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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 2002.
/_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 814-00237
GLADSTONE CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
MARYLAND 54-2040781
------------------------------ ----------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1616 ANDERSON ROAD, SUITE 208
MCLEAN, VIRGINIA 22102
----------------------------------
(Address of principal executive office)
(703) 286-7000
----------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes /X/ No /_/.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. The number of shares of the
issuer's Common Stock, $0.001 par value, outstanding as of May 1, 2002 was
10,060,178.
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GLADSTONE CAPITAL CORPORATION
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I. FINANCIAL INFORMATION.......................................................3
Item 1. Financial Statements........................................................3
Consolidated Balance Sheets as of March 31, 2002 (unaudited) and
September 30, 2001..........................................................4
Schedule of Investments as of March 31, 2002 (unaudited)....................5
Consolidated Statement of Operations for the three and six months
ended March 31, 2002 (unaudited)............................................6
Consolidated Statements of Stockholders' Equity for the six
months ended March 31, 2002 (unaudited).....................................7
Consolidated Statement of Cash Flows for the six months ended
March 31, 2002 (unaudited)..................................................8
Notes to Financial Statements (unaudited)...................................9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................12
Overview...................................................................12
Results of Operations......................................................14
Liquidity and Capital Resources............................................16
Item 3. Quantitative and Qualitative Disclosure About Market Risk..................17
Item 4. Submission of Matters to a Vote of Security Holders........................17
PART II. OTHER INFORMATION..........................................................18
Item 1. Legal Proceedings..........................................................18
Item 6. Exhibits and Reports on Form 8-K...........................................18
SIGNATURES
</Table>
Page 2
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PART I--FINANCIAL INFORMATION
GLADSTONE CAPITAL CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
CONTENTS
<Table>
Consolidated Balance Sheets..........................................4
Schedule of Investments..............................................5
Consolidated Statements of Operations................................6
Consolidated Statements of Stockholders' Equity......................7
Consolidated Statement of Cash Flows.................................8
Notes to Consolidated Financial Statements...........................9
</Table>
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GLADSTONE CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
ASSETS
(UNAUDITED)
MARCH 31, SEPTEMBER 30,
2002 2001
-------------- --------------
ASSETS
Investments at fair value (Cost 3/31/2002: $42,180,138; 9/30/2001: $0) $ 42,180,138 $ -
Cash and cash equivalents 89,351,798 131,824,080
Interest receivable-- debt securities 413,837 -
Interest receivable 23,659 34,544
Interest receivable-- officers 107,409 45,355
Prepaid assets 96,572 166,250
Other assets 335,615 135,257
-------------- --------------
TOTAL ASSETS $ 132,509,028 $ 132,205,486
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Dividends Payable $ 2,112,637 $ -
Accounts Payable 130,500 -
Accrued offering costs - 590,382
Accrued expenses and deferred liabilities 384,794 365,960
-------------- --------------
Total Liabilities $ 2,627,931 $ 956,342
-------------- --------------
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value, 50,000,000 shares authorized
and 10,060,178 shares issued and outstanding $ 10,060 $ 10,060
Capital in excess of par value 140,080,807 140,131,778
Notes receivable-- officers (8,799,119) (8,800,050)
Net realized loss - (92,644)
Distributions in excess of undistributed net realized earnings (1,410,651) -
-------------- --------------
Total Stockholders' Equity $ 129,881,097 $ 131,249,144
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 132,509,028 $ 132,205,486
============== ==============
</Table>
SEE ACCOMPANYING NOTES.
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GLADSTONE CAPITAL CORPORATION
SCHEDULE OF INVESTMENTS
AS OF MARCH 31, 2002
(UNAUDITED)
<Table>
<Caption>
COMPANY INDUSTRY INVESTMENT COST FAIR VALUE
- ------------------------- ------------------------- ----------------------- ----------- ------------
ARI Holdings, Inc. Manufacturing--auto parts Sr. Subordinated Debt $ 8,047,508 $ 8,047,508
- ------------------------- ------------------------- ----------------------- ----------- ------------
Finn Corporation Manufacturing--landscape Sr. Subordinated Debt 10,500,000 10,500,000
equipment Common Stock Warrants 37,000 37,000
for 2% ownership
- ------------------------- ------------------------- ----------------------- ----------- ------------
Marcal Paper Mills, Inc. Manufacturing--paper Sr. Subordinated Debt 7,500,000 7,500,000
products First Mortgage Facility 9,030,282 9,030,282
- ------------------------- ------------------------- ----------------------- ----------- ------------
Nextira, LLC Service--network-related Term Loan 6,248,613 6,248,613
services Credit Facility(1) 816,735 816,735
- ------------------------- ------------------------- ----------------------- ----------- ------------
Totals $42,180,138 $42,180,138
=========== ============
</Table>
- --------------------------
(1) This is an $8 million credit facility.
