1
[ALLIED CAPITAL CORPORATION LOGO]
1999
[PHOTOS]
PERFECTING THE BUSINESS OF PRIVATE FINANCE
ALLIED CAPITAL CORPORATION o 1999 ANNUAL REPORT
1999
ANNUAL
REPORT
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[GRAPHIC] FINANCIAL HIGHLIGHTS
As of and for the Years Ended December 31,
(in thousands, except per share amounts) 1999 1998
- -------------------------------------------------------------------------------------------------
Total portfolio at value ........................................... $ 1,228,497 $ 807,119
- -------------------------------------------------------------------------------------------------
Total assets ....................................................... $ 1,290,038 $ 856,079
Total debt outstanding ............................................. $ 592,850 $ 334,350
Shareholders' equity ............................................... $ 667,513 $ 491,358
Total interest and related portfolio income ........................ $ 141,140 $ 106,738
Portfolio income before net realized and unrealized gains .......... $ 71,041 $ 55,245
Total net realized and unrealized gains ............................ $ 27,529 $ 23,620
Net increase in net assets resulting from operations ............... $ 98,570 $ 78,078
Basic earnings per common share .................................... $ 1.64 $ 1.50
- -------------------------------------------------------------------------------------------------
Diluted earnings per common share .................................. $ 1.64 $ 1.50
Tax distributions per common share ................................. $ 1.60 $ 1.43
Weighted average common shares outstanding - basic ................. 59,877 51,941
- -------------------------------------------------------------------------------------------------
Weighted average common shares outstanding - diluted ............... 60,044 51,974
[BAR GRAPH]
Net Increase in Net Assets (NIA)(IN MILLIONS)
$60.5 $54.9 $61.3 $78.1 $98.6
1995 1996 1997 1998 1999
[BAR GRAPH]
Portfolio Income Before Net Realized
and Unrealized Gains (IN MILLIONS)
$41.5 $47.6 $46.1 $55.2 $71.0
1995 1996 1997 1998 1999
Earnings and Dividends Per Share
[LINE GRAPH]
Earnings Dividends
Earnings Dividends
-------- ---------
1999 1.64 1.60
1998 1.50 1.43
1997* 1.24 1.20
1996 1.17 1.23
1995 1.37 1.09
* Excludes Merger-related dividends of approximately $0.51 per share.
[BAR GRAPH]
Investment Originations (IN MILLIONS)
1995 $216.2
1996 $283.3
1997 $364.9
1998 $524.5
1999 $751.9
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[GRAPHIC] DEAR FELLOW SHAREHOLDERS
Allied Capital had another record year in 1999. We invested more than $750
million, which grew the investment portfolio 52% to $1.2 billion by year-end.
Earnings increased to $1.64 per share and dividends to shareholders increased to
$1.60 per share.
As an investment company, our purpose is to create shareholder wealth by
delivering steadily increasing earnings and dividends per share, and positioning
the business for capital appreciation. We do this by selectively investing in
high quality private and undervalued public companies that we believe provide
the potential for significant capital gains with little downside risk for our
principal. With the capital markets today dramatically and disproportionately
interested only in pure play "dot coms," we believe it is important to stick to
the investment disciplines that have served us well over the years. We believe
that the Internet revolution is real and transformational, but that the safest
way to invest is in the convergence of the bricks and mortar world and the
Internet. We are identifying already successful companies that stand to benefit
from integrating digital and Internet technologies into their business models.
In addition to financing seasoned market leaders in more mature industries, we
also focus on companies with exceptional growth potential in emerging
industries.
We continue to gain share in the private finance market. During 1999, we
successfully partnered with many of the leading middle-market private equity
firms in the United States. We also formally established a
Telecommunications/New Media group to build on our solid presence in this high
growth industry. We will continue to focus on investment opportunities in
business services, outsourcing and other such industries that are expected to
benefit from changing technologies.
[PHOTOS]
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4
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We believe that our greatest strategic advantage is a dynamic and collaborative
investment process, fueled by the talented people of Allied Capital who have
consistently delivered results for shareholders.
- --------------------------------------------------------------------------------
This year we also began to aggressively reengineer our small business finance
group to take advantage of Internet technologies. We are already originating
loans through our web site, AlliedCapitalExpress.com, and we expect substantial
loan origination growth in this area during 2000. Perhaps even more
significantly, we have begun to transform the traditional paper-intensive credit
process into a more fully digital one, which we believe will translate into even
higher returns and greater market share for this business.
Our opportunities to selectively invest in original issue commercial
mortgage-backed securities continued during 1999, and our real estate finance
group successfully exploited this unusual imbalance of supply and demand in the
capital markets by purchasing these investments at significant discounts. These
long-term investments, which are fully collateralized by commercial real estate,
should provide us with a strong stream of portfolio income for years to come.
Our annual report this year features our investment process as we continue to
work at perfecting the business of private finance, and the talented people at
Allied Capital who have consistently delivered results for shareholders. A
disciplined process and exceptional people are the keys to our performance and
we believe that we have these elements firmly in place to drive our future
growth.
/s/ Bill Walton
William L. Walton
Chairman and CEO
[PHOTOS]
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[GRAPHIC] DELIVERING CONSISTENT INVESTMENT INCOME
HIGHLY SELECTIVE INVESTING
BILLIONS REVIEWED
HIGHLY SELECTIVE INVESTING
- --------------------------
billions reviewed $12 billion
millions invested $347 million
private finance investment activity
- -----------------------------------
DELIVERING CONSISTENT RETURNS, YEAR IN AND YEAR OUT
Through a balanced income stream consisting of reliable recurring interest
income, loan sale premiums and net gains, we are positioned to consistently
deliver increasing dividends to shareholders.
