

 

 

68



Table of Contents

 


(1)             Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company.

(2)             Percentage represents interest rates in effect at September 30, 2009 and due date represents the contractual maturity date.

(3)             Last Out Tranche of senior debt, meaning if the portfolio company is liquidated, the holder of the Last Out Tranche is paid after the senior debt.

(4)             Last Out Tranche of senior debt, meaning if the portfolio company is liquidated, the holder of the Last Out Tranche is paid after the senior debt, however, the debt is also junior to another Last Out Tranche.

(5)             Fair value was based on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc.

(6)             Security valued based on the indicative bid price on or near September 30, 2009, offered by the respective syndication agent’s trading desk or secondary desk.

(7)             Security valued based on the transaction sale price subsequent to September 30, 2009 (see Note 12).

(8)             Security is non-income producing.

(9)             Access Television includes a success fee with a fair value of $1.

(10)       BERTL, CCS, U.S. Healthcare, Western Directories and a portion of LYP Holdings are currently past due on interest payments and are on non-accrual.  BERTL’s loan matured in October 2009 and the Company is actively working to recover amounts due under this loan.  However, there is no assurance that there will be any recovery of amounts past due.

(11)       Fair value of security estimated to be equal to cost due to recent recapitalization.

(12)       BAS Broadcasting’s loan matured in July 2009, CCS’ loan matured in August 2008 and SCI Cable’s loan matured in October 2008.  The Company is actively working to recover amounts due under these loans, however, there is no assurance that there will be any recovery of amounts past due.

(13)       ACE Expediters’ interest and BERTL’s interest include paid in kind (“PIK”) interest.  Please refer to Note 2 “Summary of Significant Accounting Policies.”

(14)       Subsequent to September 30, 2009, Clinton Aluminum’s senior subordinated term debt and escrow funding note were combined into one term note, with an interest rate of 12.0% and maturity date of January 2013.  In addition, a term loan was entered into for $320, with an interest rate of 12.0% and maturity date of January 2013.

(15)       Fair value was based on the total enterprise value of the portfolio company using a liquidity waterfall approach.

(16)       Lindmark’s loan agreement was amended in March 2009 such that any unpaid current interest accrues at a conditional interest rate.  The conditional interest is not recorded until paid (see Note 2, “Summary of Significant Accounting Policies — Interest Income Recognition”).

(17)       Aggregate gross unrealized depreciation for federal income tax purposes is $45,863; aggregate gross unrealized appreciation for federal income tax purposes is $2,439.  Net unrealized depreciation is $43,424 based on a tax cost of $364,393.

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

69



Table of Contents

 

GLADSTONE CAPITAL CORPORATION

CONSOLIDATED SCHEDULE OF INVESTMENTS

AS OF SEPTEMBER 30, 2008

(DOLLAR AMOUNTS IN THOUSANDS)

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

NON-CONTROL/NON-AFFILIATE INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-syndicated Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Access Television Network, Inc.

 

Service-cable airtime (infomercials)

 

Senior Term Debt (10.5%, Due 3/2009) (6)

 

$

1,923

 

$

1,774

 

 

 

 

 

 

 

 

 

 

 

ACE Expediters, Inc

 

Service-over-the-ground logistics

 

Line of Credit, $850 available (6.0%, Due 1/2011)

 

 

 

 

 

 

 

Senior Term Debt (9.8%, Due 1/2012) (6)

 

11,966

 

11,248

 

 

 

 

 

Common Stock Warrants (8)

 

200

 

142

 

 

 

 

 

 

 

 

 

 

 

ActivStyle Acquisition Co.

 

Service-medical products distribution

 

Line of Credit, $1,500 available (6.7%, Due 7/2009) (6)

 

1,100

 

1,059

 

 

Senior Term Debt (8.5%, Due 9/2012) (6)

 

4,721

 

4,543

 

 

Senior Term Debt (10.5%, Due 9/2012) (3) (6)

 

4,435

 

4,213

 

 

 

 

 

 

 

 

 

 

 

Allison Publications, LLC

 

Service-publisher of consumer oriented magazines

 

Line of Credit, $4,000 available (9.0%, Due 9/2010)

 

 

 

 

Senior Term Debt (9.0%, Due 9/2012) (6)

 

10,465

 

9,568

 

 

 

 

 

 

 

 

 

 

 

Anitox Acquisition Company

 

Manufacturing-preservatives for animal feed

 

Line of Credit, $3,000 available (6.7%, Due 1/2010) (6)

 

2,000

 

1,880

 

 

Senior Term Debt (8.5%, Due 1/2012) (6)

 

3,388

 

3,185

 

 

Senior Term Debt (10.5%, Due 1/2012) (3) (6)

 

3,688

 

3,388

 

 

 

 

 

 

 

 

 

 

 

Badanco Acquisition Corp.

 

Service-luggage design and distribution

 

Senior Subordinated Term Debt (11.5%, Due 7/2012) (6)

 

9,458

 

8,795

 

 

 

 

 

 

 

 

 

 

 

BAS Broadcasting

 

Service-radio station operator

 

Senior Term Debt (11.5%, Due 7/2013) (5)

 

7,300

 

7,209

 

 

 

 

 

Senior Term Debt (12.0%, Due 7/2009) (3) (5)

 

1,000

 

988

 

 

 

 

 

 

 

 

 

 

 

CCS, LLC

 

Service-cable TV franchise owner

 

Senior Term Debt (9.0%, Due 8/2008) (6)

 

728

 

364

 

 

 

 

 

 

 

 

 

 

 

Chinese Yellow Pages Company

 

Service-publisher of Chinese language directories

 

Line of Credit, $700 available (9.0%, Due 9/2010) (6)

 

575

 

529

 

 

Senior Term Debt (9.0%, Due 9/2010) (6)

 

702

 

638

 

 

 

 

 

 

 

 

 

 

 

Clinton Holdings, LLC

 

Distribution-aluminum sheets and stainless steel

 

Senior Subordinated Term Debt (12.0%, Due 1/2013) (6)

 

15,500

 

14,880

 

 

Common Stock Warrants (8)

 

109

 

 

 

 

 

 

 

 

 

 

 

 

CMI Acquisition, LLC

 

Service-recycling

 

Senior Subordinated Term Debt (10.2%, Due 11/2012) (6)

 

6,414

 

6,061

 

 

 

 

 

 

 

 

 

 

 

Community Media Corporation

 

Service-publisher of free weekly newspapers

 

Senior Term Debt (7.0%, Due 8/2012) (6)

 

987

 

936

 

 

 

 

 

 

 

 

 

 

 

Defiance Acquisition Corporation

 

Manufacturing-trucking parts

 

Senior Term Debt (11.0%, Due 4/2010) (3) (6)

 

6,165

 

5,055

 

 

 

 

 

 

 

 

 

 

 

Doe & Ingalls Management LLC

 

Distributor-specialty chemicals

 

Senior Term Debt (6.8%, Due 11/2010) (6)

 

3,100

 

2,945

 

 

 

 

 

Senior Term Debt (7.8%, Due 11/2010) (3) (6)

 

4,410

 

4,167

 

 

 

 

 

 

 

 

 

 

 

Finn Corporation

 

Manufacturing-landscape equipment

 

Common Stock Warrants (8)

 

37

 

1,578

 

 

 

 

 

 

 

 

 

 

 

GFRC Holdings LLC

 

Manufacturing-glass-fiber reinforced concrete

 

Line of Credit, $3,000 available (6.7%, Due 12/2010)

 

 

 

 

Senior Term Debt (9.3%, Due 12/2012) (6)

 

7,362

 

7,105

 

 

Senior Subordinated Term Debt (11.8%, Due 12/2012) (3) (6)

 

6,716

 

6,414

 

 

 

 

 

 

 

 

 

 

 

Global Materials Technologies, Inc.

 

Manufacturing-steel wool products and metal fibers

 

Senior Term Debt (13.0%, Due 11/2009) (3) (6)

 

4,640

 

4,153

 

 

 

 

 

 

 

 

 

 

 

Heartland Communications Group, LLC

 

Service-radio station operator

 

Line of Credit, $500 available (10.0%, Due 12/2008) (6)

 

105

 

79

 

 

Senior Term Debt (10.0%, Due 5/2011) (6)

 

4,523

 

3,386

 

 

 

 

 

 

 

 

 

 

 

Interfilm Holdings, Inc.

 

Service-slitter and distributor of plastic films

 

Senior Term Debt (10.5%, Due 10/2012) (6)

 

5,000

 

4,750

 

 

 

 

 

 

 

 

 

 

 

International Junior Golf Training Acquisition Company

 

Service-golf training

 

Line of Credit, $1,500 available (9.2%, Due 5/2010) (6)

 

1,400

 

1,288

 

 

Senior Term Debt (6.7%, Due 5/2012) (6)

 

2,551

 

2,347

 

 

Senior Term Debt (10.5%, Due 5/2012) (3) (6)

 

2,500

 

2,288

 

 

70



Table of Contents

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

It’s Just Lunch International, LLC

 

Service-dating service

 

Line of Credit, $750 available (6.5%, Due 6/2009) (6)

 

$

550

 

$

275

 

 

Senior Term Debt (6.7%, Due 6/2011) (6)

 

3,300

 

1,650

 

 

Senior Term Debt (10.5%, Due 6/2011) (3) (6) (9)

 

500

 

250

 

 

 

 

 

 

 

 

 

 

 

KMBQ Corporation

 

Service-AM/FM radio broadcaster

 

Line of Credit, $200 available (11.0%, Due 3/2010) (6)

 

153

 

137

 

 

 

 

 

Senior Term Debt (11.0%, Due 3/2010) (6)

 

1,792

 

1,594

 

 

 

 

 

 

 

 

 

 

 

Legend Communications of Wyoming LLC

 

Service-operator of radio stations

 

Line of Credit, $500 available (11.0%, Due 6/2011) (5)

 

397

 

392

 

 

Senior Term Debt (11.0%, Due 6/2013) (5)

 

9,250

 

9,134

 

 

 

 

 

 

 

 

 

 

 

Lindmark Outdoor Advertising LLC

 

Service-advertising

 

Senior Subordinated Term Debt (11.0%, Due 10/2012) (6)

 

11,421

 

9,651

 

 

 

 

 

 

 

 

 

 

 

Multi-Ag Media LLC

 

Service-dairy magazine publisher/information database

 

Senior Term Debt (9.0%, Due 12/2009) (6)

 

2,072

 

1,853

 

 

 

 

 

 

 

 

 

 

 

Newhall Holdings, Inc.

 

Service-distributor of personal care products and supplements

 

Line of Credit, $4,000 available (6.0%, Due 5/2010) (6)

 

2,100

 

1,880

 

 

Senior Term Debt (8.3%, Due 5/2012) (6)

 

4,230

 

3,807

 

 

Senior Term Debt (11.3%, Due 5/2012) (3) (6)

 

4,500

 

4,016

 

 

 

 

 

 

 

 

 

 

 

Northern Contours, Inc.

 

Manufacturing-veneer and laminate components

 

Senior Subordinated Term Debt (10.0%, Due 5/2010) (6)

 

6,912

 

6,082

 

 

 

 

 

 

 

 

 

 

 

Pinnacle Treatment Centers, Inc.

 

Service-Addiction treatment centers

 

Line of Credit, $500 available (6.7%, Due 12/2009)

 

 

 

 

 

 

 

Senior Term Debt (8.5%, Due 12/2011) (6)

 

3,550

 

3,319

 

 

 

 

 

Senior Term Debt (10.5%, Due 12/2011) (3) (6)

 

7,500

 

6,938

 

 

 

 

 

 

 

 

 

 

 

Precision Acquisition Group Holdings, Inc.

 

Manufacturing-consumable components for the aluminum industry

 

Equipment Note, $1,500 available (8.5%, Due 10/2011) (6)

 

1,000

 

993

 

 

Senior Term Debt (8.5%, Due 10/2010) (6)

 

4,750

 

4,714

 

 

Senior Term Debt (11.5%, Due 10/2010) (3) (6)

 

4,158

 

4,127

 

 

 

 

 

 

 

 

 

 

 

PROFITSystems Acquisition Co.

 

Service-design and develop ERP software

 

Line of Credit, $1,250 available (6.7%, Due 7/2009)

 

 

 

 

Senior Term Debt (8.5%, Due 7/2011) (6)

 

2,200

 

2,027

 

 

Senior Term Debt (10.5%, Due 7/2011) (3) (6)

 

2,900

 

2,657

 

 

 

 

 

 

 

 

 

 

 

RCS Management Holding Co.

 

Service-healthcare supplies

 

Senior Term Debt (8.5%, Due 1/2011) (3) (6)

 

2,875

 

2,695

 

 

 

 

 

Senior Term Debt (10.5%, Due 1/2011) (4) (6)

 

3,060

 

2,815

 

 

 

 

 

 

 

 

 

 

 

Reliable Biopharmaceutical Holdings, Inc.

 

Manufacturing-pharmaceutical and biochemical intermediates

 

Line of Credit, $5,000 available (9.0%, Due 10/2010) (6)

 

1,600

 

1,528

 

 

Mortgage Note (9.5%, Due 10/2014) (6)

 

7,407

 

7,147

 

 

Senior Term Debt (9.0%, Due 10/2012) (6)

 

1,800

 

1,719

 

 

Senior Term Debt (11.0%, Due 10/2012) (3) (6)

 

11,933

 

11,352

 

 

Senior Subordinated Term Debt (12.0%, Due 10/2013) (6)

 

6,000

 

5,445

 

 

Common Stock Warrants (8)

 

209

 

 

 

 

 

 

 

 

 

 

 

 

Saunders & Associates

 

Manufacturing-equipment provider for frequency control devices

 

Line of Credit, $2,500 available (6.9%, Due 5/2009)

 

 

 

 

Senior Term Debt (9.8%, Due 5/2013) (6)

 

10,945

 

10,740

 

 

 

 

 

 

 

 

 

 

 

SCI Cable, Inc.