SEE ACCOMPANYING NOTES.
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GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS SIX MONTHS
ENDED MARCH 31, ENDED MARCH 31,
2002 2002
---------------- ---------------
OPERATING INCOME
Interest income - debt $ 1,596,970 $ 1,926,627
Interest income - cash and cash equivalents 368,570 1,009,085
Interest income - officer loans 107,409 214,827
Loan and managerial assistance fees 29,102 640,911
Other income 47,500 47,500
---------------- ---------------
Total Operating Income $ 2,149,551 $ 3,838,950
---------------- ---------------
OPERATING EXPENSES
Salaries and benefits $ 327,158 $ 604,342
Rent 36,227 47,280
Professional fees 114,061 215,482
Directors' fees 5,000 7,000
General and administrative 258,623 359,384
---------------- ---------------
Total Operating Expenses $ 741,069 $ 1,233,488
---------------- ---------------
NET OPERATING INCOME(LOSS) $ 1,408,482 $ 2,605,462
================ ===============
NET INCREASE(DECREASE) IN STOCKHOLDERS' EQUITY RESULTING FROM OPERATIONS $ 1,408,482 $ 2,605,462
================ ===============
NET OPERATING INCOME PER COMMON SHARE:
Basic $ 0.14 $ 0.26
Diluted $ 0.14 $ 0.26
WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:
Basic 10,060,178 10,060,178
Diluted 10,160,417 10,153,223
</Table>
SEE ACCOMPANYING NOTES.
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GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<Table>
<Caption>
NOTES (DISTRIBUTIONS
RECEIVABLE IN EXCESS OF)
COMMON STOCK CAPITAL IN FROM SALE OF UNDISTRIBUTED TOTAL
--------------------------- EXCESS OF COMMON NET REALIZED STOCKHOLDERS'
SHARES AMOUNT PAR VALUE STOCK EARNINGS EQUITY
---------- --------- ------------- ------------ ------------- -------------
Balance at September 30, 2001 10,060,178 $ 10,060 $ 140,131,778 $ (8,800,050) $ (92,644) $ 131,249,144
Offering Costs (50,971) (50,971)
Repayment of Principal
on Notes Receivable 931 931
Net Increase in Stockholders'
Equity Resulting from
Operations 2,605,462 2,605,462
Distributions - - - - (3,923,469) (3,923,469)
---------- --------- ------------- ------------ ------------- -------------
Balance at March 31, 2002 10,060,178 $ 10,060 $ 140,080,807 $ (8,799,119) $ (1,410,651) $ 129,881,097
========== ========= ============= ============ ============= =============
</Table>
SEE ACCOMPANYING NOTES.
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GLADSTONE CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS AND CASH EQUIVALENTS
(UNAUDITED)
<Table>
<Caption>
SIX MONTHS ENDED
MARCH 31, 2002
----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in stockholders' equity resulting from operations $ 2,605,462
Adjustments to reconcile net decrease in stockholders' equity
resulting from operations to net cash provided by operating
activities:
Increase in interest receivable (465,006)
Increase in other assets (200,358)
Increase in accrued expenses and deferred liabilities 18,834
Decrease in prepaid assets 69,678
Increase in accounts payable 130,500
Increase in payment in kind interest (96,927)
----------------
Net Cash Provided by Operating Activities $ 2,062,183
----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments $ (42,083,211)
----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Offering costs $ (50,971)
Decrease in accrued offering costs (590,382)
Repayment of principal on notes receivable--officers 931
Distributions paid (1,810,832)
----------------
Net Cash Used in Financing Activities $ (2,451,254)
----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS $ (42,472,282)
----------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 131,824,080
----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 89,351,798
================
</Table>
SEE ACCOMPANYING NOTES.
