UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
| R | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended February 28, 2010
| £ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 001-33376
GSC Investment Corp.
(Exact name of Registrant as specified in its charter)
| Maryland | 20-8700615 |
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification Number) |
500 Campus Drive, Suite 220
Florham Park, New Jersey 07932
(Address of principal executive offices)
(973) 437-1000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | | Name of Each Exchange on Which Registered |
| Common Stock, par value $0.0001 per share | | The New York Stock Exchange |
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 £ No R
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes £ No R
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 R No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No R
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 Form 10-K or any amendment to this Form 10-K. £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer £ | Accelerated filer £ | Non-accelerated filer R | Smaller reporting company £ |
| | (Do not check if a smaller reporting company) | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No R
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of August 31, 2009 was approximately $13.1 million based upon a closing price of $1.5796 reported for such date by the New York Stock Exchange. Common shares held by each executive officer and director and by each person who owns 5% or more of the outstanding common shares have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of outstanding common shares of the registrant as of May 12, 2010 was 16,940,109.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Definitive Proxy Statement for its Annual Meeting of Stockholders to be held on July 7, 2010, to be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Annual Report, are incorporated by reference into Part III of this Annual Report.
NOTE ABOUT REFERENCES
In this Annual Report on Form 10-K (the “Annual Report”), the “Company,” “we,” “us” and “our” refer to GSC Investment Corp., its subsidiaries and related companies, unless the context otherwise requires. We refer to GSCP (NJ) L.P., our investment adviser, as “GSCP” or “the investment adviser” and together with its affiliates and subsidiaries, as “GSC Group.”
NOTE ABOUT TRADEMARKS
We have entered into a license agreement with GSC Group, pursuant to which GSC Group grants us a non-exclusive, royalty-free license to use the “GSC” name and logo.
NOTE ABOUT FORWARD-LOOKING STATEMENTS
Some of the statements in this Annual Report constitute forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements.
The forward-looking statements contained in this Annual Report involve risks and uncertainties, including statements as to:
| | • | our future operating results; |
| | • | our business prospects and the prospects of our portfolio companies; |
| | • | the impact of investments that we expect to make; |
| | • | our contractual arrangements and relationships with third parties; |
| | • | the dependence of our future success on the general economy and its impact on the industries in which we invest; |
| | • | the ability of our portfolio companies to achieve their objectives; |
| | • | our expected financings and investments; |
| | • | our regulatory structure and tax treatment, including our ability to operate as a business development company and a regulated investment company; |
| | • | the adequacy of our cash resources and working capital; |
| | • | the timing of cash flows, if any, from the operations of our portfolio companies; |
| | • | the ability of our investment adviser to locate suitable investments for us and to monitor and effectively administer our investments; and |
| | • | continued access to our Revolving Facility. |
For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Annual Report, please see the discussion under Part I, Item 1A “Risk Factors”. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Annual Report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this Annual Report.
TABLE OF CONTENTS
| | Page |
| | |
| PART I | 4 |
| Item 1. Business | 4 |
| Item 1A. Risk Factors | 19 |
| Item 1B. Unresolved Staff Comments | 35 |
| Item 2. Properties | 36 |
| Item 3. Legal Proceedings | 36 |
| PART II | 37 |
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 37 |
| Item 6. Selected Financial Data | 39 |
| Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations | 40 |
| Item 7A. Quantitative and Qualitative Disclosures about Market Risk | 53 |
| Item 8. Financial Statements and Supplementary Data | 54 |
| Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 54 |
| Item 9A. Controls and Procedures | 55 |
| Item 9B. Other Information | 55 |
| PART III | 56 |
| Item 10. Directors, Executive Officers and Corporate Governance | 56 |
| Item 11. Executive Compensation | 56 |
| Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 56 |
| Item 13. Certain Relationships and Related Transactions, and Director Independence | 56 |
| Item 14. Principal Accountant Fees and Services | 56 |
| PART IV | 57 |
| Item 15. Exhibits and Consolidated Financial Statement Schedules | 57 |
| Signatures | 62 |
| Consolidated Financial Statements | F-1 |
PART I
Item 1. Business
General
GSC Investment Corp. is a Maryland corporation that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). The Company is the successor by merger to GSC Investment, LLC (the “LLC”), a Maryland limited liability company that had elected to be regulated as a BDC, which was merged into the Company concurrently with the Company’s incorporation on March 21, 2007. As a result of the merger, each outstanding common share of the LLC was converted into an equivalent number of shares of the Company’s common stock.
Our investment objectives are to generate current income and capital appreciation through debt and equity investments by primarily investing in middle market companies and select high yield bonds. We have elected and qualified to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). We commenced operations on March 23, 2007 and completed our initial public offering (“IPO”) on March 28, 2007. We are externally managed and advised by our investment adviser, GSCP (NJ), L.P. (together with certain of its affiliates, “GSC Group”).
We used the net proceeds of our IPO to purchase approximately $100.7 million in aggregate principal amount of debt investments from GSC Partners CDO Fund III, Limited (“CDO Fund III”), a collateralized loan obligation (“CLO”) fund managed by our investment adviser. We used borrowings under our Facilities (as defined below) to purchase approximately $115.1 million in aggregate principal amount of debt investments in April and May 2007 from CDO Fund III and GSC Partners CDO Fund Limited (“CDO Fund I”), a collateralized debt obligation fund managed by our investment adviser. As of February 28, 2010, our portfolio consisted of $89.4 million of investments in 27 portfolio companies and one CLO.
Significant Developments in Our Business
Since the third quarter of fiscal year 2009 (November 30, 2008), due to constraints imposed by our Revolving Facility (as defined below), we have had limited investment activity in both the primary and secondary markets. On July 30, 2009, we exceeded permissible borrowing limits for 30 consecutive days, resulting in an event of default under our credit facility that is continuing as of February 28, 2010. As a result of this event of default, our lender has the right to accelerate repayment of the outstanding indebtedness under our credit facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations. As of the date of this Annual Report, our lender has not accelerated the debt, but has reserved the right to do so. There is no assurance that we will have sufficient funds available to pay in full the total amount of obligations that would become due as a result of such acceleration or that we will be able to obtain additional or alternative financing to pay or refinance any such accelerated obligations. In a report dated May 27, 2010, our independent registered public accountants have determined that there is substantial doubt regarding our ability to continue as a going concern as a result of our remaining in default of our Revolving Facility. Please see Part I, Item 1A. “Risk Factors—Risks related to our liquidity and financial condition” for more information.
Substantially all of our assets other than our investment in the subordinated notes of GSC Investment Corp. CLO 2007, Ltd. ("GSCIC CLO") are held in a special purpose subsidiary and pledged under our Revolving Facility. We commenced the two year amortization period under the Revolving Facility in January 2009, during which time all principal proceeds from the pledged assets are used to repay the Revolving Facility. In addition, during the continuance of an event of default, all interest proceeds from the pledged assets are also used to repay the Revolving Facility. As a result, the Company is required to fund its operating expenses and dividends solely from cash on hand, management fees earned from, and the proceeds of the subordinated notes of, GSCIC CLO. The deleveraging of the Company may significantly impair the Company’s ability to effectively operate.
In December 2008, the Company engaged the investment banking firm of Stifel, Nicolaus & Company, to evaluate strategic transaction opportunities and consider alternatives. On April 14, 2010, the Company announced that it entered into a definitive agreement with Saratoga Investment Advisors, LLC (“Saratoga”) to execute a $55 million recapitalization plan that would cure the existing bank default. Please see “Proposed Saratoga Transaction” below for more information.
GSC Group, the parent of our investment adviser, has been in negotiations with its secured lenders regarding a restructuring of its credit facility since defaulting on its credit facility in April 2009. A combination of planned reductions and attrition has resulted in a decrease in the number of GSC employees from 85 at the end of fiscal year 2009 to 45 at the end of fiscal year 2010. Additionally, on May 25, 2010, our Chief Financial Officer, Richard T. Allorto, Jr., who is an employee of GSC Group, announced his resignation effective July 15, 2010. While we don’t believe these staffing changes have adversely affected our operations to date, additional attrition has the potential to adversely affect our operations in the future, as we rely on GSC Group for all of our employees. In order to avoid a negative impact on our operations, GSC Group is preparing an appropriate succession plan for Mr. Allorto and securing alternative resources, including third party service providers, to insure adequate resources are available in the event of future attrition.
On May 25, 2010, our independent registered public accountants identified a material weakness in our internal control over financial reporting. See Item 9A. “Controls and Procedures” for more information. In order to remediate the material weakness, we have requested that GSC Group provide us with additional support in order to improve our internal control over financial reporting. Proposed Saratoga Transaction
On April 14, 2010, we entered into a stock purchase agreement (“the Stock Purchase Agreement”) with Saratoga and CLO Partners LLC (together with Saratoga, the “Investors”) and an assignment, assumption and novation agreement (the “Assignment Agreement”) with Saratoga, pursuant to which we assumed certain rights and obligations of Saratoga under the debt commitment letter (the “Madison Commitment Letter”) Saratoga received from Madison Capital Funding LLC (“Madison”), indicating Madison’s willingness to provide the Company with a $40 million senior secured revolving credit facility (the “Replacement Facility”), subject to the satisfaction of certain terms and conditions. We refer to the transactions contemplated by the Stock Purchase Agreement collectively as the “Saratoga Transaction.”
If the conditions to closing under the Stock Purchase Agreement are satisfied, pursuant to the Stock Purchase Agreement, we will issue and sell to the Investors 9,868,422 shares of our common stock for an aggregate purchase price of approximately $15,000,000 at a price of $1.52 per share, in a private transaction that is exempt from registration under Section 4(2) of the Securities Act of 1933 and Regulation D thereunder. Concurrently with the closing of the Saratoga Transaction and pursuant to the terms of the Stock Purchase Agreement, we will (i) enter into the Replacement Facility with Madison; (ii) enter into a registration rights agreement with the Investors; (iii) enter into a trademark license agreement with Saratoga or one of its affiliates; and (iv) replace GSCP (NJ), L.P. as the Company’s investment adviser with Saratoga Investment Advisors, LLC, by executing the Investment Advisory and Management Agreement, subject to stockholder approval, and as the Company’s administrator with an affiliate of Saratoga by executing an Administration Agreement. The Company and its current investment adviser, GSCP (NJ), L.P., have entered into a Termination and Release Agreement, to be effective as of the closing, pursuant to which GSCP (NJ), L.P., among other things, has agreed to waive any and all accrued and unpaid deferred incentive management fees up to and as of the closing of the Saratoga Transaction but will continue to receive the base management fees earned through the date of the closing.
In addition, as a condition to closing of the Saratoga Transaction and in each case to be effective as of the closing, the Company is required to procure the resignations of Robert F. Cummings, Jr. and Richard M. Hayden, both of whom are affiliates of GSCP (NJ) L.P., as members of the Board and to elect Christian L. Oberbeck and Richard A. Petrocelli, both of whom are affiliates of Saratoga, as members of the Board (the “Saratoga Directors”). The Saratoga Directors will be elected by the Board to fill the vacancies created by the resignations described above and the Saratoga Directors will be appointed to the class of directors as determined by the Board in accordance with the Company’s organizational documents. The Company’s stockholders will have the opportunity to vote for each of the Saratoga Directors when his class of directors is up for reelection. In addition, all officers of the Company will resign at closing and the Board will appoint Mr. Oberbeck as the Company’s Chief Executive Officer and Mr. Petrocelli as the Company’s Chief Financial Officer and Chief Compliance Officer.
Promptly after closing of the Saratoga Transaction, the Company will change its name from “GSC Investment Corp.” to “Saratoga Investment Corp.” and the Company intends to undertake a one-for-ten reverse stock split, pursuant to which each stockholder will receive one share of our common stock in exchange for every ten shares owned at that time. After giving effect to the shares of common stock issued in connection with the Saratoga Transaction and the one-for-ten reverse stock split, the total number of shares of our common stock outstanding will be approximately 2.7 million.
The Company will use the net proceeds from the Saratoga Transaction and a portion of the funds available to it under the Replacement Facility to pay the full amount of principal and accrued interest, including default interest, outstanding under our Revolving Facility due and payable as of the date of closing.
Following completion of the transactions contemplated by the Stock Purchase Agreement, the Investors and certain individuals affiliated with Saratoga and Saratoga Partners, including Messrs. Oberbeck and Petrocelli, will hold approximately 36.8% of the outstanding shares of common stock of the Company. Pursuant to the provisions of the 1940 Act, the Company will be deemed to be controlled by Mr. Oberbeck following consummation of the Saratoga Transaction. Mr. Oberbeck is the Managing Partner of Saratoga Partners, an affiliate of Saratoga, and has been a member of its investment committee for 15 years. Mr. Oberbeck is the primary investor in Saratoga, and CLO Partners LLC is an entity wholly-owned by Mr. Oberbeck. Saratoga Partners has also provided Saratoga with an equity commitment letter, pursuant to which Saratoga Partners has agreed to fulfill and satisfy solely the payment obligations of Saratoga and CLO Partners under the Stock Purchase Agreement, subject to the satisfaction of certain terms and conditions, including the closing conditions described herein.
For more information about Saratoga, see “—About Saratoga” below and our Preliminary Proxy Statement on Schedule 14A filed with the SEC on May 13, 2010.
Investments
Our portfolio is comprised primarily of investments in leveraged loans (comprised of both first and second lien term loans) issued by middle market companies and high yield bonds. We seek to create a diversified portfolio by investing up to 5% of our total assets in each investment, although the investment sizes may be more or less than the targeted range. These investments are sourced in both the primary and secondary markets through a network of relationships with commercial and investment banks, commercial finance companies and financial sponsors. Due to constraints imposed by our Revolving Facility, we have had limited investment activity in both the primary and secondary markets. The leveraged loans and high yield bonds that we purchase are generally used to finance buyouts, acquisitions, growth, recapitalizations and other types of transactions. Leveraged loans are generally senior debt instruments that rank ahead of subordinated debt of the portfolio company. Leveraged loans also have the benefit of security interests on the assets of the portfolio company, which may rank ahead of, or be junior to, other security interests. High yield bonds are typically subordinated to leveraged loans and generally unsecured, though a substantial amount of the high yield bonds that we currently own are secured. Substantially all of the debt investments held in our portfolio hold a non-investment grade rating by Moody’s Investors Service (“Moody’s”) and/or Standard & Poor’s or, if not rated, would be rated below investment grade if rated. High yield bonds rated below investment grade are commonly referred to as “junk bonds.” As part of our long-term strategy, we also anticipate purchasing mezzanine debt and making equity investments in middle market companies. Mezzanine debt is typically unsecured and subordinated to senior debt of the portfolio company. For purposes of this Annual Report, we generally use the term “middle market” to refer to companies with annual EBITDA of between $5 million and $50 million. EBITDA represents earnings before net interest expense, income taxes, depreciation and amortization. Investments in middle market companies are generally less liquid than equivalent investments in companies with larger capitalizations.
While our primary focus is to generate current income and capital appreciation through investments in debt and equity securities of middle market companies and high yield bonds, we intend to invest up to 30% of our assets in opportunistic investments. Opportunistic investments may include investments in distressed debt, debt and equity securities of public companies, credit default swaps, emerging market debt, and structured finance vehicles, including CLOs. As part of this 30%, we may also invest in debt of middle market companies located outside the United States. Given our primary investment focus on first and second lien term loans issued by middle market companies and high yield bonds, we believe our opportunistic investments will allow us to supplement our core investments with other investments that are within our investment adviser’s expertise that we believe offer attractive yields and/or the potential for capital appreciation. As of February 28, 2010, our investment in the subordinated notes of GSCIC CLO, a CLO we manage, constituted 18.7% of our total investments. We do not expect to manage and purchase all of the equity in another CLO transaction in the near future. We may, however, invest in CLO securities issued by other investment managers.
As a BDC, we are required to comply with certain regulatory requirements. For instance, we have to invest at least 70% of our total assets in “qualifying assets,” including securities of U.S. operating companies whose securities are not listed on a national securities exchange (i.e., New York Stock Exchange, American Stock Exchange and The NASDAQ Global Market), U.S. operating companies with listed securities that have market capitalizations of less than $250 million, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less. In addition, we are only allowed to borrow money such that our asset coverage, which, as defined in the 1940 Act, measures the ratio of total assets less total liabilities (excluding borrowings) to total borrowings, equals at least 200% after such borrowing, with certain limited exceptions.
As of February 28, 2010, our portfolio consisted of $89.4 million in investments. We seek to create a diversified portfolio that includes leveraged loans, mezzanine debt and high yield bonds by investing up to 5% of our total investments in each portfolio company, although the investment sizes may be more or less than the targeted range. As of February 28, 2010, we invested in excess of 5% of our total investments in 6 of the 27 portfolio companies and the GSCIC CLO, but in each case less than 18.7% of our total investments, and our five largest portfolio company exposures represented approximately 48.1% of our total investments. As part of our long-term strategy, we also anticipate purchasing mezzanine debt and making equity investments in middle market companies.
Leveraged loans
Our leveraged loan portfolio is comprised primarily of first lien and second lien term loans. First lien term loans are secured by a first priority perfected security interest on all or substantially all of the assets of the borrower and typically include a first priority pledge of the capital stock of the borrower. First lien term loans hold a first priority with regard to right of payment. Generally, first lien term loans offer floating rate interest payments, have a stated maturity of five to seven years, and have a fixed amortization schedule. First lien term loans generally have restrictive financial and negative covenants. Second lien term loans are secured by a second priority perfected security interest on all or substantially all of the assets of the borrower and typically include a second priority pledge of the capital stock of the borrower. Second lien term loans hold a second priority with regard to right of payment. Second lien term loans offer either floating rate or fixed rate interest payments, generally have a stated maturity of five to eight years, and may or may not have a fixed amortization schedule. Second lien term loans that do not have fixed amortization schedules require payment of the principal amount of the loan upon the maturity date of the loan. Second lien term loans have less restrictive financial and negative covenants than those that govern first lien term loans.
High yield bonds
High yield bonds are generally either senior secured or unsecured. Senior secured bonds are secured by a perfected security interest on all or substantially all of the assets of the borrower (which, however, may be contractually subordinated to liens on certain assets of the borrower). In addition, senior secured bonds may have a pledge of the capital stock of the borrower. Senior secured bonds offer either floating rate or fixed rate interest payments and generally have a stated maturity of five to eight years and do not have fixed amortization schedules. Senior secured bonds generally have less restrictive financial and negative covenants than those that govern first lien and second lien term loans.
Unsecured bonds are not secured by the underlying assets or collateral of the issuer and may be subordinate in priority of payment to senior debt of the issuer. In the event of the borrower’s liquidation, dissolution, reorganization, bankruptcy or other similar proceeding, the bondholders only have the right to share pari passu in the issuer’s unsecured assets with other equally-ranking creditors of the issuer. Unsecured bonds typically have fixed rate interest payments and a stated maturity of five to ten years and do not have fixed amortization schedules.
Mezzanine debt
Mezzanine debt usually ranks subordinate in priority of payment to senior debt and is often unsecured. However, mezzanine debt ranks senior to common and preferred equity in a borrowers’ capital structure. Mezzanine debt typically has fixed rate interest payments and a stated maturity of six to eight years and does not have fixed amortization schedules.
In some cases our debt investments may provide for a portion of the interest payable to be paid-in-kind interest. To the extent interest is paid-in-kind, it will be payable through the increase of the principal amount of the obligation by the amount of interest due on the then-outstanding aggregate principal amount of such obligation.
Equity investments
Equity investments may consist of preferred equity that is expected to pay dividends on a current basis or preferred equity that does not pay current dividends. Preferred equity generally has a preference over common equity as to distributions on liquidation and dividends. In some cases, we may acquire common equity. In general, our equity investments are not control-oriented investments and we expect that in many cases we will acquire equity securities as part of a group of private equity investors in which we are not the lead investor.
Opportunistic Investments
Opportunistic investments may include investments in distressed debt, debt and equity securities of public companies, credit default swaps, emerging market debt, structured finance vehicles, including CLOs, and debt of middle market companies located outside the United States. In January 2008, we purchased for $30 million all of the outstanding subordinated notes of GSCIC CLO, a $400 million CLO managed by us that invests primarily in leveraged loans. As of February 28, 2010, the GSCIC CLO portfolio consisted of $387.1 million in aggregate principal amount of investments in 143 obligors with an average obligor exposure of $2.7 million and $21.1 million in uninvested cash. The weighted average maturity of the portfolio is 4.0 years. We do not expect to manage and purchase all of the equity in another CLO transaction in the near future. We may, however, invest in CLO securities issued by other investment managers.
Prospective portfolio company characteristics
Our investment adviser utilizes the investment philosophy of its corporate credit and distressed investment group in identifying and selecting portfolio company investments. Our portfolio companies generally have one or more of the following characteristics:
| | • | a history of generating stable earnings and strong free cash flow; |
| | • | well constructed balance sheets, including an established tangible liquidation value; |
| | • | reasonable debt-to-cash flow multiples; |
| | • | industry leadership with competitive advantages and sustainable market shares in attractive sectors; and |
| | • | capital structures that provide appropriate terms and reasonable covenants. |
Investment selection
In managing us, GSC Group employs the same investment philosophy and portfolio management methodologies used by its corporate credit and distressed investment group. Through this investment selection process, based on quantitative and qualitative analysis, GSC Group seeks to identify issuers with superior fundamental risk-reward profiles and strong, defensible business franchises with the goal of minimizing principal losses while maximizing risk-adjusted returns. Our investment adviser’s investment process emphasizes the following:
| | • | bottoms-up, company-specific research and analysis; |
| | • | capital preservation, low volatility and minimization of downside risk; and |
| | • | investing with experienced management teams that hold meaningful equity ownership in their businesses. |
Our investment adviser’s investment process generally includes the following steps:
| | • | Initial screening. A brief analysis identifies the investment opportunity and reviews the merits of the transaction. The initial screening memorandum provides a brief description of the company, its industry, competitive position, capital structure, financials, equity sponsor and deal economics. If the deal is determined to be attractive by the senior members of the deal team, the opportunity is more fully analyzed. |
| | • | Full analysis. A full analysis includes: |
| • | Business and Industry analysis — a review of the company’s business position, competitive dynamics within its industry, cost and growth drivers and technological and geographic factors. Business and industry research often includes meetings with industry experts, consultants, other investors, customers and competitors. |
| • | Company analysis — a review of the company’s historical financial performance, future projections, cash flow characteristics, balance sheet strength, liquidation value, legal, financial and accounting risks, contingent liabilities, market share analysis and growth prospects. |
| • | Structural/security analysis — a thorough legal document analysis including but not limited to an assessment of financial and negative covenants, events of default, enforceability of liens and voting rights. |
| | • | Approval of the group head. After an investment has been identified and diligence has been completed, a report is prepared. This report is reviewed by the senior investment professional in charge of the potential investment. If such senior investment professional is in favor of the potential investment, it is presented for the approval of the group head. Additional due diligence with respect to any investment may be conducted by attorneys and independent accountants prior to the closing of the investment, as well as by other outside advisers, as appropriate. |
| | • | Approval of the investment committee. After the approval of the group head, the investment is presented to the investment committee for approval. Sale recommendations made by the investment staff must also be approved by the investment committee. Purchase and sale recommendations over $10 million per issuer require unanimous and majority approval of the investment committee, respectively. Our Chief Executive Officer, Seth M. Katzenstein, has sole discretionary authority to make purchases or sales below $10 million per issuer, subject to certain aggregate limits. |
Investment structure
In general, our investment adviser intends to select investments with financial covenants and terms that reduce leverage over time, thereby enhancing credit quality. These methods include:
| | • | maintenance leverage covenants requiring a decreasing ratio of debt to cash flow; |
| | • | maintenance cash flow covenants requiring an increasing ratio of cash flow to the sum of interest expense and capital expenditures; and |
| | • | debt incurrence prohibitions, limiting a company’s ability to re-lever. |
In addition, limitations on asset sales and capital expenditures should prevent a company from changing the nature of its business or capitalization without consent.
Our investment adviser seeks, where appropriate, to limit the downside potential of our investments by:
| | • | requiring a total return on our investments (including both interest and potential equity appreciation) that compensates us for credit risk; |
| | • | requiring companies to use a portion of their excess cash flow to repay debt; |
| | • | selecting investments with covenants that incorporate call protection as part of the investment structure; and |
| | • | selecting investments with affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights, including either observation or participation rights. |
There may be certain restrictions on our investment adviser’s ability to negotiate and structure the terms of our investments when we co-invest with other GSC Group-managed investment vehicles. See “— Co-investment” below.
Valuation process
We carry our investments at fair value, as determined in good faith by our Board of Directors. Investments for which market quotations are readily available are recorded in our financial statements at such market quotations subject to any decision by our Board of Directors to make a fair value determination to reflect significant events affecting the value of these investments. We value investments for which market quotations are not readily available at fair value as determined in good faith by our Board of Directors based on input from our investment adviser, our audit committee and, if our board or audit committee so request, a third party independent valuation firm. Determinations of fair value may involve subjective judgments and estimates. The types of factors that may be considered in a fair value pricing include the nature and realizable value of any collateral, the portfolio company’s ability to make payments, the markets in which the portfolio company does business, market yield trend analysis, comparison to publicly traded companies, discounted cash flow and other relevant factors.
Our investment in the subordinated notes of GSCIC CLO is carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar CLO subordinated notes or equity, when available.
We undertake a multi-step valuation process each quarter when valuing investments for which market quotations are not readily available, as described below:
| | • | each investment is initially valued by the responsible investment professionals and preliminary valuation conclusions are documented and discussed with our senior management; and |
| | • | an independent valuation firm engaged by our Board of Directors independently values at least one quarter of our investments each quarter so that the valuation of each investment for which market quotes are not readily available is independently valued by an independent valuation firm at least annually. |
In addition, all our investments are subject to the following valuation process:
| | • | the audit committee of our Board of Directors reviews each preliminary valuation and our investment adviser and independent valuation firm (if applicable) will supplement the preliminary valuation to reflect any comments provided by the audit committee; and |
| | • | our Board of Directors discusses the valuations and determines the fair value of each investment in good faith based on the input of our investment adviser, independent valuation firm (if applicable) and audit committee. |
Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, they may fluctuate over short periods of time and may be based on estimates. The determination of fair value by our Board of Directors may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be materially affected if the determinations regarding the fair value of our investments were materially higher or lower than the values that we ultimately realize upon the disposal of such investments.
Ongoing relationships with and monitoring of portfolio companies
Our investment adviser will closely monitor each investment the Company makes and, when appropriate, will conduct a regular dialogue with both the management team and other debtholders and seek specifically tailored financial reporting. In addition, in certain circumstances, senior investment professionals of GSC Group may take board seats or board observation seats.
Leverage
In addition to funds available from the issuance of our common stock, we use borrowed funds, known as “leverage,” to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% after giving effect to such leverage. As of February 28, 2010, our asset coverage ratio, as defined in the 1940 Act, was 250.0%.
On April 11, 2007, we entered into a $100 million revolving securitized credit facility with Deutsche Bank AG, New York Branch (the “Revolving Facility”). On May 1, 2007, we entered into a $25.7 million term securitized credit facility (the “Term Facility” and, together with the Revolving Facility, the “Facilities”), which was fully drawn at closing. In December 2007, we consolidated the Facilities by using a draw under the Revolving Facility to repay the Term Facility. Effective January 14, 2009, we terminated the revolving period of the Revolving Facility and commenced a two-year amortization period during which all principal proceeds from the collateral will be used to repay outstanding borrowings. At the end of the two year amortization period, all advances will be due and payable. In March 2009 we amended the Revolving Credit Facility to decrease the minimum required collateralization and increase the portion of the portfolio that can be invested in “CCC” rated investments in return for an increased interest rate and expedited amortization.
On July 30, 2009, we exceeded permissible borrowing limits for 30 consecutive days, resulting in an event of default under our credit facility that is continuing. As a result of this event of default, our lender has the right to accelerate repayment of the outstanding indebtedness under our credit facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations. To date, our lender has not accelerated the debt, but has reserved the right to do so.
As of February 28, 2010, we had borrowed an aggregate of $37.0 million under the Revolving Facility. During the continuance of an event of default, the interest rate on the Revolving Facility is increased from the commercial paper rate plus 4.00% to the greater of the commercial paper rate and our lender’s prime rate plus 4.00% plus a default rate of 2.00% or, if the commercial paper market is unavailable, the greater of the prevailing LIBOR rates and our lender’s prime rate plus 6.00% plus a default rate of 3.00%.
A significant percentage of our total investments have been pledged to secure our obligations under the Revolving Facility.
Dividends
We review dividends to our stockholders on a quarterly basis. Our quarterly distributions, if any, will be determined by our Board of Directors and paid out of assets legally available for distribution. Any such distributions will be taxable to our stockholders, including to those stockholders who receive additional shares of our common stock pursuant to a dividend reinvestment plan. However, since January 2009 we have suspended our quarterly dividends and have made only one distribution to our stockholders, in November 2009. See Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Dividend Policy” below for more information. Although we continue to review dividends on a quarterly basis, we do not expect to pay a dividend in every quarter.
In order to maintain our qualification as a RIC, we must for each fiscal year distribute an amount equal to at least 90% of our ordinary net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses. In addition, we will be subject to federal excise taxes to the extent we do not distribute during the calendar year at least (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. For the 2009 calendar year the Company made distributions sufficient such that we did not incur any federal excise taxes. We may elect to withhold from distribution a portion of our ordinary income for the 2010 calendar year and/or portion of the capital gains in excess of capital losses realized during the one year period ending October 31, 2010, if any, and, if we do so, we would expect to incur federal excise taxes as a result.
We maintain an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a dividend, then stockholders’ cash dividends will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash dividends.
We have distributed $2.83 per share of cash dividends to stockholders since we commenced operations in March 2007. Please see Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for additional details. We are prohibited from making distributions that cause us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or that violate our debt covenants.
Subject to certain conditions, for taxable years ending on or before December 31, 2011, we are permitted to make distributions to our stockholders in the form of shares of our common stock in lieu of cash distributions. The decision to make such distributions will be made by our Board of Directors.
About GSC Group. Our Investment Adviser
GSC Group was founded in 1999 by Alfred C. Eckert III, its Chairman and Chief Executive Officer. GSC Group specializes in complex credit-based alternative investment strategies. GSC Group is privately owned, has approximately 45 employees, and has offices in New Jersey and London. GSC Group conducts its investment advisory business through GSCP (NJ), L.P., an investment adviser registered with the U.S. Securities and Exchange Commission (the “SEC”) with over $6.7 billion of assets under management(1) as of December 31, 2009.
GSC Group operates in two main business lines: (i) the corporate credit and distressed investments group, which provides investment advisory and management services to the Company, is comprised of 12 investment professionals who manage approximately $3.6 billion of assets(1) in various collateralized loan and debt obligation funds, credit funds, and control distressed debt funds and (ii) the European lending group, which is comprised of 8 investment professionals who manage approximately $3.1 billion of assets(1) in various collateralized loan and debt obligation funds and mezzanine funds.
Our Chief Executive Officer, Seth M. Katzenstein, is a Senior Managing Director of GSC Group, and the Head of the GSC Group’s U.S. and European lending divisions with portfolio-management responsibility for the U.S. Corporate Debt business. Mr. Katzenstein has over 13 years experience in corporate finance. Mr. Katzenstein is supported by 12 investment professionals within GSC Group’s corporate credit and distressed investments group. Our Chairman, Richard M. Hayden, retired from GSC Group in September 2009.
| (1) | The methodology used by GSC Group to calculate its assets under management varies with the nature of the account and represents (i) the sum of cash, uncalled capital commitments, as applicable, and the market value of each investment or (ii) the principal balance of the underlying assets adjusted for defaulted securities plus the market value of equity securities, all as measured under the relevant account documents. In all cases, the fair value (as determined in accordance with U.S. GAAP) of the underlying assets may differ significantly from the assets under management as forth above. Assets under management does not include pooled investment vehicles comprised of asset-backed securities that are co-managed by GSC Group with a sub-advisor. |
GSCP (NJ), L.P., our investment adviser, is responsible for administering our business activities and day-to-day operations. Our investment adviser is able to leverage GSC Group’s current investment platform, resources and existing relationships with financial institutions, financial sponsors and investment firms to provide us with attractive investment opportunities. In addition to deal flow, the GSC Group investment platform assists our investment adviser in analyzing and monitoring investments. GSC Group has been investing in corporate debt since its founding in 1999. In addition to having access to GSC Group’s investment professionals, we also have access to GSC Group’s administrative professionals who provide assistance in accounting, legal, compliance and investor relations.
Our relationship with GSC Group and our investment adviser
We currently have no employees, and each of our executive officers is also an employee of GSC Group. As of May 12, 2010, GSC Group and its affiliates owned 1,928,006 shares (11.4%) of our common stock and our directors, executive officers, and senior employees of GSC Group (managing director and above) owned an additional 316,430 shares (1.9%) of our common stock. Some, but not all, of these persons are required to file statements of beneficial ownership pursuant to Section 16 of the Exchange Act.
Pursuant to our investment advisory and management agreement, our investment adviser implements our business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our Board of Directors. Our investment adviser is responsible for, among other duties, performing all of our day-to-day functions, determining investment criteria, sourcing, analyzing and executing investments, asset sales, financings and performing asset management duties. Under our investment advisory and management agreement, we have agreed to pay our investment adviser an annual base management fee based on our total assets, as defined under the 1940 Act (other than cash and cash equivalents but including assets purchased with borrowed funds), and an incentive fee based on our performance. The investment advisory and management agreement renews automatically for additional one-year terms at the end of each year subject to certain approvals by our Board of Directors and/or our stockholders. Our investment advisory and management agreement with our investment adviser has been renewed through March 21, 2011; however, if we consummate the proposed Saratoga Transaction, we will replace GSCP with Saratoga as our investment adviser and the outstanding incentive fees owed to GSCP will be waived. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Expenses” below for more information.
Pursuant to our investment advisory and management agreement, our investment adviser has formed an investment committee to advise and consult with our investment adviser’s senior management team with respect to our investment policies, investment portfolio holdings, financing and leveraging strategies and investment guidelines. Along with GSC Group’s U.S. corporate credit and distressed investments group’s investment staff, the investment committee monitors investments in our portfolio.
In April 2009, our investment adviser withheld a scheduled principal amortization payment under its credit facility, resulting in a default thereunder. Since then, our investment adviser and its secured lenders have been in negotiations regarding a consensual restructuring of its obligations under such credit facility. While we are not directly affected by our investment adviser’s default, if it is unable to restructure its credit facility, or an acceleration of the outstanding principal balance by the lenders occurs, the ability of the investment adviser to retain key individuals and perform its investment advisory duties for us could be significantly impaired. A material adverse change in the business, condition (financial or otherwise), operations or performance of our investment adviser could constitute a default under our Revolving Facility. See Item 1A “Risk Factors - Risk related to our Investment Advisor - We are dependent upon our investment advisor and its personnel.”