 

Service-cable, internet, voice provider

 

Senior Term Debt (11.0%, Due 10/2008) (6)

 

2,712

 

1,355

 

 

 

 

 

 

 

 

 

 

 

Sunburst Media - Louisiana, LLC

 

Service-radio station operator

 

Senior Term Debt (9.5%, Due 6/2011) (6)

 

7,857

 

6,728

 

 

 

 

 

 

 

 

 

 

 

Sunshine Media Holdings

 

Service-publisher regional B2B trade magazines

 

Line of Credit, $3,000 available (11.0%, Due 5/2010) (6)

 

700

 

627

 

 

Senior Term Debt (11.0%, Due 5/2012) (6)

 

17,000

 

15,300

 

 

Senior Term Debt (13.5%, Due 5/2012) (3) (6)

 

10,000

 

8,750

 

 

 

 

 

 

 

 

 

 

 

Thibaut Acquisition Co.

 

Service-design and disbribute wall covering

 

Line of Credit, $2,000 available (7.0%, Due 1/2011) (6)

 

2,000

 

1,838

 

 

Senior Term Debt (7.0%, Due 1/2011) (6)

 

2,013

 

1,849

 

 

Senior Term Debt (10.5%, Due 1/2011) (3) (6)

 

3,000

 

2,685

 

 

 

 

 

 

 

 

 

 

 

Tulsa Welding School

 

Service-private welding school

 

Line of credit, $2,000 available (9.5%, 9/2011)

 

 

 

 

 

 

 

Senior Term Debt (9.5%, 9/2013) (5)

 

4,000

 

4,000

 

 

 

 

 

Senior Term Debt (12.8%, 9/2013) (5)

 

8,000

 

8,000

 

 

 

 

 

 

 

 

 

 

 

VantaCore

 

Service-acquisition of aggregate quarries

 

Senior Subordinated Term Debt (12.0%, 8/2013) (6)

 

13,100

 

12,936

 

 

71



Table of Contents

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Viapack, Inc.

 

Manufacturing-polyethylene film

 

Senior Real Estate Term Debt (7.0%, Due 3/2011) (6)

 

$

850

 

$

780

 

 

 

 

 

Senior Term Debt (11.3%, Due 3/2011) (3) (6)

 

4,091

 

3,733

 

 

 

 

 

 

 

 

 

 

 

Visual Edge Technology, Inc.

 

Service-office equipment distribution

 

Senior Subordinated Term Debt (11.5%, Due 8/2011) (6)

 

5,000

 

2,925

 

 

 

 

 

 

 

 

 

 

 

Westlake Hardware, Inc.

 

Retail-hardware and variety

 

Senior Subordinated Term Debt (9.0%, Due 1/2011) (6)

 

15,000

 

13,800

 

 

 

 

 

Senior Subordinated Term Debt (10.3%, Due 1/2011) (6)

 

10,000

 

9,000

 

 

 

 

 

 

 

 

 

 

 

Winchester Electronics

 

Manufacturing-high bandwidth connectors and cables

 

Senior Term Debt (8.0%, Due 5/2013) (6)

 

1,699

 

1,563

 

 

Senior Subordinated Term Debt (13.0%, Due 6/2013) (6)

 

9,950

 

9,055

 

 

 

 

 

 

 

 

 

 

 

Subtotal - Non-syndicated loans

 

 

 

 

 

371,204

 

340,816

 

 

 

 

 

 

 

 

 

 

 

Syndicated Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AKQA Holdings

 

Service-market and advertising

 

Senior Term Debt (7.7%, Due 3/2013) (7)

 

$

8,273

 

$

7,980

 

 

 

 

 

 

 

 

 

 

 

Bresnan Communications, LLC

 

Service-telecommunications

 

Senior Term Debt (4.8%, Due 9/2013) (7)

 

3,001

 

2,670

 

 

 

 

 

Senior Subordinated Term Debt (7.6%, Due 3/2014) (7)

 

1,508

 

1,305

 

 

 

 

 

 

 

 

 

 

 

CHG Companies, Inc.

 

Service-healthcare staffing

 

Letter of Credit, $400 available (6.0%, Due 12/2012) (7)

 

400

 

356

 

 

 

 

 

Senior Term Debt (5.3%, Due 12/2012) (7)

 

1,572

 

1,399

 

 

 

 

 

Senior Subordinated Term Debt (8.5%, Due 12/2013) (7)

 

500

 

425

 

 

 

 

 

 

 

 

 

 

 

Country Road Communications LLC

 

Service-telecommunications

 

Senior Subordinated Term Debt (11.5%, Due 7/2013) (7)

 

5,973

 

5,880

 

 

 

 

 

 

 

 

 

 

 

Emdeon Business Services, Inc.

 

Service-healthcare technology solutions

 

Senior Term Debt (5.8%, Due 11/2013) (7)

 

2,359

 

2,027

 

 

Senior Subordinated Term Debt (8.8%, Due 5/2014) (7)

 

2,011

 

1,720

 

 

 

 

 

 

 

 

 

 

 

GTM Holdings, Inc.

 

Manufacturing-socks

 

Senior Term Debt (8.5%, Due 10/2013) (7)

 

491

 

359

 

 

 

 

 

Senior Subordinated Term Debt (11.8%, Due 4/2014) (7)

 

500

 

325

 

 

 

 

 

 

 

 

 

 

 

Greatwide Logistics Services, Inc.

 

Service-logistics and transportation

 

Senior Term Debt (non-accrual, Due 12/2013) (7) (10)

 

3,950

 

2,765

 

 

Senior Subordinated Term Debt (non-accrual, Due 6/2014) (7) (10)

 

2,000

 

700

 

 

 

 

 

 

 

 

 

 

 

Harrington Holdings, Inc.

 

Service-healthcare products distribution

 

Senior Term Debt (6.0%, Due 1/2014) (7)

 

2,463

 

2,192

 

 

Senior Subordinated Term Debt (9.7%, Due 1/2014) (7)

 

5,000

 

3,750

 

 

 

 

 

 

 

 

 

 

 

John Henry Holdings, Inc.

 

Manufacturing-packaging products

 

Senior Subordinated Term Debt (11.6%, Due 6/2011) (7)

 

8,000

 

7,600

 

 

 

 

 

 

 

 

 

 

 

Kinetek Acquisition Corp.

 

Manufacturing-custom engineered motors & controls

 

Senior Term Debt (6.2%, Due 11/2013) (7)

 

1,478

 

1,326

 

 

Senior Subordinated Term Debt (9.2%, Due 5/2014) (7)

 

1,508

 

1,275

 

 

 

 

 

 

 

 

 

 

 

Puerto Rico Cable Acquisition Company, Inc.

 

Service-telecommunications

 

Senior Subordinated Term Debt (11.3%, Due 1/2012) (7)

 

7,189

 

5,570

 

 

 

 

 

 

 

 

 

 

 

RedPrairie Holding, Inc.

 

Service-design and develop supply chain software

 

Senior Term Debt (6.1%, Due 7/2012) (7)

 

4,412

 

4,014

 

 

Senior Subordinated Term Debt (9.3%, Due 1/2013) (7)

 

3,000

 

2,550

 

 

 

 

 

 

 

 

 

 

 

RiskMetrics Group Holdings, LLC

 

Service-develop risk and wealth management solutions

 

Senior Term Debt (5.8%, Due 1/2014) (7)

 

1,936

 

1,812

 

 

 

 

 

 

 

 

 

 

 

United Maritime Group, LLC

 

Service-cargo transport

 

Senior Subordinated Term Debt (11.2%, Due 12/2013) (7)

 

1,000

 

950

 

 

 

 

 

 

 

 

 

 

 

Wesco Holdings, Inc.

 

Service-aerospace parts and distribution

 

Senior Term Debt (6.0%, Due 9/2013) (7)

 

2,451

 

2,212

 

 

Senior Subordinated Term Debt (9.5%, Due 3/2014) (7)

 

2,267

 

1,980

 

 

 

 

 

 

 

 

 

 

 

WP Evenflo Group Holdings Inc.

 

Manufacturing-infant and juvenile products

 

Senior Term Debt (5.3%, Due 2/2013) (7)

 

1,910

 

1,595

 

 

Senior Subordinated Term Debt (8.8%, Due 2/2014) (7)

 

2,000

 

1,600

 

 

 

 

 

 

 

 

 

 

 

Subtotal - Syndicated loans

 

 

 

 

 

77,152

 

66,337

 

 

 

 

 

 

 

 

 

 

 

Total Non-Control/Non-Affiliate Investments

 

 

 

 

 

$

448,356

 

$

407,153

 

 

72



Table of Contents

 

Company (1)

 

Industry

 

Investment (2)

 

Cost

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

CONTROL INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BERTL, Inc.

 

Service-web-based evaluator of digital imaging products

 

Line of Credit, $700 available (8.7%, Due 10/2009) (11) (12)

 

$

742

 

$

 

 

Common Stock (8)

 

424

 

 

 

 

 

 

 

 

 

 

 

 

LYP Holdings Corp.

 

Service-yellow pages publishing

 

Line of credit, $500 available (10.0%, 5/2009) (12)

 

75

 

 

 

 

 

 

Line of Credit, $3,000 available (non-accrual, Due 6/2009) (10) (12)

 

1,170

 

 

 

 

 

 

Senior Term Debt (non-accrual, Due 6/2011) (10) (12)

 

2,688

 

 

 

 

 

 

Senior Term Debt (non-accrual, Due 6/2011) (3) (10) (12)

 

2,750

 

 

 

 

 

 

Common Stock Warrants (8)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Healthcare Communications, Inc.

 

Service-magazine publisher/operator

 

Line of credit, $200 available (non-accrual, Due 3/2010) (10)

 

90

 

90

 

 

Line of credit, $450 available (non-accrual, Due 3/2010) (10)

 

450

 

450

 

 

Common Stock (8)

 

2,470

 

240

 

 

 

 

 

 

 

 

 

 

 

Western Directories, Inc.

 

Service-directory publisher

 

Line of credit, $1,000 available (10%, Due 8/2009) (12)

 

69

 

 

 

 

 

 

Preferred Stock (8)

 

1,584

 

 

 

 

 

 

Common Stock (8)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

Total Control Investments

 

 

 

 

 

$

12,514

 

$

780

 

 

 

 

 

 

 

 

 

 

 

Total Investments (13)

 

 

 

 

 

$

460,870

 

$

407,933

 

 


(1)             Certain of the listed securities are issued by affiliate(s) of the indicated portfolio company.

(2)             Percentage represents interest rates in effect at September 30, 2008 and due date represents the contractual maturity date.

(3)             Last Out Tranche of senior debt, meaning if the company is liquidated, the holder of the Last Out Tranche is paid after the senior debt.

(4)             Last Out Tranche of senior debt, meaning if the company is liquidated, the holder of the Last Out Tranche is paid after the senior debt, however the debt is junior to another Last Out Tranche.

(5)             Investment estimated to be equal to cost due to recent acquisition.

(6)             Fair value was based on opinions of value submitted by Standard & Poor’s Securities Evaluations, Inc.

(7)             Marketable securities, such as syndicated loans, are valued based on the indicative bid price, as of September 30, 2008, from the respective originating syndication agent’s trading desk.

(8)             Security is non-income producing.

(9)             It’s Just Lunch may borrow an additional $1,750 of the senior term debt facility, subject to certain conditions including Gladstone Capital’s approval, borrowings of $500 were outstanding at September 30, 2008.

(10)       Greatwide, LYP Holdings and U.S. Healthcare are currently past due on interest payments and are on non-accrual.

(11)       BERTL line of credit was overdrawn by $42 as of September 30, 2008.  The Company is currently restructuring the line of credit.  BERTL interest is currently being capitalized as paid in kind (“PIK”) interest.  Please refer to Note 2 “Summary of Significant Accounting Policies.”

(12)       Fair value was based on the total enterprise value of the issuer using a liquidity waterfall approach.

(13)       Aggregate gross unrealized depreciation for federal income tax purposes is $54,477; aggregate gross unrealized appreciation for federal income tax purposes is $1,540.  Net unrealized depreciation is $52,937 based on a tax cost of $460,870.

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

73



Table of Contents

 

GLADSTONE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

 

 

Year ended September 30,

 

 

 

2009

 

2008

 

2007

 

INVESTMENT INCOME

 

 

 

 

 

 

 

Interest income – non control/non affiliate investments

 

$

41,134

 

$

44,733

 

$

35,413

 

Interest income – control investments

 

933

 

64

 

 

Interest income – cash

 

11

 

335

 

256

 

Interest income – notes receivable from employees (Refer to Note 4)

 

468

 

471

 

526

 

Prepayment fees and other income

 

72

 

122

 

492

 

Total investment income

 

42,618

 

45,725

 

36,687

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

Interest expense

 

7,949

 

8,284

 

7,226

 

Loan servicing fee (Refer to Note 4)

 

5,620

 

6,117

 

3,624

 

Base management fee (Refer to Note 4)

 

2,005

 

2,212

 

2,402

 

Incentive fee (Refer to Note 4)

 

3,326

 

5,311

 

4,608

 

Administration fee (Refer to Note 4)

 

872

 

985

 

719

 

Professional fees

 

1,586

 

911

 

523

 

Amortization of deferred financing fees

 

2,778

 

1,534

 

267

 

Stockholder related costs

 

415

 

443

 

217

 

Directors’ fees

 

197

 

220

 

234

 

Insurance expense

 

241

 

227

 

249

 

Other expenses

 

278

 

325

 

328

 

Expenses before credit from Adviser

 

25,267

 

26,569

 

20,397

 

Credit to base management and incentive fees from Adviser (Refer to Note 4)

 

(3,680

)

(7,397

)

(5,971

)

Total expenses net of credit to base management and incentive fees

 

21,587

 

19,172

 

14,426

 

 

 

 

 

 

 

 

 

NET INVESTMENT INCOME

 

21,031

 

26,553

 

22,261

 

 

 

 

 

 

 

 

 

REALIZED AND UNREALIZED LOSS ON INVESTMENTS, DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT

 

 

 

 

 

 

 

Net realized (loss) gain on investments

 

(26,411

)

(787

)

44

 

Realized (loss) gain on settlement of derivative

 

(304

)

7

 

39

 

Net unrealized appreciation (depreciation) on derivative

 

304

 

(12

)

(38

)

Net unrealized appreciation (depreciation) on investments

 

9,513

 

(47,023

)

(7,354

)

Net unrealized appreciation on borrowings under line of credit

 

(350

)

 

 

Net loss on investments, derivative and borrowings under line of credit

 

(17,248

)

(47,815

)

(7,309

)

 

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS

 

$

3,783

 

$

(21,262

)

$

14,952

 