LOAN DIVIDENDS
INTEREST SALE NET TO
INCOME PREMIUM GAINS SHAREHOLDERS
[THIS GRAPHIC DEPICTS THE ELEMENTS OF INCOME -- INTEREST INCOME, LOAN SALE
PREMIUM, AND NET GAINS -- AS THEY FLOW INTO DIVIDENDS TO SHAREHOLDERS.]
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Working in
Partnership
PRIVATE FINANCE PORTFOLIO
- ---------------------------------
[GRAPHIC DEPICTS THAT 87% OF THE
PRIVATE FINANCE PORTFOLIO IS
COMPOSED OF DEBT SECURITIES AND
13% REPRESENT EQUITY SECURITIES]
PRIVATE FINANCE MODEL
- ---------------------------------
INTEREST
ON LOAN 14%
GAIN 4%
- ---------------------------------
TOTAL RETURN 18%
Delivering consistent investment income to our shareholders requires a clear
investment strategy and disciplined, deliberate execution. We have perfected our
niche in the business of private finance by combining these elements:
exceptional people working in a tightly knit partnership, a highly selective
investment process, and a carefully crafted investment structure that maximizes
upside while achieving reliable investment income.
The foundation of this business is a talented investment team working in
partnership. Superior investment talent makes a big difference. Our investors'
skills have been developed over many years through an apprenticeship process
where individual investment discipline is honed through mentoring and
experience. We amplify individual skills through partnership. Our skilled
professionals work together to challenge investment decisions, creatively
structure and maximize investment results, and guide our portfolio companies to
success.
The partnership process reinforces our highly selective investment discipline.
We pursue investments that meet certain key criteria and strictly avoid
investments where we perceive unacceptable risk. In more mature industries, we
look for companies that are clear market leaders and evidence consistent
operating results, critical mass, seasoned management, and the potential for
capital appreciation. In emerging industries, we focus on companies with
exceptional growth potential.
Once selected, the destiny of our investment's performance is controlled by a
carefully crafted investment structure. The majority of investments in our
portfolio are designed to require the contractual repayment of a debt obligation
with a high interest rate and provide warrants to purchase equity. Through this
structure, we annually earn reliable interest income while building a stable of
future capital gains.
[PHOTO]
Senior private finance professionals work in partnership to select new
investments.
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[LOGO] BUILDING CAPITAL GAINS
A SUPERIOR INVESTMENT MODEL
- -------------------------------------------------------------------------------
TRADITIONAL LENDER MODEL ALLIED CAPITAL PRIVATE FINANCE MODEL
opportunity for return capped opportunity for return beyond interest
at interest rate
[THE FIRST GRAPH DEPICTS A [THE SECOND GRAPH DEPICTS THE
TRADITIONAL LENDER MODEL WITH ALLIED CAPITAL PRIVATE FINANCE
A TYPICAL INTEREST RATE (9%) MODEL, WITH A TYPICAL INTEREST
AND A BELL CURVE DEPICTING RATE (14%) AND A BELL CURVE
VARIOUS TOTAL RETURNS OF LESS DEPICTING VARIOUS TOTAL RETURNS
THAN 9% CORRELATED TO THE PRIMARILY MORE THAN 14%. IN
PROBABILITY OF THOSE RETURNS. THIS MODEL, ALLIED CAPITAL'S
IN SUCH A MODEL, A LENDER'S OPPORTUNITY FOR RETURN IS BEYOND
OPPORTUNITY FOR RETURN IS THE INTEREST RATE AND INCLUDES
CAPPED AT THEIR INTEREST RATE, THE POTENTIAL FOR CAPITAL GAINS.]
AND ANY LOSSES WILL REDUCE
THIS RETURN.]
[PHOTO]
Our investment team works closely with portfolio company management teams as we
move toward our exit and ultimate capital gain.
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8
Enhancing
Investment
Returns
[ENTERPRISE SOFTWARE LOGO]
[COHR LOGO]
[JACK HENRY & ASSOCIATES INC. LOGO]
[PRECISION INDUSTRIES CO LOGO]
[RADIO ONE LOGO]
[GRANT BROADCASTING SYSTEMS II LOGO]
Building capital gains is an essential part of delivering exceptional total
returns to our shareholders. When we select an investment, in addition to
analyzing its credit merits, we assess its potential to provide a future capital
gain. Our ability to annually realize capital gains has been demonstrated
throughout our history.
We have realized exceptional gains by investing in the leading companies in more
mature industries and also by investing in smaller growth companies in rapidly
emerging or evolving industries. We are constantly looking to invest in dominant
companies in a broad range of industries. The growth industries we are focusing
on in 2000 include telecommunications, business outsourcing and services,
education and healthcare.
We achieve our capital gains through a variety of exit strategies, and quite
often our annual gains are generated through numerous transactions. For example,
in 1999 we had a few large gains such as our exit on the IPO of Radio One, Inc.,
which provided a $10.5 million gain. We also had many smaller gains such as
Enterprise Software, which, upon its acquisition by another company, netted us
an $838,000 gain.
Through our annual harvest of capital gains, we increase our investment returns
for shareholders over and above what we earn in contractual interest. Our
capital gains, net of any investment losses, have added an average of
approximately 5% to our private finance portfolio return for the past 20
years.
TWENTY YEARS OF NET CAPITAL GAINS FOR ALLIED CAPITAL
- --------------------------------------------------------------------------------
year % of Total Assets % of Private Finance Assets
------ ----------------- ---------------------------
1999 1.97% 5.64%
1998 2.64% 3.97%
1997 1.33% 3.80%
1996 3.29% 10.46%
1995 1.98% 5.16%
1994 1.81% 4.60%
1993 1.52% 4.85%
1992 1.44% 4.86%
1991 1.49% 2.45%
1990 0.98% 1.71%
1989 2.16% 4.82%
1988 2.74% 4.39%
1987 5.55% 8.16%
1986 4.70% 7.19%
1985 5.28% 7.70%
1984 5.62% 8.69%
1983 3.13% 4.66%
1982 2.30% 2.81%
1981 0.27% 0.35%
1980 1.01% 1.14%
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[LOGO] MANAGING OUR GROWTH
[PHOTO]
Effective deployment of our capital, human resources and technology is an
ongoing focus of our management team.