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GLADSTONE CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 2002
NOTE 1. UNAUDITED INTERIM FINANCIAL STATEMENTS
Interim financial statements of Gladstone Capital Corporation (the
"Company") are prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and pursuant to the
requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain disclosures accompanying annual financial statements
prepared in accordance with GAAP are omitted. In the opinion of management, all
adjustments, consisting solely of normal recurring accruals, necessary for the
fair presentation of financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results that ultimately may be achieved for the year. The interim
financial statements and notes thereto should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K for
the fiscal year ended September 30, 2001, as filed with the Securities and
Exchange Commission.
NOTE 2. ORGANIZATION
The Company was incorporated under the General Corporation Laws of the
State of Maryland on May 30, 2001 as a closed-end investment company. The
Company has elected to be treated as a business development company under the
Investment Company Act of 1940, as amended (the "1940 Act"). In addition, the
Company has elected to be treated for tax purposes as a regulated investment
company, or RIC, under the Internal Revenue Code of 1986, as amended (the
"Code"). The Company's investment objectives are to achieve a high level of
current income by investing in debt and equity securities of established private
businesses.
Gladstone Advisers, Inc., a wholly-owned subsidiary, conducts the daily
administrative operations of the Company.
NOTE 3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share for the six months ended March 31, 2002:
<Table>
Numerator for basic and diluted earnings per share $ 2,605,462
Denominator for basic weighted average shares 10,060,178
Employee stock options 723,330
Dilutive potential shares 93,045
Denominator for diluted weighted average shares 10,153,223
Basic earnings per common share 0.26
Diluted earnings per common share 0.26
</Table>
Page 9
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The following table sets forth the computation of basic and diluted
earnings per share for the three months ended March 31, 2002:
<Table>
Numerator for basic and diluted earnings per share $ 1,408,482
Denominator for basic weighted average shares 10,060,178
Employee stock options 723,330
Dilutive potential shares 100,239
Denominator for diluted weighted average shares 10,160,417
Basic earnings per common share 0.14
Diluted earnings per common share 0.14
</Table>
NOTE 4. NET ASSET VALUE PER SHARE
The Company's net asset value per share was $12.91 and $13.05 at March 31,
2002 and September 30, 2001, respectively.
NOTE 5. DIVIDENDS
The Company is required to pay out as a dividend 90% of its ordinary income
and short-term capital gains for each taxable year in order to maintain its
status as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. It is
the policy of the Company to pay out as a dividend up to 100% of those amounts.
The amount to be paid out as a dividend is determined by the Board of Directors
each quarter and is based on the annual earnings estimated by the management of
the Company. Based on that estimate, a dividend is declared each quarter. At
year-end the Company may pay a bonus dividend, in addition to the quarterly
dividends, to ensure that it has paid out at least 90% of its ordinary income
and short-term capital gains for the year. The Company has a policy of retaining
long-term capital gains and not paying them out as dividends.
On January 15, 2002, the Company paid a dividend of $0.18 per share on its
common stock to its stockholders of record as of December 31, 2001. On April 8,
2002, the Company paid a dividend of $0.21 per share on its common stock to it
stockholders of record as of March 28, 2002.
NOTE 6. INVESTMENT VALUATION
The Company carries its investments at fair value, as determined by the
Board of Directors. Securities that are publicly traded are valued at the
closing price on the valuation date. Debt and equity securities that are not
publicly traded are valued at fair value as determined in good faith by the
Board of Directors. In making such determination, the Board of Directors values
non-convertible debt securities at cost plus amortized original issue discount,
if any, unless adverse factors lead to a determination of a lesser valuation. In
valuing convertible debt, equity or other securities, the Board of Directors
determines the fair value based on the collateral, the issuer's ability to make
payments, the earnings of the issuer, sales to third parties of similar
securities, the comparison to publicly traded securities and other pertinent
factors. Due to the uncertainty inherent in the valuation process, such
estimates of fair value may differ significantly from the values that would have
resulted had a ready market for the securities existed, and the differences
could be material. Additionally, changes in the market environment and other
events that may occur over the life of the investments may cause the gains
ultimately realized on these investments to be different than the valuation
currently assigned.