About Saratoga
If we consummate the proposed Saratoga Transaction, we will replace our investment adviser with Saratoga Investment Advisors, LLC, a Delaware limited liability company (“Saratoga”), which is an affiliate of Saratoga Partners and was formed in connection with the Saratoga Transaction. Saratoga is an investment adviser that has registered with the SEC pursuant to the Investment Advisers Act of 1940 (as amended, the “Advisers Act”). Saratoga Partners was established in 1984 to be the middle-market private investment arm of Dillon Read & Co. Inc. and has been independent of Dillon Read & Co. Inc. since 1998. Saratoga Partners has a 25-year history of private investments in middle market companies and focuses on public and private equity, preferred stock, mezzanine investments, and senior and subordinated debt. Christian L. Oberbeck is the Chief Executive Officer of Saratoga and the Managing Partner of Saratoga Partners and has been a member of its investment committee for 15 years. Mr. Oberbeck is the primary investor in Saratoga Investment Advisors, LLC, and CLO Partners LLC is an entity wholly-owned by Mr. Oberbeck. Richard A. Petrocelli is the Chief Financial Officer and Chief Compliance Officer of Saratoga and a Managing Director of Saratoga Partners. Prior to or at the closing of the Saratoga Transaction, the obligation to acquire certain of the shares of the Company’s common stock under the Stock Purchase Agreement will be assumed by certain individuals affiliated with Saratoga or Saratoga Partners.
Competition
Our primary competitors in providing financing to private middle market companies include public and private investment funds, commercial and investment banks and commercial financing companies. Many of our competitors are substantially larger and have considerably greater financial and marketing resources than us. For example, some competitors may have 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 may allow them to consider a wider variety of investments. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC. For additional information concerning the competitive risks we face, please see Part I, Item 1A “Risk Factors—Risks related to our business—We operate in a highly competitive market for investment opportunities.”
Staffing
We do not currently have any employees and do not expect to have any employees in the future. Services necessary for our business will be provided by individuals who are employees of GSC Group, pursuant to the terms of the investment advisory and management agreement and the administration agreement. We reimburse GSC Group for our allocable portion of expenses incurred by it in performing its obligations under the administration agreement, including rent and our allocable portion of the cost of our officers and their respective staffs, subject to certain limitations. The amount payable to GSC Group under the administration agreement is capped to the effect that such amount, together with our other operating expenses, does not exceed an amount equal to 1.5% per annum of our net assets attributable to common stock. In addition, during the initial term of the administration agreement and the current renewal term (expiring March 2011), GSC Group has agreed to waive our reimbursement obligation under the administration agreement until our total assets exceed $500 million. From the commencement of operations until March 23, 2008, GSC Group reimbursed us for operating expenses to the extent that our total annual operating expenses (other than investment advisory and management fees and interest and credit facility expenses) exceeded an amount equal to 1.55% of our net assets attributable to common stock.
If we consummate the proposed Saratoga Transaction, we will enter in administration agreement with the new investment adviser, Saratoga, on substantially the same terms as our administration agreement with our current manager except for the elimination of the waiver to be reimbursed by the Company. For more information, see our Preliminary Proxy Statement on Schedule 14A filed with the SEC on May 13, 2010.
Regulation
We have elected and qualified to be treated as a BDC under the 1940 Act. As with other companies regulated by the 1940 Act, a BDC must adhere to certain substantive regulatory requirements. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters, and requires that a majority of the directors be persons other than “interested persons,” as that term is 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 BDC, unless approved by a majority of our outstanding voting securities. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of such company’s stock present at a meeting if more than 50% of the outstanding stock of such company is present and represented by proxy or (ii) more than 50% of the outstanding stock of such company.
Under the 1940 Act, we may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed a “principal underwriter” as that term is defined in the Securities Act of 1933, as amended (the “Securities Act”).
Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investment. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances.
We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value of our total assets in the securities of investment companies in general. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses. None of these policies are fundamental and may be changed without stockholder approval.
Qualifying assets
Under the 1940 Act, a BDC 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 represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our proposed business are the following:
| (1) | Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which: |
| | (a) | is organized under the laws of, and has its principal place of business in, the United States; |
| | (b) | is not an investment company (other than a small business investment company wholly owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and |
| | (c) | satisfies either of the following: |
| | (i) | does not have any class of securities listed on a national securities exchange; |
| | (ii) | has a class of securities listed on a national securities exchange but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million; |
| | (iii) | is controlled by a business development company or a group of companies including a business development company and the business development company has an affiliated person who is a director of the eligible portfolio company; |
| | (iv) | is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million; or |
| | (v) | meets such other criteria as may established by the SEC. |
| (2) | Securities of any eligible portfolio company which we control. |
| (3) | Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements. |
| (4) | Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own at least 60% of the outstanding equity of the eligible portfolio company. |
| (5) | Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of options, warrants or rights relating to such securities. |
| (6) | Cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment. |
Managerial assistance to portfolio companies
As a BDC we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. Pursuant to a separate administration agreement, our investment adviser (to the extent permitted under the 1940 Act) will provide such managerial assistance on our behalf to portfolio companies that request this assistance, recognizing that our involvement with each investment will vary based on factors including the size of the company, the nature of our investment, the company’s overall stage of development and our relative position in the capital structure. We may receive fees for these services.
In addition, a BDC 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 the types of securities described in (1), (2) or (3) above under “—Qualifying assets.” However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where the BDC 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. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, 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.
Temporary investments
As a BDC, pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. Government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the asset diversification requirements in order to qualify as a RIC for U.S. federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Our investment adviser will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Indebtedness and senior securities
As a BDC, we are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of shares of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any indebtedness and senior securities remain outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or stock 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 or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, please see Part 1, Item 1A “Risk factors—Risks related to our operation as a BDC—Regulations governing our operation as a BDC will affect our ability to, and the way in which we, raise additional capital.”
Code of ethics
As a BDC, we and our investment adviser have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to each code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements.
GSC Group has designed a compliance program to monitor its conflict-resolution policies and procedures and regularly evaluates the reasonableness of such policies and procedures. GSC Group’s compliance program monitors the implementation of and tests adherence to compliance-related policies and procedures that address GSC Group’s Code of Ethics and other compliance matters including investment allocation, trade aggregation, best execution, cross trades and proxy voting and related matters. The program is governed in part by the requirements of the 1940 Act and is headed by GSC Group’s Chief Compliance Officer.
Proxy voting policies and procedures
SEC registered investment advisers that have the authority to vote (client) proxies (which authority may be implied from a general grant of investment discretion) are required to adopt policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interests of its clients. Registered investment advisers also must maintain certain records on proxy voting. In most cases, we will invest in securities that do not generally entitle us to voting rights in its portfolio companies. When we do have voting rights, we will delegate the exercise of such rights to our investment adviser.
Our investment adviser has particular proxy voting policies and procedures in place. In determining how to vote, officers of our investment adviser will consult with each other and other investment professionals of GSC Group, taking into account our interests and the interests of our investors, as well as any potential conflicts of interest. Where appropriate, our investment adviser will consult with legal counsel to identify potential conflicts of interest. Where a potential conflict of interest exists, our investment adviser may, if it so elects, resolve it by following the recommendation of a disinterested third party, by seeking the direction of our independent directors or, in extreme cases, by abstaining from voting. While our investment adviser may retain an outside service to provide voting recommendations and to assist in analyzing votes, our investment adviser will not delegate its voting authority to any third party.
Privacy principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their non-public personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any non-public personal information relating to our stockholders, although certain non-public personal information of our stockholders may become available to us. We do not disclose any non-public personal information about our stockholders or former stockholders to anyone, except as permitted by law, or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third party administrator).
We restrict access to non-public personal information about our stockholders to employees of our investment adviser and its affiliates with a legitimate business need for the information. We maintain appropriate physical, electronic and procedural safeguards designed to protect the non-public personal information of our stockholders.
Compliance with applicable laws
As a BDC, we may be periodically examined by the SEC for compliance with the 1940 Act. Our manager is a registered investment adviser and is also subject to examination by the SEC.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
We and our investment adviser are each required to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer to be responsible for administering the policies and procedures.
Co-investment
As a BDC, we are prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates, including GSC Group, without the prior approval of our independent directors, or in some cases, the prior approval of the SEC. For example, any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any security from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits “joint” transactions with an affiliate, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we are prohibited from buying or selling any security from or to such person, or entering into joint transactions with such person, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result, we are limited in our ability to negotiate the terms of any investment (except with respect to price) in instances where we are participating in such investments with other funds managed by our affiliates. Generally, we are prohibited from knowingly purchasing securities in a primary offering from a portfolio company the securities of which are already held by our affiliates or any other fund managed by our affiliates. However, if a portfolio company offers additional securities and existing securities are held by us and our affiliates or other funds managed by our affiliates, then we may participate in a follow-on investment in such securities on a pro-rata basis. We may also purchase securities in the secondary market of a company, the securities of which are already held by our affiliates or another fund managed by our affiliates.
We and our affiliates may in the future submit an exemptive application to the SEC to permit greater flexibility to negotiate the terms of co-investments because we believe that it will be advantageous for us to co-invest with funds managed by our affiliates where such investment is consistent with the investment objectives, investment positions, investment policies, investment strategies, investment restrictions, regulatory requirements and other pertinent factors applicable to us. We believe that co-investment by the Company and funds managed by our affiliates may afford us additional investment opportunities and the ability to achieve greater diversification. Accordingly, any application would seek an exemptive order permitting us to negotiate more than price terms when investing with funds managed by our affiliates in the same portfolio companies. It is expected that any exemptive relief permitting co-investments on those terms would be granted, if at all, only upon the conditions, among others, that before such a co-investment transaction is effected, our investment adviser will make a written investment presentation regarding the proposed co-investment to the independent directors of the Company and the independent directors of the Company will review our investment adviser’s recommendation.
Moreover, it is expected that prior to committing to such a co-investment, a “required majority” (as defined in Section 57(o) of the 1940 Act) of the independent directors of the Company would conclude that (i) the terms of the proposed transaction are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company and its stockholders on the part of any person concerned; (ii) the transaction is consistent with the interests of the stockholders of the Company and is consistent with the investment objectives and policies of the Company; and (iii) the co-investment by any fund managed by our affiliates would not disadvantage the Company in making its investment, maintaining its investment position, or disposing of such investment and that participation by the Company would not be on a basis different from or less advantageous than that of the affiliated co-investor. There is no assurance that the application for exemptive relief will be granted by the SEC or that, if granted, it will be on the terms set forth above.
Resolution of potential conflicts of interest; equitable allocation of investment opportunities
Subject to the 1940 Act restrictions on co-investments with affiliates, GSC Group will offer us the right to participate in all investment opportunities that it determines are appropriate for us in view of our investment objectives, policies and strategies and other relevant factors, subject to the exception that, in accordance with GSC Group’s conflict of interest and allocation policies, we might not participate in each individual opportunity but are, on an overall basis, entitled to equitably participate with GSC Group’s other funds or other clients.
We are GSC Group’s principal investment vehicle for non-distressed second lien loans and mezzanine debt of U.S. middle market entities. Although existing and future investment vehicles managed or to be managed by GSC Group invest or may invest in mezzanine loans and second lien loans, none of these investment vehicles target non-distressed domestic second lien and mezzanine loans as the core of their portfolios. For example, while distressed debt funds managed by GSC Group’s corporate credit and distressed investments group may purchase second lien loans and mezzanine debt of private middle market companies, these funds will typically be interested in these assets in distressed situations, whereas we generally will seek to hold performing debt. Likewise, due to the high amounts of leverage deployed by various CLO funds managed by GSC Group, these funds tend to target first lien loans, while second lien and mezzanine loans are a secondary part of the strategy.
To the extent that we do compete with any of GSC Group’s clients for a particular investment opportunity, our investment adviser will allocate the investment opportunity across the funds for which the investment is appropriate based on its internal conflict of interest and allocation policies consistent with the requirements of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), subject further to the 1940 Act restrictions on co-investments with affiliates and also giving effect to priorities that may be enjoyed from to time to time by one or more funds based on their investment mandate or guidelines, or any right of first review agreed to from time to time by GSC Group. Currently GSC European Mezzanine Fund II, L.P. has a priority on investments in mezzanine securities of issuers located primarily in Europe.
Subject to the foregoing, GSC Group’s allocation policies are intended to ensure that we may generally share equitably with other GSC Group-managed investment vehicles in investment opportunities, particularly those involving a security with limited supply or involving differing classes of securities of the same issuer, which may be suitable for us and such other investment vehicles.
GSC Group has historically managed investment vehicles with similar or overlapping investment strategies and has a conflict resolution policy in place that will also address the co-investment restrictions under the 1940 Act. The policy is intended to ensure that we comply with the 1940 Act restrictions on transactions with affiliates. These restrictions will significantly impact our ability to co-invest with other funds managed by GSC Group. While the 1940 Act generally prohibits all “joint transactions” between entities that share a common investment adviser, the staff of the SEC has granted no-action relief to an investment adviser permitting purchases of a single class of privately-placed securities, provided that the investment adviser negotiates no term other than price and certain other conditions are satisfied. Neither our investment adviser nor any participant in a co-investment will have both a material pecuniary incentive and ability to cause us to participate with it in a co-investment. As a result, we only expect to co-invest on a concurrent basis with GSC Group’s funds when each fund will own the same securities of the issuer. If opportunities arise that would otherwise be appropriate for us and for one or more of GSC Group’s other funds to invest in different securities of the same issuer, our investment adviser will need to decide whether we or the other funds will proceed with the investment.
GSC Group’s allocation procedures are designed to allocate investment opportunities among the investment vehicles of GSC Group in a manner consistent with its obligations under the Advisers Act. If two or more investment vehicles with similar investment strategies are still in their investment periods, an available investment opportunity will be allocated as described below, subject to any provisions governing allocations of investment opportunities in the relevant organizational documents. As an initial step, our investment adviser will determine whether a particular investment opportunity is an appropriate investment for us and its other clients and typically will determine the amount that would be appropriate for each client by considering, among other things, the following criteria:
| | (1) | the investment guidelines and/or restrictions set forth in the applicable organizational documents; |
| | (2) | the risk and return profile of the client entity; |
| | (3) | the suitability/priority of a particular investment for the client entity; |
| | (4) | if applicable, the target position size of the investment for the client entity; |
| | (5) | the level of available cash for investment with respect to the particular client entity; |
| | (6) | the total amount of funds committed to the client; and |
| | (7) | the age of the fund and the remaining term of a fund’s investment period, if any. |
If there is an insufficient amount of an opportunity to satisfy the needs of all participants, the investment opportunity will generally be allocated pro-rata based on the initial investment amounts. Please see Part I, Item 1A “Risk Factors—Risks related to our business—There are conflicts of interest in our relationship with our investment adviser and/or affiliates of our investment adviser that could cause them to make decisions that are not in the best interests of our stockholders.” Subject to applicable law, GSC Group may modify its allocation procedures from time to time at its discretion.
Compliance with the Sarbanes-Oxley Act and the New York Stock Exchange corporate governance regulations
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) imposes a wide variety of new regulatory requirements on publicly-held companies and their insiders. The Sarbanes-Oxley Act requires us to review our policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the new regulations promulgated thereunder. We will continue to monitor our compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith. We are not required to include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting in this Annual Report pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this Annual Report.
In addition, we are subject to the corporate governance rules of the New York Stock Exchange (“NYSE”) Listed Company Manual. At our next Annual Meeting of Stockholders, to be held on July 7, 2010, we will correct a violation of NYSE rules arising from the imbalance in the number of directors in each class of directors. As a result of the decision of one Class II director not to stand for re-election in 2009, and the resignation of one GSC affiliated Class I director to maintain a majority of independent directors on our board, our board currently consists of one Class I director, one Class II director and three Class III directors. As a result, our board will consist of two Class I directors, whose terms will expire at our 2011 annual meeting, one Class II director, whose term will expire at our 2012 annual meeting and two Class III directors, whose terms expire at our 2013 annual meeting. The violation will not result in a notation being added to the GNV ticker symbol or affect our listing so long as remedial measures are taken. For more information, see our Definitive Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report. We will continue to monitor our compliance with all future listing standards and will take actions necessary to ensure that we are in compliance therewith.
Available Information
We file with or submit to the SEC annual, quarterly and current periodic reports, proxy statements and other information meeting the informational requirements of the Securities Exchange of 1934, as amended (the “Exchange Act”). You may inspect and copy these reports, proxy statements and other information at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Copies of these reports, proxy and information statements and other information may be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, Washington, D.C. 20549-0102. In addition, the SEC maintains an Internet website that contains reports, proxy and information statements and other information filed electronically by us with the SEC at http://www.sec.gov. Our Internet address is http://www.gscinvestmentcorp.com. We make available free of charge on our Internet website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. The risks set forth below are not the only risks we face. If any of the following risks occur, our business and financial condition could be materially and adversely affected. In such case, our net asset value and the trading price of our common stock could decline.
Risks related to our liquidity and financial condition
We have exceeded the permissible borrowing limits under our Revolving Facility, resulting in an event of default that permits our lenders to accelerate repayment of the outstanding indebtedness and foreclose and liquidate our assets.
The amount that may be outstanding under our Revolving Facility at any time (our “Borrowing Base”) is based on, among other things, the value of the pledged collateral. (See Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition, Liquidity and Capital Resources” in this Annual Report for details). If securities deemed to have a rating of Caa2 or below by Moody’s comprise in excess of 30% of the value of the collateral, such excess Caa2 rated securities are deemed to have a value of zero when calculating the Borrowing Base. The economic recession and resultant stress on our portfolio companies has resulted in a large number of our portfolio companies being downgraded by one or more rating agencies, and continued economic stress may result in additional downgrades in the future.
As of February 28, 2010, approximately 71.2% of the collateral was deemed to be rated Caa2 or below by Moody’s and a further 15.4% of the collateral was deemed to be rated Caa1. As a consequence, approximately 41.2% of securities pledged as collateral under our Revolving Facility are deemed to have a value of zero when calculating the Borrowing Base and has resulted in the Borrowing Base being less than our outstanding borrowings. On July 30, 2009, we exceeded permissible borrowing limits for 30 consecutive days, resulting in an event of default under our credit facility that is continuing. As a result of this event of default, our lender has the right to accelerate repayment of the outstanding indebtedness under our credit facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations.
A forced liquidation of the pledged assets under our Revolving Facility may yield less than the fair value of the assets.
As a result of the continuing event of default under our Revolving Facility, our lender has the right to accelerate the outstanding indebtedness and liquidate the pledged assets. Given the unfavorable conditions in the credit markets, the pledged assets may be liquidated for less than their fair value. If the pledged assets are sold for less than fair value, we will incur realized losses that will negatively affect net asset value and may negatively affect the price of our common stock. As a result, shareholders may realize less than the current net asset value of the common stock.
Continuance of an event of default under our Revolving Facility and/or deferral of payments from GSCIC CLO may result in a shortage of working capital.
Substantially all of our assets other than our investment in the subordinated notes of GSCIC CLO are held in a special purpose subsidiary and pledged under our Revolving Facility. We commenced the two year amortization period under the Revolving Facility in January 2009, during which time all principal proceeds from the pledged assets are used to repay the Revolving Facility. In addition, during the continuance of an event of default, all interest proceeds from the pledged assets are also used to repay the Revolving Facility. As a result, the Company is required to fund its operating expenses and dividends solely from cash on hand, management fees earned from, and the proceeds of the subordinated notes of, GSCIC CLO. Management fees and subordinated note distributions from GSCIC CLO are also subject to deferral depending on the performance of the GSCIC CLO portfolio.
If the event of default under the Revolving Facility continues, and/or distributions from GSCIC CLO are deferred, the Company may find itself with insufficient working capital to fund its operating expenses and/or pay dividends sufficient to comply with its RIC requirements. If such an event were to occur, the ability of the Company to continue to operate and/or comply with its RIC requirements would be seriously impaired.
Our independent registered public accounting firm, Ernst & Young LLP, has concluded that substantial doubt exists about our ability to continue as a going concern.
Our consolidated financial statements as of February 28, 2009 and 2010 and for the three years in the period ended February 28, 2010 were prepared on a “going concern” basis; however, our independent registered public accounting firm concluded in its report dated May 27, 2010 regarding those consolidated financial statements, that there is substantial doubt about our ability to continue as a going concern as a result of our remaining in default under our Revolving Facility, which gives our lender the right to accelerate repayment of the outstanding indebtedness and foreclose and liquidate the collateral pledged. This would have a material adverse effect on our liquidity, financial condition and operations. Our consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Risks related to the proposed Saratoga Transaction
The Saratoga Transaction is subject to closing conditions, including approval by our stockholders, and, while pending, may cause disruption in our business.
The Saratoga Transaction requires approval by our stockholders and is subject to various closing conditions. The Saratoga Transaction may also be terminated or abandoned by one or both parties under certain circumstances. Even if the Saratoga Transaction is consummated, the success of the post-transaction company and any improvement in our financial condition and operations cannot be assured.
The announcement of the Saratoga Transaction, whether or not consummated, has and may continue to result in a loss of key personnel and may disrupt our operations, which may have an impact on our financial performance. The Stock Purchase Agreement generally requires us to operate our business in the ordinary course pending consummation of the Saratoga Transaction, but includes certain contractual restrictions on the conduct of our business that may affect our ability to execute on our business strategies and attain our financial goals. Additionally, the announcement of the pending Saratoga Transaction, whether or not consummated, may impact our relationships with third parties and investors.
Failure to consummate the Saratoga Transaction could negatively impact us and, if the pending Saratoga Transaction is not consummated, we will have incurred significant expenses and our stock price may decline.
If the Saratoga Transaction is not consummated, we would still remain liable for significant transaction costs and expenses, and the focus of our management would have been diverted from seeking other potential strategic opportunities, in each case without realizing any benefits of a completed transaction. Depending on the basis for not consummating the Saratoga Transaction, we could also be required to pay Saratoga a termination fee of $1.25 million or an expense reimbursement of up to $500,000.
In addition, if the Saratoga Transaction is not consummated, we have no assurance that our lender will continue to forbear exercising its remedial rights under the Revolving Facility and may take action against the collateral pledged under the Revolving Facility. For these and other reasons, a failed transaction could adversely affect our business, operating results or financial condition. In addition, the trading price of our securities could be adversely affected to the extent that the current price reflects an assumption that the Saratoga Transaction will be completed. These matters, alone or in combination, could have a material adverse effect on our business and financial results.
Saratoga, the entity to become the Company’s investment adviser, subject to stockholder approval and consummation of the Saratoga Transaction, has no prior experience managing a business development company or a RIC.
The 1940 Act and the Code impose numerous constraints on the operations of business development companies and RICs that do not apply to the other investment vehicles previously managed by the principals of Saratoga. For example, under the 1940 Act, business development companies are required to invest at least 70% of their total assets primarily in securities of qualifying U.S. private or thinly-traded companies. Moreover, qualification for taxation as a RIC under subchapter M of the Code requires satisfaction of source-of-income and diversification requirements and our ability to avoid corporate-level taxes on our income and gains depends on our satisfaction of distribution requirements. The failure to comply with these provisions in a timely manner could prevent us from qualifying as a business development company or RIC or could force us to pay unexpected taxes and penalties, which could be material.
Saratoga, the entity to become the Company’s investment adviser if approved by the vote of the Company’s stockholders and subject to the closing of the Saratoga Transaction, is a newly-formed entity and is newly-registered with the SEC as an investment adviser pursuant to the Advisers Act. As a new entity, Saratoga does not have any prior experience managing a business development company or RIC and its lack of experience in managing a portfolio of assets under such constraints may hinder its ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objectives. Saratoga also does not have a proven track-record in managing corporate debt investments and collateralized loan obligation funds. Despite the 25-year history of Saratoga Partners, an affiliate of Saratoga, with a track record in private investments in middle market companies, there is no guarantee that Saratoga Partners’ past performance record will translate into future success.
Moreover, Saratoga intends to supplement its capabilities in the management of the Company’s investments by recruiting and hiring additional professionals with experience in the management of debt investments and collateralized loan obligations and to dedicate such individuals to the management of the Company. Although Saratoga has represented that it has had discussions with a number of qualified individuals, and the Company’s independent directors have discussed with Saratoga their interviewing criteria and processes, including the caliber of individuals being considered for such positions, and have vetted such processes to their satisfaction and in consideration of their statutory duties to the Company, there is no guarantee that Saratoga will hire or will have hired a sufficient number of professionals with adequate experience in the Company’s line of business as of or after the closing of the Saratoga Transaction.
Even if consummated, the Saratoga Transaction may not achieve the intended results and our post-transaction company may not succeed.
Certain of our stockholders may view the post-transaction company as a different and less desirable investment vehicle for their capital, and sales of shares of our common stock by such stockholders could depress the share price of our common stock. For this and the reasons set forth above, there can be no assurance that, if the Saratoga Transaction is consummated, the post-transaction company will succeed.
Risks related to current economic and market conditions
The recent global recession has impaired our portfolio companies and harmed our operating results.
The U.S. economy is tentatively recovering from a severe recession. Many of the companies in which we have made or will make investments have been adversely affected. An economic recession, including the recent recession and any future recessions or economic slowdowns, may affect the ability of a company to repay our loans or engage in a liquidity event such as a sale, recapitalization, or initial public offering. Such adverse economic conditions may decrease the value of collateral securing our loans, if any. A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt that we hold and the value of any equity securities we own. We may also incur expenses to seek recovery upon default or to negotiate new terms with a defaulting portfolio company.
Declining asset values and illiquidity in the corporate debt markets have adversely affected, and may continue to adversely affect, the fair value of our portfolio investments, reducing the value of our assets.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair market value as determined in good faith by the Board of Directors. Decreases in the values of our investments are recorded as unrealized depreciation. The recent unprecedented declines in asset values and liquidity in the corporate debt markets have resulted in significant net unrealized depreciation in our portfolio. As a result, we have incurred and, depending on market conditions, we may continue to incur, significant unrealized depreciation in our portfolio, which could have a material adverse effect on our business, financial condition and results of operations.
Our common stock could be delisted from the New York Stock Exchange if our average market capitalization over 30 consecutive trading days is below $15 million.
In order to maintain our listing on the New York Stock Exchange (“NYSE”), we must continue to meet the NYSE minimum average market capitalization requirement. At February 28, 2010, our minimum average market capitalization over the preceding 30 consecutive trading days was $28.3 million. If the average market capitalization over 30 consecutive trading days falls below $15.0 million, our common stock may be delisted, which could (i) reduce the liquidity and market price of our common stock; (ii) negatively impact our ability to raise equity financing and access the public capital markets; and (iii) materially and adversely impact our results of operations and financial condition.
Risks related to our investment advisors
We are dependent upon our investment adviser and its personnel.
We depend on the diligence, skill and network of business contacts of our investment adviser’s investment professionals and the information and deal flow generated by them in the course of their investment and portfolio management activities and on our investment advisor’s non-investment professionals for the provision of our administrative services, including legal, compliance and accounting services, necessary for our business. The departure of a significant number of the investment and non-investment professionals of our investment adviser could have a material adverse effect on our ability to operate and achieve our investment objectives.
In April 2009, our investment adviser withheld a scheduled principal amortization payment under its credit facility, resulting in a default thereunder. Since then, our investment adviser and its secured lenders have been in negotiations regarding a consensual restructuring of its obligations under such credit facility. While we are not directly affected by our investment adviser’s default, if it is unable to restructure its credit facility, or an acceleration of the outstanding principal balance by the lenders occurs, the ability of the investment adviser to retain key individuals and perform its investment advisory duties for us could be significantly impaired. A material adverse change in the business, condition (financial or otherwise), operations or performance of our investment adviser could constitute a default under our Revolving Facility.
At February 28, 2010, our investment advisor employed approximately 45 persons, down from 85 at February 28, 2009. The corporate credit and distressed investment group, which provides investment advisory and management services to the Company, employed 12 investment professional at February 28, 2010 down from 19 at February 28, 2009. On May 25, 2010, our CFO, Richard T. Allorto, Jr., announced his resignation from the Company and GSC Group, to take effect on July 15, 2010.
The Board of Directors of the Company actively monitors the financial condition of GSC Group to ensure that adequate resources are available to the Company. We expect GSC Group to continue to provide the necessary resources to the Company, supplemented with third party service providers, when and if necessary. If adequate resources are not available and the Company is not able to employ a replacement investment advisor, the Company’s ability to operate and achieve its investment objectives may be materially impaired.
If we consummate the proposed Saratoga Transaction, we will replace our current investment adviser, GSCP, with a new investment adviser, Saratoga. Saratoga has no experience managing a BDC or a RIC, and we can provide no assurance that the past performance of Saratoga Partners, the parent affiliate of Saratoga, will translate into future success. In addition, we cannot assure you that Saratoga will remain our investment adviser or that we will continue to have access to Saratoga’s investment professionals or its information and deal flow.
Our Chief Financial Officer, Richard T. Allorto, Jr., announced his resignation effective July 15, 2010.
On May 25, 2010, our Chief Financial Officer, Richard T. Allorto, Jr., announced his resignation effective July 15, 2010. The departure of Mr. Allorto may have an adverse effect on our business and future operations if GSC is unable to procure an adequate replacement, particularly if the Saratoga Transaction is not consummated in the near future or at all. In order to avoid a negative impact on our operations, GSC Group is preparing an appropriate succession plan. However, we can provide no assurance that GSC will be able to find a timely and adequate replacement for Mr. Allorto. Furthermore, a significant leadership change is inherently risky and we may be unable to manage the transition to a new CFO smoothly, which may cause a disruption to our business and could materially and adversely affect our business, financial condition and results of operations.
Risks related to our business
We employ leverage.
We currently use the Revolving Facility to leverage our portfolio and our strategy includes borrowing from and issuing senior debt securities to banks and other lenders, subject to market conditions, as well as securitizing certain of our portfolio investments. However, under current market conditions, we are not in a position to issue senior debt securities on acceptable terms.
With certain limited exceptions, as a BDC we are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The amount of leverage that we employ will depend on our investment adviser’s and our Board of Directors’ assessment of market conditions and other factors at the time of any proposed borrowing. There is no assurance that a leveraging strategy will be successful. Leverage involves risks and special considerations for stockholders, including:
| | • | A likelihood of greater volatility in the net asset value and market price of our common stock. |
| | • | Diminished operating flexibility as a result of asset coverage or investment portfolio composition requirements that are more stringent than those imposed by the 1940 Act. |
| | • | The possibility that investments will have to be liquidated at less than full value or at inopportune times to comply with debt covenants or to pay interest or dividends on the leverage. |
| | • | Increased operating expenses due to the cost of leverage, including issuance and servicing costs. |
| | • | Subordination to lenders’ superior claims on our assets as a result of which lenders will be able to receive proceeds available in the case of our liquidation before any proceeds are distributed to our shareholders. |
For example, the amount we may borrow under our Revolving Facility is determined, in part, by the fair value of our investments. As the fair value of our investments declines, we are forced to sell investments at a loss to maintain compliance with our borrowing limits. We are currently in default of our Revolving Facility for failure to maintain compliance with our borrowing limits. Other debt facilities we may enter into in the future, including the proposed Replacement Facility, contain similar provisions. Such forced sales reduce our net asset value and also make it difficult for the net asset value to recover.
Our investment adviser and our Board of Directors in their best judgment nevertheless may determine to use leverage if they expect that the benefits to our stockholders of maintaining the leveraged position will outweigh the risks.
We need to find alternative sources of leverage and/or access the equity markets to maintain and grow our business.
We commenced the two year amortization period under the Revolving Facility in January 2009, during which time all principal proceeds of our pledged investments are used to reduce the outstanding borrowings under the Revolving Facility. In addition, during the continuance of the event of default that exists under our Revolving Facility, all interest proceeds from the pledged assets are also used to repay the Revolving Facility. As a result, the Company is required to fund its operating expenses and dividends solely from cash on hand, management fees earned from, and the proceeds of the subordinated notes of, GSCIC CLO.
On the second anniversary of the amortization period, all remaining outstanding borrowings under the Revolving Facility will become due and payable. As a result of these mandatory repayments, our investment portfolio will begin to de-leverage commencing with the payment of the first principal proceeds on our portfolio, and must be completely deleveraged in two years, unless we can obtain an alternative source of financing.
On April 14, 2010, we entered into the Stock Purchase Agreement with Saratoga and CLO Partners LLC and an assignment, assumption and novation agreement with Saratoga, pursuant to which we assumed certain rights and obligations of Saratoga under the Madison Commitment Letter Saratoga received from Madison, indicating Madison’s willingness to provide the Company with a $40 million senior secured revolving credit facility, subject to the satisfaction of certain terms and conditions. However, if the Saratoga Transaction is not consummated and we do not receive the Replacement Facility from Madison, given the unfavorable conditions in the credit markets, there is no assurance we will be able to secure new financing or, if we are able to obtain financing, that the terms of such financing will be commensurate with the terms of the Revolving Facility. Because our ability to generate net investment income is based, in part, on the use of relatively inexpensive financing available under the Revolving Facility to purchase portfolio assets, the amortization of the Revolving Facility will negatively impact our ability to generate investment income (and pay dividends) in the future.
Because the amount of leverage we can employ is limited by the 1940 Act, our ability to grow depends on raising additional equity capital notwithstanding the availability of additional leverage. Under current market conditions, we are not in a position to issue additional equity capital. An inability to access the equity capital markets will limit our ability to grow our business and fully execute our business strategy.
Many of our portfolio investments are recorded at fair value as determined in good faith by our Board of Directors; such valuations are inherently uncertain and may be materially higher or lower than the values that we ultimately realize upon the disposal of such investments.
A large percentage of our portfolio is, and we expect will continue to be, comprised of investments that are not publicly traded. The value of investments that are not publicly traded may not be readily determinable. We value these investments quarterly at fair value as determined in good faith by our Board of Directors. Where appropriate, our Board of Directors may utilize the services of an independent valuation firm to aid it in determining fair value. The types of factors that may be considered in valuing our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, market yield trend analysis, comparison to publicly traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be materially affected if the determinations regarding the fair value of our investments were materially higher or lower than the values that we ultimately realize upon the disposal of such investments.
Our independent registered public accountants have identified a material weakness in our internal control over financial reporting, and our business and stock price may be adversely affected if we have not adequately addressed the weakness or if we have other material weaknesses or significant deficiencies in our internal controls over financial reporting.