 

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE

 

 

 

 

 

 

 

Basic and Diluted

 

$

0.18

 

$

(1.08

)

$

1.13

 

WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING

 

 

 

 

 

 

 

Basic and Diluted

 

21,087,574

 

19,699,796

 

13,173,822

 

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

74



Table of Contents

 

GLADSTONE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(DOLLAR AMOUNTS IN THOUSANDS)

 

 

 

Year ended September 30,

 

 

 

2009

 

2008

 

2007

 

Operations:

 

 

 

 

 

 

 

Net investment income

 

$

21,031

 

$

26,553

 

$

22,261

 

Net realized (loss) gain on sale of investments

 

(26,411

)

(787

)

44

 

Realized (loss) gain on settlement of derivative

 

(304

)

7

 

39

 

Net unrealized appreciation (depreciation) on derivative

 

304

 

(12

)

(38

)

Net unrealized appreciation (depreciation) on investments

 

9,513

 

(47,023

)

(7,354

)

Net unrealized appreciation on borrowings under line of credit

 

(350

)

 

 

Net increase (decrease) in net assets from operations

 

3,783

 

(21,262

)

14,952

 

Distributions to stockholders from:

 

 

 

 

 

 

 

Net investment income

 

(20,795

)

(25,945

)

(19,444

)

Gains

 

(27

)

(285

)

(2,697

)

Tax return on capital

 

(5,748

)

(7,149

)

 

Net decrease in net assets from distributions to stockholders

 

(26,570

)

(33,379

)

(22,141

)

Capital share transactions:

 

 

 

 

 

 

 

Issuance of common stock under shelf offering

 

 

106,226

 

57,437

 

Shelf offering costs

 

(41

)

(852

)

(672

)

Repayment of principal on employee notes

 

6

 

56

 

301

 

Reclassification of principal on employee note

 

150

 

 

 

Stock surrendered in settlement of withholding tax

 

 

 

(1,488

)

Net increase in net assets from capital share transactions

 

115

 

105,430

 

55,578

 

 

 

 

 

 

 

 

 

Total (decrease) increase in net assets

 

(22,672

)

50,789

 

48,389

 

Net assets at beginning of year

 

271,748

 

220,959

 

172,570

 

Net assets at end of year

 

$

249,076

 

$

271,748

 

$

220,959

 

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

75



Table of Contents

 

GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLAR AMOUNTS IN THOUSANDS)

 

 

 

Year ended September 30,

 

 

 

2009

 

2008

 

2007

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

Net increase (decrease) in net assets resulting from operations

 

$

3,783

 

$

(21,262

)

$

14,952

 

Adjustments to reconcile net (decrease) increase in net assets resulting from operations to net cash used in operating activities:

 

 

 

 

 

 

 

Purchase of investments

 

(26,366

)

(176,550

)

(261,700

)

Principal repayments on investments

 

47,490

 

69,183

 

86,958

 

Proceeds from sale of investments

 

49,203

 

1,299

 

34,860

 

Net amortization of premiums and discounts

 

(95

)

228

 

139

 

Increase in investment balance due to payment in kind interest

 

(166

)

(58

)

 

Amortization of deferred financing fees

 

2,778

 

1,534

 

267

 

Realized loss on investments

 

26,411

 

787

 

188

 

Realized loss on settlement of derivative

 

304

 

 

 

Unrealized (appreciation) depreciation on derivative

 

(304

)

12

 

38

 

Change in net unrealized (appreciation) depreciation on investments

 

(9,513

)

47,023

 

7,354

 

Change in net unrealized appreciation on borrowings under line of credit

 

350

 

 

 

Decrease (increase) in interest receivable

 

546

 

(1,232

)

(1,015

)

Decrease (increase) in funds due from custodian

 

1,485

 

(1,313

)

357

 

(Increase) decrease in prepaid assets

 

(35

)

31

 

(111

)

Increase in due from affiliate

 

(69

)

 

 

Increase in other assets

 

(845

)

(490

)

(185

)

Increase in accounts payable

 

59

 

2

 

2

 

(Decrease) increase in interest payable

 

(268

)

59

 

340

 

Increase in accrued expenses and deferred liabilities

 

472

 

537

 

69

 

Increase (decrease) in fees due to affiliate (Refer to Note 4)

 

377

 

(252

)

468

 

(Decrease) increase in administration fee due to Gladstone Administration (Refer to Note 4)

 

(31

)

10

 

238

 

(Decrease) increase in funds held in escrow

 

(45

)

234

 

(203

)

Net cash provided by (used in) operating activities

 

95,521

 

(80,218

)

(116,984

)

 

 

 

 

 

 

 

 

CASH FLOW FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

Redemption (purchase) of U.S. Treasury Bill

 

 

2,484

 

(2,484

)

Net cash provided by (used in) investing activities

 

 

2,484

 

(2,484

)

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

Net proceeds from the issuance of common shares

 

 

106,226

 

57,437

 

Shelf offering costs

 

(41

)

(852

)

(673

)

Borrowings from the line of credit

 

48,800

 

200,618

 

305,600

 

Repayments on the line of credit

 

(116,830

)

(194,028

)

(211,153

)

Distributions paid

 

(26,570

)

(33,379

)

(22,141

)

Receipt of principal on notes receivable – employees (Refer to Note 4)

 

6

 

56

 

301

 

Deferred financing fees

 

(2,103

)

(3,253

)

(308

)

Withholding tax obligation settlement

 

 

 

(1,488

)

Net cash (used in) provided by financing activities

 

(96,738

)

75,388

 

127,575

 

 

 

 

 

 

 

 

 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

(1,217

)

(2,346

)

8,107

 

CASH, BEGINNING OF YEAR

 

6,493

 

8,839

 

732

 

CASH, END OF YEAR

 

$

5,276

 

$

6,493

 

$

8,839

 

CASH PAID DURING PERIOD FOR INTEREST

 

$

8,278

 

$

8,226

 

$

6,886

 

CASH PAID DURING PERIOD FOR TAXES

 

$

 

$

7

 

$

 

NON-CASH FINANCING ACTIVITIES

 

 

 

 

 

 

 

Reclassification of principal on employee note (Refer to Note 4)

 

$

150

 

$

 

$

 

Cancellation of employee note receivable (Refer to Note 4)

 

$

 

$

 

$

717

 

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

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GLADSTONE CAPITAL CORPORATION

FINANCIAL HIGHLIGHTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)

 

 

 

Year ended September 30,

 

 

 

2009

 

2008

 

2007

 

Per Share Data (1)

 

 

 

 

 

 

 

Net asset value at beginning of period

 

$

12.89

 

$

14.97

 

$

14.02

 

Income from investment operations (2)

 

 

 

 

 

 

 

Net investment income

 

1.00

 

1.35

 

1.69

 

Net realized loss on the sale of investments

 

(1.25

)

(0.04

)

 

Realized loss on settlement of derivative

 

(0.01

)

 

 

Net unrealized appreciation on derivative

 

0.01

 

 

 

Net unrealized (depreciation) appreciation on investments

 

0.45

 

(2.39

)

(0.56

)

Net unrealized appreciation on borrowings under line of credit

 

(0.02

)

 

 

Total from investment operations

 

0.18

 

(1.08

)

1.13

 

Distributions to stockholders from (2)(3)

 

 

 

 

 

 

 

Net investment income

 

(0.99

)

(1.31

)

(1.48

)

Gains

 

 

(0.01

)

(0.20

)

Tax return on capital

 

(0.27

)

(0.36

)

 

Total distributions

 

(1.26

)

(1.68

)

(1.68

)

Capital share transactions

 

 

 

 

 

 

 

Issuance of common stock under shelf offering

 

 

0.72

 

1.55

 

Offering costs

 

 

(0.04

)

(0.05

)

Repayment of principal on notes receivable

 

 

 

0.06

 

Stock surrendered to settle withholding tax obligation

 

 

 

(0.06

)

Total from capital share transactions

 

 

0.68

 

1.50

 

Net asset value at end of period

 

$

11.81

 

$

12.89

 

$

14.97

 

 

 

 

 

 

 

 

 

Per share market value at beginning of period

 

$

15.24

 

$

19.52

 

$

22.01

 

Per share market value at end of period

 

$

8.93

 

$

15.24

 

$

19.52

 

Total return (4)

 

(30.94

)%

(13.90

)%

(4.40

)%

Shares outstanding at end of period

 

21,087,574

 

21,087,574

 

14,762,574

 

 

 

 

 

 

 

 

 

Statement of Assets and Liabilities Data

 

 

 

 

 

 

 

Net assets at end of period

 

$

249,076

 

$

271,748

 

$

220,959

 

Average net assets(5)

 

$

253,316

 

$

284,304

 

$

189,732

 

Senior Securities Data

 

 

 

 

 

 

 

Borrowing under line of credit

 

$

83,350

 

$

151,030

 

$

144,440

 

Asset coverage ratio (6)(7)

 

399

%

286

%

259

%

Average coverage per unit (7)

 

$

3,988

 

$

2,860

 

$

2,594

 

Ratios/Supplemental Data

 

 

 

 

 

 

 

Ratio of expenses to average net assets (8)

 

9.97

%

9.34

%

10.75

%

Ratio of net expenses to average net assets (9)

 

8.52

%

6.74

%

7.60

%

Ratio of net investment income to average net assets

 

8.30

%

9.34

%

11.73

%

 


(1)   Based on actual shares outstanding at the end of the corresponding period.

(2)   Based on weighted average basic per share data.

(3)   Distributions are determined based on taxable income calculated in accordance with income tax regulations which may differ from amounts determined under accounting principles generally accepted in the United States of America.

 

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(4)   Total return equals the change in the ending market value of the Company’s common stock from the beginning of the period taking into account dividends reinvested in accordance with the terms of its dividend reinvestment plan. Total return does not take into account dividends that may be characterized as a return of capital. For further information on estimated character of the Company’s dividends please refer to Note 9.

(5)   Average net assets are computed using the average of the balance of net assets at the end of each month of the reporting period.

(6)   As a business development company, the Company is generally required to maintain a ratio of at least 200% of total assets, less all liabilities and indebtedness not represented by senior securities, to total borrowings.

(7)   Asset coverage ratio is the ratio of the carrying value of the Company’s total consolidated assets, less all liabilities and indebtedness not represented by senior securities, to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is the asset coverage ratio expressed in terms of dollar amounts per $1,000 of indebtedness.

8)     Ratio of expenses to average net assets is computed using expenses before credits from Adviser to the base management and incentive fees and including income tax expense.

(9)   Ratio of net expenses to average net assets is computed using total expenses net of credits from Adviser to the base management and incentive fees and including income tax expense.

 

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

 

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GLADSTONE CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2009

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISE INDICATED)

 

Note 1. Organization

 

Gladstone Capital Corporation (the “Company”) was incorporated under the General Corporation Laws of the State of Maryland on May 30, 2001.  The Company is a closed-end, non-diversified management investment company that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”).  In addition, the Company has elected to be treated for tax purposes as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”).  The Company’s investment objectives are to achieve a high level of current income by investing in debt securities, consisting primarily of senior notes, senior subordinated notes and junior subordinated notes, of established private businesses that are substantially owned by leveraged buyout funds, individual investors or are family-owned businesses, with a particular focus on senior notes. In addition, the Company may acquire from others existing loans that meet this profile.

 

Gladstone Business Loan, LLC (“Business Loan”), a wholly-owned subsidiary of the Company, was established on February 3, 2003 for the purpose of holding the Company’s portfolio of loan investments.  Gladstone Capital Advisers, Inc. is also a wholly-owned subsidiary of the Company, which was established on December 30, 2003.

 

Gladstone SBIC, LP (“Gladstone SBIC”) and Gladstone SBIC GP, LLC, the general partner of Gladstone SBIC, were established on December 4, 2008 as wholly-owned subsidiaries of the Company for the purpose of applying for and holding a license to enable the Company, through Gladstone SBIC, to make investments in accordance with the United States Small Business Administration guidelines for small business investment companies.

 

Gladstone Financial Corporation (“Gladstone Financial”), a wholly-owned subsidiary of the Company, was established on November 21, 2006 for the purpose of holding a license to operate as a Specialized Small Business Investment Company.  Gladstone Financial (previously known as Gladstone SSBIC Corporation) acquired this license in February 2007.  This will enable the Company, through this subsidiary, to make investments in accordance with the United States Small Business Administration guidelines for specialized small business investment companies.

 

The financial statements of the subsidiaries are consolidated with those of the Company.

 

The Company is externally managed by Gladstone Management Corporation (the “Adviser”), an unconsolidated affiliate of the Company.

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

Consolidation

 

Under Article 6 of Regulation S-X under the Securities Act of 1933, as amended, and the authoritative accounting guidance provided by the AICPA Audit and Accounting Guide for Investment Companies, the Company is not permitted to consolidate any subsidiary or other entity that is not an investment company.

 

Use of Estimates

 

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) that require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates.

 

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Cash and Cash Equivalents

 

Cash and cash equivalents consist of demand deposits and highly liquid investments with original maturities of three months or less when purchased. Cash is carried at cost which approximated fair value as of September 30, 2009 and September 30, 2008.  There were no cash equivalents as of September 30, 2009 and September 30, 2008.

 

Concentration of Credit Risk

 

The Company places its cash and cash equivalents with financial institutions and, at times, cash held in accounts may exceed the Federal Deposit Insurance Corporation insured limit.  The Company seeks to mitigate this risk by depositing funds with major financial institutions.

 

Classification of Investments

 

The 1940 Act requires classification of the Company’s investments by its respective level of control.  As defined in the 1940 Act, “Control Investments” are investments in those portfolio companies that the Company is deemed to “Control.”  “Affiliate Investments” are investments in those portfolio companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, other than Control Investments.  “Non-Control/Non-Affiliate Investments” are those that are neither Control Investments nor Affiliate Investments.  In general, the 1940 Act prescribes that the Company has control over a portfolio company if it owns greater than 25% of the voting securities of the portfolio company.  The Company is deemed to be an affiliate of a portfolio company if it owns between 5% and 25% of the voting securities of such portfolio company or has one or more seats on the affiliated company’s board of directors.  However, if the Company holds 50% or more contractual representation on a portfolio company’s board of directors, the Company will be deemed to have control over the portfolio company.