NOTE 7. LOAN AND MANAGERIAL ASSISTANCE FEES
The 1940 Act requires that a business development company make available
managerial assistance to its portfolio companies. The company provides
managerial assistance to its portfolio companies through its wholly-owned
subsidiary, Gladstone Advisers, Inc. The Company receives fee income for
managerial assistance it renders to portfolio companies in connection with its
investments. Such fees are normally paid at the closing of the Company's
investments and are generally non-recurring. These managerial assistance
services vary by investment, but generally consist of reviewing existing credit
facilities, arranging bank financing, arranging equity financing, structuring
financing from multiple lenders, structuring financing from equity investors,
restructuring existing loans,
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raising equity and debt capital and providing general financial advice. For the
three and six months ended March 31, 2002, these fees totaled $29,102 and
$640,911, respectively.
From time to time, the Company will be invited to participate as a
co-lender in a transaction. Where the Company does not provide significant
managerial assistance services in connection with its investment, loan fees paid
to the Company in such situations will be deferred and amortized over the life
of the loan.
NOTE 8. PAYMENT IN KIND INTEREST
The Company has loans in its portfolio which contain a payment in kind
provision ("PIK"). The PIK interest is added to the principal balance of the
loan and recorded as income. To maintain the Company's status as a RIC, this
non-cash source of income must be paid out to shareholders in the form of
dividends, even though the Company has not yet collected the cash. For the three
and six months ended March 31, 2002, the Company recorded $130,458 of PIK
income.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
ALL STATEMENTS CONTAINED HEREIN, OTHER THAN HISTORICAL FACTS, MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED. THESE STATEMENTS MAY RELATE TO, AMONG OTHER THINGS,
FUTURE EVENTS OR OUR FUTURE PERFORMANCE OR FINANCIAL CONDITION. IN SOME CASES,
YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS "MAY,"
"MIGHT," "BELIEVE," "WILL," "PROVIDED," "ANTICIPATE," "FUTURE," "COULD,"
"GROWTH," "PLAN," "INTEND," "EXPECT," "SHOULD," "WOULD," "IF," "SEEK,"
"POSSIBLE," "POTENTIAL" OR THE NEGATIVE OF SUCH TERMS OR COMPARABLE TERMINOLOGY.
THESE FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES
AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS, LEVELS OF ACTIVITY,
PERFORMANCE OR ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS,
LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, (1) ADVERSE
CHANGES IN INTEREST RATES; (2) OUR FAILURE OR INABILITY TO ESTABLISH OR MAINTAIN
REFERRAL ARRANGEMENTS WITH LEVERAGED BUYOUT FUNDS AND VENTURE CAPITAL FUNDS TO
GENERATE LOAN OPPORTUNITIES; (3) THE LOSS OF ONE OR MORE OF OUR EXECUTIVE
OFFICERS, IN PARTICULAR DAVID GLADSTONE OR TERRY LEE BRUBAKER; (4) OUR INABILITY
TO ESTABLISH OR MAINTAIN A CREDIT FACILITY ON TERMS REASONABLY ACCEPTABLE TO US,
IF AT ALL; (5) OUR INABILITY TO SUCCESSFULLY SECURITIZE OUR LOAN PORTFOLIO ON
TERMS REASONABLY ACCEPTABLE TO US, IF AT ALL; (6) THE DECISION OF OUR
COMPETITORS TO AGGRESSIVELY SEEK TO MAKE SENIOR AND SUBORDINATED LOANS TO SMALL
AND MEDIUM-SIZED BUSINESSES ON TERMS MORE FAVORABLE THAN WE INTEND TO PROVIDE;
AND (7) THOSE FACTORS LISTED UNDER THE CAPTION "RISK FACTORS" OF THE ANNUAL
REPORT ON FORM 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON
DECEMBER 21, 2001. WE CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH
FORWARD-LOOKING STATEMENTS, WHICH ARE MADE PURSUANT TO THE PRIVATE SECURITIES
LITIGATION REFORM ACT ON 1995 AND, AS SUCH, SPEAK ONLY AS OF THE DATE MADE. WE
UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE
AFTER THE DATE OF THIS FORM 10-Q.
THE FOLLOWING ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE NOTES
THERETO CONTAINED ELSEWHERE IN THIS REPORT.