Our independent registered public accountants have identified a material weakness in our internal control over financial reporting. In particular, we did not maintain effective controls over the accounting and disclosure of complex investment valuations. The material weakness related to an error in the valuation reconciliation for certain investments. This error occurred as a result of an inadequate internal review and reconciliation of the inputs used in preparing the complex investment valuations. In order to remediate the material weakness, we have requested that GSC Group provide us with additional staff and support in order to improve our internal control over financial reporting.
These control deficiencies resulted in adjustments to our consolidated financial statements for the year ended February 28, 2010. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our stock could decline significantly, we may be unable to obtain additional financing to operate and expand our business, and our business and financial condition could be harmed. In addition, we face the risk that, notwithstanding our efforts to identify and remedy all material errors in those financial statements, we may discover other errors in the future. We also face the risk that the cost of identifying and remedying the errors and remediating our material weakness in internal controls will be high and could have a material adverse effect on our financial condition and results of operations.
We may be obligated to pay our investment adviser incentive compensation even if we incur a net loss, regardless of the market value of our common stock.
Our investment adviser is entitled 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. Our pre-incentive fee net investment income, for incentive compensation purposes, 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 investment 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.
Under the investment advisory and management agreement, we will defer cash payment of any incentive fee otherwise earned by our investment adviser if, during the most recent four full quarterly periods ending on or prior to the date such payment is to be made, the sum of (a) our aggregate distributions to our stockholders and (b) our change in net assets (defined as total assets less liabilities) is less than 7.5% of our net assets at the beginning of such period. These calculations will be appropriately pro rated during the first three quarters of this fiscal year and will be adjusted for any share issuances or repurchases. Furthermore, the incentive fee that we pay is not tied to the market value of our common stock.
If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in the calculation of the incentive fee will become uncollectible. The investment adviser is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a default by an entity on the obligation that resulted in the accrual of such income.
The proposed investment advisory and management agreement with Saratoga is substantially similar to the investment advisory and management agreement with our current investment adviser, except for the following material distinctions in the fee terms:
| | • | The capital gains portion of the incentive fee will be reset with respect to gains and losses from May 31, 2010, and therefore losses and gains incurred prior to such time will not be taken into account when calculating the capital gains fee, and Saratoga will be entitled to 20% of gains that arise after May 31, 2010. In addition, the cost basis for computing realized losses on investment held by the Company as of May 31, 2010 will equal the fair value of such investment as of such date. Under the investment advisory and management agreement with our current investment adviser, the capital gains fee is calculated from March 21, 2007, and the gains are substantially outweighed by losses. |
| | • | Under the “catch up” provision, 100% of the Company’s pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income that exceeds 1.875% (7.5% annualized) but is less than or equal to 2.344% in any fiscal quarter is payable to Saratoga. This will enable Saratoga to receive 20% of all net investment income as such amount approaches 2.344% in any quarter, and Saratoga will receive 20% of any additional net investment income. Under the investment advisory and management agreement with our current investment adviser, GSCP only receives 20% of the excess net investment income over 1.875%. |
| | • | The Company will no longer have deferral rights regarding incentive fees in the event that the distributions to stockholders and change in net assets is less than 7.5% for the preceding four fiscal quarters. |
Our investment adviser’s incentive compensation may cause it to pursue a high risk investment strategy.
The incentive fee payable to the investment adviser may create an incentive for the investment adviser to make investments that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to the investment adviser is determined (in the case of GSCP, 20% of the pre-incentive fee net investment income that exceeds a hurdle rate of a 1.875% quarterly return on the value of net assets, and in the case of Saratoga, 100% of the pre-incentive fee net investment income that exceeds a hurdle rate of a 1.875% quarterly return on the value of net assets, up to 2.344% in any quarter) may encourage the investment adviser to use leverage to increase the return to the Company’s investments. If the investment adviser acquires poorly-performing assets with such leverage, the loss to holders of the shares could be substantial. Moreover, if our leverage is increased, we will be exposed to increased risk of loss, bear the increased cost of issuing and servicing such senior indebtedness, and will be subject to any additional covenant restrictions imposed on us in an indenture or other instrument or by the applicable lender. Our Board of Directors will monitor the conflicts presented by this compensation structure by approving the amount of leverage that we may incur. In addition, the investment adviser receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. As a result, the investment adviser may have a tendency to invest more in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
Our investment adviser’s base compensation may cause it to increase our leverage contrary to our interest.
We pay the investment adviser a quarterly base management fee based on the value of our total assets (including any assets acquired with leverage). Accordingly, the investment adviser has an economic incentive to increase our leverage. Our Board of Directors monitors the conflicts presented by this compensation structure by approving the amount of leverage that we incur. If our leverage is increased, we will be exposed to increased risk of loss, bear the increase cost of issuing and servicing such senior indebtedness, and will be subject to any additional covenant restrictions imposed on us in an indenture or other instrument or by the applicable lender.
We operate in a highly competitive market for investment opportunities.
A number of entities compete with us to make the types of investments that we plan to make in private middle market companies. We compete with other BDCs, public and private funds, commercial and investment banks, commercial financing companies, insurance companies, high-yield investors, hedge funds, and, to the extent they provide an alternative form of financing, private equity funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than us. 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 that could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we cannot assure you that we will be able to identify and make investments that meet our investment objectives.
We do not seek to compete primarily based on the interest rates we offer and we believe that some of our competitors may make loans with interest rates that are 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. If we match our competitors’ pricing, terms and structure, we may experience decreased net interest income and increased risk of credit loss. As a result of operating in such a competitive environment, we may make investments that are on better terms to our portfolio companies than we originally anticipated, which may impact our return on these investments.
We are a non-diversified investment company within the meaning of the 1940 Act, and therefore are not limited with respect to the proportion of our assets that may be invested in securities of a single issuer. To the extent that we assume large positions in the securities of a small number of issuers, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company. However, we intend to comply with the diversification requirements imposed by the Code for qualification as a RIC.
Our financial condition and results of operation depend on our ability to manage future investments effectively.
Our ability to achieve our investment objectives depends on our ability to acquire suitable investments and monitor and administer those investments, which depends, in turn, on our investment adviser’s ability to identify, invest in and monitor companies that meet our investment criteria.
Accomplishing this result on a cost-effective basis is largely a function of our investment adviser’s structuring of the investment process and its ability to provide competent, attentive and efficient service to us. Our executive officers and the employees of our investment adviser have substantial responsibilities in connection with their roles at GSC Group and with the other GSC Group investment vehicles as well as responsibilities under the investment advisory and management agreement. Likewise, if the proposed Saratoga Transaction is consummated, the executive officers of our new investment adviser will have substantial responsibilities in connection with their roles at Saratoga and with other Saratoga investment vehicles as well as responsibilities under the investment advisory and management agreement. They may also be called upon to provide managerial assistance to our portfolio companies. These demands on their time, which will increase as the number of investments grow, may distract them or slow the rate of investment. In order to grow, our investment adviser may need to hire, train, supervise and manage new employees. However, we cannot assure you that any such employees will contribute to the work of the investment adviser. Any failure to manage our future growth effectively could have a material adverse effect on our business and financial condition.
There are conflicts of interest in our relationship with our investment adviser and/or affiliates of our investment adviser that could cause them to make decisions that are not in the best interests of our stockholders.
Subject to the restrictions of the 1940 Act, we may co-invest in investments of portfolio companies on a concurrent basis with other investment vehicles managed by affiliates of our investment adviser, such as GSC Group, or, if we consummate the proposed Saratoga Transaction, Saratoga. An affiliate-managed investment vehicle may, in certain circumstances, invest in securities issued by a company in which we have made, or are making, an investment. Similarly, in certain circumstances, we may invest in securities issued by a company in which another affiliate-managed investment vehicle has made an investment. Although certain such investments may present conflicts of interest, we nonetheless may pursue and consummate such transactions. These conflicts may include:
Co-Investment. We are prohibited from co-investing with other investment vehicles managed now or in the future by our affiliates in certain investments of portfolio companies in instances where our affiliates negotiate terms other than price. In instances where we co-invest with an affiliate-managed investment vehicle, while we will invest on the same terms and neither we nor the affiliate-managed investment vehicle may negotiate terms of the transaction other than price, conflicts of interest may arise. For example, if an investee company in which both we and an affiliate-managed investment vehicle have invested becomes distressed, and the size of our relative investments varies significantly, the decisions relating to actions to be taken could raise conflicts of interest.
Conflicts in Different Parts of Capital Structure. If a portfolio company in which we and another affiliate-managed investment vehicle hold different classes of securities encounters financial problems, decisions over the terms of any workout will raise conflicts of interest. For example, a debt holder may be better served by a liquidation of the issuer in which it will be paid in full, whereas an equity holder might prefer a reorganization that could create value for the equity holder.
Potential Conflicting Positions. Given our investment objectives and the investment objectives of other affiliate-managed investment vehicles, it is possible that we may hold a position that is contrary to a position held by another affiliate-managed investment vehicle. For example, we could hold a longer term investment in a certain portfolio company and at the same time another affiliate-managed investment vehicle could hold a short-term position in the same company. Our affiliates make each investment decision separately based upon the investment objective of each of their clients.
Shared Legal Counsel. We and other affiliate-managed investment vehicles generally engage common legal counsel in transactions in which both are participating or with respect to matters that may affect both. Although separate counsel may be engaged, the time and cost savings and other efficiencies and advantages of using common counsel will generally outweigh the disadvantages. In the event of a significant dispute or divergence of interests, typically in a work-out or other distressed situation, separate representation may become desirable, and in litigation and other circumstances, separate representation may be necessary.
Allocation of Opportunities. Our investment adviser provides investment management, investment advice or other services in relation to a number of investment vehicles that focus on corporate credit, distressed debt, mezzanine investments and structured finance products and have investment objectives that are similar to or overlap with ours. Investment opportunities that may be of interest to us may also be of interest to our affiliates’ other investment vehicles, and our affiliates may buy or sell securities for us which differ from securities which they may cause to be bought or sold for other investment vehicles. Our affiliates have greater interests in other investment vehicles they manage, including greater capital commitments to, or larger fees earned from, such investment vehicles. These differing interests may create a conflict of interest for our affiliates in determining which investment vehicle should pursue a given investment opportunity.
Material Nonpublic Information. Our affiliates or their employees, officers, principals or affiliates may come into possession of material nonpublic information in connection with business activities unrelated to our operations. The possession of such information may limit our ability to buy or sell securities or otherwise participate in an investment opportunity or to take other action we might consider in our best interest.
Cross-Trading. Subject to applicable law, we may engage in transactions directly with other investment vehicles managed by our affiliates, including the purchase or sale of all or a portion of a portfolio investment. Cross-trades can save us brokerage commissions and, in certain cases, related transaction costs. Cross-trades between affiliates may create conflicts of interest with respect to certain terms of the transaction, including price. The 1940 Act imposes substantial restrictions on cross-trades between us and investment vehicles managed by our affilaites. As a result, our Board of Directors has adopted cross-trading procedures designed to ensure compliance with the requirements of the 1940 Act and will regularly review the terms of any cross-trades.
We may compete with investment vehicles of our parent affiliate for access to our parent affiliate.
Our investment adviser and its affiliates have sponsored and currently manage other investment vehicles with an investment focus that overlaps with our focus, and may in the future sponsor or manage additional investment vehicles with an overlapping focus to ours, which, in each case, could result in us competing for access to the benefits that we expect our relationship with our parent affiliate to provide to us.
We are exposed to risks associated with changes in interest rates.
General interest rate fluctuations and changes in credit spreads on floating rate loans may have a substantial negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on investment objectives and our rate of return on invested capital. In addition, an increase in interest rates would make it more expensive to use debt to finance our investments. Decreases in credit spreads on debt that pays a floating rate of return would have an impact on the income generation of our floating rate assets. Trading prices for debt that pays a fixed rate of return tend to fall as interest rates rise. Trading prices tend to fluctuate more for fixed-rate securities that have longer maturities. Although we have no policy governing the maturities of our investments, under current market conditions we expect that we will invest in a portfolio of debt generally having maturities of up to ten years. This means that we will be subject to greater risk (other things being equal) than an entity investing solely in shorter-term securities. A decline in the prices of the debt we own could adversely affect the trading price of our common stock.
We may experience fluctuations in our quarterly results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the debt investments we make, the default rate on such investments, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Our investment adviser’s liability is limited under the investment advisory and management agreement and we will indemnify our investment adviser against certain liabilities, which may lead our investment adviser to act in a riskier manner on our behalf than it would when acting for its own account.
Our investment adviser has not assumed any responsibility to us other than to render the services described in the investment advisory and management agreement. Pursuant to the investment advisory and management agreement, our investment adviser and its general partner, officers and employees are not liable to us for their acts, under the investment advisory and management agreement, absent willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties. We have agreed to indemnify, defend and protect our investment adviser and its general partner, officers and employees with respect to all damages, liabilities, costs and expenses resulting from acts of our investment adviser not arising out of willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties under the investment advisory and management agreement. These protections may lead our investment adviser to act in a riskier manner when acting on our behalf than it would when acting for its own account. If we enter into the proposed Saratoga Transaction, the new investment advisory and management agreement will contain substantially the same indemnification provisions as under our current investment advisory and management agreement.
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 at the local, state and federal levels. These laws and regulations, as well as their interpretation, may be changed from time to time. Any change in these laws or regulations, or their interpretation, or any failure by us to comply with these laws or regulations may adversely affect our business.
As discussed below, there is a risk that certain investments that we intend to treat as qualifying assets will be determined to not be eligible for such treatment. Any such determination would have a material adverse effect on our business.
Risks related to our operation as a BDC
Our common stock may trade at a discount to our net asset value per share.
Common stock of BDCs, as closed-end investment companies, frequently trade at a discount to net asset value. Our common stock has traded at a discount to our net asset value since shortly after our initial public offering. The risk that our common stock may continue to trade at a discount to our net asset value is separate and distinct from the risk that our net asset value per share may decline.
Regulations governing our operation as a BDC will affect our ability to raise additional capital.
We have incurred indebtedness under the Revolving Facility and we may issue debt securities or preferred stock, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we are permitted, as a BDC, to incur indebtedness or issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. If the value of our assets declines, we may be unable to satisfy this test, which could prohibit us from paying dividends and prevent us from qualifying as a RIC. If we cannot satisfy this test, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in our best interests and the best interests of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any commission or discount). If our common stock trades at a discount to net asset value, this restriction could adversely affect our ability to raise capital.
To generate cash for funding new investments, we pledged a substantial portion of our portfolio investments under the Revolving Facility. Such assets are not available to secure other sources of funding or for securitization. Our ability to obtain additional secured or unsecured financing on attractive terms in the future is uncertain. Alternatively, we may in the future seek to securitize a portion of our loan portfolio. The loan and securitization markets are subject to changing market conditions, however, and we may not be able to access this market when we would otherwise deem appropriate. An inability to obtain additional leverage through secured or unsecured financing or securitization of our loan portfolio could limit our ability to grow our business, fully execute our business strategy and decrease our earnings, if any. We may also face a heightened risk of loss to the extent we hold a first loss position in a securitized loan portfolio. The 1940 Act may also impose restrictions on the structure of any securitization.
There is a risk that you may not receive distributions or that our distributions may not grow over time.
As a BDC for 1940 Act purposes and a RIC for U.S. federal income tax purposes, we intend to make distributions out of assets legally available for distribution on a quarterly basis to our stockholders once such distributions are authorized by our Board of Directors and declared by us. We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. In addition, due to the asset coverage test that is applicable to us as a BDC, we may be limited in our ability to make distributions. Further, if we invest a greater amount of assets in equity securities that do not pay current dividends, it could reduce the amount available for distribution.
A failure on our part to maintain our qualification as a BDC would significantly reduce our operating flexibility.
If we fail to qualify as a BDC, we might be regulated as a closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility.
We will be subject to corporate-level income tax if we fail to qualify as a RIC.
We will seek to qualify as a RIC under the Code, which requires us to qualify continuously as a BDC and meet certain source of income, distribution and asset diversification requirements.
The source of income requirement is satisfied if we derive at least 90% of our annual gross income from interest, dividends, payments with respect to certain securities loans, gains from the sale or other disposition of securities or options thereon or foreign currencies, or other income derived with respect to our business of investing in such securities or currencies, and net income from interests in “qualified publicly traded partnerships,” as defined in the Code.
The annual distribution requirement is satisfied if we distribute to our stockholders on an annual basis an amount equal to at least 90% of our ordinary net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses. We are subject to certain asset coverage ratio requirements under the 1940 Act and covenants under the Facilities that could, under certain circumstances, restrict us from making distributions necessary to qualify as a RIC. In such case, if we are unable to obtain cash from other sources, we may fail to qualify as a RIC and, thus, may be subject to corporate-level income tax.
To qualify as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to (i) dispose of certain investments quickly or (ii) raise additional capital to prevent the loss of our RIC qualification. Because most of our investments will be in private companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we raise additional capital to satisfy the asset diversification requirements, it could take us time to invest such capital. During this period, we will invest the additional capital in temporary investments, such as cash and cash equivalents, which we expect will earn yields substantially lower than the interest income that we anticipate receiving in respect of investments in first and second lien loans, mezzanine debt and high yield debt.
If we fail to qualify as a RIC for any reason, all of our taxable income will be subject to U.S. federal income tax at regular corporate rates. The resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on us and our stockholders.
As a BDC, we may have difficulty paying our required distributions if we recognize income before or without receiving cash in respect of such income.
For U.S. federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as original issue discount, which may arise if we receive warrants in connection with the making of a loan or possibly in other circumstances, or contracted paid-in-kind interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount, which could be significant relative to our overall investment activities, or increases in loan balances will be included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash, including, for example, non-cash income from paid-in-kind securities and deferred payment securities. In addition, we will consolidate GSCIC CLO for federal income tax purposes, and income earned thereon may differ from the distributions paid in respect of our investment in the GSCIC CLO subordinated notes because of the factors set forth above or because distributions on the subordinated notes are contractually required to be diverted for reinvestment or to pay down outstanding indebtedness.
Since in certain cases we may recognize income before or without receiving cash in respect of such income, we may have difficulty meeting the requirement that we distribute an amount equal to at least 90% of our ordinary net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, to qualify as a RIC. Accordingly, we may have to sell some of our investments (or investments in the GSCIC CLO portfolio) at times we would not consider advantageous, raise additional debt or equity capital or reduce new investments to meet these distribution requirements. If we are not able to obtain cash from other sources, or are restricted from selling investments in the GSCIC CLO portfolio by the terms of the applicable indenture, we may fail to qualify as a RIC and thus be subject to corporate-level income tax.
If our primary investments are deemed not to be qualifying assets, we could fail to qualify as a BDC or be precluded from investing according to our current business plan.
If we are to maintain our qualification as a BDC, we must not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. We believe that the leveraged loans and mezzanine investments that we propose to acquire constitute qualifying assets because, at the time of our investment, the privately held issuers will not have securities listed on a national securities exchange and the publicly traded issuers will have a market capitalization of less than $250 million.
The floating interest rate features of any indebtedness incurred by us could adversely affect us if interest rates rise.
Any indebtedness incurred by us will likely bear interest at a floating rate based on an index. As a result, if that index increases, our costs under any indebtedness incurred would become more expensive, which could have a material adverse effect on our earnings.
Risks related to our investments
Our investments may be risky, and you could lose all or part of your investment.
Substantially all of the debt investments held in the portfolio hold, and will likely continue to hold, a non-investment grade rating by Moody’s and/or Standard & Poor’s or, where not rated by any rating agency, would be below investment grade, if rated. High yield bonds rated below investment grade are commonly referred to as “junk bonds.” A below investment grade rating means that, in the rating agency’s view, there is an increased risk that the obligor on such debt will be unable to pay interest and repay principal on its debt in full. We may also invest in debt that defers or pays paid-in-kind interest. To the extent interest payments associated with such debt are deferred, such debt will be subject to greater fluctuations in value based on changes in interest rates, such debt could produce taxable income without a corresponding cash payment to us, and since we generally do not receive any cash prior to maturity of the debt, the investment will be of greater risk.
In addition, private middle market companies in which we expect to invest are exposed to a number of significant risks, including:
| | • | limited financial resources and an inability to meet their obligations, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing any guarantees we may have obtained in connection with our investment; |
| | • | shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns; |
| | • | dependence on the management talents and efforts of a small group of persons; the death, disability, resignation or termination of one or more of which could have a material adverse impact on the company and, in turn, on us; |
| | • | less predictable operating results and, possibly, substantial additional capital requirements to support their operations, finance expansion or maintain their competitive position.; and |
| | • | difficulty accessing the capital markets to meet future capital needs. |
In addition, our executive officers, directors and our investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.
The lack of liquidity in our investments may adversely affect our business.
We expect to make investments in private companies. A portion of these securities may be subject to legal and other restrictions on resale, transfer, pledge or other disposition or will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. In addition, we may face other restrictions on our ability to liquidate an investment in a business entity to the extent that we or our investment adviser has or could be deemed to have material non-public information regarding such business entity.
The debt securities in which we invest are subject to credit risk and prepayment risk.
An issuer of debt security may be unable to make interest payments and repay principal. We could lose money if the issuer of a debt obligation is, or is perceived to be, unable or unwilling to make timely principal and/or interest payments, or to otherwise honor its obligations. The downgrade of a security by rating agencies may further decrease its value.
Certain debt instruments may contain call or redemption provisions which would allow the issuer thereof to prepay principal prior to the debt instrument’s stated maturity. This is known as prepayment risk. Prepayment risk is greater during a falling interest rate environment as issuers can reduce their cost of capital by refinancing higher interest debt instruments with lower interest debt instruments. An issuer may also elect to refinance their debt instruments with lower interest debt instruments if the credit standing of the issuer improves. To the extent debt securities in our portfolio are called or redeemed, we may receive less than we paid for such security and we may be forced to reinvest in lower yielding securities or debt securities of issuers of lower credit quality.
Our investment in GSCIC CLO constitutes a leveraged investment in a portfolio of predominantly senior secured first lien term loans and is subject to additional risks and volatility.
At February 28, 2010, our investment in the subordinated notes of GSCIC CLO had a fair value of $16.7 million and constituted 18.7% of our portfolio. This investment constitutes a first loss position in a portfolio that, as of February 28, 2010, was composed of $387.1 million in aggregate principal amount of primarily senior secured first lien term loans and $21.1 million in uninvested cash. Interest payments generated from this portfolio will be used to pay the administrative expenses of GSCIC CLO and interest on the debt issued by GSCIC CLO before paying a return on the subordinated notes. Principal payments will be similarly applied to pay administrative expenses of GSCIC CLO and for reinvestment or repayment of GSCIC CLO debt before paying a return on, or repayment of, the subordinated notes. In addition, 80% of our fixed management fee and 100% our incentive management fee is subordinated to the payment of interest and principal on GSCIC CLO’s debt. Any losses on the portfolio will accordingly reduce the cash flow available to pay these management fees and provide a return on, or repayment of, our investment. Depending on the amount and timing of such losses we may experience smaller than expected returns and, potentially, the loss of our entire investment.
As the manager of the portfolio, we will have some ability to direct the composition of the portfolio, but our discretion is limited by the terms of the debt issued by GSCIC CLO, which may limit our ability to make investments that we feel are in the best interests of the subordinated notes, and the availability of suitable investments. The performance of the portfolio is also subject to many of the same risks sets forth in this Annual Report with respect to portfolio investments in senior secured first lien term loans.
Available information about privately held companies is limited.
We invest primarily in privately-held companies. Generally, little public information exists about these companies, and we are required to rely on the ability of our investment adviser’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. These companies and their financial information are not subject to the Sarbanes-Oxley Act and other rules that govern public companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments.
When we are a debt or minority equity investor in a portfolio company, we may not be in a position to control the entity, and its management may make decisions that could decrease the value of our investment.
We anticipate making both debt and minority equity investments; therefore, we will be subject to the risk that a portfolio company may make business decisions with which we disagree, and the stockholders and management of such company may take risks or otherwise act in ways that do not serve our interests. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.
Our portfolio companies may incur debt or issue equity securities that rank equally with, or senior to, our investments in such companies.
Our portfolio companies usually will have, or may be permitted to incur, other debt, or issue other equity securities that rank equally with, or senior to, our investments. By their terms, such instruments may provide that the holders are entitled to receive payment of dividends, interest or principal on or before the dates on which we are entitled to receive payments in respect of our investments. These debt instruments will usually prohibit the portfolio companies from paying interest on or repaying our investments in the event and during the continuance of a default under such debt. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of securities 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 holders, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debtor equity ranking equally with our investments, we would have to share on an equal basis any distributions with other holders in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.
If one of our portfolio companies were to go bankrupt, even though we may have structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt holding and subordinate all or a portion of our claim to that of other creditors. In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrower’s business or exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken if we actually render significant managerial assistance.
Investments in equity securities involve a substantial degree of risk.
We may purchase common stock and other equity securities. Although equity securities have historically generated higher average total returns than fixed-income securities over the long-term, equity securities also have experienced significantly more volatility in those returns and in recent years have significantly under performed relative to fixed-income securities. The equity securities we acquire may fail to appreciate and may decline in value or become worthless and our ability to recover our investment will depend on our portfolio company’s success. Investments in equity securities involve a number of significant risks, including:
| | • | any equity investment we make in a portfolio company could be subject to further dilution as a result of the issuance of additional equity interests and to serious risks as a junior security that will be subordinate to all indebtedness or senior securities in the event that the issuer is unable to meet its obligations or becomes subject to a bankruptcy process; |
| | • | to the extent that the portfolio company requires additional capital and is unable to obtain it, we may not recover our investment in equity securities; and |
| | • | in some cases, equity securities in which we invest will not pay current dividends, and our ability to realize a return on our investment, as well as to recover our investment, will be dependent on the success of our portfolio companies. Even if the portfolio companies are successful, our ability to realize the value of our investment may be dependent on the occurrence of a liquidity event, such as a public offering or the sale of the portfolio company. It is likely to take a significant amount of time before a liquidity event occurs or we can sell our equity investments. In addition, the equity securities we receive or invest in may be subject to restrictions on resale during periods in which it could be advantageous to sell. |
There are special risks associated with investing in preferred securities, including:
| | • | preferred securities may include provisions that permit the issuer, at its discretion, to defer distributions for a stated period without any adverse consequences to the issuer. If we own a preferred security that is deferring its distributions, we may be required to report income for tax purposes even though we have not received any cash payments in respect of such income; |
| | • | preferred securities are subordinated with respect to corporate income and liquidation payments, and are therefore subject to greater risk than debt; |
| | • | preferred securities may be substantially less liquid than many other securities, such as common securities or U.S. government securities; and |
| | • | preferred security holders generally have no voting rights with respect to the issuing company, subject to limited exceptions. |
Our investments in foreign debt, including that of emerging market issuers, may involve significant risks in addition to the risks inherent in U.S. investments.
Although there are limitations on our ability to invest in foreign debt, we may, from time to time, invest in debt of foreign companies, including the debt of emerging market issuers. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility. Investments in the debt of emerging market issuers may subject us to additional risks such as inflation, wage and price controls, and the imposition of trade barriers. Furthermore, economic conditions in emerging market countries are, to some extent, influenced by economic and securities market conditions in other emerging market countries. Although economic conditions are different in each country, investors’ reaction to developments in one country can have effects on the debt of issuers in other countries.
Although most of our investments will be U.S. dollar-denominated, our investments that are denominated in a foreign currency will be subject to the risk that the value of a particular currency will change in relation to one or more other currencies. Among the factors that may affect currency values are trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation, and political developments. We may employ hedging techniques to minimize these risks, but we cannot assure you that we will fully hedge against these risks or that such strategies will be effective.
We may expose ourselves to risks if we engage in hedging transactions.
We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Use of these hedging instruments may expose us to counter-party credit risk. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is generally anticipated at an acceptable price.
Our Board of Directors may change our operating policies and strategies without prior notice or stockholder approval, the effects of which may be adverse.
Our Board of Directors has the authority to modify or waive our current operating policies and our strategies without prior notice and without stockholder approval. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, financial condition, and value of our common stock. However, the effects might be adverse, which could negatively impact our ability to pay dividends and cause you to lose all or part of your investment.
Risks related to an investment in our shares
Investing in our common stock may involve an above average degree of risk.
The investments we make in accordance with our investment objectives may result in a higher amount of risk than alternative investment options and volatility or loss of principal. Our investments in portfolio companies may be highly speculative and aggressive, and therefore, an investment in our common stock may not be suitable for someone with lower risk tolerance.
The market price of our common stock may fluctuate significantly.
The market price and liquidity of the market for our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
| | • | significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which are not necessarily related to the operating performance of these companies; |
| | • | changes in regulatory policies or tax rules, particularly with respect to RICs or BDCs; |
| | • | loss of RIC qualification; |
| | • | changes in the value of our portfolio of investments; |
| | • | any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts; |
| | • | departure of our investment adviser’s key personnel; |
| | • | operating performance of companies comparable to us; |
| | • | general economic trends and other external factors; and |
| | • | loss of a major funding source. |
If the Saratoga Transaction is not consummated, provisions of our governing documents and the Maryland General Corporation Law could deter future takeover attempts and have an adverse impact on the price of our common stock.
We are governed by our charter and bylaws, which we refer to as our “governing documents.”
Our governing documents and the Maryland General Corporation Law contain provisions that, to the extent that the Saratoga Transaction is not consummated, may have the effect of delaying, deferring or preventing a future transaction or change in control of us that might involve a premium price for our stockholders or otherwise be in their best interest.
Our charter provides for the classification of our Board of Directors into three classes of directors, serving staggered three-year terms, which may render a change of control of us or removal of our incumbent management more difficult. Furthermore, any and all vacancies on our Board of Directors will be filled generally only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy will serve for the remainder of the full term until a successor is elected and qualifies.
Our Board of Directors is authorized to create and issue new series of shares, to classify or reclassify any unissued shares of stock into one or more classes or series, including preferred stock and, without stockholder approval, to amend our charter to increase or decrease the number of shares of stock that we have authority to issue, which could have the effect of diluting a stockholder’s ownership interest. Prior to the issuance of shares of stock of each class or series, including any reclassified series, our Board of Directors is required by our governing documents to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series of shares of stock.
Our governing documents also provide that our Board of Directors has the exclusive power to adopt, alter or repeal any provision of our bylaws, and to make new bylaws. The Maryland General Corporation Law also contains certain provisions that may limit the ability of a third party to acquire control of us, such as:
| | • | The Maryland Business Combination Act, which, subject to certain limitations, prohibits certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of the common stock or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder and, thereafter, imposes special minimum price provisions and special stockholder voting requirements on these combinations; and |
| | • | The Maryland Control Share Acquisition Act, which provides that “control shares” of a Maryland corporation (defined as shares of common stock which, when aggregated with other shares of common stock controlled by the stockholder, entitles the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares of common stock. |
The provisions of the Maryland Business Combination Act will not apply, however, if our Board of Directors adopts a resolution that any business combination between us and any other person will be exempt from the provisions of the Maryland Business Combination Act. Although our Board of Directors has adopted such a resolution, there can be no assurance that this resolution will not be altered or repealed in whole or in part at any time. If the resolution is altered or repealed, the provisions of the Maryland Business Combination Act may discourage others from trying to acquire control of us.
As permitted by Maryland law, our bylaws contain a provision exempting from the Maryland Control Share Acquisition Act any and all acquisitions by any person of our common stock. Although our bylaws include such a provision, such a provision may also be amended or eliminated by our Board of Directors at any time in the future.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We do not own any real estate or physical properties materially important to our business. Our corporate office is located at 500 Campus Drive, Suite 220, Florham Park, New Jersey 07932. Our telephone number is (973) 437-1000. We believe that our office facilities are suitable and adequate for our business as currently conducted and as reasonably foreseeable.
Item 3. Legal Proceedings
Neither we nor our investment adviser are currently subject to any material legal proceedings.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price range of common stock
Our common stock is quoted on the NYSE under the symbol “GNV” and started trading on March 23, 2007 at an initial public offering price of $15.00 per share. Prior to such date there was no public market for our common stock. Set forth below are the net asset value per share of our common stock and the range of high and low closing sales prices for our common stock for each full quarterly period for the years ended February 28, 2009 and 2010.
| | | | | | | |
| Fiscal 2009 | | | | | | | | | |
| First Quarter | | $ | 11.75 | | | $ | 10.67 | | | $ | 9.30 | |
| Second Quarter | | $ | 11.05 | | | $ | 11.05 | | | $ | 9.16 | |
| Third Quarter | | $ | 10.14 | | | $ | 10.86 | | | $ | 1.10 | |
| Fourth Quarter | | $ | 8.20 | | | $ | 3.15 | | | $ | 1.55 | |
| Fiscal 2010 | | | | | | | | | |
| First Quarter | | $ | 8.85 | | | $ | 3.95 | | | $ | 1.50 | |
| Second Quarter | | $ | 6.91 | | | $ | 3.49 | | | $ | 2.09 | |
| Third Quarter | | $ | 3.80 | | | $ | 3.71 | | | $ | 1.70 | |
| Fourth Quarter | | $ | 3.27 | | | $ | 2.09 | | | $ | 1.42 | |
| (1) | Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low closing sales prices. The net asset values shown are based on outstanding shares at the end of each period. |
Holders
As of May 12, 2010, there were 13 holders of record of our common stock (including Cede & Co.).
Dividend Policy
The following table summaries our dividends or distributions declared during fiscal 2009 and 2010:
| Date Declared | | Record Date | | Payment Date | | Amount per Share | |
| May 22, 2008 | | May 30, 2008 | | June 13, 2008 | | $ | 0.39 | |
| August 19, 2008 | | August 29, 2008 | | September 15, 2008 | | $ | 0.39 | |
| December 8, 2008 | | December 18, 2008 | | December 29, 2008 | | $ | 0.25 | |
| Total Dividends Declared for Fiscal 2009 | | | | | | $ | 1.03 | |
| November 13, 2009 | | November 25, 2009 | | December 31, 2009 | | $ | 1.825 | |
| Total Dividends Declared for Fiscal 2010 | | | | | | $ | 1.825 | |
We review dividends to our stockholders out of assets legally available for distribution on a quarterly basis. Our quarterly distributions, if any, will be determined by our Board of Directors. Any such distributions will be taxable to our stockholders, including to those stockholders who receive additional shares of our common stock pursuant to a dividend reinvestment plan. However, since January 2009 we have suspended our quarterly dividends and have made only one distribution to our stockholders, in November 2009. Although we continue to review dividends on a quarterly basis, we do not expect to pay a dividend in every quarter. We are prohibited from making distributions that cause us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or that violate our debt covenants.