EFFICIENT REVENUE GENERATION ($ IN MILLIONS)
- ---------------------------------------------------
Revenue* Employees at Year End
1995 $ 90.1 74
1996 $ 96.7 66
1997 $115.3 80
1998 $130.4 106
1999 $168.7 129
* Includes portfolio income and net gains.
GROWTH IN EQUITY AND ASSETS ($ IN MILLIONS)
- -------------------------------------------
Equity Assets
1995 $367.2 $ 605.4
1996 $402.1 $ 713.4
1997 $420.1 $ 807.8
1998 $491.4 $ 856.1
1999 $667.5 $1,290.0
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Growing
Through
Talent and
Technology
[ALLIED CAPITAL EXPRESS SMALL BUSINESS LOANS LOGO]
In 1999, we launched AlliedCapitalExpress.com, which has enabled companies like
Awesome Power Boats, Inc. to apply for a loan via our web-based application
process. Just 24 hours later, this MarineCity, Michigan, manufacturer knew the
status of the application, and 35 days later the due diligence was complete and
the loan was funded.
Managing our growth and maximizing the use of our resources--people, capital
and technology--builds our company's value and our shareholders' wealth.
Allied Capital's professional team possesses exceptional breadth and depth of
experience. Our unique workforce enables us to quickly study opportunities as
they arise in the capital markets and act, if appropriate, to seize profits.
Our recent expansion into CMBS investing and our move to Internet loan
origination through Allied Capital Express are two key examples of our ability
to efficiently manage human capital to maximize profitability.
Careful management of our equity and debt capital is also key to our financial
success. We have developed a controlled process of adding new equity capital
only as high return new investment opportunities occur. In addition, we
carefully maintain an appropriate level of debt capital so that we remain
adequately leveraged. Through this well managed process, each new equity dollar
results in accretive growth in per share earnings for all shareholders.
We are actively leveraging our human and capital resources through the
integration of technology in all aspects of our business. We use the power of
the Internet to source loan opportunities and coordinate information flow
between borrowers and regional offices, and throughout the Allied Capital
organization. As we use technology to drive our investment process, we
efficiently manage information to reduce our investment cycle time and thereby
improve our profitability.
Strong management has perfected our business model for private finance, enabling
our mission of continued long-term value creation for shareholders. As our
leadership in the marketplace grows, we are positioned to increase investment
earnings, enhance returns through capital gains, and grow both strong dividends
and share value for our shareholders.
[PHOTO]
We have continuously supported our growth in assets by increasing our talent
base of exceptional professionals.
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[GRAPHIC] SELECTED CONSOLIDATED FINANCIAL DATA
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1999 1998 1997 1996 1995
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OPERATING DATA
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Total interest and related portfolio income $141,140 $106,738 $97,405 $84,937 $68,817
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Total operating expenses excluding merger expenses $63,346 $44,444 $46,180 $37,361 $27,274
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Portfolio income before realized and unrealized gains $71,041 $55,245 $46,066 $47,576 $41,543
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Net realized gains $25,391 $22,541 $10,704 $19,155 $12,000
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Net unrealized gains (losses) $2,138 $1,079 $7,209 $(7,412) $9,266
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Net increase in net assets resulting from operations $98,570 $78,078 $61,304 $54,947 $60,479
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Diluted earnings per common share $1.64 $1.50 $1.24 $1.17 $1.37
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Dividends per common share (1) $1.60 $1.43 $1.20 $1.23 $1.09
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Weighted average common shares outstanding - diluted 60,044 51,974 49,251 46,733 44,010
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BALANCE SHEET DATA
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Portfolio at value $1,228,497 $807,119 $703,331 $612,411 $532,311
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Portfolio at cost $1,222,901 $803,479 $697,030 $618,319 $530,807
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Total assets $1,290,038 $856,079 $807,775 $713,360 $605,434
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Total debt outstanding $592,850 $334,350 $347,663 $274,997 $200,339
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Shareholders' equity $667,513 $491,358 $420,060 $402,134 $367,192
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Shareholders' equity per common share (NAV) $10.20 $8.79 $8.07 $8.34 $8.26
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Common shares outstanding at end of year 65,414 55,919 52,047 48,238 44,479
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OTHER DATA
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New portfolio investments $751,871 $524,530 $364,942 $283,295 $216,175
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Loan repayments $145,706 $138,081 $233,005 $179,292 $111,731
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Loan sales (2) $198,368 $81,013 $53,912 $27,715 $29,726
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Total assets managed at period end $1,577,296 $1,143,548 $935,720 $822,450 $702,567
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Realized gains $31,536 $25,757 $15,804 $30,417 $16,679
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Realized losses $(6,145) $(3,216) $(5,100) $(11,262) $(4,679)
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The Selected Consolidated Financial Data schedule reflects the operations of the
Company with all periods restated as if the Companies had merged as of the
beginning of the earliest period presented.
(1) Dividends for 1997 exclude certain Merger-related dividends. Allied I
distributed $0.34 per common share representing the 844,914 shares of
Allied Lending distributed in conjunction with the Merger. This
distribution resulted in a partial return of capital. Also in conjunction
with the Merger, the Company distributed $0.17 per share representing the
undistributed earnings of the merged companies at December 31, 1997.
(2) Loan sales for 1998 exclude loans sold through securitization in January
1998.