 

Investment Valuation Policy

 

The Company carries its investments at market value to the extent that market quotations are readily available and reliable, and otherwise at fair value, as determined in good faith by its Board of Directors.  In determining the fair value of the Company’s investments, the Adviser has established an investment valuation policy (the “Policy”).  The Policy is approved by the Company’s Board of Directors and each quarter the Board of Directors reviews whether the Adviser has applied the Policy consistently and votes whether or not to accept the recommended valuation of the Company’s investment portfolio.

 

The Company uses generally accepted valuation techniques to value its portfolio unless the Company has specific information about the value of an investment to determine otherwise. From time to time the Company may accept an appraisal of a business in which the Company holds securities. These appraisals are expensive and occur infrequently but provide a third-party valuation opinion that may differ in results, techniques and scopes used to value the Company’s investments.  When these specific third-party appraisals are engaged or accepted, the Company uses estimates of value provided by such appraisals and its own assumptions including estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date to value the investment the Company has in that business.

 

The Policy, which is summarized below, applies to publicly-traded securities, securities for which a limited market exists, and securities for which no market exists.

 

Publicly-traded securities: The Company determines the value of publicly-traded securities based on the closing price for the security on the exchange or securities market on which it is listed and primarily traded on the valuation date.  To the extent that the Company owns restricted securities that are not freely tradable, but for which a public market otherwise exists, the Company will use the market value of that security adjusted for any decrease in value resulting from the restrictive feature.

 

Securities for which a limited market exists: The Company values securities that are not traded on an established secondary securities market, but for which a limited market for the security exists, such as certain participations in, or assignments of, syndicated loans, at the quoted bid price.  In valuing these assets, the Company assesses trading activity in an asset class and evaluates variances in prices and other market insights to determine if any available quote prices are reliable.  If the Company concludes that quotes based on active markets or trading activity may be relied upon, firm bid prices are requested; however, if a firm bid price is unavailable, the Company bases the value of the security upon the indicative bid price offered by the respective originating syndication agent’s trading desk, or secondary desk, on or near the valuation date.

 

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To the extent that the Company uses the indicative bid price as a basis for valuing the security, the Adviser may take further steps to consider additional information to validate that price in accordance with the Policy.

 

In the event these limited markets become illiquid such that market prices are no longer readily available, the Company will value its syndicated loans using estimated net present values of the future cash flows or discounted cash flows (“DCF”). The use of a DCF methodology follows that prescribed by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” which provides guidance on the use of a reporting entity’s own assumptions about future cash flows and risk-adjusted discount rates when relevant observable inputs, such as quotes in active markets, are not available. When relevant observable market data does not exist, the alternative outlined in ASC 820 is the use of valuing investments based on DCF.  For the purposes of using DCF to provide fair value estimates, the Company considers multiple inputs such as a risk-adjusted discount rate that incorporates adjustments that market participants would make both for nonperformance and liquidity risks.  As such, the Company develops a modified discount rate approach that incorporates risk premiums including, among others, increased probability of default, or higher loss given default, or increased liquidity risk. The DCF valuations applied to the syndicated loans provide an estimate of what the Company believes a market participant would pay to purchase a syndicated loan in an active market, thereby establishing a fair value.  The Company will apply the DCF methodology in illiquid markets until quoted prices are available or are deemed reliable based on trading activity.

 

As of September 30, 2009, the Company assessed trading activity in its syndicated loan assets and determined that there had been a return to market liquidity and a better functioning secondary market for these assets.  Thus, firm bid prices or indicative bids were used to fair value the Company’s remaining syndicated loans at September 30, 2009.   However, for those syndicated loans where sales were completed after September 30, 2009, the Company used the respective sales prices to value those syndicated loans.

 

Securities for which no market exists: The valuation methodology for securities for which no market exists falls into three categories: (1) portfolio investments comprised solely of debt securities; (2) portfolio investments in controlled companies comprised of a bundle of securities, which can include debt and equity securities, or both; and (3) portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities.

 

(1)         Portfolio investments comprised solely of debt securities: Debt securities that are not publicly-traded on an established securities market, or for which a limited market does not exist (“Non-Public Debt Securities”), and that are issued by portfolio companies where the Company has no equity or equity-like securities, are fair valued in accordance with the terms of the Policy, which utilizes opinions of value submitted to the Company by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”). The Company may also submit paid in kind (“PIK”) interest to SPSE for their evaluation when it is determined the PIK interest is likely to be received.

 

(2)         Portfolio investments in controlled companies comprised of a bundle of investments, which can include debt and equity securities: The fair value of these investments is determined based on the total enterprise value of the portfolio company, or issuer, utilizing a liquidity waterfall approach, for the Company’s Non-Public Debt Securities and equity or equity-like securities (e.g. preferred equity, equity, or other equity-like securities) that are purchased together as part of a package, where the Company has control or could gain control through an option or warrant security, both the debt and equity securities of the portfolio investment would exit in the mergers and acquisition market as the principal market, generally through a sale or recapitalization of the portfolio company. In accordance with ASC 820-10, the Company applies the in-use premise of value which assumes the debt and equity securities are sold together. Under this liquidity waterfall approach, the Company first calculates the total enterprise value of the issuer by incorporating some or all of the following factors to determine the total enterprise value of the issuer:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  DCF or other pertinent factors.

 

In gathering the sales to third parties of similar securities, the Company may reference industry statistics and use outside experts. Once the Company has estimated the total enterprise value of the issuer, the Company will subtract the value of all the debt securities of the issuer , which are valued at the contractual principal balance. Fair values of these debt securities are discounted for any shortfall of total enterprise value over the total debt outstanding for the issuer. Once the

 

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values for all outstanding senior securities (which include the debt securities) have been subtracted from the total enterprise value of the issuer, the remaining amount, if any, is used to determine the value of the issuer’s equity or equity like securities.  If, in the Adviser’s judgment, the liquidity waterfall approach does not accurately reflect the value of the debt component, the Adviser may recommend that the Company use a valuation by SPSE, or if that is unavailable, a DCF valuation technique.

 

(3)         Portfolio investments in non-controlled companies comprised of a bundle of investments, which can include debt and equity securities: The Company values Non-Public Debt Securities that are purchased together with equity and equity-like securities from the same portfolio company, or issuer, for which the Company does not control or cannot gain control as of the measurement date, using a hypothetical secondary market as the Company’s principal market. In accordance with ASC 820-10, the Company determines its fair value of these debt securities of non-control investments assuming the sale of an individual debt security using the in-exchange premise of value. As such, the Company estimates the fair value of the debt component using estimates of value provided by SPSE and its own assumptions in the absence of observable market data, including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. Subsequent to June 30, 2009, for equity or equity-like securities of investments for which the Company does not control or cannot gain control as of the measurement date, the Company estimates the fair value of the equity using the in-exchange premise of value based on factors such as the overall value of the issuer, the relative fair value of other units of account including debt, or other relative value approaches. Consideration also is given to capital structure and other contractual obligations that may impact the fair value of the equity. Further, the Company may utilize comparable values of similar companies, recent investments and indices with similar structures and risk characteristics or its own assumptions in the absence of other observable market data and may also employ DCF valuation techniques.

 

Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been obtained had a ready market for the securities existed, and the differences could be material. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned. There is no single standard for determining fair value in good faith, as fair value depends upon circumstances of each individual case. In general, fair value is the amount that the Company might reasonably expect to receive upon the current sale of the security in an arms-length transaction in the security’s principal market.

 

Refer to Note 3 for additional information regarding fair value measurements and the Company’s adoption of ASC 820-10.

 

Interest Income Recognition

 

Interest income, adjusted for amortization of premiums and acquisition costs and for the accretion of discounts, is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days or more past due or if the Company’s qualitative assessment indicates that the debtor is unable to service its debt or other obligations, the Company will place the loan on non-accrual status and cease recognizing interest income on that loan until the borrower has demonstrated the ability and intent to pay contractual amounts due.  However, the Company remains contractually entitled to this interest.  At September 30, 2009, one Non-Control/Non-Affiliate investment and four Control investments were on non-accrual with an aggregate cost basis of approximately $10,022, or 2.8% of the cost basis of all loans in the Company’s portfolio.  At September 30, 2008, one Non-Control/Non-Affiliate investment and two Control investments were on non-accrual with a cost basis of approximately $13,098 at September 30, 2008, or 2.8% of the cost basis of all loans in the Company’s portfolio.  Conditional interest, or a success fee, is recorded when earned or upon full repayment of a loan investment.

 

Paid in Kind Interest

 

The Company has two loans in its portfolio which contain PIK provisions. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as income. To maintain the Company’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash.   For the fiscal year ended September 30, 2009, the Company recorded PIK income of $162.  For the fiscal year ended September 30, 2008, the Company recorded PIK income of $62.  There was no PIK income recorded during the fiscal year ended September 30, 2007.

 

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Services Provided to Portfolio Companies

 

As a business development company under the 1940 Act, the Company is required to make available significant managerial assistance to its portfolio companies.  The company provides these services through its Adviser, who provides these services on the Company’s behalf through its officers, who are also the Company’s officers.   Currently, neither the Company nor the Adviser receives fees in connection with managerial assistance.

 

The Adviser receives fees for other services it provides to the Company’s portfolio companies.  These other fees are typically non-recurring, are recognized as revenue when earned and are generally paid directly to the Adviser by the borrower or potential borrower upon closing of the investment.  The services the Adviser provides to portfolio companies vary by investment, but generally include a broad array of services, such as investment banking services, arranging bank and equity financing, structuring financing from multiple lenders and investors, reviewing existing credit facilities, restructuring existing investments, raising equity and debt capital, consulting turnaround management, merger and acquisition services and recruiting new management personnel.  When the Adviser receives fees for these services, 50% of certain of those fees are credited against the base management fee that the Company pays to its Adviser, while others are reimbursements for costs associated with the engagement.  Any services of this nature subsequent to the closing would typically generate a separate fee at the time of completion.

 

The Adviser also receives fees for monitoring and reviewing portfolio company investments.  These fees are recurring and are generally paid annually or quarterly in advance to the Adviser throughout the life of the investment.  Fees of this nature are recorded as revenue by the Adviser when earned and are not credited against the base management fee.

 

The Company may receive fees for non-recurring consulting or origination and closing services it provides to portfolio companies through its Adviser. These fees are paid directly to the Company and are recognized as revenue upon closing of the services provided and are reported as fee income in the consolidated statements of operations.

 

As of September 30, 2009 and 2008, Other Assets in the accompanying consolidated statements of assets and liabilities included $1,529 and $560, respectively, of reimbursements for non-recurring costs incurred on behalf of the portfolio companies.

 

Realized Gain or Loss and Unrealized Appreciation or Depreciation of Portfolio Investments

 

Gains or losses on the sale of investments are calculated by using the specific identification method.  Realized gain or loss is recognized when an investment is disposed of and is computed as the difference between the Company’s cost basis in the investment at the disposition date and the net proceeds received from such disposition.  Unrealized appreciation or depreciation displays the difference between the fair market value of the investment and the cost basis of such investment.  Unlike banks, the Company is not permitted to provide a general reserve for anticipated loan losses.  Instead, the Company must determine the fair value of each individual investment on a quarterly basis and record changes in fair value as unrealized appreciation or depreciation in its consolidated statement of operations.

 

Deferred Finance Costs

 

Costs associated with the Company’s line of credit facility with Key Equipment Finance Inc. are deferred and amortized over the life of the credit facility, generally for a period of one year.  These costs are amortized in the consolidated statement of operations as amortization of deferred financing fees using the straight line method, which closely approximates the effective interest method.

 

Investment Advisory and Management Agreement with Gladstone Management Corporation

 

The Company is externally managed pursuant to contractual arrangements with its Adviser and a wholly-owned subsidiary of the Adviser, Gladstone Administration, LLC (the “Administrator”), under which its Adviser and Administrator employ all of the Company’s personnel and pay its payroll, benefits, and general expenses directly.  On October 1, 2006, the Company entered into an amended and restated investment advisory agreement (the “Advisory Agreement”) with the Adviser and an administration agreement (the “Administration Agreement”) with the Administrator.  (Please refer to Note 4. Related Party Transactions ).

 

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Under the Advisory Agreement, the Company pays a 2% annual base management fee computed on the basis of the Company’s average gross assets, which are total assets, including investments made with the proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the two most recently completed calendar quarters, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.  During the fiscal year ended September 30, 2007, the Adviser’s board of directors waived the amount of the fee on senior syndicated loans from an annual rate of 2% to 0.5%.  Effective April 1, 2007, when the Company’s Adviser receives fees from the Company’s portfolio companies, such as investment banking fees, structuring fees or executive recruiting services fees, 50%  of certain of these fees will be credited against the base management fee that the Company would otherwise be required to pay to the Company’s Adviser.  Prior to April 1, 2007, certain of such fees were 100% credited against the 2% base management fee.

 

In addition, the Company’s Adviser services the loans held by Business Loan, in return for which the Adviser receives a 1.5% annual fee based on the monthly aggregate balance of loans held by Business Loan.  Since the Company owns these loans, all loan servicing fees paid to the Adviser are also credited directly against the 2% base management fee.

 

The incentive fee consists of two parts: an income-based incentive fee and a capital gains-based incentive fee. The income-based incentive fee rewards the Adviser if the Company’s quarterly net investment income (before giving effect to the incentive fee) exceeds 1.75% of the Company’s net assets.  The Adviser will receive an annual capital gains-based incentive fee of 20% of the Company’s realized capital gains (net of realized capital losses and unrealized capital depreciation).

 

Beginning in April 2006, the Company’s Board of Directors has accepted from the Adviser unconditional and irrevocable voluntary waivers on a quarterly basis to reduce the annual 2.0% base management fee on senior syndicated loan participations to 0.5%, to the extent that proceeds resulting from borrowings were used to purchase such syndicated loan participations. These waivers were applied through September 30, 2009, and any waived fees may not be recouped by the Adviser in the future.

 

Administration Agreement with Gladstone Administration, LLC

 

The Company has entered into the Administration Agreement with the Administrator, a wholly owned subsidiary of the Adviser, which is controlled by the Company’s chairman and chief executive officer. Pursuant to the Administration Agreement, the Administrator furnishes the Company with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities and performs, or oversees the performance of the Company’s required administrative services. Such required administrative services include, among other things, being responsible for the financial records which the Company is required to maintain and preparing reports to the Company’s stockholders and reports filed with the Securities and Exchange Commission.