In order to maintain our qualification as a RIC, we must for each fiscal year distribute an amount equal to at least 90% of our ordinary net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses. In addition, we will be subject to federal excise taxes to the extent we do not distribute during the calendar year at least (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. For the years ended February 28, 2010 and 2009, provisions of $27,445 and $140,322, respectively were recorded for federal exercise taxes. In order to maintain our qualification as a RIC, we expect to declare dividends payable from our fiscal year 2010 earnings prior to November 15, 2010 and to distribute such dividends prior to February 28, 2011. We may elect to withhold from distribution a portion of our ordinary income for the 2010 calendar year and/or portion of the capital gains in excess of capital losses realized during the one year period ending October 31, 2010, if any, and, if we do so, we would expect to incur federal excise taxes again as a result.
We maintain an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a dividend, then stockholders’ cash dividends will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash dividends. GSC Group, and the funds managed by it, do not currently participate in the dividend reinvestment plan with respect to their holdings of the company’s common stock.
Subject to certain conditions, for taxable years ending on or before December 31, 2011, we are permitted to make distributions to our stockholders in the form of shares of our common stock in lieu of cash distributions. The decision to make such distributions will be made by our Board of Directors.
Performance Graph
The following graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index and the NASDAQ Financial 100 index, for the period from March 23, 2007, the date our common stock began trading, through February 28, 2010. The graph assumes that, on March 23, 2007, a person invested $100 in each of our common stock, the Standard & Poor’s 500 Stock Index and the NASDAQ Financial 100 index. The graph measures total shareholder return, which takes into account both changes in stock price and dividends. It assumes that dividends paid are reinvested in like securities.
Sales of unregistered securities
We did not sell any securities during the period covered by this report that were not registered under the Securities Act.
Issuer purchases of equity securities
We did not purchase any shares of our common stock in the open market during the year ended February 28, 2010.
Item 6. Selected Financial Data
As of February 28, 2007, the Company (including its predecessors) had not yet commenced operations. The following selected financial and other data for the years ended February 28, 2010 and 2009 and February 29, 2008 are derived from our consolidated financial statements which have been audited by Ernst & Young LLP, an independent registered public accounting firm whose report thereon is included within this Annual Report. The data should be read in conjunction with our consolidated financial statements and notes thereto, which are included elsewhere in this Annual Report, and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
GSC INVESTMENT CORP.
SELECTED FINANCIAL DATA
(dollar amounts in thousands, except share and per share numbers)
| | | Year Ended February 28, 2010 | | | Year Ended February 28, 2009 | | | Year Ended February 29, 2008 | |
| | | | | | | | | | |
| Income Statement Data: | | | | | | | | | |
| Interest and related portfolio income: | | | | | | | | | |
| Interest | | $ | 13,324 | | | $ | 21,142 | | | $ | 20,744 | |
| Management fee and other income | | | 2,293 | | | | 2,245 | | | | 642 | |
| Total interest and related portfolio income | | | 15,617 | | | | 23,387 | | | | 21,386 | |
| Expenses: | | | | | | | | | | | | |
| Interest and credit facility financing expenses | | | 4,096 | | | | 2,605 | | | | 5,031 | |
| Base management and incentive management fees(1) | | | 2,278 | | | | 4,432 | | | | 3,650 | |
| Administrator expenses | | | 671 | | | | 961 | | | | 892 | |
| Administrative and other | | | 3,502 | | | | 2,433 | | | | 2,766 | |
| Expense reimbursement | | | (671 | ) | | | (1,010 | ) | | | (1,789 | ) |
| Total operating expenses | | | 9,876 | | | | 9,421 | | | | 10,550 | |
| Net investment income before income taxes | | | 5,741 | | | | 13,966 | | | | 10,836 | |
| Income tax expenses, including excise tax | | | (27 | ) | | | (140 | ) | | | (89 | ) |
| Net investment income | | | 5,714 | | | | 13,826 | | | | 10,747 | |
| Realized and unrealized gain (loss) on investments and derivatives | | | | | | | | | | | | |
| Net realized gain (loss) | | | (6,654 | ) | | | (7,143 | ) | | | 3,908 | |
| Net change in unrealized loss | | | (9,523 | ) | | | (27,998 | ) | | | (20,106 | ) |
| Total net loss | | | (16,177 | ) | | | (35,141 | ) | | | (16,198 | ) |
| Net decrease in net assets resulting from operations | | $ | (10,463 | ) | | $ | (21,315 | ) | | $ | (5,451 | ) |
| | | Year Ended February 28, 2010 | | | Year Ended February 28, 2009 | | | Year Ended February 29, 2008 | |
| | | | | | | | | | |
| Per Share: | | | | | | | | | |
| Earnings (loss) per common share — basic and diluted(2) | | $ | (0.99 | ) | | $ | (2.57 | ) | | $ | (0.70 | ) |
| Net investment income per share — basic and diluted(2) | | $ | 0.54 | | | $ | 1.67 | | | $ | 1.38 | |
| Net realized and unrealized gain (loss) per share — basic and diluted(2) | | $ | (1.52 | ) | | $ | (4.24 | ) | | $ | (2.08 | ) |
| Dividends declared per common share(3) | | $ | 1.83 | | | $ | 1.03 | | | $ | 1.55 | |
| Statement of assets and liabilities Data: | | | | | | | | | | | | |
| Investment assets at fair value | | $ | 89,373 | | | $ | 118,912 | | | $ | 172,837 | |
| Total assets | | | 96,935 | | | | 130,662 | | | | 192,842 | |
| Total debt outstanding | | | 36,992 | | | | 58,995 | | | | 78,450 | |
| Stockholders’ equity | | | 55,478 | | | | 68,014 | | | | 97,869 | |
| Net asset value per common share | | $ | 3.27 | | | $ | 8.20 | | | $ | 11.80 | |
| Common shares outstanding at end of year | | | 16,940,109 | | | | 8,291,384 | | | | 8,291,384 | |
| Other Data: | | | | | | | | | | | | |
| Investments funded | | $ | — | | | $ | 28,260 | | | $ | 314,003 | |
| Principal collections related to investment repayments or sales | | $ | 15,185 | | | $ | 49,195 | | | $ | 141,772 | |
| Number of portfolio investments at year end | | | 41 | | | | 45 | | | | 46 | |
| Weighted average yield of income producing debt investments — Non-control/non-affiliate | | | 9.6 | % | | | 9.7 | % | | | 10.7 | % |
| Weighted average yield on income producing debt investments — Control | | | 8.3 | % | | | 12.2 | % | | | 8.2 | % |
| (1) | See note 7 in consolidated financial statements. |
| | |
| (2) | For the years ended February 28, 2010 and 2009 and February 29, 2008, amounts are calculated using weighted average common shares outstanding of 10,613,507, 8,291,384 and 7,761,965, respectively. |
| | |
| (3) | Based on 8,291,384 common shares outstanding. |
Quarterly Data
| | | 2010 | | 2009 | |
| | | Qtr 4 | | Qtr 3 | | Qtr 2 | | Qtr 1 | | Qtr 4 | | Qtr 3 | | Qtr 2 | | Qtr 1 | |
| | | ($ in thousands, except per share numbers) | |
| | | | | | | | | (Unaudited) | | | | | | | |
| Interest and related portfolio income | | $ | 3,637 | | $ | 3,530 | | $ | 3,685 | | $ | 4,764 | | $ | 5,480 | | $ | 6,361 | | $ | 5,835 | | $ | 5,715 | |
| Net investment income | | | 1,201 | | | 869 | | | 1,080 | | | 2,564 | | | 3,288 | | | 3,887 | | | 3,455 | | | 3,195 | |
| Net realized and unrealized gain (loss) | | | (10,067 | ) | | 8,258 | | | (17,168 | ) | | 2,800 | | | (17,296 | ) | | (11,438 | ) | | (6,023 | ) | | (384 | ) |
| Net increase (decrease) in net assets resulting from operations | | | (8,866 | ) | | 9,128 | | | (16,088 | ) | | 5,364 | | | (14,008 | ) | | (7,551 | ) | | (2,567 | ) | | 2,811 | |
| Net investment income per common share at end of each quarter | | $ | 0.07 | | $ | 0.10 | | $ | 0.13 | | $ | 0.31 | | $ | 0.40 | | $ | 0.47 | | $ | 0.42 | | $ | 0.39 | |
| Net realized and unrealized gain (loss) per common share at end of each quarter | | $ | (0.59 | ) | $ | 0.91 | | $ | (2.07 | ) | $ | 0.34 | | $ | (2.09 | ) | $ | (1.38 | ) | $ | (0.73 | ) | $ | (0.05 | ) |
| Dividends declared per common share | | $ | – | | $ | 1.825 | | $ | – | | $ | – | | $ | – | | $ | 0.25 | | $ | 0.39 | | $ | 0.39 | |
| Net asset value per common share | | $ | 3.27 | | $ | 3.80 | | $ | 6.91 | | $ | 8.85 | | $ | 8.20 | | $ | 10.14 | | $ | 11.05 | | $ | 11.75 | |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this Annual Report. In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Part I, Item 1A “Risk Factors” and “Note about Forward-Looking Statements” appearing elsewhere herein.
Overview
GSC Investment Corp. is a Maryland corporation that has elected to be treated as a BDC. Our investment objectives are to generate current income and capital appreciation through debt and equity investments by primarily investing in middle market companies and select high yield bonds. We have elected and qualified to be treated as a RIC under subchapter M of the Code. We commenced operations on March 23, 2007, and completed our IPO on March 28, 2007. We are externally managed and advised by our investment adviser, GSCP (NJ), L.P.
We used the net proceeds of our IPO to purchase approximately $100.7 million in aggregate principal amount of debt investments from CDO Fund III, a CLO fund managed by our investment adviser. We used borrowings under our credit facilities to purchase approximately $115.1 million in aggregate principal amount of debt investments in April and May 2007 from CDO Fund III and CDO Fund I, a collateralized debt obligation fund managed by our investment adviser. As of February 28, 2010, our portfolio consisted of $89.4 million, principally invested in 27 portfolio companies and one CLO.
Recent Developments
On April 14, 2010, we entered into the Stock Purchase Agreement with Saratoga and CLO Partners LLC, pursuant to which, subject to approval by our stockholders and the satisfaction of certain closing conditions described therein, we intend to consummate the Saratoga Transaction whereby Saratoga will acquire approximately 37% of our common stock, appoint Saratoga as our new investment adviser, replace our existing Revolving Facility with the Replacement Facility with Madison, and replace our two GSC Group-affiliated board members and all of our executive officers, resulting in a change of control of the Company. For more information regarding the proposed Saratoga Transaction, see Part I, Item 1. “Business—Proposed Saratoga Transaction.”
Revenues
We generate revenue in the form of interest income and capital gains on the debt investments that we hold and capital gains, if any, on equity interests that we may acquire. We expect our debt investments, whether in the form of first and second lien term loans, mezzanine debt or high yield bonds, to have terms of up to ten years, and to bear interest at either a fixed or floating rate. Interest on debt will be payable generally either quarterly or semi-annually. In some cases our debt investments may provide for a portion of the interest to be paid-in-kind (“PIK”). To the extent interest is paid-in-kind, it will be payable through the increase of the principal amount of the obligation by the amount of interest due on the then-outstanding aggregate principal amount of such obligation. The principal amount of the debt and any accrued but unpaid interest will generally become due at the maturity date. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, fees for providing managerial assistance or investment management services and possibly consulting fees. Any such fees will be generated in connection with our investments and recognized as earned. We may also invest in preferred equity securities that pay dividends on a current basis.
Pursuant to an agreement with our investment adviser entered into on October 17, 2006, prior to becoming a BDC, we acquired the right to act as investment adviser to CDO Fund III and collect the management fees related thereto from March 20, 2007 until the liquidation of the CDO Fund III assets. We paid our investment adviser a fair market price of $0.1 million for the right to act as investment adviser to CDO Fund III.
On January 22, 2008 we entered into a collateral management agreement with GSCIC CLO pursuant to which we will act as its collateral manager and receive a senior collateral management fee of 0.10% and a subordinate collateral management fee of 0.40% of the outstanding principal amount of GSCIC CLO’s assets, paid quarterly to the extent of available proceeds. We are also entitled to an incentive management fee equal to 20% of excess cash flow to the extent the GSCIC CLO subordinated notes receive an internal rate of return equal to or greater than 12%.
We recognize interest income on our investment in the subordinated notes of GSCIC CLO using the effective interest method, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the investment from the date the estimated yield was changed.
Expenses
Our primary operating expenses include the payment of investment advisory and management fees, professional fees, directors and officers insurance, fees paid to independent directors and administrator expenses, including our allocable portion of our administrator’s overhead. Our allocable portion is based on the ratio of our total assets to the total assets administered by our administrator. Our investment advisory and management fees compensate our investment adviser for its work in identifying, evaluating, negotiating, closing and monitoring our investments. We bear all other costs and expenses of our operations and transactions, including those relating to:
| | • | calculating our net asset value (including the cost and expenses of any independent valuation firm); |
| | • | expenses incurred by our investment adviser payable to third parties, including agents, consultants or other advisers, in monitoring our financial and legal affairs and in monitoring our investments and performing due diligence on our prospective portfolio companies; |
| | • | interest payable on debt, if any, incurred to finance our investments; |
| | • | offerings of our common stock and other securities; |
| | • | investment advisory and management fees; |
| | • | fees payable to third parties, including agents, consultants or other advisers, relating to, or associated with, evaluating and making investments; |
| | • | transfer agent and custodial fees; |
| | • | independent directors’ fees and expenses; |
| | • | costs of preparing and filing reports or other documents of the SEC; |
| | • | the costs of any reports; |
| | • | proxy statements or other notices to stockholders, including printing costs; |
| | • | to the extent we are covered by any joint insurance policies, our allocable portion of the insurance premiums for such joint policies; |
| | • | direct costs and expenses of administration, including auditor and legal costs; and |
| | • | all other expenses incurred by us or our administrator in connection with administering our business. |
The amount payable to GSC Group as administrator under the administration agreement is capped to the effect that such amount, together with our other operating expenses, does not exceed an amount equal to 1.5% per annum of our net assets attributable to common stock. In addition, for the current one-year term of the administration agreement (expiring March 21, 2011), GSC Group has waived our reimbursement obligation under the administration agreement until our total assets exceed $500 million.
Pursuant to the investment advisory and management agreement, we pay GSC Group as investment adviser a quarterly base management fee of 1.75% of the average value of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds) at the end of the two most recently completed fiscal quarters, and appropriately adjusted for any share issuances or repurchases during the applicable fiscal quarter, and an incentive fee.
The incentive fee has two parts:
| | • | A fee, payable quarterly in arrears, equal to 20% of our pre-incentive fee net investment income, expressed as a rate of return on the value of the net assets at the end of the immediately preceding quarter, that exceeds a 1.875% quarterly (7.5% annualized) hurdle rate measured as of the end of each fiscal quarter. Under this provision, in any fiscal quarter, our investment adviser receives no incentive fee unless our pre-incentive fee net investment income exceeds the hurdle rate of 1.875%. Amounts received as a return of capital are not included in calculating this portion of the incentive fee. Since the hurdle rate is based on net assets, a return of less than the hurdle rate on total assets may still result in an incentive fee. |
| | • | A fee, payable at the end of each fiscal year, equal to 20% of our net realized capital gains, if any, computed net of all realized capital losses and unrealized capital depreciation, in each case on a cumulative basis, less the aggregate amount of capital gains incentive fees paid to the investment adviser through such date. |
We will defer cash payment of any incentive fee otherwise earned by our investment adviser if, during the most recent four full fiscal quarter period ending on or prior to the date such payment is to be made, the sum of (a) our aggregate distributions to our stockholders and (b) our change in net assets (defined as total assets less liabilities) (before taking into account any incentive fees payable during that period) is less than 7.5% of our net assets at the beginning of such period. These calculations will be appropriately pro rated for the first three fiscal quarters of operation and adjusted for any share issuances or repurchases during the applicable period. Such incentive fee will become payable on the next date on which such test has been satisfied for the most recent four full fiscal quarters or upon certain terminations of the investment advisory and management agreement. We commenced deferring cash payment of incentive fees during the quarterly period ended August 31, 2007, and have continued to defer such payments through the current quarterly period. For the fiscal year ended February 28, 2010, the Company owes GSCP $2.3 million in fees for services provided to the Company for the 2010 fiscal year; as of April 30, 2010, $2.3 million remained unpaid, with $435,000 to be paid on or about May 28, 2010 and the remaining $1.9 million to be waived if the Saratoga Transaction is consummated. GSCP will no longer provide services to us if the Saratoga Transaction is consummated.
If we consummate the proposed Saratoga Transaction, the terms of the investment advisory and management agreement with our new investment adviser, Saratoga, will be substantially similar to the terms of our current agreement with GSCP, except for the following material distinctions in the fee terms:
| | • | The capital gains portion of the incentive fee will be reset with respect to gains and losses from May 31, 2010, and therefore losses and gains incurred prior to such time will not be taken into account when calculating the capital gains fee, and Saratoga will be entitled to 20% of gains that arise after May 31, 2010. In addition, the cost basis for computing realized losses on investment held by the Company as of May 31, 2010 will equal the fair value of such investment as of such date. Under the investment advisory and management agreement with our current investment adviser, the capital gains fee is calculated from March 21, 2007, and the gains are substantially outweighed by losses. |
| | • | Under the “catch up” provision, 100% of the Company’s pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income that exceeds 1.875% (7.5% annualized) but is less than or equal to 2.344% in any fiscal quarter is payable to Saratoga. This will enable Saratoga to receive 20% of all net investment income as such amount approaches 2.344% in any quarter, and Saratoga will receive 20% of any additional net investment income. Under the investment advisory and management agreement with our current investment adviser, GSCP only receives 20% of the excess net investment income over 1.875%. |
| | • | The Company will no longer have deferral rights regarding incentive fees in the event that the distributions to stockholders and change in net assets is less than 7.5% for the preceding four fiscal quarters. |
To the extent that any of our leveraged loans are denominated in a currency other than U.S. dollars, we may enter into currency hedging contracts to reduce our exposure to fluctuations in currency exchange rates. We may also enter into interest rate hedging agreements. Such hedging activities, which will be subject to compliance with applicable legal requirements, may include the use of interest rate caps, futures, options and forward contracts. Costs incurred in entering into or settling such contracts will be borne by us.
From the commencement of operations until March 23, 2008, GSC Group reimbursed us for operating expenses to the extent that our total annual operating expenses (other than investment advisory and management fees and interest and credit facility expenses) exceeded an amount equal to 1.55% of our net assets attributable to common stock.
Portfolio and investment activity
Corporate Debt Portfolio Overview(1)
| | | At February 28, 2010 | | At February 28, 2009 | | At February 29, 2008 |
| | | ($ in millions) |
| Number of investments | | | 38 | | | | 42 | | | | 43 | |
| Number of portfolio companies | | | 27 | | | | 35 | | | | 36 | |
| Average investment size | | $ | 1.9 | | | $ | 2.3 | | | $ | 3.3 | |
| Weighted average maturity | | 2.5 | years | | 3.3 | years | | 3.8 | years |
| Number of industries | | | 19 | | | | 22 | | | | 23 | |
| Average investment per portfolio company | | $ | 2.7 | | | $ | 2.8 | | | $ | 4.0 | |
| Non-Performing or delinquent investments | | $ | 18.5 | | | $ | 0.4 | | | $ | — | |
| Fixed rate debt (% of interest bearing portfolio) | | $ | 33.0(46.9 | %) | | $ | 40.3(41.8 | %) | | $ | 57.0(39.6 | %) |
| Weighted average current coupon | | | 11.6 | % | | | 11.7 | % | | | 11.6 | % |
| Floating rate debt (% of interest bearing portfolio) | | $ | 37.4(53.1 | %) | | $ | 56.2(58.2 | %) | | $ | 86.8(60.4 | %) |
| Weighted average current spread over LIBOR | | | 7.6 | % | | | 5.9 | % | | | 5.6 | % |
| (1) | Excludes our investment in the subordinated notes of GSCIC CLO and investments in common stocks and limited partnership interests. |
During the fiscal year ended February 28, 2010, we made no investments in new or existing portfolio companies and had $15.2 million in aggregate amount of exits and repayments resulting in net repayments of $15.2 million for the year.
During the fiscal year ended February 28, 2009, we made 17 investments in an aggregate amount of $23.1 million in new portfolio companies and $5.2 million in investments in existing portfolio companies. Also during the fiscal year ended February 28, 2009, we had $49.2 million in aggregate amount of exits and repayments resulting in net repayments of $20.9 million for the year.
During the fiscal year ended February 29, 2008, we made 144 investments in an aggregate amount of $314.0 million. Also during the fiscal year ended February 29, 2008, we had $141.8 million in aggregate amount of exits and repayments, resulting in net investments of $172.2 million in aggregate amount for the year.
Our portfolio composition at February 28, 2010 and February 29, 2009 was as follows:
Portfolio composition
| | | At February 28, 2010 | | | At February 28, 2009 | |
| | | Percentage of Total Portfolio | | | Weighted Average Current Yield | | | Percentage of Total Portfolio | | | Weighted Average Current Yield | |
| First lien term loans | | | 18.6 | % | | | 8.6 | % | | | 14.4 | % | | | 6.8 | % |
| Second lien term loans | | | 22.7 | | | | 8.1 | | | | 34.5 | | | | 9.0 | |
| Senior secured notes | | | 31.0 | | | | 11.6 | | | | 21.7 | | | | 11.6 | |
| Unsecured notes | | | 6.4 | | | | 12.2 | | | | 10.4 | | | | 12.3 | |
| GSCIC CLO subordinated notes | | | 18.7 | | | | 8.3 | | | | 18.8 | | | | 12.2 | |
| Equity interests | | | 2.6 | | | | N/A | | | | 0.1 | | | | N/A | |
| Limited partnership interests | | | — | | | | N/A | | | | 0.1 | | | | N/A | |
| Total | | | 100.0 | % | | | 9.3 | % | | | 100.0 | % | | | 10.2 | % |
Our investment in the subordinated notes of GSCIC CLO represents a first loss position in a portfolio that, at February 28, 2010 and 2009, was composed of $387.1 and $416.0 million, respectively, in aggregate principal amount of predominantly senior secured first lien term loans. This investment is subject to unique risks. (See Part I, Item 1A “Risk Factors—Risks related to our investments—Our investment in GSCIC CLO constitutes a leveraged investment in a portfolio of predominantly senior secured first lien term loans and is subject to additional risks and volatility”) We do not consolidate the GSCIC CLO portfolio in our financial statements. Accordingly, the metrics below do not include the underlying GSCIC CLO portfolio investments. However, at February 28, 2010, five GSCIC CLO portfolio investments were in default and over 92.3% of the GSCIC CLO portfolio investments had a CMR (as defined below) color rating of green or yellow.
GSC Group normally grades all of our investments using an internally developed credit and monitoring rating system (“CMR”). Prior to November 30, 2009 the CMR rating consists of two components: (i) a numerical debt score and (ii) a corporate letter rating. The numerical debt score is based on the objective evaluation of six risk categories: (i) leverage, (ii) seniority in the capital structure, (iii) fixed charge coverage ratio, (iv) debt service coverage/liquidity, (v) operating performance, and (vi) business/industry risk. The numerical debt score ranges from 1.00 to 5.00, which can generally be characterized as follows:
| | • | 1.00-2.00 represents investments that hold senior positions in the capital structure and, typically, have low financial leverage and/or strong historical operating performance; |
| | • | 2.00-3.00 represents investments that hold relatively senior positions in the capital structure, either senior secured, senior unsecured, or senior subordinate, and have moderate financial leverage and/or are performing at or above expectations; |
| | • | 3.00-4.00 represents investments that are junior in the capital structure, have moderate financial leverage and/or are performing at or below expectations; and |
| | • | 4.00-5.00 represents investments that are highly leveraged and/or have poor operating performance. |
The numerical debt score is designed to produce higher scores for debt positions that are more subordinate in the capital structure. Therefore, second lien term loans, high-yield bonds and mezzanine debt will generally be assigned scores of 2.25 or higher.
The CMR also consists of a corporate letter rating whereby each credit is assigned a letter rating based on several subjective criteria, including perceived financial and operating strength and covenant compliance. The corporate letter ratings range from (A) through (F) and are characterized as follows: (A) equals strong credit, (B) equals satisfactory credit, (C) equals special attention credit, (D) equals payment default risk, (E) equals payment default, (F) equals restructured equity security.
Effective November 30, 2009, the CMR consisted of a single component: a color rating. The color rating is based on several criteria, including financial and operating strength, probability of default, and restructuring risk. The color ratings are characterized as follows: (Green) - strong credit; (Yellow) - satisfactory credit; (Red) - payment default risk, in payment default and/or significant restructuring activity.
The CMR distribution of our investments at February 28, 2010 was as follows:
Portfolio CMR distribution
| | | At February 28, 2010 | |
| Color Score | | Investments at Fair Value | | | Percentage of Total Portfolio | |
| | | ($ in thousands) | |
| Green | | $ | 9,479 | | | | 10.6 | % |
| Yellow | | | 27,763 | | | | 31.1 | |
| Red | | | 33,222 | | | | 37.2 | |
| N/A(1) | | | 18,909 | | | | 21.1 | |
| Total | | $ | 89,373 | | | | 100.0 | % |
| (1) | Predominantly comprised of our investment in the subordinated notes of GSCIC CLO. |
The CMR distribution of our investments, using the legacy rating components, at February 28, 2009 was as follows:
Portfolio CMR distribution
| | | At February 28, 2009 | |
| Numerical Debt Score | | Investments at Fair Value | | | Percentage of Total Portfolio | |
| | | ($ in thousands) | |
| 1.00 - 1.99 | | $ | 8,941 | | | | 7.5 | % |
| 2.00 - 2.99 | | | 33,831 | | | | 28.5 | |
| 3.00 - 3.99 | | | 49,076 | | | | 41.2 | |
| 4.00 - 4.99 | | | 4,614 | | | | 3.9 | |
| 5.00 | | | — | | | | — | |
| N/A(1) | | | 22,450 | | | | 18.9 | |
| Total | | $ | 118,912 | | | | 100.0 | % |
| | | At February 28, 2009 | |
| Corporate Letter Rating | | Investments at Fair Value | | | Percentage of Total Portfolio | |
| | | ($ in thousands) | |
| A | | $ | 4,602 | | | | 3.9 | % |
| B | | | 36,818 | | | | 30.9 | |
| C | | | 42,700 | | | | 35.9 | |
| D | | | 11,668 | | | | 9.8 | |
| E | | | 674 | | | | 0.6 | |
| F | | | — | | | | — | |
| N/A(1) | | | 22,450 | | | | 18.9 | |
| Total | | $ | 118,912 | | | | 100.0 | % |
| (1) | Predominantly comprised of our investment in the subordinated notes of GSCIC CLO. |
The following table shows the portfolio composition by industry grouping at fair value at February 28, 2010 and February 28, 2009.
Portfolio composition by industry grouping at fair value
| | | At February 28, 2010 | | | At February 28, 2009 | |
| | | Investments at Fair Value | | | Percentage of Total Portfolio | | | Investments at Fair Value | | | Percentage of Total Portfolio | |
| | | ($ in thousands) | |
| Structured Finance Securities(1) | | $ | 16,698 | | | | 18.7 | % | | $ | 22,341 | | | | 18.8 | % |
| Packaging | | | 9,791 | | | | 11.0 | | | | 10,070 | | | | 8.5 | |
| Consumer Products | | | 7,508 | | | | 8.4 | | | | 7,843 | | | | 6.6 | |
| Healthcare Services | | | 7,190 | | | | 8.0 | | | | 6,010 | | | | 5.0 | |
| Apparel | | | 6,910 | | | | 7.7 | | | | 6,616 | | | | 5.5 | |
| Publishing | | | 6,710 | | | | 7.5 | | | | 6,477 | | | | 5.4 | |
| Electronics | | | 6,617 | | | | 7.4 | | | | 6,849 | | | | 5.8 | |
| Manufacturing | | | 6,399 | | | | 7.2 | | | | 14,480 | | | | 12.2 | |
| Metals | | | 3,794 | | | | 4.3 | | | | 5,693 | | | | 4.8 | |
| Homebuilding | | | 3,634 | | | | 4.1 | | | | 3,490 | | | | 2.9 | |
| Natural Resources | | | 2,989 | | | | 3.3 | | | | 4,470 | | | | 3.8 | |
| Logistics | | | 2,230 | | | | 2.5 | | | | 2,134 | | | | 1.8 | |
| Environmental | | | 2,060 | | | | 2.3 | | | | 3,592 | | | | 3.0 | |
| Food and Beverage | | | 1,697 | | | | 1.9 | | | | 1,707 | | | | 1.4 | |
| Printing | | | 1,614 | | | | 1.8 | | | | 1,638 | | | | 1.4 | |
| Oil and Gas | | | 1,129 | | | | 1.2 | | | | 7,359 | | | | 6.2 | |
| Financial Services | | | 984 | | | | 1.1 | | | | 3,162 | | | | 2.7 | |
| Education | | | 634 | | | | 0.7 | | | | 674 | | | | 0.6 | |
| Building Products | | | 530 | | | | 0.6 | | | | 1,426 | | | | 1.2 | |
| Consumer Services | | | 255 | | | | 0.3 | | | | 244 | | | | 0.2 | |
| Insurance | | | — | | | | — | | | | 1,493 | | | | 1.3 | |
| Software | | | — | | | | — | | | | 773 | | | | 0.6 | |
| Chemicals | | | — | | | | — | | | | 371 | | | | 0.3 | |
| Total | | $ | 89,373 | | | | 100.0 | % | | $ | 118,912 | | | | 100.0 | % |
| (1) | Predominantly comprised of our investment in the subordinated notes of GSCIC CLO. |
The following table shows the portfolio composition by geographic location at fair value at February 28, 2010 and February 28, 2009. The geographic composition is determined by the location of the corporate headquarters of the portfolio company.
Portfolio composition by geographic location at fair value
| | | At February 28, 2010 | | | At February 28, 2009 | |
| | | Investments at Fair Value | | | Percentage of Total Portfolio | | | Investments at Fair Value | | | Percentage of Total Portfolio | |
| | | ($ in thousands) | |
| Midwest | | $ | 23,637 | | | | 26.5 | % | | $ | 31,716 | | | | 26.7 | % |
| Other(1) | | | 16,698 | | | | 18.7 | | | | 22,449 | | | | 18.9 | |
| West | | | 14,695 | | | | 16.4 | | | | 16,137 | | | | 13.6 | |
| International | | | 12,781 | | | | 14.3 | | | | 12,165 | | | | 10.2 | |
| Northeast | | | 11,631 | | | | 13.0 | | | | 12,578 | | | | 10.6 | |
| Southeast | | | 9,931 | | | | 11.1 | | | | 23,094 | | | | 19.4 | |
| Mid-Atlantic | | | — | | | | — | | | | 773 | | | | 0.6 | |
| Total | | $ | 89,373 | | | | 100.0 | % | | $ | 118,912 | | | | 100.0 | % |
| (1) | Predominantly comprised of our investment in the subordinated notes of GSCIC CLO. |
Results of operations
For the years ended February 28, 2010 and 2009 and February 29, 2008
Operating results for the years ended February 28, 2010 and 2009 and February 29, 2008 are as follows;
| | | For the Year Ended | |
| | | February 28, 2010 | | | February 28, 2009 | | | February 29, 2008 | |
| | | | | | ($ in thousands) | | | | |
| Total investment income | | $ | 15,617 | | | $ | 23,387 | | | $ | 21,386 | |
| Total expenses before waiver and reimbursement | | | 10,547 | | | | 10,431 | | | | 12,339 | |
| Total expense waiver and reimbursement | | | (671 | ) | | | (1,010 | ) | | | (1,789 | ) |
| Total expenses net of expense waiver and reimbursement | | | 9,876 | | | | 9,421 | | | | 10,550 | |
| Net investment income before income taxes | | | 5,741 | | | | 13,966 | | | | 10,836 | |
| Income tax expense, including excise tax | | | (27 | ) | | | (140 | ) | | | (89 | ) |
| Net investment income | | | 5,714 | | | | 13,826 | | | | 10,747 | |
| Net realized gains (losses) | | | (6,654 | ) | | | (7,143 | ) | | | 3,908 | |
| Net unrealized losses | | | (9,523 | ) | | | (27,998 | ) | | | (20,106 | ) |
| Net decrease in net assets resulting from operations | | $ | (10,463 | ) | | $ | (21,315 | ) | | $ | (5,451 | ) |
Investment income
The composition of our investment income in each period was as follows:
Investment Income
| | | February 28, 2010 | | | February 28, 2009 | | | February 29, 2008 | |
| | | | | | ($ in thousands) | | | | |
| Interest from investments | | $ | 13,300 | | | $ | 20,967 | | | $ | 20,378 | |
| Management of GSCIC CLO | | | 2,057 | | | | 2,050 | | | | 599 | |
| Interest from cash and cash equivalents and other income | | | 260 | | | | 370 | | | | 409 | |
| Total | | $ | 15,617 | | | $ | 23,387 | | | $ | 21,386 | |
For the year ended February 28, 2010, total investment income decreased $7.8 million, or 33% compared to the fiscal year ended February 28, 2009. The decrease is predominantly attributable to a decrease in the effective interest rate earned on our investment in the subordinated notes of GSCIC CLO, an increase in the allowance for impaired loans and bonds, and a smaller total average portfolio. Interest income from our investment in the subordinated notes of GSCIC CLO decreased $2.0 million, or 45%, to $2.4 million for the year ended February 28, 2010 from $4.4 million for the fiscal year ended February 28, 2009. The allowance for impaired loans and bonds increased $2.1 million, for the year ended February 28, 2010 from no allowance for the fiscal year ended February 28, 2009.
For the year ended February 28, 2009, total investment income increased $2.0 million, or 9.3% compared to the fiscal year ended February 29, 2008. The increase is predominantly attributable to the management fee earned from GSCIC CLO during the fiscal year ended February 28, 2009 and the Company’s being operational for only eleven months during the fiscal year ended February 29, 2008.
For the fiscal years ended February 28, 2010 and 2009 and February 29, 2008, total PIK income was $0.9 million, $0.8 million and $0.4 million, respectively.