10 ALLIED CAPITAL CORPORATION 1999 ANNUAL REPORT
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[LOGO] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in this section should be read in conjunction with the
Company's 1999 Consolidated Financial Statements and Notes thereto. In addition,
this Annual Report, which includes Management's Discussion and Analysis,
contains certain forward-looking statements. These statements include the plans
and objectives of management for future operations and financial objectives,
loan portfolio growth and availability of funds. These forward-looking
statements are subject to the inherent uncertainties in predicting future
results and conditions. Certain factors that could cause actual results and
conditions to differ materially from those projected in these forward-looking
statements are set forth below in the Investment Considerations section. Other
factors that could cause actual results to differ materially include the
uncertainties of economic, competitive and market conditions, and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
included herein are reasonable, any of the assumptions could be inaccurate and
therefore, there can be no assurance that the forward-looking statements
included herein will prove to be accurate. Therefore, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved.
ALLIED CAPITAL CORPORATION 1999 ANNUAL REPORT 11
13
OVERVIEW
The Company provides capital to small and middle-market companies in a
variety of different industries and in diverse geographic locations. Our lending
and investment activity is focused in three areas:
- Private finance
- Commercial real estate finance, and
- Small business finance originated for sale under our Allied Capital
Express brand name.
[PIE CHARTS]
The Company's portfolio composition at December 31, 1999, 1998 and 1997 was as follows:
COMMERCIAL REAL SMALL BUSINESS
PRIVATE FINANCE ESTATE FINANCE FINANCE
1999 53% 42% 5%
1998 48% 44% 8%
1997 29% 64% 7%
The Company's earnings depend primarily on the level of interest and
related portfolio income and net realized and unrealized gains earned on the
Company's investment portfolio after deducting interest paid on borrowed capital
and operating expenses. Interest income results from the stated interest rate
earned on a loan and the amortization of loan origination points and discounts.
The level of interest income is directly related to the balance of the
investment portfolio multiplied by the weighted average yield on the portfolio.
The Company's ability to generate interest income is dependent on economic,
regulatory and competitive factors that influence interest rates and loan
originations, and the Company's ability to secure financing for its investment
activities.
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PORTFOLIO AND INVESTMENT ACTIVITY
Total portfolio investment activity and yields as of and for the years
ended December 31, 1999, 1998 and 1997 were as follows:
TOTAL PORTFOLIO
1999 1998 1997
-------- ------ ------
(IN MILLIONS)
Portfolio at Value........................... $1,228.5 $807.1 $703.3
New Investments.............................. $ 751.9 $524.5 $364.9
Repayments................................... $ 145.7 $138.0 $233.0
Sales........................................ $ 198.4 $304.4 $ 53.9
Yield........................................ 13.0% 12.5% 11.7%
PRIVATE FINANCE
Private finance investment activity and yields as of and for the years
ended December 31, 1999, 1998 and 1997 were as follows:
PRIVATE FINANCE
1999 1998 1997
------ ------ ------
(IN MILLIONS)
Portfolio at Value............................. $647.0 $388.6 $204.7
New Investments................................ $346.7 $236.0 $ 66.7
Repayments..................................... $ 87.5 $ 41.3 $ 66.5
Yield.......................................... 14.2% 14.6% 12.6%
The private finance portfolio increased 67% and 90% during the years ended
December 31, 1999 and 1998, respectively. The Company's increasing capital base
has enabled it to make larger private finance investments, supporting the
significant increase in originations in 1999 and 1998. During 1999, the Company
originated 27 new private financings with an average investment size of $12.4
million and a weighted average current yield on loans and debt securities of
13.6%. During 1998, the Company originated 22 new private financings with an
average investment size of $10.2 million and a weighted average
15
current yield on loans and debt securities of 14.0%. The current yield on the
private finance portfolio will fluctuate over time depending on the equity
"kicker" or warrants received with each financing. Private finance investments
are generally structured such that equity kickers may provide an additional
investment return of up to 1,000 basis points.
COMMERCIAL REAL ESTATE FINANCE
Commercial real estate finance investment activity and yields as of and for
the years ended December 31, 1999, 1998 and 1997 were as follows:
COMMERCIAL REAL ESTATE FINANCE
1999 1998 1997
------ ------ ------
(IN MILLIONS)
Portfolio at Value............................. $520.0 $355.0 $451.6
New Investments................................ $288.7 $214.6 $249.0
Repayments..................................... $ 51.5 $ 92.5 $154.5
Sales.......................................... $ 86.1 $256.9 $ 0.0
Yield.......................................... 12.3% 10.4% 11.4%
The commercial real estate finance portfolio increased 46.5% and decreased
21.4% for the years ended December 31, 1999 and 1998, respectively. During 1999
and 1998, the Company began to migrate its portfolio from investments in lower
yielding commercial real estate loans to higher yielding real estate
investments.
During 1998, the Company reduced its commercial mortgage loan origination
activity for its own portfolio due to declining interest rates and began to sell
its loans to other lenders. Then, beginning in the fourth quarter of 1998, the
Company began to take advantage of a unique market opportunity to acquire
non-investment grade commercial mortgage-backed securities ("CMBS") at
significant discounts from the face amount of the bonds. Turmoil in the CMBS
market created a lack of liquidity for the traditional buyers of non-investment
grade bonds. As a result, yields on these bonds increased to an attractive level
for the Company to purchase the securities. The Company opportunistically
purchased CMBS during 1999 and will continue to do so during 2000 while
maintaining a balanced portfolio. The Company believes that CMBS is an
attractive asset class because of the yields that can be earned on a security
that is fully secured by commercial mortgage loans.
The underlying pool of approximately 2,000 loans that are collateral for
our CMBS have the following ranges of loan to value ("LTV") and debt service
coverage ratios ("DSCR").