 

The Administration Agreement requires the Company to reimburse the Administrator for the performance of its obligations under the Administration Agreement. The reimbursement is based upon the allocable portion of the Administrator’s overhead, including, but not limited to, rent and the allocable portion of salaries and benefits of the Company’s chief financial officer, controller, chief compliance officer, internal counsel, treasurer and their respective staff.

 

Federal Income Taxes

 

The Company intends to continue to qualify for treatment as a RIC under subchapter M of the Code. As a RIC, the Company will not be subject to federal income tax on the portion of its taxable income and gains distributed to stockholders. To qualify as a RIC, the Company must meet certain source-of-income, asset diversification, and annual distribution requirements.  Under the annual distribution requirement, the Company is required to distribute at least 90% of its investment company taxable income, as defined by the Code. The Company intends to distribute at least 90% of its ordinary income, and as a result, no income tax provisions have been recorded. The Company may, but does not intend to, pay out a return of capital.

 

ASC 740-10, “Income Taxes” requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authorities.  Tax positions not deemed to satisfy the “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the current year.  As of September 30, 2009 tax years 2006, 2007, 2008 and 2009 were open.  The Company has evaluated the implications of ASC 870, for all open tax years and in all major tax jurisdictions, and determined that there is no material impact on the consolidated financial statements.

 

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Dividends

 

Distributions to stockholders are recorded on the ex-dividend date. The Company is required to pay out at least 90% of its ordinary income and short-term capital gains for each taxable year as a dividend to its stockholders in order to maintain its status as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. It is the policy of the Company to pay out as a dividend up to 100% of those amounts. The amount to be paid out as a 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 and is paid out monthly over the course of the respective quarter. At year-end the Company may pay a bonus dividend, in addition to the monthly 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 may retain long-term capital gains, if any, and not pay them out as dividends.  If the Company decides to retain long-term capital gains, the portion of the retained capital gains will be subject to a 35% tax.

 

Recent Accounting Pronouncements

 

On July 1, 2009, the FASB issued FASB Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles,” which has been codified as ASC 105-10, “Generally Accepted Accounting Principles” (“ASC 105-10”) (the “Codification”).  ASC 105-10 establishes the exclusive authoritative reference for U.S. GAAP for use in financial statements, except for SEC rules and interpretive releases, which are also authoritative GAAP for SEC registrants. The Codification does not change current U.S. GAAP but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place.  All existing accounting standard documents have been superseded and all other accounting literature not included in the Codification is considered non-authoritative.   The Codification was effective for the Company during the year ended September 30, 2009 and did not have an impact on its financial condition or results of operations.  The Company has included the references to the Codification, as appropriate, in these consolidated financial statements.

 

ASC 320, “Investments-Debt and Equity Securities” was issued to make the guidance on other-than-temporary impairment more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.  ASC 320-10  requires significant additional disclosures for both annual and interim periods, including the amortized cost basis of available-for-sale and held-to-maturity debt, the methodology and key inputs used to measure the credit portion of other-than-temporary impairment, and a roll forward of amounts recognized in earnings for securities by major security type.  ASC 320-10 requires that entities identify major security classes consistent with how the securities are managed based on the nature and risks of the security, and also expands, for disclosure purposes, the list of major security types identified in ASC 320. ASC 320-10 is effective for interim and annual reporting periods ending after June 15, 2009.  The Company’s adoption of this pronouncement did not have a material impact on the consolidated financial statements.

 

ASC 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements.  ASC 820-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The Company’s adoption of this pronouncement did not have a material impact on the consolidated financial statements.

 

ASC 820-10-35-15A, “Fair Value Measurements and Disclosures,” further clarifies the application of the standard in a market that is not active. More specifically, ASC 820-10-35-51E states that significant judgment should be applied to determine if observable data in a dislocated market represents forced liquidations or distressed sales and are not representative of fair value in an orderly transaction.  ASC 820-10-35-55A provides further guidance that the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.  In addition, ASC 820-10-35-55B provides guidance on the level of reliance of broker quotes or pricing services when measuring fair value in a non active market stating that less reliance should be placed on a quote that does not reflect actual market transactions and a quote that is not a binding offer.  The guidance is effective upon issuance for all financial statements that have not been issued and any changes in valuation techniques as a result of applying the guidance are accounted for as a change in accounting estimate. The Company’s adoption of this pronouncement did not have a material impact on the consolidated financial statements.

 

ASC 820-10-35-51A, “Fair Value Measurements and Disclosures,” provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased when compared with normal market activity for the asset or liability.  ASC 820-10-35-51E provides guidance on identifying circumstances that indicate

 

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when a transaction is not orderly.  ASC 820-10-35-51D emphasizes that the fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.  The guidance is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively.  Early adoption is permitted for periods ending after March 15, 2009. The Company’s adoption of this pronouncement did not have a material impact on the consolidated financial statements.

 

ASC 825, “Financial Instruments,” requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements, whether recognized or not recognized in the statement of financial position. The guidance in ASC 825 is effective for interim periods ending after June 15, 2009. The Company adopted this pronouncement during the quarter ended June 30, 2009, and the adoption had no material impact on the Company’s consolidated financial statements .

 

ASC 855-10-50, “Subsequent Events,” was issued in an effort to incorporate accounting guidance that originated as auditing standards into the body of authoritative literature issued by the FASB.  Moving the accounting requirements out of the auditing literature and into the accounting literature is consistent with the FASB’s objective to codify all authoritative U.S. accounting guidance related to a particular topic in one place.  It also provided an opportunity to consider international convergence issues.  The FASB has established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  Although there is new terminology, the standard is based on the same principles as those that previously existed in the auditing standards.  The new standard, which includes a required disclosure of the date through which an entity has evaluated subsequent events, is effective for interim or annual periods ending after June 15, 2009.  The Company’s adoption of this pronouncement did not have a material impact on the consolidated financial statements.

 

ASC 860, “Transfers and Servicing,” removes the concept of a qualifying special-purpose entity (“QSPE”) and removes the exception from applying to variable interest entities that are QSPEs. This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This statement is effective for fiscal years beginning after November 15, 2009, and is effective for the Company’s fiscal year beginning October 1, 2010. The Company is currently evaluating the impact of adopting this standard on the consolidated financial statements.

 

ASC 845, “Variable Interest Entities” amends the accounting and disclosure requirements for the consolidation of variable interest entities (“VIEs”). The elimination of the concept of a QSPE, as discussed above, removes the exception from applying the consolidation guidance within this amendment. This amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. The amendment also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise’s involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise’s financial statements. Finally, an enterprise will be required to disclose significant judgments and assumptions used to determine whether or not to consolidate a VIE. This amendment is effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company is currently evaluating the impact of adopting this standard on the consolidated financial statements.

 

Note 3. Investments

 

The Company adopted guidance for fair value measurements on October 1, 2008. In part, this guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. The guidance provides a consistent definition of fair value that focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. The guidance also establishes the following three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

 

·                  Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets;

 

·                  Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current,

 

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little public information exists or instances where prices vary substantially over time or among brokered market makers; and

 

·                  Level 3— inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect the Company’s own assumptions that market participants would use to price the asset or liability based upon the best available information.

 

As of September 30, 2009, all of the Company’s assets were valued using Level 3 inputs.

 

The following table presents the financial instruments carried at fair value as of September 30, 2009, by caption on the accompanying consolidated statements of assets and liabilities for each of the three levels of hierarchy:

 

 

 

As of September 30, 2009

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total Fair Value
Reported in
Consolidated Statements of
Assets and Liabilities

 

Senior Term Debt

 

$

 

$

 

$

213,106

 

$

213,106

 

Senior Subordinated Term Debt

 

 

 

105,794

 

105,794

 

Preferred Equity Securities

 

 

 

 

 

Common Equity Securities

 

 

 

2,069

 

2,069

 

Total investments at fair value

 

$

 

$

 

$

320,969

 

$

320,969

 

 

Changes in Level 3 Fair Value Measurements

 

The following table provides a roll-forward in the changes in fair value during the year from September 30, 2008 to September 30, 2009 for all investments for which the Company determines fair value using unobservable (Level 3) factors. When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated by external sources). Accordingly, the losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology.

 

Fair value measurements using unobservable data inputs (Level 3)

 

 

 

Non-Control/
Non-Affiliate
Investments

 

Control
Investments

 

Derivative

 

Total

 

Fair value as of September 30, 2008

 

$

407,153

 

$

780

 

$

 

$

407,933

 

Realized losses (a)

 

(26,411

)

 

(304

)

(26,715

)

Reversal of prior period depreciation on realization (b)

 

24,531

 

 

304

 

24,835

 

Unrealized (depreciation) appreciation (b)

 

(16,582

)

1,564

 

 

(15,018

)

New investments, repayments, and settlements, net (c)

 

(101,694

)

31,628

 

 

(70,066

)

Transfers in (out) of Level 3

 

 

 

 

 

Fair value as of September 30, 2009

 

$

286,997

 

$

33,972

 

$

 

$

320,969

 

 


(a)          Included in net realized loss on investments and realized gain on settlement of derivative on the accompanying consolidated statement of operations for the year ended September 30, 2009.

(b)         Included in unrealized appreciation (depreciation) on investments on the accompanying consolidated statement of operations for the year ended September 30, 2009.

(c)          Includes increases in the cost basis of investments resulting from new portfolio investments, the amortization of discounts, premiums and closing fees as well as decreases in the cost basis of investments resulting from principal repayments or sales.

 

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Non-Control/Non-Affiliate Investments

 

At September 30, 2009 and 2008, the Company held Non-Control/Non-Affiliate investments in the aggregate of approximately $286,997 and $407,153, at fair value, respectively.

 

Control and Affiliate Investments

 

At September 30, 2009 and September 30, 2008, the Company held Control investments in the aggregate of approximately $33,972 and $780, at fair value, respectively.  At September 30, 2009, the Control investments were comprised of BERTL, Inc. (“BERTL”), Clinton Holdings, LLC (“Clinton”), Defiance Integrated Technologies, Inc. (“Defiance”), Lindmark Acquisition, LLC (“Lindmark”), LYP Holdings Corp. (“LYP Holdings”), U.S. Healthcare Communications, Inc. (“U.S. Healthcare”) and Western Directories, Inc. (“Western Directories”).

 

·                  BERTL: The Company originally purchased a past due debt instrument in MCA Communications, LLC, and the Company accepted a deed in lieu of foreclosure in satisfaction of BERTL’s obligations under the debt instrument in September 2007.  BERTL is a web-based evaluator of digital imaging products.

 

·                  Clinton: In September 2009, the Company took control of certain Clinton entities by exercising contractual rights under the investment documents.  Clinton is a distributor of aluminum sheets and stainless steel.

 

·                  Defiance: In July 2009, the Company acquired from the previous owner certain assets of Defiance Acquisition Corp., consisting of tangible and intangible personal property.  The Company acquired these assets through a newly formed subsidiary, Defiance, and intends to continue the business under its control.  Defiance is a manufacturer of trucking parts.

 

·                  Lindmark: In March 2009, the Company acquired from the previous owner certain assets of Lindmark Outdoor Advertising, LLC, consisting of all tangible and intangible personal property.  The Company acquired these assets through a newly formed subsidiary, Lindmark, and intends to continue the business under its control.  Lindmark is a billboard advertising company.

 

·                  LYP Holdings: In July 2008, the Company acquired from the previous owner certain assets of LocalTel, Inc., consisting of all tangible and intangible personal property.  The Company acquired these assets through a newly formed subsidiary, LYP Holdings, and intends to continue the business under its control.  LYP Holdings is a publisher of community yellow page directories.

 

·                  U.S. Healthcare: The Company offered at public sale certain assets of U.S. Healthcare Communications, LLC in January 2008, consisting generally of all fixtures of tangible and intangible personal property.  The Company acquired these assets in the sale through a newly formed subsidiary, U.S. Healthcare, and intends to continue the business under its control.  U.S. Healthcare is a trade magazine operator.

 

·                  Western Directories: In August 2008, the Company acquired from the previous owner certain assets of West Coast Yellow Pages, Inc., consisting of all tangible and intangible personal property.  The Company acquired these assets through a newly formed subsidiary, Western Directories, and intends to continue the business under its control.  Western Directories is a publisher of community yellow page directories.