The composition of our operating expenses in each period was as follows:
Operating Expenses
| | | February 28, 2010 | | | February 28, 2009 | | | February 29, 2008 | |
| | | | | | ($ in thousands) | | | | |
| Interest and credit facility expense | | $ | 4,096 | | | $ | 2,605 | | | $ | 5,031 | |
| Base management fees | | | 1,951 | | | | 2,680 | | | | 2,939 | |
| Professional fees | | | 2,071 | | | | 1,166 | | | | 1,410 | |
| Incentive management fees | | | 328 | | | | 1,752 | | | | 711 | |
| Administrator expenses | | | 671 | | | | 961 | | | | 892 | |
| Insurance expenses | | | 870 | | | | 682 | | | | 587 | |
| Directors fees | | | 295 | | | | 295 | | | | 314 | |
| General and administrative expenses | | | 265 | | | | 290 | | | | 262 | |
| Other | | | — | | | | — | | | | 193 | |
| Total operating expenses before manager waiver and reimbursement | | $ | 10,547 | | | $ | 10,431 | | | $ | 12,339 | |
For the year ended February 28, 2010, total operating expenses before manager expense waiver and reimbursement increased $0.1 million, or 1.1% compared to the fiscal year ended February 28, 2009. For the year ended February 28, 2009, total operating expenses before manager expense waiver and reimbursement decreased $1.9 million, or 15.4% compared to the fiscal year ended February 29, 2008.
For the year ended February 28, 2010, the increase in interest and credit facility expense is primarily attributable to an increase in the interest rate on our credit facility from the commercial paper rate plus 70 basis points to the greater of the commercial paper rate and our lender’s prime rate plus 4.00% plus a default rate of 2.00%, and a one time non-cash charge of $0.5 million as a result of the write-off of deferred financing costs on our credit facility, in each case, as a result of our July 30, 2009 event of default (please see “—Financial Condition, Liquidity and Capital Resources” below for more information). For the year ended February 28, 2010, the weighted average interest rate on the Revolving Facility was 6.80% compared to 3.59% for the fiscal year ended February 28, 2009.
For the year ended February 28, 2009, the decrease in interest and credit facility expense is primarily attributable to decreased borrowing under the Revolving Facility (please see “––Financial Condition, Liquidity and Capital Resources” below for more information).
For the year ended February 28, 2010, base management fees decreased $0.7 million, or 27.2% compared to the fiscal year ended February 28, 2009. For the year ended February 28, 2009, base management fees decreased $0.3 million, or 8.8% compared to the fiscal year ended February 29, 2008. The reduction in base management fees results from the decrease in the average value of our total net assets and the continued reduction in the total portfolio size.
For the year ended February 28, 2010, professional fees increased $0.9 million, or 77.6% compared to the fiscal year ended February 28, 2009. The increase in professional fees is attributable to additional legal and professional fees associated with the evaluation of strategic transaction opportunities including the proposed Saratoga Transaction. For the year ended February 28, 2009, professional fees decreased $0.2 million, or 17.3% compared to the fiscal year ended February 29, 2008.
For the year ended February 28, 2010, incentive management fees decreased $1.4 million, or 81.3% compared to the fiscal year ended February 28, 2009. The decrease in incentive management fees is primarily attributable to the decrease in investment income and the increase in operating expenses which resulted in a failure to meet the quarterly hurdle rate of 1.875% for the quarters ended August 31, 2009 and November 30, 2009 resulting in no incentive management fees for these quarters. If the Saratoga Transaction is consummated, the outstanding incentive fees owed to GSCP will be waived. See “—Overview—Expenses” above for more information.
For the year ended February 28, 2009, incentive management fees increased $1.0 million, or 146.3%, compared to the fiscal year ended February 29, 2008. The increase in incentive management fees resulted from the combination of higher net investment income and lower operating expenses between the two periods, and was partially offset by a decrease in base management fees resulting from a decrease in the average value of our total net assets, and decreased professional fees.
For the year ended February 28, 2010, manager expense waiver and reimbursement decreased $0.3 million, or 33.6% compared to the fiscal year ended February 28, 2009. The decrease is primarily attributable to lower total compensation expense incurred by the Administrator relating to the allocation of those persons providing administrative support and services to the Company.
For the year ended February 28, 2009, manager expense waiver and reimbursement decreased $0.8 million, or 43.5% compared to the fiscal year ended February 28, 2009. The decrease was due to the termination of the expense reimbursement agreement as of March 23, 2008, pursuant to which GSC Group had reimbursed the Company for operating expenses (other than investment advisory and management fees and interest and credit facility expenses) in excess of 1.55% of net assets attributable to common stock.
Net realized gains/losses on sales of investments
For the fiscal year ended February 28, 2010, the Company had $15.2 million of sales, repayments, exits or restructurings resulting in $6.7 million of net realized losses. Net realized losses were comprised of $1.1 million of gross realized gains and $7.8 million of gross realized losses. The most significant realized gains and losses during the year ended February 28, 2010 were as follows:
Fiscal year ended February 28, 2010
| Issuer | | Asset Type | | Gross Proceeds | | | Cost | | | Net Realized Gain/(Loss) | |
| | | | | ($ in thousands) | |
| Atlantis Plastics Films, Inc. | | First Lien Term Loan | | $ | 521 | | | $ | — | | | $ | 482 | |
| Asurion Corporation | | First Lien Term Loan | | | 1,930 | | | | (1,725 | ) | | | 205 | |
| Edgen Murray II, L.P. | | Second Lien Term Loan | | | 3,000 | | | | (2,832 | ) | | | 168 | |
| USS Mergerco, Inc. | | Second Lien Term Loan | | | 3,159 | | | | (5,847 | ) | | | (2,688 | ) |
| Targus Group International, Inc. | | Second Lien Term Loan | | | 2,121 | | | | (4,793 | ) | | | (2,672 | ) |
| Blaze Recycling & Metals, LLC | | Senior Secured Notes | | | 1,538 | | | | (2,495 | ) | | | (957 | ) |
For the fiscal year ended February 28, 2009, the Company had $49.2 million of sales, repayments or exits resulting in $7.2 million of net realized losses. Net realized losses were comprised of $0.6 million of gross realized gains and $7.8 million of gross realized losses. The most significant realized gains and losses during the year ended February 28, 2009 were as follows:
Fiscal year ended February 28, 2009
| Issuer | | Asset Type | | Gross Proceeds | | | Cost | | | Net Realized Gain/(Loss) | |
| | | | | ($ in thousands) | |
| Key Safety Systems | | First Lien Term Loan | | $ | 2,063 | | | $ | 1,857 | | | $ | 206 | |
| SILLC Holdings, LLC | | Second Lien Term Loan | | | 23,049 | | | | 22,878 | | | | 171 | |
| EuroFresh, Inc. | | Unsecured Notes | | | 2,880 | | | | 6,900 | | | | (4,020 | ) |
| Atlantis Plastics Films, Inc. | | First Lien Term Loan | | | 3,073 | | | | 6,053 | | | | (2,980 | ) |
| Claire’s Stores, Inc. | | First Lien Term Loan | | | 2,103 | | | | 2,584 | | | | (481 | ) |
| Jason Incorporated | | Unsecured Notes | | | 1,581 | | | | 1,700 | | | | (119 | ) |
For the fiscal year ended February 29, 2008, the Company had $141.8 million of sales, repayments or exits resulting in $3.2 million of net realized gains. Net realized gains were comprised of $4.1 million of gross realized gains and $0.9 million of gross realized losses. The most significant realized gains and losses during the year ended February 29, 2008 were as follows:
Fiscal year ended February 29, 2008
| Issuer | | Asset Type | | Gross Proceeds | | | Cost | | | Net Realized Gain/(Loss) | |
| | | | | ($ in thousands) | |
| Sportcraft, LTD | | Second Lien Term Loan | | $ | 9,000 | | | $ | 7,302 | | | $ | 1,698 | |
| SILLC Holdings, LLC | | Senior Secured Notes | | | 22,821 | | | | 21,838 | | | | 983 | |
| McMillin Companies, LLC | | Senior Secured Notes | | | 3,300 | | | | 3,066 | | | | 234 | |
Net unrealized appreciation/depreciation on investments
For the year ended February 28, 2010, the Company had net unrealized losses of $9.5 million, which was comprised of $7.4 million in unrealized appreciation, $25.5 million in unrealized depreciation and $8.6 million related to the reversal of prior period net unrealized depreciation recorded upon the exit of an investment. The most significant changes in net unrealized appreciation and depreciation for the year ended February 28, 2010 are as follows:
Fiscal year ended February 28, 2010
| Issuer | | Asset Type | | Cost | | | Fair Value | | | Total Unrealized Depreciation | | | YTD Change in Unrealized Appreciation/ (Depreciation) | |
| | | | | ($ in thousands) | |
| Terphane Holdings Corp. | | Senior Secured Notes | | $ | 10,437 | | | $ | 9,791 | | | $ | (646 | ) | | $ | 2,091 | |
| Penton Media, Inc. | | First Lien Term Loan | | | 3,908 | | | | 3,478 | | | | (430 | ) | | | 1,286 | |
| IDI Acquisition Corp. | | Senior Secured Notes | | | 3,679 | | | | 3,621 | | | | (58 | ) | | | 1,136 | |
| Jason Incorporated | | Unsecured Notes | | | 13,700 | | | | 1,688 | | | | (12,012 | ) | | | (8,190 | ) |
| GSCIC CLO | | Other/Structured Finance Securities | | | 29,233 | | | | 16,698 | | | | (12,535 | ) | | | (4,970 | ) |
| Energy Alloys, LLC | | Second Lien Term Loan | | | 6,239 | | | | 1,129 | | | | (5,110 | ) | | | (4,197 | ) |
For the year ended February 28, 2009, the Company had net unrealized losses of $28.0 million, which was comprised of $0.1 million in unrealized appreciation, $36.1 million in unrealized depreciation and $8.0 million related to the reversal of prior period net unrealized depreciation recorded upon the exit of an investment. The most significant changes in net unrealized appreciation and depreciation for the year ended February 28, 2009 are as follows:
| Fiscal year ended February 28, 2009 | |
| Issuer | | Asset Type | | Cost | | | Fair Value | | | Total Unrealized Depreciation | | | YTD Change in Unrealized Depreciation | |
| | | | | ($ in thousands) | |
| GSCIC CLO | | Other/Structured Finance Securities | | $ | 29,905 | | | $ | 22,341 | | | $ | (7,564 | ) | | $ | (6,480 | ) |
| Jason Incorporated | | Unsecured Notes | | | 13,700 | | | | 9,878 | | | | (3,822 | ) | | | (3,453 | ) |
| Grant U.S. Holdings LLP | | Second Lien Term Loan | | | 6,140 | | | | 2,388 | | | | (3,752 | ) | | | (2,553 | ) |
| McMillin Companies, LLC | | Unsecured Notes | | | 7,295 | | | | 3,490 | | | | (3,805 | ) | | | (2,522 | ) |
| Penton Media, Inc. | | First Lien Term Loan | | | 3,724 | | | | 2,008 | | | | (1,716 | ) | | | (1,906 | ) |
| Network Communications | | Unsecured Notes | | | 5,082 | | | | 2,503 | | | | (2,579 | ) | | | (1,884 | ) |
| Terphane Holdings Corp. | | Senior Secured Notes | | | 10,431 | | | | 7,694 | | | | (2,737 | ) | | | (1,863 | ) |
The $6.5 million net unrealized depreciation in our investment in the GSCIC CLO subordinated notes was due to an increase in the assumed portfolio default rate and present value discount rate in our discounted cash flow model. These changes were made to reflect the current market environment for CLO equity investments and not as a result of any change in the underlying GSCIC CLO portfolio.
For the year ended February 29, 2008, the Company had net unrealized losses of $20.1 million, which was comprised of $0.5 million in unrealized appreciation and $20.6 million in unrealized depreciation. The most significant changes in net unrealized appreciation and depreciation for the year ended February 29, 2008 are as follows:
| Fiscal year ended February 29, 2008 | |
| Issuer | | Asset Type | | Cost | | | Fair Value | | | Total Unrealized Depreciation | | | YTD Change in Unrealized Depreciation | |
| | | | | ($ in thousands) | |
| Eurofresh, Inc. | | Unsecured Notes | | $ | 6,891 | | | $ | 3,850 | | | $ | (3,041 | ) | | $ | (3,041 | ) |
| SILLC Holdings, LLC | | Second Lien Term Loan | | | 22,865 | | | | 20,283 | | | | (2,582 | ) | | | (2,582 | ) |
| Atlantis Plastics Films, Inc. | | First Lien Term Loan | | | 6,492 | | | | 4,298 | | | | (2,194 | ) | | | (2,194 | ) |
| Bankruptcy Management | | Second Lien Term Loan | | | 4,902 | | | | 3,555 | | | | (1,347 | ) | | | (1,347 | ) |
| McMillin Companies LLC | | Unsecured Notes | | | 7,195 | | | | 5,912 | | | | (1,283 | ) | | | (1,283 | ) |
| Grant U.S. Holdings LLP | | Second Lien Term Loan | | | 5,365 | | | | 4,167 | | | | (1,198 | ) | | | (1,198 | ) |
Net realized gains/losses on derivatives
For the fiscal year ended February 28, 2009, the Company recorded a net realized gain on derivatives of $30,454 relating to our investment in the GSCIC CLO warehouse facility. For the fiscal year ended February 29, 2008, the Company recorded a net realized gain on derivatives of $0.7 million from the same warehouse facility (see “— Off-balance sheet arrangements” below).
Net unrealized appreciation/depreciation on derivatives
For the fiscal year ended February 28, 2010, changes in the value of the interest rate caps purchased pursuant to the credit facilities resulted in an unrealized appreciation of $2,634 versus an unrealized depreciation of $37,221 and $54,266 for the fiscal years ended February 28, 2009 and February 29, 2008.
Changes in net asset value from operations
For the fiscal years ended February 28, 2010 and 2009 and February 29, 2008, we recorded a net decrease in net assets resulting from operations of $10.5 million, $21.3 million and $5.5 million, respectively. Based on 10,613,507 weighted average common shares outstanding as of February 28, 2010, our per share net decrease in net assets resulting from operations was $0.99 for the fiscal year ended February 28, 2010. This compares to a per share decrease in net assets resulting from operations of $2.57 for the fiscal year ended February 28, 2009 (based on 8,291,384 weighted average common shares outstanding as of February 28, 2009) and a per share decrease in net assets resulting from operations of $0.70 for the fiscal year ended February 29, 2008 (based on 7,761,965 weighted average common shares outstanding for the fiscal year ended February 29, 2008).
Financial condition, liquidity and capital resources
The Company’s liquidity and capital resources have been generated primarily from the net proceeds of its IPO, advances from the Revolving Facility and the Term Facility, as well as cash flows from operations. On March 28, 2007, we completed our IPO and issued 7,250,000 common shares and received net proceeds of $100.7 million.
On April 11, 2007, we entered into a $100.0 million revolving securitized credit facility (the “Revolving Facility”). On May 1, 2007, we entered into a $25.7 million term securitized credit facility (the “Term Facility” and, together with the Revolving Facility, the “Facilities”), which was fully drawn at closing. In December 2007, we consolidated the Facilities by using a draw under the Revolving Facility to repay the Term Facility. In response to the market wide decline in financial asset prices, which has negatively affect the value of our portfolio, we terminated the revolving period of the Revolving Facility effective January 14, 2009 and commenced a two-year amortization period during which all principal proceeds from the collateral will be used to repay outstanding borrowings. In March 2009 we amended the Revolving Credit Facility to decrease the minimum required collateralization and increase the portion of the portfolio that can be invested in “CCC” rated investments in return for an increased interest rate and expedited amortization.
A Borrowing Base violation will occur if our outstanding borrowings exceed the Borrowing Base at any time. We can cure a Borrowing Base violation by reducing our borrowing below the Borrowing Base (by, e.g., selling collateral and repaying borrowings) or pledging additional collateral to increase the Borrowing Base. If we fail to cure a Borrowing Base violation within the specified time, a default under the Revolving Facility shall occur. On July 30, 2009 an unremedied Borrowing Base violation became an event of default, which is currently continuing. As a result of this event of default, our lender has the right to accelerate repayment of the outstanding indebtedness under the Revolving Facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations. As a result of the continuing default, the Company may be forced to sell its investments to raise funds to repay outstanding amounts. Such forced sales may result in values that could be less than carrying values reported in these financial statements. The deleveraging of the Company may significantly impair the Company’s ability to effectively operate. To date, our lender has not accelerated the debt with respect to this event of default, but has reserved the right to do so. Please see Part I, Item 1A. “Risk Factors—Risks related to our liquidity and financial condition” for more information.
During the continuance of an event of default, the interest rate on the Revolving Facility is increased from the commercial paper rate plus 4.00% to the greater of the commercial paper rate and our lender’s prime rate plus 4.00% plus a default rate of 2.00% or, if the commercial paper market is unavailable, the greater of the prevailing LIBOR rates and our lender’s prime rate plus 6.00% plus a default rate of 3.00%. Under this formula, the current interest rate at February 28, 2010 was 9.25%.
At February 28, 2010, we had $37.0 million in borrowings under the Revolving Facility versus $59.0 million in borrowings at February 28, 2009. The actual amount that we are permitted to borrow under the Revolving Facility at any given time (the “Borrowing Base”) is dependent upon the amount and quality of the collateral securing the Revolving Facility. Our Borrowing Base was $1.7 million at February 28, 2010 versus $59.9 million at February 28, 2009. The decline in our Borrowing Base during this period is mainly attributable to the decline in the value of the pledged collateral and the downgrade of certain public ratings or private credit estimates of the pledged collateral.
Substantially all of our assets other than our investment in the subordinated notes of GSCIC CLO are held in a special purpose subsidiary and pledged under our Revolving Facility. We commenced the two year amortization period under the Revolving Facility in January 2009, during which time all principal proceeds from the pledged assets are used to repay the Revolving Facility. In addition, during the continuance of an event of default, all interest proceeds from the pledged assets are also used to repay the Revolving Facility. As a result, the Company is required to fund is operating expenses and dividends solely from cash on hand, management fees earned from, and the proceeds of the subordinated notes of, GSCIC CLO. Please see Part I, Item 1A. “Risk Factors—Risks related to our liquidity and financial condition” for more information.
In April 2009, our investment adviser withheld a scheduled principal amortization payment under its credit facility, resulting in a default thereunder. Since then, our investment adviser and its secured lenders have been in negotiations regarding a consensual restructuring of its obligations under such credit facility. While we are not directly affected by our investment adviser’s default, a material adverse change in the business, condition (financial or otherwise), operations or performance of our investment adviser could constitute a default under our Revolving Facility.
Our asset coverage ratio, as defined in the 1940 Act, was 250%, 215% and 225% for the years ended February 28, 2010 and 2009 and February 29, 2008, respectively.
At February 28, 2010 and 2009 and February 29, 2008, the fair value of investments, cash and cash equivalents and cash and cash equivalents, securitization accounts were as follows:
| | | At February 28, 2010 | | | At February 28, 2009 | | | February 29, 2008 | |
| | | Fair Value | | | Percent of Total | | | Fair Value | | | Percent of Total | | | Fair Value | | | Percent of Total | |
| | | ($ in thousands) | |
| Cash and cash equivalents | | $ | 3,352 | | | | 3.6 | % | | $ | 6,356 | | | | 5.0 | % | | $ | 1,073 | | | | 0.6 | % |
| Cash and cash equivalents, securitization accounts | | | 226 | | | | 0.2 | | | | 1,178 | | | | 0.9 | | | | 14,581 | | | | 7.7 | |
| First lien term loans | | | 16,653 | | | | 17.9 | | | | 17,118 | | | | 13.5 | | | | 26,362 | | | | 14.0 | |
| Second lien term loans | | | 20,267 | | | | 21.8 | | | | 41,043 | | | | 32.5 | | | | 62,446 | | | | 33.1 | |
| Senior secured notes | | | 27,742 | | | | 29.9 | | | | 25,832 | | | | 20.4 | | | | 31,657 | | | | 16.8 | |
| Unsecured notes | | | 5,690 | | | | 6.1 | | | | 12,381 | | | | 9.8 | | | | 23,280 | | | | 12.4 | |
| Structured finance securities | | | 16,698 | | | | 18.0 | | | | 22,341 | | | | 17.7 | | | | 28,915 | | | | 15.3 | |
| Common stock | | | 2,323 | | | | 2.5 | | | | 89 | | | | 0.1 | | | | - | | | | - | |
| Other/limited partnership interests | | | - | | | | - | | | | 109 | | | | 0.1 | | | | 176 | | | | 0.1 | |
| Total | | $ | 92,951 | | | | 100.0 | % | | $ | 126,447 | | | | 100.0 | % | | $ | 188,490 | | | | 100.0 | % |
On November 13, 2009, our Board of Directors declared a dividend of $1.825 per share payable on December 31, 2009, to common stockholders of record on November 25, 2009. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.1 million or $0.25 per share.
Based on shareholder elections, the dividend consisted of $2.1 million in cash and 8,648,725 shares of common stock, or 104% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 13.7% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $1.5099 per share, which equaled the volume weighted average trading price per share of the common stock on December 24 and 28, 2009.
On December 8, 2008, our Board of Directors declared a cash dividend of $0.25 per share payable on December 29, 2008, to common stockholders of record on December 18, 2008.
Contractual obligations
The following table shows our payment obligations for repayment of debt and other contractual obligations at February 28, 2010:
| | | | | | Payment Due by Period |
| | | Total | | | Less Than 1 Year | | 1-3 Years | | 3-5 Years | | More Than 5 Years |
| | | ($ in thousands) |
| Long-Term Debt Obligations | | $ | 36,992 | | | $ | 36,992 | | $ | — | | $ | — | | $ | — |
Off-balance sheet arrangements
At February 28, 2010 and 2009, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Our business activities contain elements of market risk. We consider our principal market risks to be fluctuations in interest rates and the inherent difficulty of determining the fair value of our investments that do not have a readily available market value. Managing these risks is essential to our business. Accordingly, we have systems and procedures designed to identify and analyze our risks, to establish appropriate policies and thresholds and to continually monitor these risks and thresholds by means of administrative and information technology systems and other policies and processes.
Interest Rate Risk
Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, including relative changes in different interest rates, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire leveraged loans, high yield bonds and other debt investments and the value of our investment portfolio.
Our investment income is affected by fluctuations in various interest rates, including LIBOR and the prime rate. A large portion of our portfolio is, and we expect will continue to be, comprised of floating rate investments that utilize LIBOR. Our interest expense is affected by fluctuations in the commercial paper rate or, if the commercial paper market is unavailable, LIBOR. At February 28, 2010, we had $37.0 million of borrowings outstanding at a floating rate tied to the prevailing commercial paper rate plus a margin of 0.70%.
In April and May 2007, pursuant to the Revolving Facility, the Company entered into two interest rate cap agreements with notional amounts of $34.0 million (increased to $40.0 million in May 2007) and $60.9 million. These agreements provide for a payment to the Company in the event LIBOR exceeds 8%, mitigating our exposure to increases in LIBOR. At February 28, 2010, the aggregate interest rate cap agreement notional amount was $65.6 million.
We have analyzed the potential impact of changes in interest rates on interest income from investments net of interest expense on the Revolving Facility. Assuming that our investments as of February 28, 2010 were to remain constant for a full fiscal year and no actions were taken to alter the existing interest rate terms, a hypothetical change of 1% in interest rates would cause a corresponding change of approximately $0.2 million to our interest income net of interest expense.
Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the statement of assets and liabilities and other business developments that could magnify or diminish our sensitivity to interest rate changes, nor does it account for divergences in LIBOR and the commercial paper rate, which have historically moved in tandem but, in times of unusual credit dislocations, have experienced periods of divergence. Accordingly no assurances can be given that actual results would not materially differ from the potential outcome simulated by this estimate.
Portfolio Valuation
We carry our investments at fair value, as determined in good faith by our Board of Directors. Investments for which market quotations are readily available are fair valued at such market quotations. We value investments for which market quotations are not readily available at fair value as determined in good faith by our Board under our valuation policy and a consistently applied valuation process. For investments that are thinly traded, we review the depth and quality of the available quotations to determine if market quotations are readily available. If the available quotations are indicative only, we may determine that market quotations are not readily available. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments, and the differences could be material. In addition, 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 that are assigned.
The types of factors that we may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, third party valuations, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, market yield trend analysis, comparison to publicly-traded securities, recent sales of or offers to buy comparable companies, and other relevant factors. The fair value of our investment in the subordinated notes of GSCIC CLO is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions which are adjusted to reflect changes in historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar CLO subordinated notes or equity, when available
The table below describes the primary considerations made by our Board of Directors in determining the fair value of our investments at February 28, 2010:
| | | Fair Value | | | Percent of Total Investments | |
| | | ($ in thousands) | |
| Third party independent valuation firm | | $ | 37,975 | | | | 42.5 | % |
| Market yield trend analysis and enterprise valuation | | | 27,485 | | | | 30.7 | |
| Discounted cash flow model | | | 16,698 | | | | 18.7 | |
| Readily available market maker, broker quotes | | | 7,215 | | | | 8.1 | |
| Total fair valued investments | | $ | 89,373 | | | | 100.0 | % |
Item 8. Financial Statements and Supplementary Data
Our financial statements are annexed to this Annual Report beginning on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
Our CEO and our CFO have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our CEO and CFO have concluded that our current disclosure controls and procedures are effective as of the end of the period covered by this report.
Management’s annual report on internal control over financial reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined by Rule 13a-15(f) of the Exchange Act) and for the assessment of the effectiveness of internal control over financial reporting. Under the supervision and with the participation of management, including the CEO and CFO, the Company conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). During the audit of our financial statements for the period ended February 28, 2010, our independent auditors informed us that they identified a material weakness in our internal control over financial reporting for complex investment valuation. The material weakness related to an error in the valuation reconciliation for certain investments. This error occurred as a result of an inadequate internal review and reconciliation of the inputs used in preparing the complex investment valuations. We have corrected these errors and believe that the audited consolidated financial statements included in this Annual Report reflect the proper treatment and valuation of the complex investments.
In order to improve the effectiveness of our internal control over financial reporting in general, and to remediate the material weakness identified by our independent auditors, we have undertaken the measure described below.
We have enhanced monitoring controls in our accounting and finance department, including additional management reviews for all complex and non-routine transactions to ensure that all investment valuation reconciliations are performed properly.
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
Changes in internal controls over financial reporting
There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of Exchange Act) that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item will be contained in the Company’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting and is incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item will be contained in the Company’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item will be contained in the Company’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item will be contained in the Company’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information required by this item will be contained in the Company’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting and is incorporated herein by reference.
PART IV
Item 15. Exhibits and Consolidated Financial Statement Schedules
Consolidated Financial Statements
The following financial statements of the Company are filed herewith:
Reports of Independent Registered Public Accounting Firm
Consolidated Statement of Assets and Liabilities as of February 28, 2010 and 2009
Consolidated Statements of Operations for the years ended February 28, 2010 and 2009 and February 29, 2008
Consolidated Schedule of Investments as of February 28, 2010 and 2009
Consolidated Statements of Changes in Net Assets for the years ended February 28, 2010 and 2009 and February 29, 2008
Consolidated Statements of Cash Flows for the years ended February 28, 2010 and 2009 and February 29, 2008
Notes to Consolidated Financial Statements
Exhibits
EXHIBIT INDEX
Exhibit Number | | Description |
| 3.1 | | Articles of Incorporation of GSC Investment Corp.(8) |
| | | |
| 3.2 | | Amended and Restated Bylaws of GSC Investment Corp.(9) |
| | | |
| 4.1 | | Specimen certificate of GSC Investment Corp.’s common stock, par value $0.0001 per share.(4) |
| | | |
| 4.2 | | Registration Rights Agreement dated March 27, 2007 between GSC Investment Corp., GSC CDO III L.L.C., GSCP (NJ) L.P. and the other investors party thereto.(8) |
| | | |
| 4.3 | | Form of Dividend Reinvestment Plan.(1) |
| | | |
| 10.1 | | Amended and Restated Limited Partnership Agreement of GSC Partners CDO Investors III, L.P. dated August 27, 2001.(2) |
| | | |
| 10.2 | | Amended and Restated Limited Partnership Agreement of GSC Partners CDO GP III, L.P. dated October 16, 2001.(2) |
| | | |
| 10.3 | | Collateral Management Agreement dated November 5, 2001 among GSC Partners CDO Fund III, Limited and GSCP (NJ), L.P.(2) |
| | | |
| 10.4 | | Contribution and Exchange Agreement dated October 17, 2006 among GSC Investment LLC, GSC CDO III, L.L.C., GSCP (NJ), L.P., and the other investors party thereto.(1) |
| | | |
| 10.5 | | Amendment to the Contribution and Exchange Agreement dated as of March 20, 2007 among GSC Investment LLC, GSC CDO III, L.L.C., GSCP (NJ), L.P., and the other investors party thereto.(11) |
| | | |
| 10.6 | | Form of Regulations of American Stock Transfer and Trust Company.(3) |
| | | |
| 10.7 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Peter K. Barker, as director of GSC Investment LLC.(8) |
| | | |
| 10.8 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Robert F. Cummings, Jr., as director of GSC Investment LLC.(8) |
| | | |
| 10.9 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Richard M. Hayden, as director of GSC Investment LLC.(8) |
| | | |
| 10.10 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Thomas V. Inglesby, as director of GSC Investment LLC.(8) |
| | | |
| 10.11 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Steven M. Looney, as director of GSC Investment LLC.(8) |
| | | |
| 10.12 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Charles S. Whitman III, as director of GSC Investment LLC.(8) |
| | | |
| 10.13 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and G. Cabell Williams, as director of GSC Investment LLC.(8) |
| | | |
| 10.14 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Richard T. Allorto, Jr., as Chief Financial Officer of GSC Investment LLC.(8) |
| | | |
| 10.15 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and David L. Goret, as Vice President and Secretary of GSC Investment LLC.(8) |
| | | |
| 10.16 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Michael J. Monticciolo, as Chief Compliance Officer of GSC Investment LLC.(8) |
| 10.17 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Daniel I. Castro, Jr., as member of the investment committee of GSCP (NJ), LP.(8) |
| | | |
| 10.18 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Robert F. Cummings, Jr., as member of the investment committee of GSCP (NJ), LP.(8) |
| | | |
| 10.19 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Richard M. Hayden, as member of the investment committee of GSCP (NJ), LP.(8) |
| | | |
| 10.20 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Thomas V. Inglesby, as member of the investment committee of GSCP (NJ), LP.(8) |
| | | |
| 10.21 | | Indemnification Agreement dated March 20, 2007 between GSC Investment LLC and Thomas J. Libassi, as member of the investment committee of GSCP (NJ), LP.(8) |
| | | |
| 10.22 | | Assignment and Assumption Agreement dated March 20, 2007 among GSCP (NJ), L.P. and GSC Investment LLC.(8) |
| | | |
| 10.23 | | Investment Advisory and Management Agreement dated March 21, 2007 between GSC Investment LLC and GSCP (NJ) L.P.(8) |
| | | |
| 10.24 | | Custodian Agreement dated March 21, 2007 between GSC Investment LLC and U.S. Bank National Association.(8) |
| | | |
| 10.25 | | Administration Agreement dated March 21, 2007 between GSC Investment Corp. and GSCP (NJ) L.P.(8) |
| | | |
| 10.26 | | Trademark License Agreement dated March 21, 2007 between GSC Investment Corp. and GSCP (NJ) L.P.(8) |
| | | |
| 10.27 | | Notification of Fee Reimbursement dated March 21, 2007.(8) |
| | | |
| 10.28 | | Portfolio Acquisition Agreement dated March 23, 2007 between GSC Investment Corp. and GSC Partners CDO Fund III, Limited.(8) |
| | | |
| 10.29 | | Credit Agreement dated as of April 11, 2007 among GSC Investment Funding LLC, GSC Investment Corp., GSC (NJ), L.P., the financial institutions from time to time party thereto, the commercial paper lenders from time to time party thereto and Deutsche Bank AG, New York Branch.(5) |
| | | |
| 10.30 | | Purchase and Sale Agreement between GSC Investment Corp. and GSC Investment Funding LLC dated as of April 11, 2007.(5) |
| | | |
| 10.31 | | Amendment No. 1 to Credit Agreement, dated as of May 1, 2007 among GSC Investment Funding LLC, Deutsche Bank AG, New York Branch, GSC Investment Corp., and GSCP (NJ), L.P.(6) |
| | | |
| 10.32 | | Credit Agreement dated as of May 1, 2007 among GSC Investment Funding II LLC, GSC Investment Corp., GSC (NJ), L.P., the financial institutions from time to time party thereto, the commercial paper lenders from time to time party thereto and Deutsche Bank AG, New York Branch.(6) |
| | | |
| 10.33 | | Purchase Sale Agreement dated as of May 1, 2007 between GSC Investment Funding II LLC and GSC Investment Corp.(6) |
| | | |
| 10.34 | | Purchase and Sale Agreement dated as of May 1, 2007 between GSC Investment Corp. and GSC Partners CDO Fund Limited.(6) |
| | | |
| 10.35 | | Amendment to Investment Advisory and Management Agreement dated May 23, 2007 between GSC Investment Corp. and GSCP (NJ), L.P.(7) |
| | | |
| 10.36 | | Indemnification Agreement dated October 9, 2007 between GSC Investment Corp. and David Goret, as member of the disclosure committee of GSC Investment Corp.(11) |
| | | |
| 10.37 | | Indemnification Agreement dated October 9, 2007 between GSC Investment Corp. and David Rice, as member of the disclosure committee of GSC Investment Corp.(11) |
| | | |
| 10.38 | | Agreement Terminating Fee Reimbursement dated as of April 15, 2008 between GSCP (NJ), L.P. and GSC Investment Corp.(10) |
| | | |
| 10.39 | | Amendment No. 3 to Credit Agreement, dated as of August 8, 2008 among GSC Investment Funding LLC and Deutsche Bank AG, New York Branch(12) |
| 10.40 | | Indemnification Agreement dated October 15, 2008 between GSC Investment Corp. and Seth M, Katzenstein, as director of GSC Investment Corp.(13) |
| | | |
| 10.41 | | Indemnification Agreement dated October 15, 2008 between GSC Investment Corp. and Seth M. Katzenstein as Chief Executive Officer and President of GSC Investment Corp.(13) |
| | | |
| 10.42 | | Indemnification Agreement dated as of October 13, 2009 between GSC Investment Corp. and Eric Rubenfeld, as Vice President and Secretary of GSC Investment Corp.(14) |
| | | |
| 10.43 | | Second Amendment to the Administration Agreement by and between GSC Investment Corp. and GSCP (NJ), L.P.(15) |
| | | |
| 10.44 | | Third Amendment to the Investment Advisory and Management Agreement dated March 31, 2010 between GSC Investment Corp. and GSCP (NJ), L.P.(15) |
| | | |
| 10.45 | | Agreement to Waive Certain Rights Under the Administration Agreement dated March 21, 2010 by and between GSC Investment Corp. and GSCP (NJ), L.P.(15) |
| | | |
| 10.46 | | Stock Purchase Agreement dated as of April 14, 2010 among GSC Investment Corp., Saratoga Investment Advisors, LLC and CLO Partners LLC.(16) |
| | | |
| 14.1 | | Code of Ethics of the Company adopted under Rule 17j-1.(3) |
| | | |
| 21.1 | | List of Subsidiaries.(11) |
| | | |
| 31.1 | | Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 31.2 | | Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.1 | | Chief Executive Officer and Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
____________
| (1) | Incorporated by reference to Amendment No. 2 to GSC Investment LLC’s Registration Statement on Form N-2, File No. 333-138051, filed on January 12, 2007. |
| (2) | Incorporated by reference to Amendment No. 4 to GSC Investment LLC’s Registration Statement on Form N-2, File No. 333-138051, filed on February 23, 2007. |
| (3) | Incorporated by reference to Amendment No. 6 to GSC Investment Corp.’s Registration Statement on Form N-2, File No. 333-138051, filed on March 22, 2007. |
| (4) | Incorporated by reference to GSC Investment Corp’s Registration Statement on Form 8-A, File No. 001-33376, filed on March 21, 2007. |
| (5) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated April 11, 2007. |
| (6) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated May 1, 2007. |
| (7) | Incorporated by reference to GSC Investment Corp.’s Form 10-K for the fiscal year ended February 28, 2007, file No. 001-33376. |
| (8) | Incorporated by reference to GSC Investment Corp.’s Form 10-Q for the quarterly period ended May 31, 2007, File No. 001-33376. |
| (9) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated February 19, 2008. |
| (10) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated April 15, 2008. |
| (11) | Incorporated by reference to GSC Investment Corp.’s Form 10-K for the fiscal year ended February 29, 2008, File No. 001-33376. |
| (12) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated August 8, 2008. |
| (13) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated October 15, 2008. |
| (14) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated November 12, 2009. |
| (15) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated March 31, 2010. |
| (16) | Incorporated by reference to GSC Investment Corp.’s Form 8-K, File No. 001-33376 dated April 14, 2010. |
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.
| | GSC Investment Corp. |
| | | |
| Date: May 28, 2010 | By: | /s/ Seth M. Katzenstein |
| | | Seth M. Katzenstein |
| | | Chief Executive Officer and President |
| | | GSC Investment Corp. |
* * * * *
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 capacities and on the dates indicated.
| Signature | | Title | | Date |
| | | | | |
| /s/ Richard M. Hayden | | Chairman of the Board of Directors | | May 28, 2010 |
| RICHARD M. HAYDEN | | | | |
| | | | | |
| /s/ Seth M. Katzenstein | | Chief Executive Officer and President | | May 28, 2010 |
| SETH M. KATZENSTEIN | | | | |
| | | | | |
| /s/ Richard T. Allorto, Jr. | | Chief Financial Officer | | May 28, 2010 |
| RICHARD T. ALLORTO, JR. | | | | |
| | | | | |
| /s/ Robert F. Cummings Jr. | | Member of the Board of Directors | | May 28, 2010 |
| ROBERT F. CUMMINGS, JR. | | | | |
| | | | | |
| /s/ Steven M. Looney | | Member of the Board of Directors | | May 28, 2010 |
| STEVEN M. LOONEY | | | | |
| | | | | |
| /s/ Charles S. Whitman III | | Member of the Board of Directors | | May 28, 2010 |
| CHARLES S. WHITMAN III | | | | |
| | | | | |
| /s/ G. Cabell Williams | | Member of the Board of Directors | | May 28, 2010 |
| G. CABELL WILLIAMS | | | | |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Reports of Independent Registered Public Accounting Firm | F-2 |
| Consolidated Statement of Assets and Liabilities as of February 28, 2010 and 2009 | F-3 |
| Consolidated Statements of Operations for the years ended February 28, 2010 and 2009 and February 29, 2008 | F-4 |
| Consolidated Schedule of Investments as of February 28, 2010 and 2009 | F-5 |
| Consolidated Statements of Changes in Net Assets for the years ended February 28, 2010 and 2009 and February 29, 2008 | F-11 |
| Consolidated Statements of Cash Flows for the years ended February 28, 2010 and 2009 and February 29, 2008 | F-12 |
| Notes to Consolidated Financial Statements | F-13 |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of GSC Investment Corp.