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CMBS PORTFOLIO BY LTV
LOAN TO VALUE RANGES $ %
-------------------- - ---
(IN MILLIONS)
Less than 60%....................................... $ 978.4 11%
60 - 65%............................................ 560.7 7%
65 - 70%............................................ 1,406.1 16%
70 - 75%............................................ 2,796.7 32%
75 - 80%............................................ 2,777.4 32%
Greater than 80%.................................... 180.2 2%
-------- ---
$8,699.5 100%
======== ===
Weighted average LTV................................ 70.8%
CMBS PORTFOLIO BY DSCR
DEBT SERVICE COVERAGE
RATIO RANGES $ %
--------------------- - ---
(IN MILLIONS)
1.00 - 1.25......................................... $1,968.1 23%
1.26 - 1.50......................................... 4,972.8 57%
1.51 - 1.75......................................... 1,146.4 13%
1.76 - 2.00......................................... 343.2 4%
Greater than 2.00................................... 269.0 3%
-------- ---
$8,699.5 100%
======== ===
Weighted average DSCR............................... 1.36
The increase in the commercial real estate portfolio during 1999 was
primarily due to the purchase of $245.9 million in CMBS with a face value of
$507.9 million and a weighted average yield to maturity of 14.6% after assuming
a 1% loss rate on the underlying collateral mortgage pool. In addition, the
Company sold approximately $86.1 million of commercial mortgage loans with a
weighted average yield of approximately 9.5% and redeployed the proceeds into
higher yielding assets.
The decrease in the commercial real estate portfolio during 1998 was due to
the sale through securitization of approximately $295 million in lower yielding
commercial mortgage loans, and the sale of whole loans to third parties
aggregating approximately $33.5 million.
SMALL BUSINESS FINANCE
During the second quarter of 1999, the Company combined its commercial real
estate loan origination activity with its SBA 7(a) lending activity in order to
increase its loans originated for sale business under the Allied Capital Express
brand name. Through Allied Capital Express, the Company provides small business
and commercial real estate loans up to $3 million. The majority of the loans
originated in this area are originated for sale, generally at premiums of up to
10% of the loan amount.
17
Allied Capital Express loan activity and yields as of and for the years
ended December 31, 1999, 1998 and 1997 were as follows:
SMALL BUSINESS FINANCE
1999 1998 1997
------ ----- -----
(IN MILLIONS)
Portfolio at Value............................... $ 61.4 $63.6 $47.1
New Investments.................................. $116.5 $73.9 $49.2
Repayments....................................... $ 6.7 $ 4.2 $12.0
Sales............................................ $112.3 $47.5 $53.9
Yield............................................ 11.5% 11.2% 11.4%
Allied Capital Express loan origination activity for 1999 has increased due
to the opening of new regional office locations and from opportunities created
by the Internet site launched during 1999. Loans in the Allied Capital Express
program are originated for sale; therefore, the increase in loan sales is the
result of the increase in originations. In addition, beginning in 1999, the
Company began to sell 90% of the unguaranteed portion of SBA 7(a) loans through
a structured finance agreement with a commercial paper conduit. In 1999, $36.4
million of unguaranteed portions of SBA 7(a) loans were sold under this
facility. Allied Capital Express targets small commercial real estate loans that
are, in many cases, originated in conjunction with SBA 7(a) loans. SBA 7(a)
loans are originated with variable interest rates priced at spreads ranging from
1.75% to 2.75% over the prime lending rate.
18
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
The following table summarizes Allied Capital's operating results for the
years ended December 31, 1999, 1998 and 1997:
RESULTS OF OPERATIONS
PERCENT PERCENT
1999 1998 CHANGE CHANGE 1998 1997 CHANGE CHANGE
-------- -------- -------- ------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INTEREST AND RELATED PORTFOLIO INCOME
Interest............................. $119,772 $79,921 $39,851 50% $79,921 $86,882 $(6,961) (8%)
Premiums from loan dispositions...... 14,284 5,949 8,335 140% 5,949 7,277 (1,328) (18%)
Post-Merger gain on securitization of
commercial mortgage loans.......... -- 14,812 (14,812) (100%) 14,812 -- 14,812 100%
Investment advisory fees and other
income............................. 7,084 6,056 1,028 17% 6,056 3,246 2,810 87%
-------- ------- ------- ----- ------- ------- ------- -----
Total interest and related
portfolio income............. 141,140 106,738 34,402 32% 106,738 97,405 9,333 10%
-------- ------- ------- ----- ------- ------- ------- -----
EXPENSES
Interest............................. 34,860 20,694 14,166 68% 20,694 26,952 (6,258) (23%)
Employee............................. 16,136 11,829 4,307 36% 11,829 10,258 1,571 15%
Administrative....................... 12,350 11,921 429 4% 11,921 8,970 2,951 33%
Merger............................... -- -- -- -- -- 5,159 (5,159) (100%)
-------- ------- ------- ----- ------- ------- ------- -----
Total operating expenses....... 63,346 44,444 18,902 43% 44,444 51,339 (6,895) (13%)
-------- ------- ------- ----- ------- ------- ------- -----
Formula and cut-off awards........... 6,753 7,049 (296) (4%) 7,049 -- 7,049 100%
-------- ------- ------- ----- ------- ------- ------- -----
Portfolio income before net
realized and unrealized
gains........................ 71,041 55,245 15,796 29% 55,245 46,066 9,179 20%
-------- ------- ------- ----- ------- ------- ------- ----
NET REALIZED AND UNREALIZED GAINS
Net realized gains................... 25,391 22,541 2,850 13% 22,541 10,704 11,837 111%
Net unrealized gains................. 2,138 1,079 1,059 98% 1,079 7,209 (6,130) (85%)
-------- ------- ------- ----- ------- ------- ------- -----
Total net realized and
unrealized gains............. 27,529 23,620 3,909 17% 23,620 17,913 5,707 32%
-------- ------- ------- ----- ------- ------- ------- -----
Income before minority interests and
income taxes......................... 98,570 78,865 19,705 25% 78,865 63,979 14,886 23%
Minority interests..................... -- -- -- -- -- 1,231 (1,231) (100%)
Income tax expense..................... -- 787 (787) (100%) 787 1,444 (657) (45%)
-------- ------- ------- ----- ------- ------- ------- -----
Net increase in net assets resulting
from operations...................... $ 98,570 $78,078 $20,492 26% $78,078 $61,304 $16,774 27%
======== ======= ======= ===== ======= ======= ======= =====
Diluted earnings per share............. $ 1.64 $ 1.50 $ 0.14 9% $ 1.50 $ 1.24 $ 0.26 21%
======== ======= ======= ===== ======= ======= ======= =====
Weighted average shares outstanding --
diluted.............................. 60,044 51,974 8,070 16% 51,974 49,251 2,723 6%
Net increase in net assets resulting from operations (NIA) results from
total interest and related portfolio income earned, less total expenses incurred
in the operations of the Company, plus net realized and unrealized gains or
losses. NIA as a percentage of average shareholders equity, which is also known
as return on equity, was 17%, 17% and 15% for the years ended December 31, 1999,
1998 and 1997, respectively. NIA, excluding the formula and cut-off award, in
1999 and 1998 as a percentage of average shareholders' equity was 18.6% and
18.8%, respectively.