 

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Investment Concentrations

 

At September 30, 2009, the Company had aggregate investments in 48 portfolio companies and approximately 66.1% of the aggregate fair value of such investments was senior term debt, approximately 33.0% was senior subordinated term debt, no investments were in junior subordinated debt and approximately 0.9% was in equity securities.  The following table outlines the Company’s investments by type at September 30, 2009 and September 30, 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Senior Term Debt

 

$

240,172

 

$

212,290

 

$

297,910

 

$

265,297

 

Senior Subordinated Term Debt

 

118,743

 

105,794

 

157,927

 

140,676

 

Preferred Equity Securities

 

2,028

 

 

1,584

 

 

Common Equity Securities

 

3,450

 

2,885

 

3,449

 

1,960

 

 

 

 

 

 

 

 

 

 

 

Total Investments

 

$

364,393

 

$

320,969

 

$

460,870

 

$

407,933

 

 

Investments at fair value consisted of the following industry classifications as of September 30, 2009 and September 30, 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

 

 

Percentage

 

 

 

Percentage

 

Industry Classification

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Aerospace & Defense

 

$

 1,857

 

0.6

%

0.7

%

$

 4,192

 

1.0

%

1.6

%

Automobile

 

7,999

 

2.5

%

3.2

%

5,055

 

1.2

%

1.9

%

Broadcast (TV & Radio)

 

43,403

 

13.5

%

17.4

%

52,336

 

12.8

%

19.2

%

Buildings & Real Estate

 

12,882

 

4.0

%

5.2

%

13,519

 

3.3

%

5.0

%

Cargo Transport

 

5,427

 

1.7

%

2.2

%

15,805

 

3.9

%

5.8

%

Chemicals, Plastics & Rubber

 

15,884

 

4.9

%

6.4

%

16,375

 

4.0

%

6.0

%

Diversified/Conglomerate Manufacturing

 

1,236

 

0.4

%

0.5

%

3,195

 

0.8

%

1.2

%

Diversified Natural Resources, Precious Metals & Minerals

 

13,589

 

4.2

%

5.5

%

12,936

 

3.2

%

4.8

%

Electronics

 

27,899

 

8.7

%

11.2

%

35,208

 

8.6

%

13.0

%

Farming & Agriculture

 

9,309

 

2.9

%

3.7

%

10,031

 

2.5

%

3.7

%

Finance

 

 

 

 

1,812

 

0.4

%

0.7

%

Healthcare, Education & Childcare

 

58,054

 

18.1

%

23.3

%

76,642

 

18.8

%

28.2

%

Home & Office Furnishings

 

16,744

 

5.2

%

6.7

%

15,379

 

3.8

%

5.7

%

Leisure, Amusement, Movies &   Entertainment

 

5,091

 

1.6

%

2.0

%

8,097

 

2.0

%

3.0

%

Machinery

 

9,202

 

2.9

%

3.7

%

9,834

 

2.4

%

3.6

%

Mining, Steel, Iron & Non-Precious Metals

 

21,926

 

6.8

%

8.8

%

25,095

 

6.2

%

9.2

%

Personal & Non-durable Consumer Products

 

8,714

 

2.7

%

3.5

%

9,703

 

2.4

%

3.6

%

Printing & Publishing

 

37,864

 

11.8

%

15.2

%

60,440

 

14.8

%

22.2

%

Retail Stores

 

23,669

 

7.4

%

9.5

%

22,800

 

5.6

%

8.4

%

Textiles & Leather

 

220

 

0.1

%

0.1

%

9,479

 

2.3

%

3.5

%

Total

 

$

320,969

 

100.0

%

 

 

$

407,933

 

100.0

%

 

 

 

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The investments at fair value consisted of the following geographic regions of the United States as of September 30, 2009 and September 30, 2008:

 

 

 

September 30, 2009

 

September 30, 2008

 

 

 

 

 

Percentage

 

 

 

Percentage

 

Geographic
Region

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Fair Value

 

Total
Investments

 

Net
Assets

 

Midwest

 

$

172,263

 

53.7

%

69.2

%

$

206,271

 

50.6

%

75.9

%

West

 

65,678

 

20.5

%

26.4

%

85,294

 

20.9

%

31.4

%

Southeast

 

34,708

 

10.8

%

13.9

%

49,374

 

12.1

%

18.2

%

Mid-Atlantic

 

28,437

 

8.9

%

11.4

%

50,807

 

12.4

%

18.7

%

Northeast

 

14,170

 

4.4

%

5.7

%

10,617

 

2.6

%

3.9

%

U.S. Territory

 

5,713

 

1.8

%

2.3

%

5,570

 

1.4

%

2.0

%

 

 

$

320,969

 

100.0

%

 

 

$

407,933

 

100.0

%

 

 

 

The geographic region depicts the location of the headquarters for the Company’s portfolio companies.  A portfolio company may have a number of other locations in other geographic regions.

 

Investment Principal Repayment

 

The following table summarizes the contractual principal repayment and maturity of the Company’s investment portfolio by fiscal year, assuming no voluntary prepayments:

 

Fiscal Year Ending September 30,

 

Amount

 

2010

 

$

50,033

 

2011

 

86,116

 

2012

 

72,836

 

2013

 

123,225

 

2014

 

19,347

 

Thereafter

 

6,851

 

Total Contractual Repayments

 

358,408

 

Investments in equity securities

 

5,478

 

Unamortized premiums, discounts and investment acquisition costs on debt securities

 

507

 

Total

 

$

364,393

 

 

Note 4. Related Party Transactions

 

Loans to Employees

 

The Company provided loans to employees of the Adviser, who at the time of the loans were joint employees of the Company and either the Adviser, or the Company’s previous investment adviser, Gladstone Capital Advisers, Inc., for the exercise of options under the Company’s Amended and Restated 2001 Equity Incentive Plan (the “2001 Plan”), which has since been terminated and is no longer in operation.  The loans require the quarterly payment of interest at the market rate in effect at the date of issue, have varying terms not exceeding ten years and have been recorded as a reduction of net assets.  The loans are evidenced by full recourse notes that are due upon maturity or 60 days following termination of employment, and the shares of common stock purchased with the proceeds of the loan are posted as collateral.  No new loans were issued during the fiscal years ended September 30, 2009 and 2008, and the Company received $6, $56 and $301 of principal repayments during the fiscal years ended September 30, 2009, 2008 and 2007, respectively.  The Company recognized interest income from all employee stock option loans of $468, $471 and $526, respectively, for the fiscal years ended September 30, 2009, 2008 and 2007.  The outstanding principal balances due on all employee stock option loans at September 30, 2009 and 2008 were $9,019 and $9,175, respectively.

 

During the three months ended September 30, 2009, $150 of an employee stock option loan to a former employee of the Adviser was transferred from notes receivable — employees to other assets in connection with the termination of his employment with the Adviser and the later amendment of the loan.  The interest on the loan from the time the employee stopped working for the Adviser is included in other income on the consolidated statement of operations.

 

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In July 2007, a loan to an employee, and the shares pledged as collateral under the loan under a related pledge agreement, were cancelled due to an event of default which was triggered by a stop loss provision in the employee’s promissory note and pledge agreement.  The provision specified that in the event that the aggregate value of the shares pledged under the note, as determined by the intra-day trading price of the shares on Nasdaq, became less than or equal to the aggregate outstanding principal amount of the note, the note would become immediately due and collectible through cancellation of the shares under the terms of the pledge agreement.  The Company cancelled 37,109 shares which, in turn, cancelled via a non-cash transaction the remaining outstanding principal of the note of approximately $717.

 

Investment Advisory and Management Agreement

 

The Company is externally managed by the Adviser, which is controlled by our chairman and chief executive officer, under a contractual investment advisory agreement.  On October 1, 2006, the Company entered into the Advisory Agreement.  Under the Advisory Agreement, the Company pays the Adviser an annual base management fee of 2% of its average total assets, which is defined as total assets less cash and cash equivalents pledged to creditors calculated as of the end of the two most recently completed fiscal quarters and also consists of a two-part incentive fee.

 

The first part of the incentive fee is an income-based incentive fee which rewards the Adviser if the Company’s quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of the Company’s net assets (the “hurdle rate”). The Company pays the Adviser an income incentive fee with respect to its pre-incentive fee net investment income in each calendar quarter as follows:

 

·             no incentive fee in any calendar quarter in which its pre-incentive fee net investment income does not exceed the hurdle rate (7% annualized);

·             100% of pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in any calendar quarter (8.75% annualized); and

·             20% of the amount of pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized).

 

The second part of the incentive fee is a capital gains-based incentive fee that is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date) and equals 20% of the Company’s realized capital gains as of the end of the fiscal year. In determining the capital gains-based incentive fee payable to the Adviser, the Company calculates the cumulative aggregate realized capital gains and cumulative aggregate realized capital losses since the Company’s inception, and the aggregate unrealized capital depreciation as of the date of the calculation, as applicable, with respect to each of the investments in its portfolio.

 

The Adviser’s board of directors voluntarily waived, for the fiscal quarters within the fiscal year ended September 30, 2009, the annual 2.0% base management fee to 0.5% for senior syndicated loan participations and also waived in its entirety the incentive fee due for the quarter ended September 30, 2009.

 

In addition to the base management and incentive fees under the Advisory Agreement, certain fees received by the Adviser from the Company’s portfolio companies are paid by the Adviser and credited under the Advisory Agreement.  Effective April 1, 2007, 50% of certain of the fees received by the Adviser are credited against the base management fee, whereas prior to such date 100% of those fees were credited against the base management fee.  In addition, the Company continues to pay its direct expenses including, but not limited to, directors’ fees, legal and accounting fees, stockholder related expenses, and directors and officers insurance under the Advisory Agreement.

 

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The following tables summarize the management fees, incentive fees and associated credits reflected in the accompanying consolidated statements of operations:

 

 

 

Year Ended September 30,

 

 

 

2009

 

2008

 

2007

 

Base management fee (1)

 

$

2,005

 

$

2,212

 

$

2,402

 

Credit for fees received by Adviser from the portfolio companies

 

(89

)

(1,678

)

(1,660

)

Fee reduction for the voluntary, irrevocable waiver of 2% fee on senior syndicated loans to 0.5% per annum (2)

 

(265

)

(408

)

(481

)

Net base management fee

 

$

1,651

 

$

126

 

$

261

 

 

 

 

 

 

 

 

 

Incentive fee

 

$

3,326

 

$

5,311

 

$

4,608

 

Credit from voluntary, irrevocable waiver issued by Adviser’s board of directors

 

(3,326

)

(5,311

)

(3,830

)

Net incentive fee

 

$

 

$

 

$

778

 

 

 

 

 

 

 

 

 

Credit for fees received by Adviser from the portfolio companies

 

$

(89

)

$

(1,678

)

$

(1,660

)

Fee reduction for the voluntary, irrevocable waiver of 2% fee on senior syndicated loans to 0.5% per annum

 

(265

)

(408

)

(481

)

Incentive fee credit

 

(3,326

)

(5,311

)

(3,830

)

Credit to base management and incentive fees from Adviser

 

$

(3,680

)

$

(7,397

)

$

(5,971

)

 


(1)          Base management fee is net of loan servicing fees per the terms of the Advisory Agreement.

(2)          The board of our Adviser voluntarily, irrevocably and unconditionally waived, for the year ended September 30, 2009 and 2008, the annual 2.0% base management fee to 0.5% for senior syndicated loan participations.  Fees waived cannot be recouped by the Adviser in the future.

 

Overall, the base management fee due to the Adviser cannot exceed 2.0% of total assets (as reduced by cash and cash equivalents pledged to creditors) during any given fiscal year.  Amounts included in Due to Adviser in the accompanying consolidated statements of assets and liabilities were as follows:

 

 

 

September 30,
2009

 

September 30,
2008

 

Unpaid base management fee to Adviser

 

$

617

 

$

83

 

Unpaid loan servicing fees to Adviser

 

217

 

374

 

Total Due to Adviser

 

$

834

 

$

457

 

 

As of September 30, 2009, Due from Adviser totaled $69, which included reimbursements for non-recurring costs incurred on behalf of the portfolio companies.

 

Loan Servicing and Portfolio Company Fees

 

The Adviser also services the loans held by Business Loan, in return for which it receives a 1.5% annual fee based on the monthly aggregate outstanding balance of the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loan servicing fees paid to the Adviser have been and continue to be treated as reductions directly against the 2% management fee, under the Advisory Agreement.  For fiscal years ended September 30, 2009 and 2008, these loan servicing fees totaled $5,620 and $6,117, respectively, all of which were deducted against the 2% base management fee in order to derive the base management fee, which is presented as the line item Base management fee in the accompanying consolidated statements of operations.  As of September 30, 2009 and 2008, the Company owed $217 and $374, respectively, of unpaid loan servicing fees to the Adviser, which are recorded in Fees due to Adviser in the accompanying consolidated statements of assets and liabilities.

 

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Administration Agreement

 

Under the Administration Agreement, the Company pays separately for administrative services.  The Administration Agreement provides for payments equal to the Company’s allocable portion of the Administrator’s overhead expenses in performing its obligations under the Administration Agreement, including, but not limited to, rent for employees of the Administrator, and the allocable portion of salaries and benefits expenses of the Company’s chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.  For the fiscal years ended September 30, 2009 and 2008, the Company recorded administration fees of $872 and $985, respectively.  As of September 30, 2009 and 2008, the Company owed $216 and $247, respectively, of unpaid administration fees to the Adviser, which is recorded in the Fee due to Administrator in the accompanying consolidated statements of assets and liabilities.  On July 8, 2009, the Company’s Board of Directors approved the renewal of its Administration Agreement with the Administrator through August 31, 2010.

 

Note 5. Line of Credit

 

On May 15, 2009, the Company, through its wholly-owned subsidiary, Gladstone Business Loan, LLC, entered into a third amended and restated credit agreement providing for a $127,000 revolving line of credit arranged by Key Equipment Finance Inc. “(KEF”) as administrative agent, replacing Deutsche Bank AG as administrative agent (the “KEF Facility”).  Branch Banking and Trust Company (“BB&T”) also joined the KEF Facility as a committed lender.  In connection with entering into the KEF Facility, the Company borrowed $35,881 under the KEF Facility to make a final payment to Deutsche Bank AG in satisfaction of all unpaid principal and interest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to $200,000 through the addition of other committed lenders to the facility.  Without the addition of other committed lenders, the KEF Facility provides a total commitment of $127,000 through December 31, 2009, $102,000 from January 1, 2010 to May 11, 2010 and $77,000 thereafter.  The KEF Facility matures on May 14, 2010 and, if the facility is not renewed or extended by this date, all principal and interest will be due and payable within one year of maturity. In addition, if the facility is not renewed, the Company’s lenders have the right to apply all principal and interest collections to amounts outstanding under the KEF Facility.  Advances under the KEF Facility will generally bear interest at the 30-day LIBOR or the commercial paper rate (subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of 0.75% per annum on undrawn amounts.  As of September 30, 2009, there was a cost basis of approximately $83,000 of borrowings outstanding under the KEF Facility at an average rate of 7.36%, and the remaining borrowing capacity under the KEF Facility was $44,000.  Available borrowings are subject to various constraints imposed under the KEF Facility, based on the aggregate loan balance pledged by Business Loan. Interest is payable monthly during the term of the KEF Facility.

 

In October and November of 2009, the Company reduced the size of the KEF Facility by $15,000 and $5,000, respectively, from $127,000 to $107,000.  See further discussion in Note 12, Subsequent Events.

 

The KEF Facility contains covenants that require Business Loan to maintain its status as a separate entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions), and restrict material changes to the Company’s credit and collection policies.  The facility also limits payments of distributions. Further, the KEF Facility requires the Company to pay distributions only from estimated net investment income.  As a result of that change from its prior credit facility, the Company reduced its distribution from 14 cents per share per month to 7 cents per share per month. As of September 30, 2009, Business Loan was in compliance with all of the facility covenants.