OVERVIEW
We were incorporated under the General Corporation Laws of the State of
Maryland on May 30, 2001. Our investment objectives are to achieve a high level
of current income by investing in debt securities, consisting primarily of
senior notes, senior subordinated notes and junior subordinated notes, of
established private businesses that are backed by leveraged buyout funds,
venture capital funds or others, with a particular emphasis on senior
subordinated notes. In addition, we may acquire existing loans that meet this
profile from leveraged buyout funds, venture capital funds and others. We will
also seek to provide our stockholders with long-term capital growth through the
appreciation in the value of warrants or other equity instruments that we may
receive when we make loans. We operate as a closed-end, non-diversified
management investment company, and have elected to be treated as a business
development company under the Investment Company Act of 1940, as amended (the
"1940 Act").
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We seek out small and medium-sized businesses that meet certain criteria,
including (1) the potential for growth in cash flow, (2) adequate assets for
loan collateral, (3) experienced management teams with significant ownership
interest in the borrower, (4) profitable operations based on the borrower's cash
flow, (5) reasonable capitalization of the borrower (usually by leveraged buyout
funds or venture capital funds) and (6) the potential to realize appreciation
and gain liquidity in our equity position. We anticipate that this liquidity
will be achieved through a merger or acquisition of the borrower, a public
offering by the borrower or by exercise of our right to require the borrower to
buy back its warrants. We lend to borrowers that need funds to finance growth,
restructure their balance sheets or effect a change of control.
Our loans typically range from $5 million to $15 million, mature in no more
than seven years and accrue interest at a fixed rate or an annualized variable
rate that exceeds the prime rate. Most, if not all, of the debt securities we
acquire are unrated by credit rating agencies. To the extent possible, our loans
generally are collateralized by a security interest in the borrower's assets.
Interest payments are generally made monthly or quarterly with amortization of
principal generally being deferred for several years. The principal amount of
the loans and any accrued but unpaid interest generally become due at maturity
at five to seven years. When we receive a warrant to purchase stock in a
borrower in connection with a loan, the warrant will typically have a nominal
exercise price and entitle us to purchase a modest percentage of the borrower's
stock.
In addition, as a business development company under the 1940 Act, we are
required to provide significant managerial assistance to our portfolio
companies. We provide these services, for which we receive fees, through our
wholly-owned subsidiary, Gladstone Advisers, Inc. Such fees are typically only
paid to us at the closing of the investments and are generally non-recurring,
however in some instances they may have a recurring component. The specific
services we provide vary by portfolio company, but generally consist of
reviewing existing credit facilities, arranging bank financing, arranging equity
financing, structuring financing from multiple lenders, structuring financing
from equity investors, restructuring existing loans, raising equity and debt
capital and providing general financial advice. We record these fees as
managerial assistance fee revenue in the period in which the fees are paid.
Prior to making an investment, we ordinarily enter into a non-binding
commitment letter with the potential borrower. These non-binding commitments are
generally subject to a number of conditions, including but not limited to the
satisfactory completion of our due diligence investigations of the potential
borrower's business. Typically, upon execution of this non-binding commitment
letter, the potential borrower pays us a small non-refundable fee (usually no
more than 0.1% of our proposed investment) for our services rendered through the
commitment date. We recognize this fee as revenue upon execution of the
non-binding commitment letter.
In the event that we expend significant effort in considering and
negotiating a potential investment that ultimately is not consummated, we
generally will seek reimbursement from the proposed borrower for our reasonable
expenses incurred in connection with the proposed transaction. Any amounts
collected are recognized as "other income" in the quarter in which such
reimbursement is received. Also, in the event that we have incurred significant
legal fees in connection with the transaction, we will typically also seek
reimbursement for these expenses from the proposed borrower. However, there can
be no guarantee that we will be successful in collecting any such
reimbursements.
To date, we have made seven different loans to, or investments in, five
companies for a total of approximately $46.7 million, including one investment
that we closed after the end of the second fiscal quarter. We have a further
commitment to lend up to, approximately, an additional $7.2 million to one of
our portfolio companies under a credit facility. In addition, we are earnestly
working toward the consummation of more
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investments. These prospective loans are subject to, among other things, the
satisfactory completion of our due diligence investigation of each borrower,
acceptance of terms and structure and necessary consents. With respect to each
prospective loan, we will only agree to provide the loan if, among other things,
the results of our due diligence investigations are satisfactory, the terms and
conditions of the loan are acceptable and all necessary consents are received.