Total interest and related portfolio income is primarily a function of the
level of interest income earned and the balance of portfolio assets. In
addition, total interest and related portfolio income includes premiums from
loan dispositions, prepayment premiums, and investment advisory fees and other
income.
19
[3 bar graph]
TOTAL INTEREST AND RELATED PORTFOLIO INCOME
PORTFOLIO INCOME (IN MILLIONS) PORTFOLIO INCOME PER SHARE
1997 $ 97.4 $1.97
1998 $106.7 $2.05
1999 $141.1 $2.35
The increase in interest income earned results primarily from continued
growth of the Company's investment portfolio and the Company's focus on
increasing its overall portfolio yield. The Company's investment portfolio,
excluding non-interest bearing equity interests in portfolio companies,
increased by 51% to $1,141.2 million at December 31, 1999 from $757.7 million at
December 31, 1998, and increased by 14% during 1998 from $666.5 million at
December 31, 1997. The weighted average yield on the interest bearing
investments in the portfolio at December 31, 1999, 1998 and 1997 was as follows:
[Portfolio graph]
PRIVATE FINANCE COMMERCIAL REAL ESTATE FINANCE SMALL BUSINESS FINANCE TOTAL PORTFOLIO
YIELD ON PORTFOLIO
1997 12.6% 11.4% 11.4% 11.7%
1998 14.6% 10.4% 11.2% 12.5%
1999 14.2% 12.3% 11.5% 13.0%
Included in net premiums from loan dispositions are premiums from loan
sales and premiums received on the early repayment of loans. Premiums from loan
sales were $10.5 million, $3.8 million and $3.2 million for the years ended
December 31, 1999, 1998 and 1997, respectively. This premium income results
primarily from the premium paid by purchasers of loans originated through Allied
Capital Express, less the origination commissions associated with the loans
sold. In addition to selling the guaranteed portion of the SBA 7(a) loans, in
1999 the Company began to sell 90% of the unguaranteed portion of SBA 7(a) loans
through a structured finance agreement with a commercial paper conduit. The 176%
increase in premiums from loan sales in 1999 is primarily the result of a
significant increase in the sale of the guaranteed SBA 7(a) loans and
unguaranteed portions of SBA 7(a) loans. SBA 7(a) loan sales were $93.7 million,
$37.0 million and $43.4 million for the years ended December 31, 1999, 1998 and
1997, respectively.
Prepayment premiums were $3.8 million, $2.2 million and $4.1 million for
the years ended December 31, 1999, 1998 and 1997, respectively. While the
scheduled maturities of private finance and commercial real estate loans range
from five to ten years, it is not
20
unusual for the Company's borrowers to refinance or pay off their debts to the
Company ahead of schedule. Because the Company seeks to finance primarily
seasoned, performing companies, such companies at times can secure lower cost
financing as their balance sheets strengthen, or as more favorable interest
rates become available. Therefore, the Company generally structures its loans to
require a prepayment premium for the first three to five years of the loan.
Total interest and related portfolio income for 1998 includes a one-time
gain on sale of $14.8 million resulting from a commercial mortgage loan
securitization transaction that was completed in January 1998. Excluding the
1998 gain on sale, total interest and related portfolio income increased for the
year ended December 31, 1999 by 53% as compared to the year ended December 31,
1998. The proceeds of $238.4 million from this transaction were used to repay
outstanding debt.
Our operating expenses include interest, employee and administrative
expenses. The Company's single largest expense is interest on indebtedness. The
fluctuations in interest expense during 1999, 1998 and 1997 are attributable to
changes in the level of borrowings by the Company and its subsidiaries under
various notes payable and debentures and revolving credit facilities. The
Company's borrowing activity and weighted average interest cost, including fees
and closing costs, were as follows:
BORROWINGS
1999 1998 1997
------ ------ ------
(IN MILLIONS)
Total Outstanding Debt......................... $592.9 $334.4 $347.7
Average Outstanding Debt....................... $461.5 $261.3 $336.8
Weighted Average Cost.......................... 7.9% 7.5% 7.3%
BDC Asset Coverage*............................ 228% 273% 243%
- -------------------------
* As a BDC, the Company is generally required to maintain a ratio of 200% of
total assets to total borrowings.