 

The Company elected to apply ASC 825, “Financial Instruments,” specifically for the KEF Facility, which was consistent with its application of ASC 820 to its investments.  ASC 825 requires that the Company apply a fair value methodology to the KEF Facility. The Company estimated the fair value of the KEF Facility using estimates of value provided by an independent third party and its own assumptions in the absence of observable market data, including estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date.  The following table presents the KEF Facility carried at fair value as of September 30, 2009, by caption on the accompanying consolidated statements of assets and liabilities for each of the three levels of hierarchy established by ASC 820-10:

 

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As of September 30, 2009

 

 

 

 

 

 

 

 

 

Total Fair Value

 

 

 

 

 

 

 

 

 

Reported in

 

 

 

 

 

 

 

 

 

Consolidated
Statement of

 

 

 

Level 1

 

Level 2

 

Level 3

 

Assets and Liabilities

 

Borrowings under Line of Credit (a)

 

$

 

$

 

$

83,350

 

$

83,350

 

Total

 

$

 

$

 

$

83,350

 

$

83,350

 

 


(a)          Unrealized appreciation of $350 is reported on the accompanying consolidated statements of operations for the year ended September 30, 2009.

 

In conjunction with entering into the KEF Facility, the Company amended a performance guaranty, which remains substantially similar to the form under the previous facility.  The loan documents require the Company to maintain a minimum net worth of $200,000 plus 50% of all equity issuances after May 2009, to maintain “asset coverage” with respect to “senior securities representing indebtedness” of at least 200%, in accordance with Section 18 of the 1940 Act, and to maintain its status as a BDC under the 1940 Act and as a RIC under the Code.  As of September 30, 2009, the Company was in compliance with all covenants under the performance guaranty.

 

The Company’s continued compliance with these covenants, however, depends on many factors, some of which are beyond the Company’s control.  In particular, depreciation in the valuation of its assets, which valuation is subject to changing market conditions that are presently very volatile, affects the Company’s ability to comply with these covenants.  Given the continued deterioration in the capital markets, net unrealized depreciation in the Company’s portfolio may occur in future periods and threaten the Company’s ability to comply with the covenants under the KEF Facility.  Accordingly, there are no assurances that the Company will continue to comply with these covenants.  Failure to comply with these covenants would result in a default which, if the Company is unable to obtain a waiver from the lenders, could accelerate the Company’s repayment obligations under the KEF Facility and thereby have a material adverse impact on its liquidity, financial condition, results of operations and ability to pay distributions.

 

There can be no guarantee that the Company will be able to renew, extend or replace the KEF Facility on terms that are favorable to the Company, or at all.  The Company’s ability to obtain replacement financing will be constrained by current economic conditions affecting the credit markets.  Consequently, any renewal, extension or refinancing of the KEF Facility will likely result in significantly higher interest rates and related charges and may impose significant restrictions on the use of borrowed funds with regard to its ability to fund investments or maintain distributions.  For instance, in connection with the establishment of the Company’s KEF Facility in May 2009, the size of the line was reduced from $162,000 under its prior facility to $127,000 under its KEF Facility and Deutsche Bank AG, who was a committed lender under its prior credit facility elected not to participate in the KEF Facility and withdrew its commitment.  If the Company is not able to renew, extend or refinance the KEF Facility, this would likely have a material adverse effect on its liquidity and ability to fund new investments or pay distributions to its stockholders.  The Company’s inability to pay distributions could result in it failing to qualify as a RIC.  Consequently, any income or gains could become taxable at corporate rates.  If the Company is unable to secure replacement financing, it will be forced to sell certain assets on disadvantageous terms, which may result in realized losses such as those recently recorded in connection with the syndicated loan sales, which resulted in a realized loss of approximately $26,411 during the year ended September 30, 2009.  Such realized losses could materially exceed the amount of any unrealized depreciation on these assets as of the Company’s most recent balance sheet date, which would have a material adverse effect on its results of operations.  In addition to selling assets, or as an alternative, the Company may issue equity in order to repay amounts outstanding under the KEF Facility.  Based on the recent trading prices of its stock, such an equity offering may have a substantial dilutive impact on the Company’s existing stockholders’ interest in the Company’s earnings and assets and voting interest in it.

 

Note 6. Interest Rate Cap Agreement

 

Pursuant to its previous revolving credit facility (the “DB Facility”), the Company had an interest rate cap agreement, with an initial notional amount of $35,000 at a cost of $304 that effectively limited the interest rate on a portion of the borrowings under the line of credit.  The interest rate cap agreement expired in February 2009.

 

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At September 30, 2008, the interest rate cap agreement had a nominal fair market value, which is recorded in other assets on the Company’s consolidated statement of assets and liabilities.  The Company recorded changes in the fair market value of the interest rate cap agreement monthly based on the current market valuation at month end as unrealized depreciation or appreciation on derivative on the Company’s consolidated statement of operations. The agreement provided that the Company’s floating interest rate or cost of funds on a portion of the portfolio’s borrowings would be capped at 5% when the LIBOR was in excess of 5%.  During the year ended September 30, 2009, the Company recorded $304 of loss from the interest rate cap agreement, recorded as a realized loss on the settlement of derivative on the Company’s consolidated statements of operations.  During the year ended September 30, 2008, the Company recorded $7 of income from the interest rate cap agreement, recorded as a realized gain on the settlement of derivative on the Company’s consolidated statements of operations.

 

Note 7. Common Stock Transactions

 

Transactions in common stock were as follows:

 

 

 

Shares

 

Total Value

 

Balance as of September 30, 2007

 

14,762,574

 

$

235,922

 

Issuance of common stock under shelf offerings (1)

 

6,325,000

 

105,374

 

Return of capital statement of position adjustment (2)

 

 

(7,132

)

Balance as of September 30, 2008

 

21,087,574

 

$

334,164

 

Shelf offering costs

 

 

(41

)

Return of capital statement of position adjustment (2)

 

 

(5,899

)

Balance as of September 30, 2009

 

21,087,574

 

$

328,224

 

 


(1)   On October 19, 2007, the Company completed an offering of  2,500,000 shares of its common stock at a price of $18.70 per share, less an underwriting discount of $1.03 per share, or 6%.  On November 19, 2007, the underwriter exercised its over-allotment option and the Company sold an additional 375,000 shares of common stock at the same price.

 

On February 5, 2008, the Company completed an offering of  3,000,000 shares of its common stock at a price of $17.00 per share, less an underwriting discount of $0.935 per share, or 6%.  On February 26, 2008, the underwriter exercised its over-allotment option and the Company sold an additional 450,000 shares of common stock at the same price.

 

(2)   The timing and characterization of certain income and capital gains distributions are determined annually in accordance with federal tax regulations which may differ from GAAP.  These differences primarily relate to items recognized as income for financial statement purposes and realized gains for tax purposes.  As a result, net investment income and net realized gain (loss) on investment transactions for a reporting period may differ significantly from distributions during such period.  Accordingly, the Company made a reclassification among certain of its capital accounts without impacting the net asset value of the Company.

 

Note 8. Net Increase (Decrease) in Net Assets Resulting from Operations per Share

 

The following table sets forth the computation of basic and diluted net increase (decrease) in net assets resulting from operations per share for the fiscal years ended September 30, 2009, 2008 and 2007:

 

 

 

Year ended September 30,

 

 

 

2009

 

2008

 

2007

 

Numerator for basic and diluted net increase (decrease) in net assets resulting from operations per share

 

$

3,783

 

$

(21,262

)

$

14,952

 

 

 

 

 

 

 

 

 

Denominator for basic and diluted shares

 

21,087,574

 

19,699,796

 

13,173,822

 

Basic net increase (decrease) in net assets resulting from operations per common share

 

$

0.18

 

$

(1.08

)

$

1.13

 

 

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Note 9. Distributions

 

Distributions

 

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, three monthly dividends are declared each quarter.  At year-end the Company may pay a bonus dividend, in addition to the monthly dividends, to ensure that it has paid out at least 90% of its ordinary income and realized net short-term capital gains for the year.  Long-term capital gains are composed of success fees, prepayment fees and gains from the sale of securities held for one year or more. The Company may decide to retain long-term capital gains from the sale of securities, if any, and not pay them out as dividends, however, the Board of Directors may decide to declare and pay out capital gains during any fiscal year.  If the Company decides to retain long-term capital gains, the portion of the retained capital gains will be subject to a 35% tax.  The tax characteristics of all dividends will be reported to stockholders on Form 1099 at the end of each calendar year.  The following table lists the per share dividends paid for the fiscal years ended September 30, 2009 and 2008:

 

Fiscal
Year

 

Record Date

 

Payment Date

 

Dividend per
Share

 

2009

 

October 23, 2008

 

October 31, 2008

 

$

0.140

 

 

 

November 19, 2008

 

November 28, 2008

 

0.140

 

 

 

December 22, 2008

 

December 31, 2008

 

0.140

 

 

 

January 22, 2009

 

January 31, 2009

 

0.140

 

 

 

February 19, 2009

 

February 27, 2009

 

0.140

 

 

 

March 23, 2009

 

March 30, 2009

 

0.140

 

 

 

April 27, 2009

 

May 8, 2009

 

0.070

 

 

 

May 29, 2009

 

June 11, 2009

 

0.070

 

 

 

June 22, 2009

 

June 30, 2009

 

0.070

 

 

 

July 23, 2009

 

July 31, 2009

 

0.070

 

 

 

August 21, 2009

 

August 31, 2009

 

0.070

 

 

 

September 22, 2009

 

September 30, 2009

 

0.070

 

 

 

 

 

Annual Total:

 

$

1.260

 

 

 

 

 

 

 

 

 

2008

 

October 23, 2007

 

October 31, 2007

 

$

0.140

 

 

 

November 21, 2007

 

November 30, 2007

 

0.140

 

 

 

December 20, 2007

 

December 31, 2007

 

0.140

 

 

 

January 23, 2008

 

January 31, 2008

 

0.140

 

 

 

February 21, 2008

 

February 29, 2008

 

0.140

 

 

 

March 21, 2008

 

March 31, 2008

 

0.140

 

 

 

April 22, 2008

 

April 30, 2008

 

0.140

 

 

 

May 21, 2008

 

May 30, 2008

 

0.140

 

 

 

June 20, 2008

 

June 30, 2008

 

0.140

 

 

 

July 23, 2008

 

July 31, 2008

 

0.140

 

 

 

August 21, 2008

 

August 29, 2008

 

0.140

 

 

 

September 22, 2008

 

September 30, 2008

 

0.140

 

 

 

 

 

Annual Total:

 

$

1.680

 

 

Aggregate distributions declared and paid for the 2009 and 2008 fiscal years were approximately $26,570 and $33,379, respectively, which were declared based on an estimate of net investment income for each year.

 

Distribution of Income and Gains  Net investment income of the Company is declared and distributed to stockholders monthly.  Net realized gains from investment transactions, in excess of available capital loss carryforwards, would be taxable to the Company if not distributed, and, therefore, generally will be distributed at least annually.

 

The timing and characterization of certain income and capital gains distributions are determined annually in accordance with federal tax regulations which may differ from GAAP.  These differences primarily relate to items recognized as income for

 

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financial statement purposes and realized gains for tax purposes.  As a result, net investment income and net realized gain (loss) on investment transactions for a reporting period may differ significantly from distributions during such period.  Accordingly, the Company may periodically make reclassifications among certain of its capital accounts without impacting the net asset value of the Company.

 

The Company’s components of net assets on a tax-basis were as follows:

 

 

 

Year Ended September 30,

 

 

 

2009

 

2008

 

Post-October tax loss

 

$

(26,354

)

$

 

 

In addition, the tax character of distributions paid to stockholders by the Company is summarized as follows:

 

 

 

Year Ended September 30,

 

 

 

2009

 

2008

 

2007

 

Distributions from Ordinary Income

 

$

20,795

 

$

26,110

 

$

19,444

 

Distributions from Long Term Capital Gains

 

27

 

120

 

2,697

 

Distributions from Tax Return on Capital

 

5,748

 

7,149

 

 

Total Distributions

 

$

26,570

 

$

33,379

 

$

22,141

 

 

Note 10. Commitments and Contingencies

 

As of September 30, 2009, the Company was not party to any signed and non-binding term sheets for potential investments.

 

Note 11. Federal and State Income Taxes

 

The Company has historically operated, and intends to continue to operate, in a manner to qualify for treatment as a RIC under Subchapter M of the Code.  As a RIC, the Company is not subject to federal or state income tax on the portion of its taxable income and gains distributed to stockholders.  To qualify as a RIC, the Company is required to distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code and as such no income tax provisions have been recorded for the individual companies of Gladstone Capital Corporation and Gladstone Business Loan, LLC.

 

Note 12.  Subsequent Events

 

The Company evaluated all events that have occurred subsequent to September 30, 2009 through the date of the filing of this Form 10-K on November 23, 2009.

 

Distributions

 

On October 6, 2009, the Company’s Board of Directors declared the following monthly cash distributions:

 

Record Date

 

Payment Date

 

Dividend per Share

 

October 22, 2009

 

October 30, 2009

 

$

0.07

 

November 19, 2009

 

November 30, 2009

 

$

0.07

 

December 22, 2009

 

December 31, 2009

 

$

0.07

 

 

Investment Activity

 

Subsequent to September 30, 2009, the Company extended $1,556 in revolver draws and additional investments to existing portfolio companies.  The Company also received $7,839 in scheduled and unscheduled loan repayments.

 

The Company entered into an agreement to sell the Kinetek and Wesco syndicated loans that were held in its portfolio of investments at September 30, 2009 to investors in the syndicated loan market.  The loans had an aggregate cost value of approximately $3,702 and aggregate fair value of $2,781 as of September 30, 2009.  On November 23, 2009, the Company

 

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closed the sale of the loans for $2,781 in net proceeds.  The loans are included in the Company’s consolidated assets as of September 30, 2009 and the loans are valued at the respective sales prices.

 

Line of Credit

 

On October 9, 2009 and November 9, 2009, the Company reduced the size of the KEF Facility by $15,000 and $5,000, respectively, from $127,000 to $107,000.  Under the KEF Facility the first $50,000 of commitment reductions are applied against KEF’s commitment.  Therefore, the entire $20,000 was subtracted from KEF’s commitment, reducing it from $100,000 to $80,000 and leaving BB&T’s commitment unchanged at $27,000.  As a result of the manner in which the Company’s borrowing base is calculated under the KEF Facility, the reductions did not affect the Company’s availability under the KEF Facility.