Our management has initiated its due diligence investigations of the potential
borrowers, however we can not assure you that we will not discover facts in the
course of completing our due diligence that would render a particular investment
imprudent or that any of these loans will actually be made.
We carry our investments on our balance sheet at fair value, as determined
by our board of directors. Securities that are publicly traded will be valued at
their respective closing price prices on the valuation date. Debt and equity
securities that are not publicly traded are valued at fair value as determined
in good faith by our board of directors. In making such determination, our board
of directors values non-convertible debt securities at cost plus amortized
original issue discount, if any, unless adverse factors lead to a determination
of a lesser valuation. In valuing convertible debt, equity or other securities,
our board of directors determines the fair value based on the collateral, the
issuer's ability to make payments, the earnings of the issuer, sales to third
parties of similar securities, the comparison to publicly traded securities and
other pertinent factors. Due to the uncertainty inherent in the valuation
process, such estimates of fair value may differ significantly from the values
that would have resulted had a ready market for the securities existed, and the
differences could be material. Additionally, changes in the market environment
and other events that may occur over the life of the investments may cause the
gains ultimately realized on these investments to be different than the
valuation currently assigned.
We initially expected that it would take approximately one year to
substantially fully invest the proceeds from our initial public offering.
However, the terrorist attacks on the United States on September 11, 2001 and
the ensuing economic uncertainty have resulted in a delay in the rate at which
we have been able to enter into loans. We anticipate that we are approximately
six months behind our original schedule for closing loans.
RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 2002
OPERATING INCOME
Operating income for the six months ended March 31, 2002 was approximately
$3.8 million. This amount consisted of approximately $1 million in interest
income from our invested cash and cash equivalents, approximately $1.9 million
in interest income from our investments in debt securities of private companies,
approximately $641,000 in fee income, approximately $215,000 in interest income
from loans to our employees in connection with the exercise of employee stock
options and approximately $47,000 of other income related to fees collected from
companies with whom investment negotiations have been terminated.
The interest on invested cash and cash equivalents primarily reflects the
interest we received on the investment of the proceeds of our initial public
offering in short-term investment grade securities during the six months. As we
acquire debt securities, we expect that income from invested cash and cash
equivalents will decline as a percentage of total revenue and that interest
income from debt securities will increase and become our predominant source of
revenue.
Income from investments in debt securities of private companies was modest
for the six months ended March 31, 2002 since we did not close our first
investment until November 6, 2001 and the remaining three investments did not
close until late December 2001 and because we made no new investments in the
most recent quarter. As we continue to invest the proceeds of our initial public
offering in debt securities of private companies, we expect that we will
generate additional income from these debt securities, which we anticipate will
be at interest rates significantly greater than the rates that we are currently
receiving on our deposited cash and cash equivalents.
Fee income for the six months ended March 31, 2002 consisted primarily of
managerial assistance fees received in the first fiscal quarter in connection
with investments we closed in that quarter. It also includes $12,000 of income
from an up-front fee paid by a company with which we consummated an investment
after the end of the
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quarter, but prior to the filing of this Form 10-Q, and approximately $17,000 in
fees associated with our outstanding credit facility with Nextira, LLC.
For the six months ended March 31, 2002, other income was comprised of
$20,000 in up-front fees for two proposed investments that were ultimately
terminated and approximately $27,000 in reimbursed expenses incurred in
connection with one of those investments.
The only significant continuing revenue associated with the investments we
have already closed is interest paid and, potentially, capital gains received in
connection with the liquidation of any associated equity interest (e.g.,
warrants). While in some instances we may also receive on-going managerial fee
revenue in connection with a consummated investment, any such amounts are
insignificant.
OPERATING EXPENSES
Operating expenses for the six months ended March 31, 2002 were
approximately $1.2 million. This amount consisted primarily of salaries and
benefits, professional fees, rent and general and administrative expenses.
Salaries and benefits consisted of approximately $604,000 for the six
months ended March 31, 2002; we expect this expense to increase as we hire
additional loan officers. The remainder of the operating expenses incurred for
the six months ended March 31, 2002 consisted of approximately $215,000 in
professional fees, $47,000 in rent and $359,000 in general and administrative
expenses.