Employee expenses include salaries and employee benefits. The increase in
salaries and employee benefits for the periods presented reflects the increase
in total employees, combined with wage increases and the experience level of
employees hired. Total employees were 129, 106 and 80 at December 31, 1999, 1998
and 1997, respectively. The Company has been an active recruiter throughout 1999
and 1998 for experienced investment and operational personnel, and the Company
will continue to actively recruit and hire new professionals in 2000 to support
anticipated portfolio growth.
Administrative expenses include the leases for the Company's headquarters
in Washington, DC, and its regional offices. Administrative expenses also
include travel costs, stock record expenses, directors' fees, legal and
accounting fees and various other expenses. The increase in administrative
expenses from 1998 to 1999 was primarily the result of increases in costs
associated with the new headquarters and four new regional offices. The increase
in administrative expenses from 1997 to 1998 was partially the result of twelve
full months of costs associated with two new offices that were established in
the third and fourth quarters of 1997.
21
In 1997, the Company incurred Merger expenses totaling $5.2 million, which
consisted primarily of investment banking fees of $3.1 million, legal fees of
$1.0 million and costs associated with the solicitation of proxies of
approximately $0.6 million.
For the years ended December 31, 1999, 1998 and 1997, employee and
administrative costs as a percentage of total interest and related portfolio
income less interest expense plus net realized and unrealized capital gains was
21%, 22% and 22%, respectively.
The formula and cut-off awards totaled $6.8 million and $7.0 million, or
$0.11 per share and $0.14 per share, for the years ended December 31, 1999 and
1998, respectively.
The formula award expense totaled $6.2 million for each of the years ended
December 31, 1999 and 1998. The formula award was designed as an incentive
compensation program that would replace canceled stock options that were
canceled as a result of the Company's 1997 Merger and would balance share
ownership among key officers. The formula award vests over a three-year period,
on the anniversary date of the Merger, beginning on December 31, 1998. Assuming
all officers who received a formula award remain with the Company over the
vesting period, the Company will expense the remaining formula award of
approximately $6.2 million during 2000.
The cut-off award expense totaled $0.6 million and $0.8 million for the
years ended December 31, 1999 and 1998, respectively. The cut-off award was
designed to cap the appreciated value in unvested options at the Merger
announcement date in order to set the foundation to balance option awards upon
the Merger. The cut-off award will only be payable if the award recipient is
employed by the Company on a future vesting date. Total cut-off award that will
vest in 2000 is estimated at $0.5 million.
Net realized gains resulted from the sale of equity securities associated
with certain private finance investments and commercial mortgage loans and the
realization of unamortized discount resulting from the sale and early repayment
of private finance and commercial mortgage loans, offset by losses on
investments. Realized gains and losses for the years ended December 31, 1999,
1998 and 1997 were as follows:
NET GAINS
1999 1998 1997
----- ----- -----
(IN MILLIONS)
Realized Gains.................................... $31.5 $25.8 $15.8
Realized Losses................................... (6.1) (3.3) (5.1)
----- ----- -----
Net Realized Gains................................ $25.4 $22.5 $10.7
===== ===== =====
Net Unrealized Gains.............................. $ 2.1 $ 1.1 $ 7.2
===== ===== =====
Realized gains of $31.5 million during 1999 primarily resulted from
transactions involving six portfolio companies, Radio One, Inc. ($10.5 million),
COHR, Inc. ($5.3 million), Grant Broadcasting Systems II ($5.1 million), Jack
Henry and Associates, Inc. ($3.6 million), Precision Industries Co. ($3.3
million), and Enterprise Software ($0.8 million). The Company reversed
previously recorded unrealized appreciation of $14.6 million when gains were
realized in 1999. Realized gains in 1998 and 1997 resulted primarily from
transactions involving 10 and 6 portfolio companies, respectively.
22
Realized losses in 1999, 1998 and 1997 represented 0.5%, 0.4 % and 0.6% of
the Company's total assets, respectively. Realized losses of $6.1 million during
1999 resulted primarily from the liquidation of one portfolio investment,
CeraTech Holdings Corporation ($2.5 million). The remaining losses consisted of
several losses of less than $0.5 million each. Losses realized in 1999 had been
recognized in NIA over time as unrealized depreciation when the Company
determined that the respective portfolio security's value had become impaired.
Thus, the Company reversed previously recorded unrealized depreciation totaling
$5.4 million, $3.6 million and $6.7 million when the related losses were
realized in 1999, 1998, and 1997, respectively.
Net unrealized gains for 1999, 1998 and 1997 consisted of valuation changes
resulting from the Board of Directors' valuation of the Company's assets and the
effect of reversals of unrealized appreciation or depreciation resulting from
realized gains or losses. At December 31, 1999, net unrealized appreciation in
the portfolio totaled $4.5 million and was composed of unrealized appreciation
of $32.1 million, resulting primarily from appreciated equity interests in
portfolio companies, and unrealized depreciation of $27.6 million resulting
primarily from underperforming loan and equity interests in the portfolio. At
December 31, 1998 and 1997, net unrealized appreciation in the portfolio totaled
$2.4 million and $1.3 million, respectively, and was composed of unrealized
appreciation of $27.3 million and $19.2 million, and unrealized depreciation of
$24.9 million and $17.9 million, respectively.
The Company employs a standard grading system for the entire portfolio.
Grade 1 is used for those investments from which a capital gain is expected.
Grade 2 is used for investments performing in accordance with plan. Grade 3 is
used for investments that require closer monitoring; however, no loss of
interest or principal is expected. Grade 4 is used for investments for which
some loss of contractually due interest is expected, but no loss of principal is
expected. Grade 5 is used for investments for which some loss of principal is
expected and the investment is written down to net realizable value.