 

Registration Statement

 

On October 20, 2009, the Company filed a registration statement on Form N-2 with the SEC.  If and when it is declared effective, it will permit the Company to issue, through one or more transactions, up to an aggregate of $300,000 in securities, consisting of common stock, senior common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock, or a combination of these securities.

 

Note 13. Selected Quarterly Data (Unaudited)

 

 

 

Year Ended September 30, 2009

 

 

 

Quarter
Ended
December 31,
2008

 

Quarter
Ended
March 31,
2009

 

Quarter
Ended
June 30,
2009

 

Quarter
Ended
September 30,
2009

 

 

 

 

 

 

 

 

 

 

 

Total Investment Income

 

$

11,808

 

$

10,929

 

$

10,598

 

$

9,283

 

Net Investment Income

 

5,881

 

5,555

 

5,435

 

4,160

 

Net (Decrease) Increase in Net Assets Resulting From Operations

 

(9,103

)

10,280

 

(788

)

3,394

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted Earnings per Weighted Average Common Share

 

$

(0.43

)

$

0.48

 

$

(0.04

)

$

0.17

 

 

 

 

Year Ended September 30, 2008

 

 

 

Quarter
Ended
December 31,
2007

 

Quarter
Ended
March 31,
2008

 

Quarter
Ended
June 30,
2008

 

Quarter
Ended
September 30,
2008

 

 

 

 

 

 

 

 

 

 

 

Total Investment Income

 

$

11,402

 

$

11,350

 

$

11,420

 

$

11,553

 

Net Investment Income

 

7,303

 

6,442

 

6,697

 

6,110

 

Net Increase (Decrease) in Net Assets Resulting From Operations

 

1,900

 

(11,904

)

2,809

 

(14,068

)

 

 

 

 

 

 

 

 

 

 

Basic and Diluted Earnings per Weighted Average Common Share

 

$

0.11

 

$

(0.61

)

$

0.13

 

$

(0.67

)

 

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

Not applicable.

 

Item 9A. Controls and Procedures.

 

a)  Disclosure Controls and Procedures

 

As of September 30, 2009 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness and design and operation of our disclosure controls and procedures.  Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective in timely alerting management, including the Chief Executive Officer and Chief Financial Officer, of material information about us required to be included in periodic SEC filings.  However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

b) Management’s Annual Report on Internal Control Over Financial Reporting

 

Refer to the Management’s Report on Internal Control over Financial Reporting located in Item 8 of this Form 10-K.

 

c) Attestation Report of the Registered Public Accounting Firm

 

Refer to the Report of Independent Registered Public Accounting Firm located in Item 8 of this Form 10-K.

 

d) Change in Internal Control over Financial Reporting

 

There were no changes in internal controls for the fiscal quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information.

 

Not applicable.

 

PART III

 

We will file a definitive Proxy Statement for our 2010 Annual Meeting of Stockholders (the “2010 Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of the 2010 Proxy Statement that specifically address the items set forth herein are incorporated by reference.

 

Item 10. Directors, Executive Officers and Corporate Governance

 

The information required by Item 10 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

Item 11. Executive Compensation

 

The information required by Item 11 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Executive Compensation” and “Director Compensation”

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information required by Item 12 is hereby incorporated by reference from our 2010 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management.”

 

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Item 13. Certain Relationships and Related Transactions and Director Independence

 

The information required by Item 13 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Certain Transactions” and “Director Independence.”

 

Item 14. Principal Accountant Fees and Services.

 

The information required by Item 14 is hereby incorporated by reference from our 2010 Proxy Statement under the caption “Independent Registered Public Accounting Firm Fees.”

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

a.                                       DOCUMENTS FILED AS PART OF THIS REPORT

 

1.                                       The following financial statements are filed herewith:

 

Report of Management on Internal Controls

Report of Independent Registered Public Accounting Firm

Consolidated Statements of Assets and Liabilities as of September 30, 2009 and September 30, 2008

Consolidated Schedule of Investments as of September 30, 2009

Consolidated Schedule of Investments as of September 30, 2008

Consolidated Statements of Operations for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

Consolidated Statements of Changes in Net Assets for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

Consolidated Statements of Cash Flows for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

Financial Highlights for the years ended September 30, 2009, September 30, 2008 and September 30, 2007

Notes to Consolidated Financial Statements

 

2.                                       Financial statement schedules

 

·                  Schedule 12-14 Investments in and Advances to Affiliates

 

No other financial statement schedules are filed herewith because (1) such schedules are not required or (2) the information has been presented in the aforementioned financial statements.

 

·                  Exhibits

 

The following exhibits are filed as part of this report or are hereby incorporated by reference to exhibits previously filed with the SEC:

 

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.

3.3

 

Amendment to By-laws, incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2003 (File No. 814-00237), filed February 17, 2004.

3.4

 

Second amendment to By-laws, incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (File No. 814-00237), filed July 10, 2007.

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.

 

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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

 

Promissory Note of David Gladstone in favor of the Company, dated August 23, 2001, incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2001, filed October 4, 2001.

10.2

 

Promissory Note of Terry Brubaker in favor of the Company, dated August 23, 2001, incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2001, filed October 4, 2001.

10.3*

 

Joint Directors Nonqualified Excess Plan of Gladstone Commercial Corporation, Gladstone Capital Corporation and Gladstone Investment Corporations, dated as of July 11, 2006, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 814-00237), filed on July 12, 2006.

10.4

 

Custodian Agreement between Gladstone Capital Corporation and The Bank of New York, dated as of May 5, 2006, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (File No. 814-00237), filed August 1, 2006.

10.5*

 

Amended and Restated Investment Advisory and Management Agreement between Gladstone Capital Corporation and Gladstone Management Corporation, dated as of October 1, 2006 incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (File No. 814-00237), filed on October 5, 2006 (renewed on July 8, 2009).

10.6*

 

Administration Agreement between Gladstone Capital Corporation and Gladstone Administration, LLC, dated as of October 1, 2006 incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (File No. 814-00237), filed on October 5, 2006 (renewed on July 8, 2009).

10.7

 

Third Amended and Restated Credit Agreement dated as of May 15, 2009 by and among Gladstone Business Loan, LLC as Borrower, Gladstone Management Corporation as Servicer, the Committed Lenders named therein, the CP Lenders named therein, the Managing Agents named therein, and Key Equipment Finance Inc. as Administrative Agent, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 814-00237), filed May 19, 2009.

11

 

Computation of Per Share Earnings (included in the notes to the audited financial statements contained in this report).

21

 

Subsidiaries of the Registrant.

23

 

Consent of PricewaterhouseCoopers LLP.

31.1

 

Certification of Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of 2002.

32.1

 

Certification of Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley Act of 2002.

 


*                                         Denotes management contract or compensatory plan or arrangement.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

GLADSTONE CAPITAL CORPORATION

 

 

Date: November 23, 2009

By:

/s/ GRESFORD GRAY

 

 

Gresford Gray

 

 

Chief Financial Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.

 

Date: November 23, 2009

By:

/s/ DAVID GLADSTONE

 

 

David Gladstone

 

 

Chief Executive Officer and Chairman of the Board of Directors (principal executive officer)

 

 

 

Date: November 23, 2009

By:

/s/ TERRY LEE BRUBAKER

 

 

Terry Lee Brubaker

 

 

Vice Chairman, Chief Operating Officer and Director

 

 

 

Date: November 23, 2009

By:

/s/ GEORGE STELLJES III

 

 

George Stelljes III

 

 

President, Chief Investment Officer and Director

 

 

 

Date: November 23, 2009

By:

/s/ DAVID A.R. DULLUM

 

 

David A.R. Dullum

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ GRESFORD GRAY

 

 

Gresford Gray

 

 

Chief Financial Officer (principal financial and accounting officer)

 

 

 

Date: November 23, 2009

By:

/s/ ANTHONY W. PARKER

 

 

Anthony W. Parker

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ MICHELA A. ENGLISH

 

 

Michela A. English

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ PAUL ADELGREN

 

 

Paul Adelgren

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ MAURICE COULON

 

 

Maurice Coulon

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ JOHN OUTLAND

 

 

John Outland

 

 

Director

 

 

 

Date: November 23, 2009

By:

/s/ GERARD MEAD

 

 

Gerard Mead

 

 

Director

 

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Table of Contents

 

SCHEDULE 12-14

 

GLADSTONE CAPITAL CORPORATION
INVESTMENTS IN AND ADVANCES TO AFFILIATES

 

Name of Issuer (1)

 

Title of Issue or Nature of
Indebtedness

 

Number of Shares or
Principal Amount of
Indebtedness Held at
September 30, 2009

 

Interest Earned for
the year Ended
September 30, 2009

 

Equity in Net Profit
(Loss) for the year ended
September 30, 2009 (3)

 

Value at
September 30,
2009

 

CONTROL INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BERTL, Inc.

 

Line of Credit

 

$

930

 

56

 

 

$

 

 

 

Common Stock (2)

 

424

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Clinton Holdings, LLC

 

Senior Subordinated Term Debt

 

15,500

 

 

 

12,013

 

 

 

Escrow Funding Note

 

640

 

 

 

496

 

 

 

Common Stock Warrants (2)

 

109

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Defiance Integrated Technologies, Inc.

 

Senior Term Debt

 

6,005

 

185

 

 

6,005

 

 

Senior Term Debt

 

1,178

 

 

 

1,178

 

 

 

Common Stock (2)

 

1

 

 

 

816

 

 

 

 

 

 

 

 

 

 

 

 

 

Lindmark Acquisition, LLC

 

Senior Subordinated Term Debt

 

12,000

 

344

 

 

10,410

 

 

 

Senior Subordinated Term Debt

 

1,553

 

 

 

1,049

 

 

 

Common Stock (2)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LYP Holdings Corp.

 

Line of Credit

 

1,168

 

57

 

 

1,168

 

 

 

Senior Term Debt

 

325

 

20

 

 

 

325

 

 

 

Line of Credit

 

1,170

 

24

 

 

421

 

 

 

Senior Term Debt

 

2,688

 

95

 

 

 

 

 

Senior Term Debt

 

2,750

 

120

 

 

 

 

 

Common Stock Warrants (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Healthcare Communications, Inc.

 

Line of Credit

 

169

 

 

 

91

 

 

Line of Credit

 

450

 

 

 

 

 

 

Common Stock (2)

 

2,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Western Directories, Inc.

 

Line of Credit

 

1,234

 

32

 

 

 

 

 

Preferred Stock (2)

 

1,584

 

 

 

 

 

 

Common Stock (2)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Control Investments

 

 

 

$

52,350

 

$

933

 

$

 

$

33,972

 

 

Name of Issuer (1)

 

Title of Issue or Nature of
Indebtedness

 

Number of Shares or
Principal Amount of
Indebtedness Held at
September 30, 2008

 

Interest Earned for
the year Ended
September 30, 2008

 

Equity in Net Profit
(Loss) for the year ended
September 30, 2008 (3)

 

Value at
September 30,
2008

 

CONTROL INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BERTL, Inc.

 

Line of Credit

 

$

742

 

62

 

 

$

 

 

 

Common Stock (2)

 

424

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LYP Holdings Corp.

 

Line of Credit

 

75

 

1

 

 

 

 

 

Line of Credit

 

1,170

 

 

 

 

 

 

Senior Term Debt

 

2,688

 

 

 

 

 

 

Senior Term Debt

 

2,750

 

 

 

 

 

 

Common Stock Warrants (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Healthcare Communications, Inc.

 

Line of Credit

 

90

 

 

 

90

 

 

Line of Credit

 

450

 

 

 

450

 

 

 

Common Stock (2)

 

2,470

 

 

 

240

 

 

 

 

 

 

 

 

 

 

 

 

 

Western Directories, Inc.

 

Line of Credit

 

70

 

1

 

 

 

 

 

Preferred Stock (2)

 

1,584

 

 

 

 

 

 

Common Stock (2)

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Control Investments

 

 

 

$

12,514

 

$

64

 

$

 

$

780

 

 


(1)          Certain of the listed securities are issued by affiliates(s) of the indicated portfolio company

(2)          Security is non-income producing.

(3)          In accordance with Regulation S-X, rule 6-03(c)(i), the Company does not consolidate its portfolio investments. Therefore, no equity in net profit (loss) was recorded as of September 30, 2009.

 

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Table of Contents

 

Name of Issuer (1)

 

Title of Issue or Nature of
Indebtedness

 

Value of Each Item at
September 30, 2008

 

Gross
Additions

 

Gross
Reductions

 

Value of Each Item at
September 30, 2009

 

CONTROL INVESTMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BERTL, Inc.

 

Line of Credit

 

$

 

 

 

$

 

 

 

Common Stock (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Clinton Holdings, LLC

 

Senior Subordinated Term Debt

 

 

12,013

 

 

12,013

 

 

 

Escrow Funding Note

 

 

496

 

 

496

 

 

 

Common Stock Warrants (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Defiance Integrated Technologies, Inc.

 

Senior Term Debt

 

 

6,005

 

 

6,005

 

 

Senior Term Debt

 

 

1,178

 

 

1,178

 

 

 

Common Stock (2)

 

 

816

 

 

816

 

 

 

 

 

 

 

 

 

 

 

 

 

Lindmark Acquisition, LLC

 

Senior Subordinated Term Debt

 

 

10,410

 

 

10,410

 

 

 

Senior Subordinated Term Debt

 

 

1,049

 

 

1,049

 

 

 

Common Stock (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LYP Holdings Corp.

 

Line of Credit

 

 

1,168

 

 

1,168

 

 

 

Senior Term Debt

 

 

325

 

 

 

325

 

 

 

Line of Credit

 

 

421

 

 

421

 

 

 

Senior Term Debt

 

 

 

 

 

 

 

Senior Term Debt

 

 

 

 

 

 

 

Common Stock Warrants (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Healthcare Communications, Inc.

 

Line of Credit

 

90

 

1

 

 

91

 

 

Line of Credit

 

450

 

 

(450

)

 

 

 

Common Stock (2)

 

240

 

 

(240

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Western Directories, Inc.

 

Line of Credit

 

 

 

 

 

 

 

Preferred Stock (2)

 

 

 

 

 

 

 

Common Stock (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Control Investments

 

 

 

$

780

 

$

33,882

 

$

(690

)

$

33,972

 

 


(1)          Certain of the listed securities are issued by affiliates(s) of the indicated portfolio company

(2)          Security is non-income producing.

 

104