We have audited the accompanying consolidated statement of assets and liabilities of GSC Investment Corp. (the “Company”), including the consolidated schedule of investments as of February 28, 2010 and February 28, 2009 , and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended February 28, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes 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. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GSC Investment Corp. at February 28, 2010 and February 28, 2009, and the consolidated results of its operations, changes in its net assets and its cash flows for each of the three years in the period ended February 28, 2010 in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that GSC Investment Corp. will continue as a going-concern. As more fully described in Note 3, the Company remained in default of its Revolving Facility. As a result of the default, the Company’s lender has the right to accelerate repayment of the outstanding indebtedness and foreclose and liquidate the collateral pledged. This would have a material adverse effect on the Company’s liquidity, financial condition and operations. This condition raises substantial doubt about the Company’s ability to continue as a going-concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
New York, NY
May 27, 2010
GSC Investment Corp.
Consolidated Statement of Assets and Liabilities
| | | As of | |
| | | February 28, 2010 | | | February 28, 2009 | |
| | | | | | | |
| ASSETS | | | | | | |
| | | | | | | |
| Investments at fair value | | | | | | |
| Non-control/non-affiliate investments (amortized cost of $117,678,275 and $137,020,449, respectively) | | $ | 72,674,847 | | | $ | 96,462,919 | |
| Control investments (cost of $29,233,097 and $29,905,194, respectively) | | | 16,698,303 | | | | 22,439,029 | |
| Affiliate investments (cost of $0 and $0, respectively) | | | - | | | | 10,527 | |
| Total investments at fair value (amortized cost of $146,911,372 and $166,925,643, respectively) | | | 89,373,150 | | | | 118,912,475 | |
| Cash and cash equivalents | | | 3,352,434 | | | | 6,356,225 | |
| Cash and cash equivalents, securitization accounts | | | 225,424 | | | | 1,178,201 | |
| Outstanding interest rate cap at fair value (cost of $131,000 and $131,000, respectively) | | | 42,147 | | | | 39,513 | |
| Interest receivable, net of reserve | | | 3,473,961 | | | | 3,087,668 | |
| Deferred credit facility financing costs, net | | | - | | | | 529,767 | |
| Management fee receivable | | | 327,928 | | | | 237,370 | |
| Other assets | | | 140,272 | | | | 321,260 | |
| Total assets | | $ | 96,935,316 | | | $ | 130,662,479 | |
| | | | | | | | | |
| LIABILITIES | | | | | | | | |
| Revolving credit facility | | $ | 36,992,222 | | | $ | 58,994,673 | |
| Management and incentive fees payable | | | 3,071,093 | | | | 2,880,667 | |
| Accounts payable and accrued expenses | | | 1,111,081 | | | | 700,537 | |
| Interest and credit facility fees payable | | | 267,166 | | | | 72,825 | |
| Due to manager | | | 15,602 | | | | - | |
| Total liabilities | | $ | 41,457,164 | | | $ | 62,648,702 | |
| | | | | | | | | |
| NET ASSETS | | | | | | | | |
| Common stock, par value $.0001 per share, 100,000,000 common shares authorized, 16,940,109 and 8,291,384 common shares issued and outstanding, respectively | | $ | 1,694 | | | $ | 829 | |
| Capital in excess of par value | | | 128,339,497 | | | | 116,943,738 | |
| (Distributions in excess of accumulated net investment income) / Accumulated undistributed net investment income | | | (2,846,135 | ) | | | 6,122,492 | |
| Accumulated net realized loss from investments and derivatives | | | (12,389,830 | ) | | | (6,948,628 | ) |
| Net unrealized depreciation on investments and derivatives | | | (57,627,074 | ) | | | (48,104,654 | ) |
| Total Net Assets | | | 55,478,152 | | | | 68,013,777 | |
| | | | | | | | | |
| Total liabilities and Net Assets | | $ | 96,935,316 | | | $ | 130,662,479 | |
| | | | | | | | | |
| NET ASSET VALUE PER SHARE | | $ | 3.27 | | | $ | 8.20 | |
See accompanying notes to consolidated financial statements.
Consolidated Statements of Operations
| | | For the year ended February 28, 2010 | | | For the year ended February 28, 2009 | | | For the year ended February 29, 2008 | |
| | | | | | | | | | |
| INVESTMENT INCOME | | | | | | | | | |
| Interest from investments | | | | | | | | | |
| Non-control/Non-affiliate investments | | $ | 10,902,482 | | | $ | 16,572,973 | | | $ | 20,115,301 | |
| Control investments | | | 2,397,514 | | | | 4,393,818 | | | | 262,442 | |
| Total interest income | | | 13,299,996 | | | | 20,966,791 | | | | 20,377,743 | |
| Interest from cash and cash equivalents | | | 23,624 | | | | 175,567 | | | | 366,312 | |
| Management fee income | | | 2,057,397 | | | | 2,049,717 | | | | 599,476 | |
| Other income | | | 236,259 | | | | 195,135 | | | | 42,548 | |
| Total investment income | | | 15,617,276 | | | | 23,387,210 | | | | 21,386,079 | |
| | | | | | | | | | | | | |
| EXPENSES | | | | | | | | | | | | |
| Interest and credit facility financing expenses | | | 4,096,041 | | | | 2,605,367 | | | | 5,031,233 | |
| Base management fees | | | 1,950,760 | | | | 2,680,231 | | | | 2,938,659 | |
| Professional fees | | | 2,071,027 | | | | 1,166,111 | | | | 1,409,806 | |
| Administrator expenses | | | 670,720 | | | | 960,701 | | | | 892,112 | |
| Incentive management fees | | | 327,684 | | | | 1,752,254 | | | | 711,363 | |
| Insurance | | | 869,969 | | | | 682,154 | | | | 586,784 | |
| Directors fees and expenses | | | 294,932 | | | | 295,017 | | | | 313,726 | |
| General & administrative | | | 265,575 | | | | 289,477 | | | | 261,653 | |
| Cost of acquiring management contract | | | - | | | | - | | | | 144,000 | |
| Organizational expense | | | - | | | | - | | | | 49,542 | |
| Expenses before expense waiver and reimbursement | | | 10,546,708 | | | | 10,431,312 | | | | 12,338,878 | |
| Expense waiver and reimbursement | | | (670,720 | ) | | | (1,010,416 | ) | | | (1,789,028 | ) |
| Total expenses net of expense waiver and reimbursement | | | 9,875,988 | | | | 9,420,896 | | | | 10,549,850 | |
| | | | | | | | | | | | | |
| NET INVESTMENT INCOME BEFORE INCOME TAXES | | | 5,741,288 | | | | 13,966,314 | | | | 10,836,229 | |
| | | | | | | | | | | | | |
| Income tax expense, including excise tax | | | (27,445 | ) | | | (140,322 | ) | | | (88,951 | ) |
| | | | | | | | | | | | | |
| NET INVESTMENT INCOME | | | 5,713,843 | | | | 13,825,992 | | | | 10,747,278 | |
| | | | | | | | | | | | | |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: | | | | | | | | | | | | |
| Net realized gain/(loss) from investments | | | | | | | | | | | | |
| Non-Control/Non-Affiliate investments | | | (6,653,983 | ) | | | (7,173,118 | ) | | | 2,707,402 | |
| Control investments | | | - | | | | - | | | | 428,673 | |
| Affiliate investments | | | - | | | | - | | | | 39,147 | |
| Net realized gain from derivatives | | | - | | | | 30,454 | | | | 732,526 | |
| Net unrealized depreciation on investments | | | (9,525,054 | ) | | | (27,961,244 | ) | | | (20,051,923 | ) |
| Net unrealized appreciation/(depreciation) on derivatives | | | 2,634 | | | | (37,221 | ) | | | (54,266 | ) |
| Net loss on investments | | | (16,176,403 | ) | | | (35,141,129 | ) | | | (16,198,441 | ) |
| | | | | | | | | | | | | |
| NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS | | $ | (10,462,560 | ) | | $ | (21,315,137 | ) | | $ | (5,451,163 | ) |
| | | | | | | | | | | | | |
| WEIGHTED AVERAGE - BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE | | $ | (0.99 | ) | | $ | (2.57 | ) | | $ | (0.70 | ) |
| | | | | | | | | | | | | |
| WEIGHTED AVERAGE COMMON STOCK OUTSTANDING - BASIC AND DILUTED | | | 10,613,507 | | | | 8,291,384 | | | | 7,761,965 | |
See accompanying notes to consolidated financial statements.
GSC Investment Corp.
Consolidated Schedule of Investments
February 28, 2010
Company (a, c) | | Industry | | Investment Interest Rate/Maturity | | Principal/ Number of Shares | | | Cost | | | Fair Value | | | % of Stockholders' Equity | |
| Non-control/Non-affiliated investments - 131.0% (b) | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| GFSI Inc (d) | | Apparel | | Senior Secured Notes 10.50%, 6/1/2011 | | $ | 7,082,000 | | | $ | 7,082,000 | | | $ | 6,909,907 | | | | 12.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Legacy Cabinets, Inc. (d, i) | | Building Products | | First Lien Term Loan 6.58%, 8/18/2012 | | | 1,479,842 | | | | 1,463,159 | | | | 444,841 | | | | 0.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Legacy Cabinets, Inc. (d, i) | | Building Products | | Second Lien Term Loan 12.50%, 8/18/2013 | | | 1,862,420 | | | | 1,828,197 | | | | 85,113 | | | | 0.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Building Products | | | 3,342,262 | | | | 3,291,356 | | | | 529,954 | | | | 1.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Hopkins Manufacturing Corporation (d) | | Consumer Products | | Second Lien Term Loan 7.50%, 1/26/2012 | | | 3,250,000 | | | | 3,247,947 | | | | 3,003,650 | | | | 5.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Targus Group International, Inc. (d) | | Consumer Products | | First Lien Term Loan 10.25%, 11/22/2012 | | | 3,109,712 | | | | 2,936,092 | | | | 2,738,101 | | | | 4.9 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Targus Holdings, Inc. (d) | | Consumer Products | | Unsecured Notes 10.00%, 12/14/2015 | | | 1,538,235 | | | | 1,538,235 | | | | 1,529,467 | | | | 2.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Targus Holdings, Inc. (d, i) | | Consumer Products | | Common | | | 62,413 | | | | 566,765 | | | | 237,169 | | | | 0.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Consumer Products | | | 7,960,360 | | | | 8,289,039 | | | | 7,508,387 | | | | 13.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| CFF Acquisition LLC (d) | | Consumer Services | | First Lien Term Loan 7.50%, 7/31/2013 | | | 306,855 | | | | 306,855 | | | | 255,242 | | | | 0.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| M/C Communications, LLC (d) | | Education | | First Lien Term Loan 6.75%, 12/31/2012 | | | 831,174 | | | | 831,174 | | | | 616,897 | | | | 1.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| M/C Communications, LLC (d, i) | | Education | | Class A Common Stock | | | 166,327 | | | | 30,241 | | | | 16,633 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Education | | | 997,501 | | | | 861,415 | | | | 633,530 | | | | 1.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Advanced Lighting Technologies, Inc. (d) | | Electronics | | Second Lien Term Loan 6.23%, 6/1/2014 | | | 2,000,000 | | | | 1,814,950 | | | | 1,764,600 | | | | 3.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Group Dekko (d) | | Electronics | | Second Lien Term Loan 10.50%, 1/20/2012 | | | 6,913,293 | | | | 6,913,293 | | | | 4,852,440 | | | | 8.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Electronics | | | 8,913,293 | | | | 8,728,243 | | | | 6,617,040 | | | | 11.9 | % |
| | | | | | | | | | | | | | | | | | | | | |
| USS Parent Holding Corp. (d, i) | | Environmental | | Non Voting Common Stock | | | 765 | | | | 133,002 | | | | 86,745 | | | | 0.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| USS Parent Holding Corp. (d, i) | | Environmental | | Voting Common Stock | | | 17,396 | | | | 3,025,798 | | | | 1,973,453 | | | | 3.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Environmental | | | 18,161 | | | | 3,158,800 | | | | 2,060,198 | | | | 3.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Bankruptcy Management Solutions, Inc. (d) | | Financial Services | | Second Lien Term Loan 6.48%, 7/31/2013 | | | 4,837,500 | | | | 4,814,623 | | | | 983,464 | | | | 1.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Big Train, Inc. (d) | | Food and Beverage | | First Lien Term Loan 7.75%, 3/31/2012 | | | 1,931,121 | | | | 1,451,316 | | | | 1,696,876 | | | | 3.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| IDI Acquisition Corp. (d) | | Healthcare Services | | Senior Secured Notes 10.75%, 12/15/2011 | | | 3,800,000 | | | | 3,679,489 | | | | 3,620,640 | | | | 6.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| PRACS Institute, LTD (d) | | Healthcare Services | | Second Lien Term Loan 8.26%, 4/17/2013 | | | 4,093,750 | | | | 4,058,633 | | | | 3,568,931 | | | | 6.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Healthcare Services | | | 7,893,750 | | | | 7,738,122 | | | | 7,189,571 | | | | 13.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| McMillin Companies LLC (d) | | Homebuilding | | Senior Secured Notes 9.53%, 10/31/2013 | | | 7,700,000 | | | | 7,334,121 | | | | 3,634,400 | | | | 6.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Worldwide Express Operations, LLC (d) | | Logistics | | First Lien Term Loan 10.00%, 6/30/2013 | | | 2,820,467 | | | | 2,816,547 | | | | 2,230,143 | | | | 4.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Jason Incorporated (d, i) | | Manufacturing | | Unsecured Notes 13.00%, 11/1/2010 | | | 12,000,000 | | | | 12,000,000 | | | | 1,478,400 | | | | 2.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Jason Incorporated (d, i) | | Manufacturing | | Unsecured Notes 13.00%, 11/1/2010 | | | 1,700,000 | | | | 1,700,000 | | | | 209,440 | | | | 0.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Specialized Technology Resources, Inc. (d) | | Manufacturing | | Second Lien Term Loan 7.23%, 12/15/2014 | | | 5,000,000 | | | | 4,799,666 | | | | 4,711,000 | | | | 8.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Manufacturing | | | 18,700,000 | | | | 18,499,666 | | | | 6,398,840 | | | | 11.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Elyria Foundry Company, LLC (d) | | Metals | | Senior Secured Notes 13.00%, 3/1/2013 | | | 5,000,000 | | | | 4,883,382 | | | | 3,785,500 | | | | 6.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Elyria Foundry Company, LLC (d, i) | | Metals | | Warrants | | | 3,000 | | | | - | | | | 8,610 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Metals | | | 5,003,000 | | | | 4,883,382 | | | | 3,794,110 | | | | 6.8 | % |
See accompanying notes to consolidated financial statements.
Company (a, c) | | Industry | | Investment Interest Rate/Maturity | | Principal/ Number of Shares | | | Cost | | | Fair Value | | | % of Stockholders' Equity | |
| Abitibi-Consolidated Company of Canada (d, e) | | Natural Resources | | First Lien Term Loan 11.00%, 3/30/2009 | | $ | 2,948,639 | | | $ | 2,948,639 | | | $ | 2,830,694 | | | | 5.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Grant U.S. Holdings LLP (d, e, i) | | Natural Resources | | Second Lien Term Loan 10.75%, 9/20/2013 | | | 6,349,512 | | | | 6,349,348 | | | | 158,738 | | | | 0.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Natural Resources | | | 9,298,151 | | | | 9,297,987 | | | | 2,989,432 | | | | 5.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Energy Alloys, LLC (d) | | Oil and Gas | | Second Lien Term Loan 3.00%, 6/30/2015 | | | 6,239,318 | | | | 6,239,318 | | | | 1,128,693 | | | | 2.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Energy Alloys, LLC (d, i) | | Oil and Gas | | Warrants | | | 3 | | | | - | | | | - | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Oil and Gas | | | 6,239,321 | | | | 6,239,318 | | | | 1,128,693 | | | | 2.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 12.50%, 6/15/2010 | | | 4,850,000 | | | | 4,850,000 | | | | 4,549,785 | | | | 8.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 12.50%, 6/15/2010 | | | 5,087,250 | | | | 5,087,250 | | | | 4,772,349 | | | | 8.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 10.92%, 6/15/2010 | | | 500,000 | | | | 500,000 | | | | 469,050 | | | | 0.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Packaging | | | 10,437,250 | | | | 10,437,250 | | | | 9,791,184 | | | | 17.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Custom Direct, Inc. (d) | | Printing | | First Lien Term Loan 3.06%, 12/31/2013 | | | 1,832,053 | | | | 1,527,103 | | | | 1,614,222 | | | | 2.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affinity Group, Inc. (d) | | Publishing | | First Lien Term Loan 12.75%, 3/31/2010 | | | 361,020 | | | | 360,554 | | | | 361,020 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affinity Group, Inc. (d) | | Publishing | | First Lien Term Loan 12.75%, 3/31/2010 | | | 386,625 | | | | 386,129 | | | | 386,626 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Brown Publishing Company (d, i) | | Publishing | | Second Lien Term Loan 8.76%, 9/19/2014 | | | 1,203,226 | | | | 1,198,390 | | | | 10,709 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Network Communications, Inc. (d) | | Publishing | | Unsecured Notes 10.75%, 12/1/2013 | | | 5,000,000 | | | | 5,067,619 | | | | 2,473,000 | | | | 4.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Penton Media, Inc. (d) | | Publishing | | First Lien Term Loan 2.50%, 2/1/2013 | | | 4,847,802 | | | | 3,908,440 | | | | 3,478,299 | | | | 6.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Publishing | | | 11,798,673 | | | | 10,921,132 | | | | 6,709,654 | | | | 12.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Sub Total Non-control/Non-affiliated investments | | | | | | | | | | | 117,678,275 | | | | 72,674,847 | | | | 131.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Control investments - 30.1% (b) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| GSC Partners CDO GP III, LP (h, i) | | Financial Services | | 100% General Partnership Interest | | | - | | | | - | | | | - | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| GSC Investment Corp. CLO 2007 LTD. (f, h) | | Structured Finance Securities | | Other/Structured Finance Securities 8.27%, 1/21/2020 | | | 30,000,000 | | | | 29,233,097 | | | | 16,698,303 | | | | 30.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Sub Total Control investments | | | | | | | | | | | 29,233,097 | | | | 16,698,303 | | | | 30.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affiliate investments - 0.0% (b) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| GSC Partners CDO GP III, LP (g, i) | | Financial Services | | 6.24% Limited Partnership Interest | | | - | | | | - | | | | - | | | | 0.0 | % |
| Sub Total Affiliate investments | | | | | | | | | | | - | | | | - | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| TOTAL INVESTMENT ASSETS - 161.1% (b) | | | | | | | | | | $ | 146,911,372 | | | $ | 89,373,150 | | | | 161.1 | % |
See accompanying notes to consolidated financial statements.
Outstanding interest rate cap | | Interest rate | | Maturity | | Notional | | | Cost | | | Fair Value | | | % of Stockholders'
Equity | |
| Interest rate cap | | | 8.0 | % | 2/9/2014 | | $ | 39,183,673 | | | $ | 87,000 | | | $ | 30,097 | | | | 0.1 | % |
| Interest rate cap | | | 8.0 | % | 11/30/2013 | | | 26,433,408 | | | | 44,000 | | | | 12,050 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | |
| Sub Total Outstanding interest rate cap | | | | | | | | | | | $ | 131,000 | | | $ | 42,147 | | | | 0.1 | % |
| (a) | All of the Fund’s equity and debt investments are issued by eligible portfolio companies, as defined in the Investment Company Act of 1940, except Abitibi-Consolidated Company of Canada, Grant U.S. Holdings LLP, GSC Investment Corp. CLO 2007 Ltd., Terphane Holdings Corp., and GSC Partners CDO GP III, LP. |
| | |
| (b) | Percentages are based on net assets of $55,478,152 as of February 28, 2010. |
| | |
| (c) | Fair valued investment (see Note 4 to the consolidated financial statements). |
| | |
| (d) | All or a portion of the securities are pledged as collateral under a revolving securitized credit facility (see Note 8 to the consolidated financial statements). |
| | |
| (e) | Non-U.S. company. The principal place of business for Terphane Holdings Corp is Brazil, and for Abitibi-Consolidated Company of Canada and Grant U.S. Holdings LLP is Canada. |
| | |
| (f) | 8.27% represents the modeled effective interest rate that is expected to be earned over the life of the investment. |
| | |
| (g) | As defined in the Investment Company Act, we are an "Affiliate" of this portfolio company because we own 5% or more of the portfolio company's outstanding voting securities. Transactions during the period in which the issuer was an Affiliate are as follows: |
| | | | | | | | | | | | Interest | | | Management | | | Net Realized | | | Net unrealized | |
Company | | Purchases | | | Redemptions | | | Sales (cost) | | | Income | | | fee income | | | gains/(losses) | | | gains/(losses) | |
GSC Partners CDO GP III, LP | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | (10,527 | ) |
| (h) | As defined in the Investment Company Act, we are an "Affiliate" of this portfolio company because we own 5% or more of the portfolio company's outstanding voting securities. In addition, as defined in the Investment Company Act, we "Control" this portfolio company because we own more than 25% of the portfolio company's outstanding voting securities. Transactions during the period in which the issuer was both an Affiliate and a portfolio company that we Control are as follows: |
| | | | | | | | | | | | Interest | | | Management | | | Net Realized | | | Net unrealized | |
Company | | Purchases | | | Redemptions | | | Sales (cost) | | | Income | | | fee income | | | gains/(losses) | | | gains/(losses) | |
GSC Investment Corp. CLO 2007 LTD. | | $ | - | | | $ | - | | | $ | - | | | $ | 2,397,514 | | | $ | 2,057,397 | | | $ | - | | | $ | (4,970,217 | ) |
GSC Partners CDO GP III, LP | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | (98,412 | ) |
| (i) | Non-income producing at February 28, 2010. |
See accompanying notes to consolidated financial statements.
GSC Investment Corp.
Consolidated Schedule of Investments
February 28, 2009
Company (a, c) | | Industry | | Investment Interest Rate/Maturity | | Principal | | | Cost | | | Fair Value | | | % of Stockholders' Equity | |
| Non-control/Non-affiliated investments - 141.8% (b) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| GFSI Inc (d) | | Apparel | | Senior Secured Notes 10.50%, 6/1/2011 | | $ | 7,082,000 | | | $ | 7,082,000 | | | $ | 6,616,004 | | | | 9.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Legacy Cabinets, Inc. (d) | | Building Products | | First Lien Term Loan 5.75%, 8/18/2012 | | | 1,437,555 | | | | 1,420,872 | | | | 975,956 | | | | 1.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Legacy Cabinets, Inc. (d) | | Building Products | | Second Lien Term Loan 9.75%, 8/18/2013 | | | 1,862,420 | | | | 1,828,197 | | | | 450,519 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Building Products | | | 3,299,975 | | | | 3,249,069 | | | | 1,426,475 | | | | 2.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.75%, 12/20/2013 | | | 32,381 | | | | 27,281 | | | | 6,152 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.47%, 12/20/2013 | | | 77,141 | | | | 64,991 | | | | 14,657 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.16%, 12/20/2014 | | | 92,962 | | | | 78,320 | | | | 17,663 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.16%, 12/20/2014 | | | 92,962 | | | | 78,320 | | | | 17,663 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.16%, 12/20/2014 | | | 92,962 | | | | 78,320 | | | | 17,663 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.75%, 12/20/2013 | | | 121,428 | | | | 102,303 | | | | 23,071 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 5.75%, 12/20/2013 | | | 231,354 | | | | 194,916 | | | | 43,957 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 7.00%, 12/20/2014 | | | 403,388 | | | | 339,854 | | | | 76,644 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 7.00%, 12/20/2014 | | | 403,388 | | | | 339,854 | | | | 76,644 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Lyondell Chemical Company (d) | | Chemicals | | First Lien Term Loan 7.00%, 12/20/2014 | | | 403,388 | | | | 339,854 | | | | 76,644 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Chemicals | | | 1,951,354 | | | | 1,644,013 | | | | 370,758 | | | | 0.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Hopkins Manufacturing Corporation (d) | | Consumer Products | | Second Lien Term Loan 7.70%, 1/26/2012 | | | 3,250,000 | | | | 3,246,870 | | | | 2,627,950 | | | | 3.9 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Targus Group International, Inc. (d) | | Consumer Products | | First Lien Term Loan 4.67%, 11/22/2012 | | | 3,122,943 | | | | 2,895,723 | | | | 2,089,561 | | | | 3.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Targus Group International, Inc. (d) | | Consumer Products | | Second Lien Term Loan 9.75%, 5/22/2013 | | | 5,000,000 | | | | 4,777,205 | | | | 3,126,000 | | | | 4.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Consumer Products | | | 11,372,943 | | | | 10,919,798 | | | | 7,843,511 | | | | 11.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| CFF Acquisition LLC (d) | | Consumer Services | | First Lien Term Loan 8.57%, 7/31/2013 | | | 308,912 | | | | 308,912 | | | | 243,793 | | | | 0.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| M/C Communications, LLC (d) | | Education | | First Lien Term Loan 13.12%, 12/31/2010 | | | 1,697,164 | | | | 1,590,350 | | | | 674,283 | | | | 1.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Advanced Lighting Technologies, Inc. (d) | | Electronics | | Second Lien Term Loan 8.53%, 6/1/2014 | | | 2,000,000 | | | | 1,771,457 | | | | 1,503,200 | | | | 2.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Group Dekko (d) | | Electronics | | Second Lien Term Loan 6.45%, 1/20/2012 | | | 6,670,000 | | | | 6,670,000 | | | | 5,321,326 | | | | 7.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| IPC Systems, Inc. (d) | | Electronics | | First Lien Term Loan 3.71%, 3/31/2014 | | | 46,332 | | | | 42,367 | | | | 24,621 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Electronics | | | 8,716,332 | | | | 8,483,824 | | | | 6,849,147 | | | | 10.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| USS Mergerco, Inc. (d) | | Environmental | | Second Lien Term Loan 4.73%, 6/29/2013 | | | 5,960,000 | | | | 5,846,833 | | | | 3,592,092 | | | | 5.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Bankruptcy Management Solutions, Inc. (d) | | Financial Services | | Second Lien Term Loan 6.70%, 7/31/2013 | | | 4,887,500 | | | | 4,858,282 | | | | 3,053,221 | | | | 4.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Big Train, Inc. (d) | | Food and Beverage | | First Lien Term Loan 4.98%, 3/31/2012 | | | 2,478,660 | | | | 1,671,647 | | | | 1,706,557 | | | | 2.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| IDI Acquisition Corp. (d) | | Healthcare Services | | Senior Secured Notes 10.75%, 12/15/2011 | | | 3,800,000 | | | | 3,623,605 | | | | 2,428,580 | | | | 3.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| PRACS Institute, LTD (d) | | Healthcare Services | | Second Lien Term Loan 11.13%, 4/17/2013 | | | 4,093,750 | | | | 4,047,419 | | | | 3,581,213 | | | | 5.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Healthcare Services | | | 7,893,750 | | | | 7,671,024 | | | | 6,009,793 | | | | 8.9 | % |
| | | | | | | | | | | | | | | | | | | | | |
| McMillin Companies LLC (d) | | Homebuilding | | Senior Secured Notes 9.53%, 4/30/2012 | | | 7,700,000 | | | | 7,294,643 | | | | 3,489,640 | | | | 5.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Asurion Corporation (d) | | Insurance | | First Lien Term Loan 3.76%, 7/3/2014 | | | 2,000,000 | | | | 1,704,665 | | | | 1,493,400 | | | | 2.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Worldwide Express Operations, LLC (d) | | Logistics | | First Lien Term Loan 6.95%, 6/30/2013 | | | 2,820,779 | | | | 2,815,612 | | | | 2,133,637 | | | | 3.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Jason Incorporated (d) | | Manufacturing | | Unsecured Notes 13.00%, 11/1/2010 | | | 12,000,000 | | | | 12,000,000 | | | | 8,652,000 | | | | 12.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Jason Incorporated (d) | | Manufacturing | | Unsecured Notes 13.00%, 11/1/2010 | | | 1,700,000 | | | | 1,700,000 | | | | 1,225,700 | | | | 1.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Specialized Technology Resources, Inc. (d) | | Manufacturing | | Second Lien Term Loan 7.48%, 12/15/2014 | | | 5,000,000 | | | | 4,769,304 | | | | 4,602,000 | | | | 6.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Manufacturing | | | 18,700,000 | | | | 18,469,304 | | | | 14,479,700 | | | | 21.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Blaze Recycling & Metals, LLC (d) | | Metals | | Senior Secured Notes 10.88%, 7/15/2012 | | | 2,500,000 | | | | 2,494,342 | | | | 1,850,500 | | | | 2.7 | % |
See accompanying notes to consolidated financial statements.