We believe that this level of operating expenses is not necessarily
indicative of our future operating expenses. We estimate that over time, as we
begin to more fully deploy the proceeds of our initial public offering, our
operating expenses will be approximately two percent of our net assets.
NET OPERATING INCOME
As a result of the operating income and operating expenses described above,
we had net operating income of approximately $2.6 million for the six months
ended March 31, 2002. Based on a weighted-average of 10,060,178 (basic) and
10,153,223 (fully diluted) shares outstanding, our net operating income per
common share for the six months ended March 31, 2002 was $0.26 (basic and fully
diluted).
FOR THE THREE MONTHS ENDED MARCH 31, 2002
OPERATING INCOME
Operating income for the quarter ended March 31, 2002 was approximately
$2.1 million. This amount consisted of approximately $369,000 in interest income
from our invested cash and cash equivalents, approximately $1.6 million in
interest income from our investments in debt securities of private companies,
approximately $29,000 in fee income, approximately $107,000 in interest income
from loans to our employees in connection with the exercise of employee stock
options and approximately $47,000 of other income related to fees collected from
companies with whom investment negotiations have been terminated.
The interest on invested cash and cash equivalents primarily reflects the
interest we received on the investment of the proceeds of our initial public
offering in short-term investment grade securities during the quarter. As we
acquire debt securities, we expect that income from invested cash and cash
equivalents will decline as a percentage of total revenue and that interest
income from debt securities will increase and become our predominant source of
revenue.
Income from investments in debt securities of private companies increased
during the quarter ended March 31, 2002 as compared to the quarter ended
December 31, 2001 as a result of the fact we were able to realize interest
income on all four of our investments for the entire quarter. We did not close
our first investment until November 6, 2001 and the remaining three investments
did not close until late December 2001. However, as noted above we did not make
any additional investments during the three months ended March 31, 2002.
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<Page>
Fee income for the quarter ended March 31, 2002 consisted of a $12,000
up-front fee paid by a borrower with whom we consummated an investment after the
end of the quarter, but prior to the filing of this Form 10-Q, and approximately
$17,000 in fees associated with our outstanding credit facility with Nextira,
LLC.
Other income for the quarter ended March 31, 2002 was comprised of $20,000
in up-front fees for two proposed investments that were ultimately terminated
and approximately $27,000 in reimbursed expenses incurred in connection with one
of those investments.
The only significant continuing revenue associated with the investments we
have already closed is interest paid and, potentially, capital gains received in
connection with the liquidation of any associated equity interest (e.g.,
warrants). While in some instances we may also receive on-going managerial fee
revenue in connection with a consummated investment, any such amounts are
insignificant.
OPERATING EXPENSES
Operating expenses for the quarter ended March 31, 2002 were approximately
$741,000. This amount consisted primarily of salaries and benefits, professional
fees, rent and general and administrative expenses.
Salaries and benefits consisted of approximately $327,000 for the quarter
ended March 31, 2002; we expect this expense to increase as we hire additional
loan officers. The remainder of the operating expenses incurred for the quarter
ended March 31, 2002 consisted of approximately $114,000 in professional fees,
$36,000 in rent and $259,000 in general and administrative expenses.
We believe that this level of operating expenses is not necessarily
indicative of our future operating expenses. We estimate that over time, as we
begin to more fully deploy the proceeds of our initial public offering, our
operating expenses will be approximately two percent of our net assets.
NET OPERATING INCOME
As a result of the operating income and operating expenses described above,
we had net operating income of approximately $1.4 million for the quarter ended
March 31, 2002. Based on a weighted-average of 10,060,178 (basic) and 10,160,417
(fully diluted) shares outstanding, our net operating income per common share
for the quarter ended March 31, 2002 was $0.14 (basic and fully diluted).
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2002, we had investments in debt securities of, or loans to,
four private companies, totaling approximately $41.4 million of total investment
assets. We have also loaned approximately $800,000 to one portfolio company
under an $8 million credit facility.
On May 2, 2002, we closed an investment in Kozy Shack Enterprises, Inc., a
processed food manufacturing and distributing company. The investment consisted
of a senior subordinated loan of $4.5 million with a term of four years and
carries an interest rate of 18%. This investment was part of a larger $18.8
million credit facility.
We currently have a number of non-binding investment commitments
outstanding that we hope to close in the next ninety days.