Company (a, c) | | Industry | | Investment Interest Rate/Maturity | | Principal | | | Cost | | | Fair Value | | | % of Stockholders' Equity | |
| Elyria Foundry Company, LLC (d) | | Metals | | Senior Secured Notes 13.00%, 3/1/2013 | | $ | 5,000,000 | | | $ | 4,853,894 | | | $ | 3,753,000 | | | | 5.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Elyria Foundry Company, LLC | | Metals | | Warrants | | | - | | | | - | | | | 89,610 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Metals | | | 7,500,000 | | | | 7,348,236 | | | | 5,693,110 | | | | 8.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Abitibi-Consolidated Company of Canada (d, e) | | Natural Resources | | First Lien Term Loan 11.50%, 3/30/2009 | | | 2,948,640 | | | | 2,940,073 | | | | 2,081,740 | | | | 3.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Grant U.S. Holdings LLP (d, e) | | Natural Resources | | Second Lien Term Loan 9.81%, 9/20/2013 | | | 6,139,928 | | | | 6,139,764 | | | | 2,388,432 | | | | 3.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Natural Resources | | | 9,088,568 | | | | 9,079,837 | | | | 4,470,172 | | | | 6.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Edgen Murray II, L.P. (d) | | Oil and Gas | | Second Lien Term Loan 7.24%, 5/11/2015 | | | 3,000,000 | | | | 2,815,938 | | | | 2,072,700 | | | | 3.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Energy Alloys, LLC (d) | | Oil and Gas | | Second Lien Term Loan 11.75%, 10/5/2012 | | | 6,200,000 | | | | 6,200,000 | | | | 5,286,740 | | | | 7.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Oil and Gas | | | 9,200,000 | | | | 9,015,938 | | | | 7,359,440 | | | | 10.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Stronghaven, Inc. (d) | | Packaging | | Second Lien Term Loan 13.00%, 10/31/2010 | | | 2,500,000 | | | | 2,500,000 | | | | 2,375,500 | | | | 3.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 12.50%, 6/15/2009 | | | 4,850,000 | | | | 4,846,976 | | | | 3,575,420 | | | | 5.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 12.50%, 6/15/2009 | | | 5,087,250 | | | | 5,084,820 | | | | 3,750,321 | | | | 5.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Terphane Holdings Corp. (d, e) | | Packaging | | Senior Secured Notes 12.02%, 6/15/2009 | | | 500,000 | | | | 499,670 | | | | 368,600 | | | | 0.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Packaging | | | 12,937,250 | | | | 12,931,466 | | | | 10,069,841 | | | | 14.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Custom Direct, Inc. (d) | | Printing | | First Lien Term Loan 4.21%, 12/31/2013 | | | 2,049,694 | | | | 1,618,148 | | | | 1,638,526 | | | | 2.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Advanstar Communications Inc. (d) | | Publishing | | First Lien Term Loan 3.71%, 5/31/2014 | | | 1,970,000 | | | | 1,553,133 | | | | 807,700 | | | | 1.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affinity Group, Inc. (d) | | Publishing | | First Lien Term Loan 3.01%, 6/24/2009 | | | 476,261 | | | | 468,285 | | | | 418,872 | | | | 0.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affinity Group, Inc. (d) | | Publishing | | First Lien Term Loan 2.98%, 6/24/2009 | | | 511,811 | | | | 503,239 | | | | 450,137 | | | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Brown Publishing Company (d) | | Publishing | | Second Lien Term Loan 8.76%, 9/19/2014 | | | 1,203,226 | | | | 1,198,390 | | | | 288,774 | | | | 0.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Network Communications, Inc. (d) | | Publishing | | Unsecured Notes 10.75%, 12/1/2013 | | | 5,000,000 | | | | 5,082,100 | | | | 2,503,000 | | | | 3.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Penton Media, Inc. (d) | | Publishing | | First Lien Term Loan 3.35%, 2/1/2013 | | | 4,897,651 | | | | 3,723,761 | | | | 2,008,037 | | | | 3.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | Total Publishing | | | 14,058,949 | | | | 12,528,908 | | | | 6,476,520 | | | | 9.6 | % |
| | | | | | | | | | | | | | | | | | | | | |
| GXS Worldwide, Inc. (d) | | Software | | Second Lien Term Loan 8.63%, 9/30/2013 | | | 1,000,000 | | | | 887,940 | | | | 773,299 | | | | 1.2 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Sub Total Non-control/Non-affiliated investments | | | | | | | | | | | 137,020,449 | | | | 96,462,919 | | | | 141.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Control investments - 33.0% (b) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| GSC Partners CDO GP III, LP (h) | | Financial Services | | 100% General Partnership interest | | | - | | | | - | | | | 98,412 | | | | 0.1 | % |
| | | | | | | | | | | | | | | | | | | | | |
GSC Investment Corp. CLO 2007 LTD. (f, h) | | Structured Finance Securities | Other/Structured Finance Securities 12.15%, 1/21/2020 | | | 30,000,000 | | | | 29,905,194 | | | | 22,340,617 | | | | 32.9 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Sub Total Control investments | | | | | | | | | | | 29,905,194 | | | | 22,439,029 | | | | 33.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Affiliate investments - 0.0% (b) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| GSC Partners CDO GP III, LP (g) | | Financial Services | | 6.24% Limited Partnership Interest | | | - | | | | - | | | | 10,527 | | | | 0.0 | % |
| Sub Total Affiliate investments | | | | | | | | | | | - | | | | 10,527 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| TOTAL INVESTMENT ASSETS - 174.8% (b) | | | | | | | | | | $ | 166,925,643 | | | $ | 118,912,475 | | | | 174.8 | % |
| Outstanding interest rate cap | | Interest rate | | Maturity | | Notional | | | Cost | | | Fair Value | | | % of Stockholders' Equity | |
| Interest rate cap | | | 8.0 | % | 2/9/2014 | | $ | 40,000,000 | | | $ | 87,000 | | | $ | 27,682 | | | | 0.1 | % |
Company (a, c) | | Industry | | Investment Interest Rate/Maturity | | Principal | | Cost | | Fair Value | | | % of Stockholders' Equity | |
| Interest rate cap | | | 8.0 | % | 11/30/2013 | | | 26,433,408 | | | | 44,000 | | | | 11,831 | | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | |
| Sub Total Outstanding interest rate cap | | | | | | | | | | | $ | 131,000 | | | $ | 39,513 | | | | 0.1 | % |
| (a) | All of the Fund’s equity and debt investments are issued by eligible portfolio companies, as defined in the Investment Company Act of 1940, except Abitibi-Consolidated Company of Canada, Grant U.S. Holdings LLP, GSC Investment Corp. CLO 2007, Terphane Holdings Corp., and GSC Partners CDO GP III, LP. |
| | |
| (b) | Percentages are based on net assets of $68,013,777 as of February 28, 2009. |
| | |
| (c) | Fair valued investment (see Note 4 to the consolidated financial statements). |
| | |
| (d) | All or a portion of the securities are pledged as collateral under a revolving securitized credit facility (see Note 7 to the consolidated financial statements). |
See accompanying notes to consolidated financial statements.
| (e) | Non-U.S. company. The principal place of business for Terphane Holdings Corp is Brazil, and for Abitibi-Consolidated Company of Canada and Grant U.S. Holdings LLP is Canada. |
| | |
| (f) | 12.15% represents the modeled effective interest rate that is expected to be earned over the life of the investment. |
| | |
| (g) | As defined in the Investment Company Act, we are an "Affiliate" of this portfolio company because we own 5% or more of the portfolio company's outstanding voting securities. Transactions during the period in which the issuer was an Affiliate are as follows: |
| | | | | | | | | | | | Interest | | | Management | | | Net Realized | | | Net unrealized | |
| Company | | Purchases | | | Redemptions | | | Sales (cost) | | | Income | | | fee income | | | gains/(losses) | | | gains/(losses) | |
| GSC Partners CDO GP III, LP | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | (5,706 | ) |
| (h) | As defined in the Investment Company Act, we are an "Affiliate" of this portfolio company because we own 5% or more of the portfolio company's outstanding voting securities. In addition, as defined in the Investment Company Act, we "Control" this portfolio company because we own more than 25% of the portfolio company's outstanding voting securities. Transactions during the period in which the issuer was both an Affiliate and a portfolio company that we Control are as follows: |
| | | | | | | | | | | | Interest | | | Management | | | Net Realized | | | Net unrealized | |
Company | | Purchases | | | Redemptions | | | Sales (cost) | | | Income | | | fee income | | | gains/(losses) | | | gains/(losses) | |
| GSC Investment Corp. CLO 2007 LTD. | | $ | - | | | $ | - | | | $ | - | | | $ | 4,393,818 | | | $ | 2,049,717 | | | $ | - | | | $ | (6,479,722 | ) |
| GSC Partners CDO GP III, LP | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | | (61,741 | ) |
See accompanying notes to consolidated financial statements.
GSC Investment Corp.
Consolidated Statements of Changes in Net Assets
| | | For the year ended February 28, 2010 | | | For the year ended February 28, 2009 | | | For the year ended February 29, 2008 | |
| | | | | | | | | | |
| INCREASE/(DECREASE) FROM OPERATIONS: | | | | | | | | | |
| Net investment income | | $ | 5,713,843 | | | $ | 13,825,992 | | | $ | 10,747,278 | |
| Net realized gain/(loss) from investments | | | (6,653,983 | ) | | | (7,173,118 | ) | | | 3,175,222 | |
| Net realized gain from derivatives | | | - | | | | 30,454 | | | | 732,526 | |
| Net unrealized depreciation on investments | | | (9,525,054 | ) | | | (27,961,244 | ) | | | (20,051,923 | ) |
| Net unrealized appreciation/(depreciation) on derivatives | | | 2,634 | | | | (37,221 | ) | | | (54,266 | ) |
| Net decrease in net assets from operations | | | (10,462,560 | ) | | | (21,315,137 | ) | | | (5,451,163 | ) |
| DECREASE FROM SHAREHOLDER DISTRIBUTIONS: | | | | | | | | | | | | |
| Distributions declared | | | (15,131,775 | ) | | | (8,540,126 | ) | | | (12,851,645 | ) |
| Net decrease in net assets from shareholder distributions | | | (15,131,775 | ) | | | (8,540,126 | ) | | | (12,851,645 | ) |
| CAPITAL SHARE TRANSACTIONS: | | | | | | | | | | | | |
| Stock dividend distribution | | | 13,058,710 | | | | - | | | | - | |
| Issuance of common stock, net | | | - | | | | - | | | | 116,301,011 | |
| Net increase in net assets from capital share transactions | | | 13,058,710 | | | | - | | | | 116,301,011 | |
| | | | | | | | | | | | | |
| Total increase/(decrease) in net assets | | | (12,535,625 | ) | | | (29,855,263 | ) | | | 97,998,203 | |
| Net assets at beginning of year | | | 68,013,777 | | | | 97,869,040 | | | | (129,163 | ) |
| Net assets at end of year | | $ | 55,478,152 | | | $ | 68,013,777 | | | $ | 97,869,040 | |
| | | | | | | | | | | | | |
| Net asset value per common share | | $ | 3.27 | | | $ | 8.20 | | | $ | 11.80 | |
| Common shares outstanding at end of year | | | 16,940,109 | | | | 8,291,384 | | | | 8,291,384 | |
| | | | | | | | | | | | | |
| (Distributions in excess of accumulated net investment income) / Accumulated undistributed net investment income | | $ | (2,846,135 | ) | | $ | 6,122,492 | | | $ | 455,576 | |
See accompanying notes to consolidated financial statements.
GSC Investment Corp.
Consolidated Statements of Cash Flows
| | | For the year ended February 28, 2010 | | | For the year ended February 28, 2009 | | | For the year ended February 29, 2008 | |
| | | | | | | | | | |
| Operating activities | | | | | | | | | |
| NET DECREASE IN NET ASSETS FROM OPERATIONS | | $ | (10,462,560 | ) | | $ | (21,315,137 | ) | | $ | (5,451,163 | ) |
| ADJUSTMENTS TO RECONCILE NET DECREASE IN NET ASSETS FROM OPERATIONS TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES: | | | | | | | | | | | | |
| Paid-in-kind interest income | | | (858,730 | ) | | | (819,905 | ) | | | (365,592 | ) |
| Net accretion of discount on investments | | | (966,191 | ) | | | (1,323,644 | ) | | | (765,255 | ) |
| Amortization of deferred credit facility financing costs | | | 633,349 | | | | 193,464 | | | | 502,468 | |
| Net realized loss from investments | | | 6,653,983 | | | | 7,173,118 | | | | (3,175,222 | ) |
| Net realized (gain) loss from derivatives | | | - | | | | - | | | | (732,526 | ) |
| Net unrealized depreciation on investments | | | 9,525,054 | | | | 27,961,244 | | | | 20,051,923 | |
| Unrealized (appreciation) depreciation on derivatives | | | (2,634 | ) | | | 37,221 | | | | 54,266 | |
| Proceeds from sale and redemption of investments | | | 15,185,210 | | | | 49,193,508 | | | | 141,772,158 | |
| Purchase of investments | | | - | | | | (28,259,995 | ) | | | (314,002,526 | ) |
| (Increase) decrease in operating assets: | | | | | | | | | | | | |
| Cash and cash equivalents, securitization accounts | | | 952,777 | | | | 13,402,772 | | | | (14,580,973 | ) |
| Interest receivable | | | (386,293 | ) | | | (732,546 | ) | | | (2,355,122 | ) |
| Due from manager | | | - | | | | 940,903 | | | | (940,903 | ) |
| Management fee receivable | | | (90,558 | ) | | | (21,456 | ) | | | (215,914 | ) |
| Other assets | | | 180,988 | | | | (281,911 | ) | | | (39,349 | ) |
| Deferred offering costs | | | - | | | | - | | | | 808,617 | |
| Increase (decrease) in operating liabilities: | | | | | | | | | | | | |
| Payable for unsettled trades | | | - | | | | (11,329,150 | ) | | | 11,329,150 | |
| Management and incentive fees payable | | | 190,426 | | | | 1,937,606 | | | | 943,061 | |
| Accounts payable and accrued expenses | | | 410,544 | | | | (12,885 | ) | | | 608,422 | |
| Interest and credit facility fees payable | | | 194,341 | | | | (219,482 | ) | | | 292,307 | |
| Due to manager | | | 15,602 | | | | (11,048 | ) | | | (62,762 | ) |
| Accrued offering costs | | | - | | | | - | | | | (760,000 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES | | | 21,175,308 | | | | 36,512,677 | | | | (167,084,935 | ) |
| | | | | | | | | | | | | |
| Financing activities | | | | | | | | | | | | |
| Issuance of shares of common stock | | | - | | | | - | | | | 108,750,000 | |
| Offering costs and sales load | | | - | | | | - | | | | (8,068,750 | ) |
| Borrowings on debt | | | - | | | | 7,800,000 | | | | 167,958,119 | |
| Paydowns on debt | | | (22,002,451 | ) | | | (27,255,327 | ) | | | (89,508,119 | ) |
| Credit facility financing cost | | | (103,582 | ) | | | - | | | | (1,225,699 | ) |
| Cost of interest rate cap | | | - | | | | - | | | | (131,000 | ) |
| Payments of cash dividends | | | (2,073,066 | ) | | | (11,773,766 | ) | | | (9,618,005 | ) |
| NET CASH USED BY FINANCING ACTIVITIES | | | (24,179,099 | ) | | | (31,229,093 | ) | | | 168,156,546 | |
| | | | | | | | | | | | | |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | (3,003,791 | ) | | | 5,283,584 | | | | 1,071,611 | |
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR | | | 6,356,225 | | | | 1,072,641 | | | | 1,030 | |
| CASH AND CASH EQUIVALENTS, END OF YEAR | | $ | 3,352,434 | | | $ | 6,356,225 | | | $ | 1,072,641 | |
| | | | | | | | | | | | | |
| Supplemental Information: | | | | | | | | | | | | |
| Interest paid during the year | | $ | 3,268,351 | | | $ | 2,631,385 | | | $ | 4,236,458 | |
| Federal excise tax paid during the year | | $ | 140,322 | | | $ | 88,951 | | | $ | - | |
| Supplemental non-cash information | | | | | | | | | | | | |
| Issuance of common stock for acquisition of investments in GSC CDO III, LLC and GSC Partners CDO GP III, L.P. | | $ | - | | | $ | - | | | $ | 15,619,761 | |
| Paid-in-kind interest income | | $ | 858,730 | | | $ | 819,905 | | | $ | 365,592 | |
| Net accretion of discount on investments | | $ | 966,191 | | | $ | 1,323,644 | | | $ | 765,255 | |
| Amortization of deferred credit facility financing costs | | $ | 633,349 | | | $ | 193,464 | | | $ | 502,468 | |
| Stock dividend distribution | | $ | 13,058,710 | | | $ | - | | | $ | - | |
See accompanying notes to consolidated financial statements.
GSC INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Basis of Presentation
GSC Investment Corp. (the “Company”, “we” and “us”) is a non-diversified closed end management investment company incorporated in Maryland that has elected to be treated and is regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We commenced operations on March 23, 2007 and completed our initial public offering (“IPO”) on March 28, 2007. We have elected to be treated as a regulated investment company (“RIC”) under subchapter M of the Internal Revenue Code (the “code”). We expect to continue to qualify and to elect to be treated for tax purposes as a RIC. Our investment objectives are to generate both current income and capital appreciation through debt and equity investments by primarily investing in private middle market companies and select high yield bonds.
GSC Investment, LLC (the “LLC”) was organized in May 2006 as a Maryland limited liability company. As of February 28, 2007, the LLC had not yet commenced its operations and investment activities.
On March 21, 2007, the Company was incorporated and concurrently, the LLC was merged with and into the Company in accordance with the procedure for such merger in the LLC’s limited liability company agreement and Maryland law. In connection with such merger, each outstanding common share of the LLC was converted into an equivalent number of shares of common stock of the Company and the Company is the surviving entity.
We are externally managed and advised by our investment adviser, GSCP (NJ), L.P. (individually and collectively with its affiliates, “GSC Group” or the “Manager”), pursuant to an investment advisory and management agreement.
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U. S. generally accepted accounting principles (“GAAP”) and include the accounts of the Company and its special purpose financing subsidiaries, GSC Investment Funding, LLC and GSC Investment Funding II, LLC. All intercompany accounts and transactions have been eliminated in consolidation. All references made to the “Company,” “we,” and “us” in the financial statements encompassing of these consolidated subsidiaries, except as stated otherwise.
Note 2. Summary of Significant Accounting Policies
In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162” (“SFAS 168”). SFAS 168 established the Accounting Standards Codification (“ASC” or the “Codification”) as the source of authoritative GAAP in the United States (the “GAAP hierarchy”) to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Once the Codification is in effect, all of its content will carry the same level of authority and the GAAP hierarchy will be modified to include only two levels of GAAP, authoritative and non-authoritative. SFAS 168, now codified as ASC 105, is effective for financial statements issued for interim and annual periods ending after September 15, 2009. This adoption by the Company has changed the Company’s references to GAAP accounting standards but did not impact any of the Company’s significant accounting policies or its results of operations or financial position.
Use of Estimates in the Preparation of Financial Statements
The preparation of the accompanying consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the period reported. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include short-term, liquid investments in a money market fund. Cash and cash equivalents are carried at cost which approximates fair value.
Cash and cash equivalents, Securitization Accounts
Cash and cash equivalents, securitization accounts include amounts held in designated bank accounts in the form of cash and short-term liquid investments in money market funds representing payments received on securitized investments or other reserved amounts associated with the Company’s securitization facilities. The Company is required to use a portion of these amounts to pay interest expense, reduce borrowings, or pay other amounts in accordance with the related securitization agreements. Cash held in such accounts may not be available for the general use of the Company.
Investment Classification
The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which we own more than 25% of the voting securities or maintain greater than 50% of the board representation. Under the 1940 Act, “Affiliated Investments” are defined as those non-control investments in companies in which we own between 5% and 25% of the voting securities. Under the 1940 Act, “Non-affiliated Investments” are defined as investments that are neither Control Investments or Affiliated Investments.
Investment Valuation
The fair value of the Company’s assets and liabilities which qualify as financial instruments under ASC 825 (previously, SFAS No. 107, “Disclosure About Fair Value of Financial Instruments”), approximates the carrying amounts presented in the consolidated statements of assets and liabilities.
Investments for which market quotations are readily available are fair valued at such market quotations obtained from independent third party pricing services and market makers subject to any decision by our board of directors to make a fair value determination to reflect significant events affecting the value of these investments. We value investments for which market quotations are not readily available at fair value as determined, in good faith, by our board of directors based on input from our Manager, our audit committee and, if our board or audit committee so request, a third party independent valuation firm. Determinations of fair value may involve subjective judgments and estimates. The types of factors that may be considered in a fair value pricing include the nature and realizable value of any collateral, the portfolio company’s ability to make payments, market yield trend analysis, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors.
We undertake a multi-step valuation process each quarter when valuing investments for which market quotations are not readily available, as described below:
| | • | Each investment is initially valued by the responsible investment professionals and preliminary valuation conclusions are documented and discussed with our senior management; and |
| | • | An independent valuation firm engaged by our board of directors reviews at least one quarter of these preliminary valuations each quarter so that the valuation of each investment for which market quotes are not readily available is reviewed by the independent valuation firm at least annually. |
In addition, all our investments are subject to the following valuation process.
| | • | The audit committee of our board of directors reviews each preliminary valuation and our investment adviser and independent valuation firm (if applicable) will supplement the preliminary valuation to reflect any comments provided by the audit committee; and |
| | • | Our board of directors discuss the valuations and determine the fair value of each investment, in good faith, based on the input of our investment adviser, independent valuation firm (if applicable) and audit committee. |
Our equity investment in GSC Investment Corp. CLO 2007, Ltd. (“GSCIC CLO”) is carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar CLO equity, when available, as determined by our investment advisor and recommended to our board of directors.
Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, they may fluctuate over short periods of time and may be based on estimates. The determination of fair value by our board of directors may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be materially affected if the determinations regarding the fair value of our investments were materially higher or lower than the values that we ultimately realize upon the disposal of such investments.
We account for derivative financial instruments in accordance with ASC 815 (previously, SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”). ASC 815 requires recognizing all derivative instruments as either assets or liabilities on the consolidated statement of assets and liabilities at fair value. The Company values derivative contracts at the closing fair value provided by the counterparty. Changes in the values of derivative contracts are included in the consolidated statement of operations.
Investment Transactions and Income Recognition
Purchases and sales of investments and the related realized gains or losses are recorded on a trade-date basis. Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on its investments when it is determined that interest is no longer collectible. If any cash is received after it is determined that interest is no longer collectible, we treat the cash as payment on the principal balance until the entire principal balance has been repaid, before any interest income is recognized. Discounts and premiums on investments purchased are accreted/amortized over the life of the respective investment using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortizations of premium on investments.
Loans are generally placed on non-accrual status when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as a reduction in principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current. The Company may make exceptions to this if the loan has sufficient collateral value and is in the process of collection.
Interest income on our investment in GSCIC CLO is recorded using the effective interest method in accordance with the provision of ASC 325 (previously, EITF 99-20), based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the investment from the date the estimated yield was changed.
Paid-in-Kind Interest
The Company includes in income certain amounts that it has not yet received in cash, such as contractual paid-in-kind interest (“PIK”), which represents contractually deferred interest added to the investment balance that is generally due at maturity. We stop accruing PIK if we do not expect the issuer to be able to pay all principal and interest when due.
Organizational Expenses
Organizational expenses consist principally of professional fees incurred in connection with the organization of the Company and have been expensed as incurred.
Deferred Credit Facility Financing Costs
Financing costs incurred in connection with each respective credit facility have been deferred and are being amortized using the straight line method over the life of each respective facility.
Indemnifications
In the ordinary course of its business, the Company may enter into contracts or agreements that contain indemnifications or warranties. Future events could occur that lead to the execution of these provisions against the Company. Based on its history and experience, management feels that the likelihood of such an event is remote.
Income Taxes
The Company has filed an election to be treated for tax purposes as a RIC under Subchapter M of the Code and, among other things, intends to make the requisite distributions to its stockholders which will relieve the Company from federal income taxes. Therefore, no provision has been recorded for federal income taxes.
In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its stockholders at least 90% of its investment company taxable income, as defined by the Code, for each fiscal tax year. The Company will be subject to a nondeductible U.S. federal excise tax of 4% on undistributed income if we do not distribute at least 98% of our ordinary income in any calendar year and 98% of our capital gain net income for each one-year period ending on October 31.
Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned. For the years ended February 28, 2010 and 2009, provisions of $27,445 and $140,322, respectively were recorded for federal excise taxes and as of each respective year end date the amounts remained unpaid and included in accounts payable on the accompanying consolidated statement of assets and liabilities. The $27,445 payable remains unpaid and the $140,322 payable has been subsequently paid.
We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, which is codified in FASB ASC Topic 740, Income Taxes (“ASC 740”) on February 28, 2008. ASC 740 clarifies the accounting for income taxes by prescribing the minimum recognition threshold that an uncertain tax position is required to meet before tax benefits associated with such uncertain tax position are recognized in the consolidated financial statements. Our adoption of ASC 740 did not require a cumulative effect adjustment to the February 28, 2008 undistributed net realized earnings. We classify interest and penalties, if any, related to unrecognized tax benefits as a component of provision for income taxes.
Based on our analysis of our tax position, we concluded that we did not have any uncertain tax positions that met the recognition or measurement criteria of ASC 740. We did not have any unrecognized tax benefits as of both February 28, 2010 and February 28, 2009.
The Company files federal and state tax returns. The federal and state tax returns for fiscal years 2008 through 2010 remain subject to examination by the IRS and state and local tax authorities.
Dividends
Dividends to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the board of directors. Net realized capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for reinvestment.
The Company has adopted a dividend reinvestment plan that provides for reinvestment of our dividend distributions on behalf of our stockholders unless a stockholder elects to receive cash. As a result, if our board of directors authorizes, and we declare, a cash dividend, then our stockholders who have not ‘‘opted out’’ of our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash dividends. If the Company’s common stock is trading below net asset value at the time of valuation, the plan administrator will receive the dividend or distribution in cash and will purchase common stock in the open market, on the New York Stock Exchange or elsewhere, for the account of each Participant.
New Accounting Pronouncements
In May 2009, the FASB issued ASC 855 (previously, SFAS No. 165, “Subsequent Events”), which addresses accounting and disclosure requirements related to subsequent events. ASC 855 requires management to evaluate subsequent events through the date the financial statements are either issued or available to be issued. ASC 855 is effective for interim or annual financial periods ending after June 15, 2009 and should be applied prospectively. The adoption of ASC 855 did not have a material effect on our financial condition or results of operations.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140”, (“SFAS No. 166”) which amends the derecognition guidance in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, eliminates the concept of a “qualifying special-purpose entity” (“QSPE”) and requires more information about transfers of financial assets, including securitization transactions as well as a company’s continuing exposure to the risks related to transferred financial assets. SFAS No. 166 is now codified in ASC 860. The amended requirements are effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009 and early adoption is prohibited. The Company is currently evaluating the impact on our interim consolidated financial statements of adopting ASC 860.
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASU 2010-06”), which amends ASC 820 and requires additional disclosure related to recurring and non-recurring fair value measurement in respect of transfers in and out of Level 1 and 2 and activity in Level 3 fair value measurements. The update also clarifies existing disclosure about inputs and valuation techniques. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures related to activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal year. Management is currently evaluating the impact on our consolidated financial statements of adopting ASU 2010-06.
Risk Management
In the ordinary course of its business, the Company manages a variety of risks, including market risk and credit risk. Market risk is the risk of potential adverse changes to the value of investments because of changes in market conditions such as interest rate movements and volatility in investment prices.
Credit risk is the risk of default or non-performance by portfolio companies equivalent to the investment’s carrying amount.
The Company is also exposed to credit risk related to maintaining all of its cash and cash equivalents including those in securitization accounts at a major financial institution and credit risk related to the derivative counterparty.
The Company has investments in lower rated and comparable quality unrated high yield bonds and bank loans. Investments in high yield investments are accompanied by a greater degree of credit risk. The risk of loss due to default by the issuer is significantly greater for holders of high yield securities, because such investments are generally unsecured and are often subordinated to other creditors of the issuer.
Note 3. Going Concern
As of February 28, 2010, the Company remained in default on its Revolving Facility (see Note 8) and as a result of the default, our lender has the right to accelerate repayment of the outstanding indebtedness and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations. The deleveraging of the Company may significantly impair the Company’s ability to effectively operate. There is no assurance that we will have sufficient funds available to pay in full the total amount of obligations that would become due as a result of such acceleration or that we will be able to obtain additional or alternative financing to pay or refinance any such accelerated obligations. However, we continue to believe that we will have adequate liquidity to continue to fund our operations and the interest payments on our outstanding debt, including any default interest.
On April 14, 2010 the Company entered into a definitive agreement with Saratoga Investment Advisors, LLC (“Saratoga”) and CLO Partners LLC (“CLO Partners”) and announced a $55 million recapitalization plan to cure the debt default. The recapitalization plan includes Saratoga and CLO Partners purchasing approximately 9.8 million shares of common stock of GSC Investment Corp. for $1.52 per share pursuant to a definitive stock purchase agreement and a commitment from Madison Capital Funding LLC to provide the Company with a $40 million senior secured revolving credit facility. Upon the closing of the transaction, the Company will immediately borrow funds under the new credit facility that, when added to the $15 million equity investment, will be sufficient to repay the full amount of the Company's existing debt and to provide the Company with working capital thereafter. The plan is subject to shareholder approval.
A fundamental principle of the preparation of financial statements in accordance with GAAP is the assumption that an entity will continue in existence as a going concern, which contemplates continuity of operations and the realization of assets and settlement of liabilities occurring in the ordinary course of business. This principle is applicable to all entities except for entities in liquidation or entities for which liquidation appears imminent. In accordance with this requirement, our policy is to prepare our consolidated financial statements on a going concern basis unless we intend to liquidate or have no other alternative but to liquidate. Our consolidated financial statements have been prepared on a going concern basis and do not reflect any adjustments that might specifically result from the outcome of this uncertainty or our debt restructuring activities.
Note 4. Investments
The Company values all investments in accordance with ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”) (previously, SFAS No. 157, “Fair Value Measurements”). ASC 820 requires enhanced disclosures about assets and liabilities that are measured and reported at fair value. As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
ASC 820 provides 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, and identifying transactions that are not orderly. In those circumstances, further analysis and/or significant adjustment to the transaction or quoted prices may be required at the measurement date under current market conditions.
ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.
Based on the observability of the inputs used in the valuation techniques the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the inputs used to determine fair values. Investments carried at fair value are classified and disclosed in one of the following three categories:
| | • | Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. |
| | • | Level 2 – Valuations based on inputs other than quoted prices in active markets, which are either directly or indirectly observable. |
| | • | Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The inputs into the determination of fair value may require significant management judgment or estimation. Such information may be the result of consensus pricing information or broker quotes which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimer would result in classification as Level III information, assuming no additional corroborating evidence. |
In addition to using the above inputs in investment valuations, we continue to employ the valuation policy approved by our board of directors that is consistent with ASC 820 (see Note 2). Consistent with our valuation policy, we evaluate the source of inputs, including any markets in which our investments are trading, in determining fair value.
The following table presents fair value measurements of investments as of February 28, 2010 (dollars in thousands):
| | | Fair Value Measurements Using | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Non-control/non-affiliate investments | | $ | — | | | $ | — | | | $ | 72,675 | | | $ | 72,675 | |
| Control investments | | | — | | | | — | | | | 16,698 | | | | 16,698 | |
| Affiliate investments | | | — | | | | — | | | | — | | | | — | |
| Total investments at fair value | | $ | — | | | $ | — | | | $ | 89,373 | | | $ | 89,373 | |
The following table presents fair value measurements of investments as of February 28, 2009 (dollars in thousands):
| | | Fair Value Measurements Using | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Non-control/non-affiliate investments | | $ | — | | | $ | — | | | $ | 96,463 | | | $ | 96,463 | |
| Control investments | | | — | | | | — | | | | 22,439 | | | | 22,439 | |
| Affiliate investments | | | — | | | | — | | | | 10 | | | | 10 | |
| Total investments at fair value | | $ | — | | | $ | — | | | $ | 118,912 | | | $ | 118,912 | |
The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the year ended February 28, 2010 (dollars in thousands):
| | | Non-control/ non-affiliate | | | Control Investments | | | Affiliate Investments | | | Total | |
| Balance as of February 28, 2009 | | $ | 96,464 | | | $ | 22,438 | | | $ | 10 | | | $ | 118,912 | |
| Net unrealized losses | | | (4,447 | ) | | | (5,068 | ) | | | (10 | ) | | | (9,525 | ) |
| Purchases and other adjustments to cost | | | 1,825 | | | | – | | | | – | | | | 1,825 | |
| Sales and redemptions | | | (14,513 | ) | | | (672 | ) | | | – | | | | (15,185 | ) |
| Net realized loss from investments | | | (6,654 | ) | | | – | | | | – | | | | (6,654 | ) |
| Balance as of February 28, 2010 | | $ | 72,675 | | | $ | 16,698 | | | $ | – | | | $ | 89,373 | |
Purchases and other adjustments to cost include purchases of new investments at cost, effects of refinancing/restructuring, accretion/amortization of income from discount/premium on debt securities, and PIK.
Sale and redemptions represent net proceeds received from investments sold during the year.
Net transfers in and/or out represent existing investments that were either previously categorized as another level and the inputs to the model became unobservable or investments that were previously classified as the lowest significant input became observable during the period. These investments transfers are recorded at their end of period fair values.
The composition of our investments as of February 28, 2010, at amortized cost and fair value were as follows (dollars in thousands):
| | | Investments at Amortized Cost | | | Investments at Fair Value | | | Fair Value Percentage of Total Portfolio | |
| First lien term loans | | $ | 18,936 | | | $ | 16,653 | | | | 18.6 | % |
| Second lien term loans | | | 41,264 | | | | 20,267 | | | | 22.7 | |
| Senior secured notes | | | 33,416 | | | | 27,742 | | | | 31.0 | |
| Unsecured notes | | | 20,306 | | | | 5,690 | | | | 6.4 | |
| Structured Finance Securities | | | 29,233 | | | | 16,698 | | | | 18.7 | |
| Common stock/equities | | | 3,756 | | | | 2,323 | | | | 2.6 | |
| Limited partnership interest | | | – | | | | – | | | | – | |
| Total | | $ | 146,911 | | | $ | 89,373 | | | | 100.0 | % |
The composition of our investments as of February 28, 2009, at amortized cost and fair value were as follows (dollars in thousands):
| | | Investments at Amortized Cost | | | Investments at Fair Value | | | Fair Value Percentage of Total Portfolio | |
| First lien term loans | | $ | 24,901 | | | $ | 17,117 | | | | 14.4 | % |
| Second lien term loans | | | 57,558 | | | | 41,043 | | | | 34.5 | |
| Senior secured notes | | | 35,780 | | | | 25,832 | | | | 21.7 | |
| Unsecured notes | | | 18,782 | | | | 12,381 | | | | 10.4 | |
| Structured Finance Securities | | | 29,905 | | | | 22,341 | | | | 18.8 | |
| Common stock/equities | | | – | | | | – | | | | – | |
| Limited partnership interest | | | – | | | | 198 | | | | 0.2 | |
| Total | | $ | 166,926 | | | $ | 118,912 | | | | 100.0 | % |
Note 5. Investment in GSC Investment Corp. CLO 2007, Ltd.
On January 22, 2008, we invested $30 million in all of the outstanding subordinated notes of GSC Investment Corp. CLO 2007, Ltd., a $400 million CLO managed by us that invests primarily in senior secured loans. Additionally, we entered into a collateral management agreement with GSCIC CLO pursuant to which we will act as collateral manager to it. In return for our collateral management services, we are entitled to a senior collateral management fee of 0.10% and a subordinate collateral management fee of 0.40% of the outstanding principal amount of GSCIC CLO’s assets, to be paid quarterly to the extent of available proceeds. We are also entitled to an incentive management fee equal to 20% of excess cash flow to the extent the GSCIC CLO subordinated notes receive an internal rate of return equal to or greater than 12%. For the years ended February 28, 2010 and 2009 and February 29, 2008 we accrued $2.1, $2.0 and $0.6 million in management fee income, respectively and $2.4, $4.4 and $0.3 million in interest income, respectively, from GSCIC CLO. We did not accrue any amounts related to the incentive management fee as the 12% hurdle rate has not yet been achieved.