Cash provided by operating activities for the six months ended March 31,
2002, consisting primarily of the items described in "Results of Operations,"
was approximately $2.1 million. Net cash used in investing activities was
approximately $42 million for the six months ended March 31, 2002 and primarily
consisted of the amounts used to make investments in our four portfolio
companies. Net cash used in financing activities was approximately $2.5 million
for the six months ended March 31, 2002 and consisted primarily of the repayment
of accrued costs of approximately $640,000 associated with our initial public
offering and the payment of our first quarter dividend of approximately $1.8
million.
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During the quarter ended March 31, 2002, cash and cash equivalents
decreased from approximately $90.4 million at the beginning of the quarter to
approximately $89.4 million at the end of the quarter. This decrease of
approximately $1 million was largely the result of our operating and financing
activities, described above.
In order to qualify as a regulated investment company and to avoid
corporate level tax on the income we distribute to our stockholders, we are
required, under Subchapter M of the Internal Revenue Code, to distribute at
least 90% of our ordinary income and short-term capital gains to our
stockholders on an annual basis. In accordance with these requirements, on
December 10, 2001, we declared a quarterly cash dividend of $0.18 per share on
our common stock which was paid on January 15, 2002 to stockholders of record as
of December 31, 2002 and on March 14, 2002 we declared a quarterly cash dividend
of $0.21 per share which was paid on April 8, 2002 to stockholders of record as
of March 28, 2002. These dividends were paid from ordinary income.
We anticipate borrowing funds to obtain additional capital once the
proceeds of our initial public offering have been fully invested. We also intend
to pursue a strategy of securitizing our loan portfolio in approximately two
years. We would use the cash we receive upon the sale of interests in our loans
to repay bank borrowings and make additional loans. We can not assure you that
this securitization strategy will be successful.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are subject to financial market risks, including changes in interest
rates. We expect that approximately 50% of the loans in our portfolio will be
made at fixed rates, with approximately 50% made at variable rates. To date, we
have made only four investments and substantially all of the remainder of our
assets are invested in money market instruments.
We also expect to borrow funds to finance future lending activities after
we have substantially fully invested the proceeds of our initial public
offering. These future borrowings may be at fixed rates or variable rates. To
date, we have not yet borrowed any funds.
We expect to hedge against interest rate fluctuations in the future by
using standard hedging instruments such as futures, options and forward
contracts. While hedging activities may insulate us against adverse fluctuations
in interest rates, they may also limit our ability to participate in the
benefits of lower interest rates with respect to our portfolio of investments.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On March 26, 2002 the Company held its 2002 Annual Stockholders' Meeting
(the "Annual Meeting"). At the Annual Meeting, the Company's stockholders voted
to ratify the selection of Ernst & Young LLP as the Company's independent
auditors for the fiscal year ended September 30, 2002. Votes for this proposal,
and for the election of Anthony W. Parker as a director of the Company, are
listed in the table below.
<Table>
<Caption>
PROPOSAL 1: ELECTION OF DIRECTOR PROPOSAL 2: RATIFICATION OF
INDEPENDENT AUDITORS
Votes in favor of the proposal 9,648,126 9,633,686
Votes against the 34,308 22,328
proposal/withheld
Exceptions/ 0 26,420
abstentions
--------- ---------
Total shares voted 9,682,434 9,682,434
========= =========
</Table>
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Neither the Company nor its subsidiary is currently subject to any material
legal proceeding, nor, to the Company's knowledge, is any material legal
proceeding threatened against the Company or its subsidiary.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.1 Articles of Amendment and Restatement of the Articles of Incorporation,
incorporated by reference to Exhibit a.2 to Pre-Effective Amendment No. 1
to the Registration Statement on Form N-2 (File No. 333-63700), filed July
27, 2001.
3.2 By-laws, incorporated by reference to Exhibit b to Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-2 (File No. 333-63700), filed
July 27, 2001.
11 Computation of Per Share Earnings (included in the notes to the unaudited
financial statements contained in this report).
All other exhibits for which provision is made in the applicable
regulations of the Securities and Exchange Commission are not required under the
related instruction or are inapplicable and therefore have been omitted.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the period for
which this report is filed.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GLADSTONE CAPITAL CORPORATION
BY: /s/ Harry Brill
-------------------------------------
Harry Brill
Chief Financial Officer and Treasurer
Date: May 14, 2002
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