Note 6. Income Taxes
The Company intends to operate so as to qualify to be taxed as a RIC under Subchapter M of the Code and, as such, will not be subject to federal income tax on the portion of taxable income and gains distributed to stockholders.
The Company owns 100% of GSCIC CLO, an Exempted Company incorporated in the Cayman Islands. For financial reporting purposes, the GSCIC CLO is not included as part of the consolidated financial statements. For federal income tax purposes, the Company has requested and received approval from the Internal Revenue Service to treat the GSCIC CLO as a disregarded entity. As such, for federal income tax purposes and for purposes of meeting the RIC qualification and diversification tests, the results of operations of the GSCIC CLO are included with those of the Company.
To qualify as a RIC, the Company is required to meet certain income and asset diversification tests in addition to distributing at least 90% of its investment company taxable income, as defined by the Code. Because federal income tax regulations differ from GAAP, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Differences may be permanent or temporary in nature. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes. As of February 28, 2010 and 2009, the Company reclassified for book purposes amounts arising from permanent book/tax differences primarily related to nondeductible excise tax, meals & entertainment, market discount, interest income with respect to the GSCIC CLO which is consolidated for tax purposes, and the tax character of distributions as follows (dollars in thousands):
| | | February 28, 2010 | | | February 28, 2009 | |
Accumulated net investment income/(loss) | | $ | 449 | | | $ | 381 | |
| Accumulated net realized gains (losses) on investments | | 1,213 | | | (1,106 | ) |
| Additional paid-in-capital | | (1,662 | ) | | 725 | |
For income tax purposes, distributions paid to shareholders are reported as ordinary income, return of capital, long term capital gains or a combination thereof. The tax character of distributions paid for the years ended December 31, 2009 was as follows (dollars in thousands):
| | | December 31, 2009 | | | December 31, 2008 | |
| Ordinary Income | | $ | 15,132 | | | $ | 8,540 | |
| Capital gains | | | - | | | | - | |
Return of capital | | | - | | | | - | |
| Total | | $ | 15,132 | | | $ | 8,540 | |
For federal income tax purposes, as of February 28, 2010, the aggregate gross unrealized appreciation for all securities in which there is an excess of value over tax cost is $17.3 million and the aggregate gross unrealized depreciation for all securities in which there is an excess of tax cost over value is $78.8 million. The aggregate cost of securities for federal income tax purposes is $481.3 million.
At February 28, 2010 and 2009, the components of accumulated losses on a tax basis as detailed below differ from the amounts reflected per the Company’s consolidated statements of assets and liabilities by temporary book/tax differences primarily arising from the consolidation of the GSCIC CLO for tax purposes, market discount and original issue discount income, interest income accrual on defaulted bonds, write-off of investments, and amortization of organizational expenditures (dollars in thousands).
| | | February 28, 2010 | | | February 28, 2009 | |
| Post October loss deferred | | $ | (4,560 | ) | | $ | - | |
Accumulated capital losses | | | (17,306 | ) | | | (3,195 | ) |
| Other temporary differences | | (2,208 | ) | | (119 | ) |
| Undistributed ordinary income | | 3,950 | | | 6,312 | |
| Unrealized depreciation | | (61,539 | ) | | (146,540 | ) |
| Components of accumulated losses | | $ | (81,663 | ) | | $ | (143,542 | ) |
Post-October losses represent losses realized on investments from November 1, 2009 to February 28, 2010, in accordance with federal income tax regulations, the Company has elected to defer and treat as having arisen in the following fiscal year.
The Company has incurred capital losses of $14.1 and $3.2 million for the years ended February 28, 2010 and 2009. Such capital losses will be available to offset future capital gains if any and if unused, will expire on February 28, 2018 and 2017.
Management has analyzed the Company’s tax positions taken on federal income tax returns for all open years (fiscal years 2008-2010), and has concluded that no provision for uncertain income tax positions is required in the Company’s financial statements.
Note 7. Agreements
On March 21, 2007, the Company entered into an investment advisory and management agreement (the “Management Agreement”) with GSC Group, our investment advisor. The initial term of the Management Agreement is two years, with automatic, one-year renewals at the end of each year subject to certain approvals by our board of directors and/or our stockholders. Pursuant to the Management Agreement, our investment adviser implements our business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our board of directors. Our investment adviser is responsible for, among other duties, determining investment criteria, sourcing, analyzing and executing investments transactions, asset sales, financings and performing asset management duties. Under the Management Agreement, we have agreed to pay our investment adviser a management fee for investment advisory and management services consisting of a base management fee and an incentive fee.
The base management fee of 1.75% is calculated based on the average value of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds) at the end of the two most recently completed fiscal quarters, and appropriately adjusted for any share issuances or repurchases during the applicable fiscal quarter.
The incentive fee consists of the following two parts:
The first, payable quarterly in arrears, equals 20% of our pre-incentive fee net investment income (not including excise taxes), expressed as a rate of return on the value of the net assets at the end of the immediately preceding quarter, that exceeds a 1.875% quarterly (7.5% annualized) hurdle rate measured as of the end of each fiscal quarter. Under this provision, in any fiscal quarter, our investment adviser receives no incentive fee unless our pre-incentive fee net investment income, as defined above, exceeds the hurdle rate of 1.875%. Amounts received as a return of capital are not included in calculating this portion of the incentive fee. Since the hurdle rate is based on net assets, a return of less than the hurdle rate on total assets may still result in an incentive fee.
The second, payable at the end of each fiscal year equals 20% of our net realized capital gains, if any, computed net of all realized capital losses and unrealized capital depreciation, in each case on a cumulative basis, less the aggregate amount of such incentive fees paid to the investment adviser through such date.
We will defer cash payment of any incentive fee otherwise earned by our investment adviser if, during the most recent four full fiscal quarter period ending on or prior to the date such payment is to be made, the sum of (a) our aggregate distributions to our stockholders and (b) our change in net assets (defined as total assets less liabilities) (before taking into account any incentive fees payable during that period) is less than 7.5% of our net assets at the beginning of such period. These calculations will be appropriately pro rated for the first three fiscal quarters of operation and adjusted for any share issuances or repurchases during the applicable period. Such incentive fee will become payable on the next date on which such test has been satisfied for the most recent four full fiscal quarters or upon certain terminations of the investment advisory and management agreement.
For the years ended February 28, 2010 and 2009 and February 29, 2008 we incurred $2.0, $2.7 and $2.9 million in base management fees and $0.3, $1.8 and $0.7 million in incentive fees related to pre-incentive fee net investment income, respectively. For the years ended February 28, 2010 and 2009 and February 29, 2008, we incurred no incentive management fees related to net realized capital gains. As of February 28, 2010 and 2009, $0.5 million and $0.6 million of base management fees and $2.6 million and $2.3 million of incentive fees, respectively, were unpaid and included in management and incentive fees payable in the accompanying consolidated statement of assets and liabilities.
As of February 28, 2010, the end of the fourth quarter of fiscal year 2010, the sum of our aggregate distributions to our stockholders and our change in net assets (defined as total assets less liabilities) (before taking into account any incentive fees payable during that period) was less than 7.5% of our net assets at the beginning of the first fiscal quarter of fiscal year 2010. Accordingly, the payment of the incentive fee for the quarter ended February 28, 2010 has been deferred along with all previously deferred incentive fees. The total deferred incentive fee payable at February 28, 2010 and 2009 were $2.6 million and $2.3 million, respectively.
On March 21, 2007, the Company entered into a separate administration agreement (the “Administration Agreement”) with GSC Group, pursuant to which GSC Group, as our administrator, has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations and provide managerial assistance on our behalf to those portfolio companies to which we are required to provide such assistance. Our allocable portion is based on the proportion that our total assets bears to the total assets or a subset of total assets administered by our administrator.
For the years ended February 28, 2010 and 2009 and February 29, 2008 we expensed $0.7, $1.0 and $0.9 million of administrator expenses, respectively, pertaining to bookkeeping, record keeping and other administrative services provided to the Company in addition to our allocable portion of rent and other overhead related expenses. GSC Group has agreed not to be reimbursed by the Company for any expenses incurred in performing its obligations under the Administration Agreement until the Company’s total assets exceeds $500 million. Additionally, the Company’s requirement to reimburse GSC Group is capped such that the amounts payable, together with the Company’s other operating expenses, will not exceed an amount equal to 1.5% per annum of the Company’s net assets attributable to the Company’s common stock. Accordingly, for the years ended February 28, 2010 and 2009 and February 29, 2008, we have recorded $0.7, $1.0 and $1.8 million in expense waiver and reimbursement, respectively, under the Administration Agreement in the accompanying consolidated statement of operations.
On March 23, 2007, the Manager provided the Company with a Notification of Fee Reimbursement (the “Expense Reimbursement Agreement”). The Expense Reimbursement Agreement provides for the Manager to reimburse the Company for operating expenses to the extent that our total annual operating expenses (other than investment advisory and management fees, interest and credit facility expenses, and organizational expense) exceed an amount equal to 1.55% of our net assets attributable to common stock. The Manager is not entitled to recover any reimbursements under this agreement in future periods. The term of the Expense Reimbursement Agreement is for a period of 12 months beginning March 23, 2007 and for each twelve months period thereafter unless otherwise agreed by the Manager and the Company. On April 15, 2008, the Manager and the Company agreed not to extend the agreement for an additional twelve month period and terminated the Expense Reimbursement Agreement as of March 23, 2008. For the years ended February 28, 2009 and February 29, 2008, we recorded $49,715 and $0.9 million in expense waiver and reimbursement, respectively under the Expense Reimbursement Agreement in the accompanying consolidated statement of operations.
Note 8. Borrowings
As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.
On April 11, 2007, we formed GSC Investment Funding LLC (“GSC Funding”), a wholly owned consolidated subsidiary of the Company, through which we entered into a revolving securitized credit facility (the “Revolving Facility”) with Deutsche Bank AG, as administrative agent, under which we may borrow up to $100 million. A significant percentage of our total assets have been pledged under the Revolving Facility to secure our obligations thereunder. Under the Revolving Facility, funds are borrowed from or through certain lenders at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus 0.70% payable monthly. As of February 28, 2010 and 2009, there was $37.0 million and $59.0 million outstanding under the Revolving Facility, respectively. For the years ended February 28, 2010 and 2009 and February 29, 2008, we recorded $3.5, $2.4 and $4.0 million of interest expense and $0.6, $0.2 and $0.2 million of amortization of deferred financing costs related to the Revolving Facility, respectively. For the years ended February 28, 2010 and 2009 and February 29, 2008 the interest rates on the outstanding borrowings ranged from 1.37% to 9.25%, 1.50% to 5.22% and 4.45% to 6.62%, respectively.
On May 1, 2007, we formed GSC Investment Funding II LLC (“GSC Funding II”), a wholly owned consolidated subsidiary of the Company, through which we entered into a $25.7 million term securitized credit facility (the “Term Facility” and, together with the Revolving Facility, the “Facilities”) with Deutsche Bank AG, as administrative agent, which was fully drawn at closing. A significant percentage of our total assets were pledged under the Term Facility to secure our obligations thereunder. The Term Facility bears interest at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus 0.70%, payable quarterly. For the year ended February 29, 2008, we recorded $0.6 million of interest expense and $0.3 of amortization of deferred financing costs related to the Term Facility.
Each of the Facilities contain limitations as to how borrowed funds may be used, such as restrictions on industry concentrations, asset size, payment frequency and status, average life, collateral interests and investment ratings. The Facilities also include certain requirements relating to portfolio performance the violation of which could result in the early amortization of the Facilities, limit further advances (in the case of the Revolving Facility) and, in some cases, result in an event of default, allowing the lenders to accelerate repayment of amounts owed thereunder.
On December 12, 2007, the Company consolidated its Facilities by using the proceeds of a draw under the Revolving Facility to repay and terminate the Term Facility and transferring all assets in GSC Funding II to GSC Funding. The Company’s aggregate indebtedness and cost of funding were unchanged as a result of this consolidation.
In March 2009 we amended the Revolving Credit Facility to increase the portion of the portfolio that can be invested in "CCC" rated investments in return for an increased interest rate and expedited amortization. As a result of these transactions, we expected to have additional cushion under our Borrowing Base (as defined below) that would allow us to better manage our capital in times of declining asset prices and market dislocation. If we are not able to obtain new sources of financing, however, we expect our portfolio will gradually de-lever as principal payments are received, which may negatively impact our net investment income and ability to pay dividends.
At February 28, 2010 and 2009 we had $37.0 million and $59.0 million in borrowings under the Revolving Facility, respectively. The actual amount that may be outstanding at any given time (the “Borrowing Base”) is dependent upon the amount and quality of the collateral securing the Revolving Facility. Our Borrowing Base was $1.7 million at February 28, 2010 versus $59.9 million at February 28, 2009. The decline in our Borrowing Base in fiscal year 2010 is mainly attributable to the decline in the value of the pledged collateral and the downgrade of certain public ratings or private credit estimates of the pledged collateral.
For purposes of determining the Borrowing Base, most assets are assigned the values set forth in our most recent quarterly report filed with the SEC. Accordingly, the February 28, 2010 Borrowing Base relies upon the valuations set forth in the quarterly report for the quarter ended November 30, 2009. The valuations presented in this annual report will not be incorporated into the Borrowing Base until after this report is filed with the SEC.
On July 30, 2009 we exceeded the permissible borrowing limit for 30 consecutive days, resulting in an event of default under our Revolving Facility that is continuing. As a result of this event of default, our lender has the right to accelerate repayment of the outstanding indebtedness under and Revolving Facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral would have a material adverse effect on our liquidity, financial condition and operations. As a result of the continuing default, the Company may be forced to sell its investments to raise funds to repay outstanding amounts. Such forced sales may result in values that could be less than carrying values reported in these financial statements. The deleveraging of the Company may significantly impair the Company’s ability to effectively operate. Please see Part I, Item 1A. “Risk Factors—An event of default under the Revolving Facility may lead to a forced liquidation of the pledged assets that may yield less than the fair value of the assets” for more information. Our lender has elected not to accelerate the obligation to date, but has reserved the right to do so.
During the continuance of an event of default, the interest rate on the Revolving Facility is increased from the commercial paper rate plus 4.00% to the greater of the commercial paper rate and our lender’s prime rate plus 4.00% plus a default rate of 2.00% or, if the commercial paper market is unavailable, the greater of the prevailing LIBOR rates and our lender’s prime rate plus 6.00% plus a default rate of 3.00%.
Note 9. Interest Rate Cap Agreements
In April and May 2007, pursuant to the requirements of the Facilities, GSC Funding and GSC Funding II entered into interest rate cap agreements with Deutsche Bank AG with notional amounts of $34 million and $60.9 million at costs of $75,000, and $44,000, respectively. In May 2007 GSC Funding increased the notional under its agreement from $34 million to $40 million for an additional cost of $12,000. The agreements expire in February 2014 and November 2013 respectively. These interest rate caps are treated as free-standing derivatives under ASC 815 and are presented at their fair value on the consolidated statement of assets and liabilities in their fair value are included on the consolidated statement of operations.
The agreements provide for a payment to the Company in the event LIBOR exceeds 8%, mitigating our exposure to increases in LIBOR. With respect to calculating the payments under these agreements, the notional amount is determined based on a pre-determined schedule set forth in the respective agreements which provides for a reduction in the notional at specified dates until the maturity of the agreements. As of February 28, 2010 we did not receive any such payments as the LIBOR has not exceeded 8%. At February 28, 2010, the total notional outstanding for the interest rate caps was $65.6 million with an aggregate fair value of $0.04 million, which is recorded in outstanding interest cap at fair value on the Company’s consolidated statement of assets and liabilities. For the years ended February, 28, 2010 and 2009, and February 29, 2008, the Company recorded $2,634 of unrealized appreciation, $37,221 of unrealized depreciation and $54,226 of unrealized depreciation, respectively, on derivatives in the consolidated statement of operations related to the change in the fair value of the interest rate cap agreements.
The table below summarizes our interest rate cap agreements as of February 28, 2010 (dollars in thousands):
| Instrument | | Type | | Notional | | | Interest Rate | | Maturity | | Fair Value | |
| Interest Rate Cap | | Free Standing Derivative | | $ | 39,184 | | | | 8.0 | % | Feb 2014 | | $ | 30 | |
| Interest Rate Cap | | Free Standing Derivative | | | 26,433 | | | | 8.0 | | Nov 2013 | | | 12 | |
| | | Net fair value | | | | | | | | | | | $ | 42 | |
The table below summarizes our interest rate cap agreements as of February 28, 2009 (dollars in thousands):
| Instrument | | Type | | Notional | | | Interest Rate | | Maturity | | Fair Value | |
| Interest Rate Cap | | Free Standing Derivative | | $ | 40,000 | | | | 8.0 | % | Feb 2014 | | $ | 28 | |
| Interest Rate Cap | | Free Standing Derivative | | | 26,433 | | | | 8.0 | | Nov 2013 | | | 12 | |
| | | Net fair value | | | | | | | | | | | $ | 40 | |
Note 10. Directors Fees
The independent directors receive an annual fee of $40,000. They also receive $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board meeting and receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting. In addition, the chairman of the Audit Committee receives an annual fee of $5,000 and the chairman of each other committee receives an annual fee of $2,000 for their additional services in these capacities. In addition, we have purchased directors’ and officers’ liability insurance on behalf of our directors and officers. Independent directors have the option to receive their directors’ fees in the form of our common stock issued at a price per share equal to the greater of net asset value or the market price at the time of payment. No compensation is paid to directors who are “interested persons.” For the years ended February 28, 2010 and 2009 and February 29, 2008 we accrued $0.3, $0.3 and $0.3 million for directors fees expense, respectively and $25,432, $18,017 and $13,226 for reimbursement of out-of-pocket expenses, respectively. As of February 28, 2010 and 2009, $54,000 and $5,250 in directors fees expense were unpaid and included in accounts payable and accrued expenses in the consolidated statements of assets and liabilities. As of February 28, 2010, we had not issued any common stock to our directors as compensation for their services.
Note 11. Stockholders’ Equity
On May 16, 2006, GSC Group capitalized the LLC, by contributing $1,000 in exchange for 67 shares, constituting all of the issued and outstanding shares of the LLC.
On March 20, 2007, the Company issued 959,955 and 81,362 shares of common stock, priced at $15.00 per share, to GSC Group and certain individual employees of GSC Group, respectively, in exchange for the general partnership interest and a limited partnership interest in GSC Partners CDO III GP, LP, collectively valued at $15.6 million. At this time, the 67 shares owned by GSC Group in the LLC were exchanged for 67 shares of GSC Investment Corp.
On March 28, 2007, the Company completed its IPO of 7,250,000 shares of common stock, priced at $15.00 per share, before underwriting discounts and commissions. Total proceeds received from the IPO, net of $7.1 million in underwriter’s discount and commissions, and $1.0 million in offering costs, were $100.7 million.
On November 13, 2009, we declared a dividend of $1.825 per share payable on December 31, 2009. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.1 million or $0.25 per share. Based on shareholder elections, the dividend consisted of $2.1 million in cash and 8,648,725 of newly issued shares of common stock.
Note 12. Earnings Per Share
In accordance with the provisions of FASB ASC 260, “Earnings per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.
On November 13, 2009, we declared a dividend of $1.825 per share payable on December 31, 2009. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.1 million or $0.25 per share.
Based on shareholder elections, the dividend consisted of $2.1 million in cash and 8,648,725 shares of common stock, or 104% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 13.7% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $1.5099 per share, which equaled the volume weighted average trading price per share of the common stock on December 24 and 28, 2009. The financial statements for the period ended November 30, 2009 were retroactively adjusted to reflect the increase in common stock as a result of the dividend in accordance with the provisions of ASC 505-20-550 regarding disclosure of a capital structure change after the interim balance sheet but before the release of the financial statements.
The following information sets forth the computation of the weighted average basic and diluted net decrease in net assets per share from operations for the years ended February 28, 2010 and 2009 and February 29, 2008 (dollars in thousands except per share amounts):
| Basic and diluted | | February 28, 2010 | | | February 28, 2009 | | | February 29, 2008 | |
| Net decrease in net assets from operations | | $ | (10,463 | ) | | $ | (21,315 | ) | | $ | (5,451 | ) |
| Weighted average common shares outstanding | | | 10,613,507 | | | | 8,291,384 | | | | 7,761,965 | |
| Loss per common share-basic and diluted | | $ | (0.99 | ) | | $ | (2.57 | ) | | $ | (0.70 | ) |
Note 13. Dividend
The following table summarizes dividends declared during the years ended February 28, 2010 and 2009 and February 29, 2008 (dollars in thousands except per share amounts):
| Date Declared | | Record Date | | Payment Date | | Amount Per Share * | | | Total Amount | |
| November 13, 2009 | | November 25, 2009 | | December 31, 2009 | | $ | 1.825 | | | $ | 15,132 | |
| | | | | | | | | | | | | |
| Total dividends declared | | | | | | $ | 1.825 | | | $ | 15,132 | |
| Date Declared | | Record Date | | Payment Date | | Amount Per Share * | | | Total Amount | |
| May 22, 2008 | | May 30, 2008 | | June 13, 2008 | | $ | 0.39 | | | $ | 3,234 | |
| August 19, 2008 | | August 29, 2008 | | September 15, 2008 | | | 0.39 | | | | 3,234 | |
| December 8, 2008 | | December 18, 2008 | | December 29, 2008 | | | 0.25 | | | | 2,072 | |
| | | | | | | | | | | | | |
| Total dividends declared | | | | | | $ | 1.03 | | | $ | 8,540 | |
| Date Declared | | Record Date | | Payment Date | | Amount Per Share * | | | Total Amount | |
| May 21, 2007 | | May 29, 2007 | | June 6, 2007 | | $ | 0.24 | | | $ | 1,990 | |
| August 14, 2007 | | August 24, 2007 | | August 31, 2007 | | | 0.36 | | | | 2,985 | |
| November 15, 2007 | | November 30, 2007 | | December 3, 2007 | | | 0.38 | | | | 3,151 | |
| December 28, 2007 | | January 18, 2008 | | January 28, 2008 | | | 0.18 | | | | 1,492 | |
| February 20, 2008 | | February 29, 2008 | | March 10, 2008 | | | 0.39 | | | | 3,234 | |
| | | | | | | | | | | | | |
| Total dividends declared | | | | | | $ | 1.55 | | | $ | 12,852 | |
* Amount per share is calculated based on the number of shares outstanding at the date of declaration.
Note 14. Financial Highlights
The following is a schedule of financial highlights for the years ended February 28, 2010 and 2009 and February 29, 2008:
| Per share data: | | February 28, 2010 | | | February 28, 2009 | | | February 29, 2008 | |
| | | | | | | | | | |
| Public offering cost at IPO, March 23, 2007 | | $ | - | | | $ | - | | | $ | 15.00 | |
| Sales load | | | - | | | | - | | | | (0.85 | ) |
| Offering cost | | | - | | | | - | | | | (0.12 | ) |
| Net asset value at beginning of period/IPO | | | 8.20 | | | | 11.80 | | | | 14.03 | |
| | | | | | | | | | | | | |
| Net investment income (1) | | | 0.54 | | | | 1.67 | | | | 1.30 | |
| Net realized gains (losses) on investments and derivatives | | | (0.63 | ) | | | (0.86 | ) | | | 0.47 | |
| Net unrealized depreciation on investments and derivatives | | | (0.90 | ) | | | (3.38 | ) | | | (2.45 | )* |
| Net decrease in stockholders’ equity | | | (0.99 | ) | | | (2.57 | ) | | | (0.68 | ) |
| | | | | | | | | | | | | |
| Distributions declared from net investment income | | | (1.83 | ) | | | (1.03 | ) | | | (1.37 | ) |
| Distributions declared from net realized capital gains | | | - | | | | - | | | | (0.18 | ) |
Other (5) | | | (2.11 | ) | | | - | | | | - | |
| Total distributions to stockholders | | | (3.94 | ) | | | (1.03 | ) | | | (1.55 | ) |
| | | | | | | | | | | | | |
| Net asset value at end of period | | $ | 3.27 | | | $ | 8.20 | | | $ | 11.80 | |
| Net assets at end of period | | $ | 55,478,152 | | | $ | 68,013,777 | | | $ | 97,869,040 | |
| Shares outstanding at end of period | | | 16,940,109 | | | | 8,291,384 | | | | 8,291,384 | |
| | | | | | | | | | | | | |
| Per share market value at end of period | | $ | 1.92 | | | $ | 1.99 | | | $ | 11.04 | |
Total return based on market value (2) | | | 113.10 | % | | | (70.33 | )% | | | 0.45 | % |
Total return based on net asset value (3) | | | (11.92 | )% | | | 14.40 | % | | | 10.96 | % |
* Net unrealized depreciation on investments and derivatives per share amount includes the net loss incurred prior to the IPO.
| Ratio/Supplemental data: | | | | | | | | | |
| Ratio of net investment income net of expense waiver and reimbursement to average net assets (4) | | | 9.12 | % | | | 16.21 | % | | | 9.63 | % |
| Ratio of operating expenses net of expense waiver and reimbursement to average net assets (4) | | | 8.71 | % | | | 5.94 | % | | | 4.31 | % |
| Ratio of incentive management fees to average net assets | | | 0.52 | % | | | 2.05 | % | | | 0.64 | % |
| Ratio of credit facility related expenses to average net assets | | | 6.54 | % | | | 3.05 | % | | | 4.51 | % |
| Ratio of total expenses net of expense waiver and reimbursement to average net assets (4) | | | 15.77 | % | | | 11.04 | % | | | 9.45 | % |
| (1) | Net investment income excluding expense waiver and reimbursement equals $0.48, $1.55 and $1.08 per share for the years ended February 28, 2010 and 2009 and February 29, 2008, respectively. |
| (2) | Total annual return historical and resumes changes in share price, reinvestments of all dividends and distributions, and no sales change for the year. |
| (3) | Total annual return is historical and assumes changes in net assets value, reinvestments of all dividends and distributions, and no sales change for the year. |
| (4) | For the year ended February 28, 2010, excluding the expense waiver and reimbursement arrangement, the ratio of net investment income, operating expenses, total expenses to average net assets is 8.10%, 9.78% and 16.84%, respectively. For the year ended February 28, 2009, excluding the expense waiver and reimbursement arrangement, the ratio of net investment income, operating expenses, total expenses to average net assets is 15.19%, 7.12% and 12.23%, respectively. For the year ended February 29, 2008, excluding the expense waiver and reimbursement arrangement, the ratio of net investment income, operating expenses, total expenses to average net assets is 8.11%, 5.91% and 11.05%, respectively. |
| (5) | Represents the impact of the different share amounts used in calculating per share data as a result of calculating certain per share data based upon the weighted average basic shares outstanding during the period and certain per share data based on the shares outstanding as of period end. |
Note 15. Related Party Transaction
On March 20, 2007, the Company issued 959,955 and 81,362 shares of common stock, priced at $15.00 per share, to GSC Group and certain individual employees of GSC Group, respectively, in exchange for the general partnership interest and a limited partnership interest in GSC Partners CDO III GP, LP, collectively valued at $15.6 million. Additionally, GSC Group assigned its rights to act as collateral manager for GSC Partners CDO Fund III, Limited (“CDO III”) to the Company. The Company paid GSC Group $0.1 million to acquire the rights to act as collateral manager and expected to receive collateral management fees of $0.2 million. For the year ended February 29, 2008 we received $0.4 million of management fee income from CDO III and received distributions of $16.1 million from our partnership interests resulting in a realized gain of $0.5 million. As of February 28, 2010, the fair value of the general partnership interest and limited partnership interest was zero.
On January 10, 2008, GSC Group notified our Dividend Reinvestment Plan Administrator that it was electing to receive dividends and other distributions in cash (rather than in additional shares of common stock) with respect to all shares of stock held by it and the investment funds under its control. For the year ended February 29, 2008, GSC Group received 35,911 of additional shares under the dividend reinvestment plan. As of February 28, 2010, GSC Group and its affiliates own approximately 11.4% of the outstanding common shares of the Company.
On January 22, 2008, we entered into a collateral management agreement with GSCIC CLO pursuant to which we will act as collateral manager to it. In return for our collateral management services, we are entitled to a senior collateral management fee of 0.10% and a subordinate collateral management fee of 0.40% of the outstanding principal amount of GSCIC CLO’s assets, to be paid quarterly to the extent of available proceeds. We are also entitled to an incentive management fee equal to 20% of excess cash flow to the extent the GSCIC CLO subordinated notes receive an internal rate of return equal to or greater than 12%. We do not expect to enter into additional collateral management agreements in the near future.
In April 2009, our investment adviser withheld a scheduled principal amortization payment under its credit facility, resulting in a default thereunder. Since then, our investment adviser and its secured lenders have been in negotiations regarding a consensual restructuring of its obligations under such credit facility. While we are not directly affected by our investment adviser’s default, if it is unable to restructure its credit facility, or an acceleration of the outstanding principal balance by the lenders occurs, the ability of the investment adviser to retain key individuals and perform its investment advisory duties for us could be significantly impaired.
Note 16. Selected Quarterly Data (Unaudited)
| | | 2010 | |
| ($ in thousands, except per share numbers) | | Qtr 4 | | | Qtr 3 | | | Qtr 2 | | | Qtr 1 | |
| Interest and related portfolio income | | $ | 3,637 | | | $ | 3,530 | | | $ | 3,685 | | | $ | 4,764 | |
| Net investment income | | | 1,201 | | | | 869 | | | | 1,080 | | | | 2,564 | |
| Net realized and unrealized gain (loss) | | | (10,067 | ) | | | 8,258 | | | | (17,168 | ) | | | 2,800 | |
| Net increase (decrease) in net assets resulting from operations | | | (8,866 | ) | | | 9,128 | | | | (16,088 | ) | | | 5,364 | |
| Net investment income per common share at end of each quarter | | $ | 0.07 | | | $ | 0.10 | | | $ | 0.13 | | | $ | 0.31 | |
| Net realized and unrealized gain (loss) per common share at end of each quarter | | $ | (0.59 | ) | | $ | 0.91 | | | $ | (2.07 | ) | | $ | 0.34 | |
| Dividends declared per common share | | $ | – | | | $ | 1.825 | | | $ | – | | | $ | – | |
| Net asset value per common share | | $ | 3.27 | | | $ | 3.80 | | | $ | 6.91 | | | $ | 8.85 | |
| | | 2009 | |
| ($ in thousands, except per share numbers) | | Qtr 4 | | | Qtr 3 | | | Qtr 2 | | | Qtr 1 | |
| Interest and related portfolio income | | $ | 5,476 | | | $ | 6,361 | | | $ | 5,835 | | | $ | 5,715 | |
| Net investment income | | | 3,289 | | | | 3,887 | | | | 3,455 | | | | 3,195 | |
| Net realized and unrealized loss | | | (17,296 | ) | | | (11,438 | ) | | | (6,023 | ) | | | (384 | ) |
| Net increase (decrease) in net assets resulting from operations | | | (14,008 | ) | | | (7,551 | ) | | | (2,567 | ) | | | 2,811 | |
| Net investment income per common share at end of each quarter | | $ | 0.40 | | | $ | 0.47 | | | $ | 0.42 | | | $ | 0.39 | |
| Net realized and unrealized loss per common share at end of each quarter | | $ | (2.09 | ) | | $ | (1.38 | ) | | $ | (0.73 | ) | | $ | (0.05 | ) |
| Dividends declared per common share | | $ | – | | | $ | 0.25 | | | $ | 0.39 | | | $ | 0.39 | |
| Net asset value per common share | | $ | 8.20 | | | $ | 10.14 | | | $ | 11.05 | | | $ | 11.75 | |
| | | 2008 | |
| ($ in thousands, except per share numbers) | | Qtr 4 | | | Qtr 3 | | | Qtr 2 | | | Qtr 1 | |
| Interest and related portfolio income | | $ | 5,520 | | | $ | 5,882 | | | $ | 5,882 | | | $ | 4,102 | |
| Net investment income | | | 2,562 | | | | 3,070 | | | | 3,157 | | | | 1,958 | |
| Net realized and unrealized gain (loss) | | | (11,972 | ) | | | (2,009 | ) | | | (3,939 | ) | | | 1,722 | |
| Net increase (decrease) in net assets resulting from operations | | | (9,410 | ) | | | 1,061 | | | | (782 | ) | | | 3,680 | |
| Net investment income per common share at end of each quarter | | $ | 0.32 | | | $ | 0.37 | | | $ | 0.38 | | | $ | 0.23 | |
| Net realized and unrealized gain (loss) per common share at end of each quarter | | $ | (1.46 | ) | | $ | (0.24 | ) | | $ | (0.47 | ) | | $ | 0.21 | |
| Dividends declared per common share | | $ | 0.57 | | | $ | 0.38 | | | $ | 0.36 | | | $ | 0.24 | |
| Net asset value per common share | | $ | 11.80 | | | $ | 13.51 | | | $ | 13.76 | | | $ | 14.21 | |
Note 17. Subsequent Events
There have been no subsequent events that occurred during such period that would require disclosure in this Form 10-K or would be required to be recognized in the consolidated financial statements as of and for the years then ended, except as disclosed below.
On March 2, 2010 the Company received a full par redemption of $0.7 million related to Affinity Group, Inc. On March 11, 2010, a portion of the proceeds from this redemption were used to make a repayment of $0.7 million of outstanding borrowings.
On April 9, 2010 the Company received a full par redemption of $1.8 million related to Custom Direct, Inc. On April 13, 2010, the proceeds from this redemption plus a portion of interest collections related to Elyria Foundry Company were used to make a repayment of $1.9 million of outstanding borrowings.
On April 14, 2010 the Company entered into a definitive agreement with Saratoga Investment Advisors, LLC (“Saratoga”) and CLO Partners LLC (“CLO Partners”) and announced a $55 million recapitalization plan to cure the debt default. The recapitalization plan includes Saratoga and CLO Partners purchasing approximately 9.8 million shares of common stock of GSC Investment Corp. for $1.52 per share pursuant to a definitive stock purchase agreement and a commitment from Madison Capital Funding LLC to provide the Company with a $40 million senior secured revolving credit facility. Upon the closing of the transaction, the Company will immediately borrow funds under the new credit facility that, when added to the $15 million equity investment, will be sufficient to repay the full amount of the Company's existing debt and to provide the Company with working capital thereafter. The plan is subject to shareholder approval.
On May 4, 2010 the Company received an interest payment of $0.4 million related to McMillin Companies, LLC. On May 14, 2010, a portion of the proceeds were used to make a repayment of $0.3 million of outstanding borrowings.
On May 13, 2010 the Company filed a Preliminary Proxy Statement on Schedule 14A related to the proposed Saratoga transaction.