At December 31, 1999, the Company's portfolio was graded as follows:
PORTFOLIO BY GRADE
PORTFOLIO PERCENTAGE OF
GRADE AT VALUE TOTAL PORTFOLIO
- ----- ------------- ---------------
(IN MILLIONS)
1........................................... $ 156.0 12.7%
2........................................... 1,002.9 81.7%
3........................................... 22.5 1.8%
4........................................... 32.2 2.6%
5........................................... 14.9 1.2%
-------- ------
$1,228.5 100.0%
======== ======
Grade 5 private finance investments totaled $12.6 million at value at
December 31, 1999, or 1.0% of the Company's total portfolio based on the
valuation of the Board of Directors. The value of these Grade 5 private finance
investments has been reduced from an aggregate cost of $31.3 million in order to
reflect the Company's estimate of the net realizable value of these investments
upon disposition. This reduction in value has been
23
recorded previously as unrealized depreciation over several years in the
Company's earnings. The Company continues to follow its historical practices of
working with a troubled portfolio company in order to recover the maximum amount
of the Company's investment, but records unrealized depreciation for the
expected full amount of the potential loss when such exposure is identified.
Grade 5 private finance investments at December 31, 1998 and 1997 totaled $6.4
million and $12.9 million at value, or 0.8% and 1.8% of the Company's total
portfolio, respectively.
At December 31, 1999, the credit quality of the Company's CMBS portfolio
remained strong, and delinquencies in the underlying collateral pool were
negligible. The yield used to accrue interest on this portfolio assumes a 1%
loss rate on the entire underlying collateral mortgage pool.
For the total investment portfolio, loans greater than 120 days delinquent
were $18.6 million at value at December 31, 1999, or 1.5% of the total
portfolio. Included in this category are loans valued at $11.7 million that are
fully secured by real estate. Loans greater than 120 days delinquent generally
do not accrue interest. In addition, the Company is not accruing interest on a
$14.2 million investment that was not yet 120 days delinquent at December 31,
1999, but is expected to be in this category in the first quarter of 2000. Loans
greater than 120 days delinquent at December 31, 1998 were $10.4 million at
value, or 1.3% of the total portfolio, which included $6.6 million that were
fully secured by real estate.
Because the Company has elected to be taxed as a regulated investment
company ("RIC") under Subchapter M of the Code, the Company is not taxed on its
investment company taxable income or realized capital gains, to the extent that
such income or gains are distributed, or deemed to be distributed, to
shareholders. Annual tax distributions may differ from NIA for the fiscal year
due to timing differences in the recognition of income and expenses, returns of
capital and net unrealized appreciation or depreciation, which are not included
in taxable income.
In order to maintain its RIC status, the Company must, in general, (1)
derive at least 90% of its gross income from dividends, interest and gains from
the sale of securities; (2) meet investment diversification requirements as
defined in the Code; and (3) distribute annually to shareholders at least 90% of
its investment company taxable ordinary income. The Company intends to take all
steps necessary to continue to meet the RIC qualifications. However, there can
be no assurance that the Company will continue to elect or qualify for such
treatment in future years.
The weighted average common shares outstanding used to compute basic
earnings per share were 59.9 million, 51.9 million and 49.2 million for the
years ended December 31, 1999, 1998 and 1997, respectively. The increases in the
weighted average shares reflect the issuance of new shares and the issuance of
shares pursuant to a dividend reinvestment plan.
All per share amounts included in management's discussion and analysis have
been computed using the weighted average shares used to compute diluted earnings
per share, which were 60.0 million, 52.0 million and 49.3 million for the years
ended December 31, 1999, 1998 and 1997, respectively.
24
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS
At December 31, 1999, the Company had $18.2 million in cash and cash
equivalents. The Company invests otherwise uninvested cash in U.S. government or
agency-issued or guaranteed securities that are backed by the full faith and
credit of the United States, or in high quality, short-term repurchase
agreements fully collateralized by such securities. The Company's objective is
to manage to a low cash balance and fund new originations with its credit
facilities.
DEBT
The Company had outstanding debt at December 31, 1999 as follows:
DEBT
ANNUAL
AMOUNT INTEREST
OUTSTANDING COST*
------------- --------
(IN MILLIONS)
Notes payable and debentures:
Unsecured long-term notes payable............. $419.0 7.7%
SBA debentures................................ 62.7 8.0%
OPIC loan..................................... 5.7 6.6%
------ ----
Total notes payable and debentures.... $487.4 7.7%
====== ====
Revolving credit facilities:
Revolving line of credit...................... $ 82.0 9.3%
Master loan and security agreement............ 23.5 6.9%
------ ----
Total revolving credit facilities..... $105.5 8.8%
------ ----
Total debt............................ $592.9 7.9%
====== ====
- -------------------------
* The annual interest cost includes the cost of commitment fees and other
facility fees.
UNSECURED LONG-TERM NOTES PAYABLE. The Company has issued long-term debt
to private institutional lenders, primarily insurance companies. The notes have
five- or seven-year maturities. The notes require payment of interest only
semi-annually, and all principal is due upon maturity.
SBA DEBENTURES. The Company, through its SBIC subsidiary, has debentures
payable to the SBA with terms of ten years. The notes require payment of
interest only semi-annually, and all principal is due upon maturity. The Company
may borrow up to $101 million from the SBA under the SBIC program. At December
31, 1999, the Company had a commitment from the SBA for an additional $12.0
million of debt, which was borrowed in January 2000.
REVOLVING LINE OF CREDIT. The Company has a two-year, $340 million
unsecured revolving line of credit that expires in March 2001. This facility may
be expanded up to $400 million. At the Company's option, the credit facility
bears interest at a rate equal to
25
(i) the one-month London Inter-Bank Offered Rate ("LIBOR") plus 1.25% or (ii)
the higher of (a) the NationsBank, N.A. prime rate and (b) the Federal Funds
rate plus 0.50%. The credit facility requires monthly payments of interest, and
all principal is due upon maturity. In January 2000, the Company increased its
unsecured revolving line of credit to $360 million and is currently negotiating
to extend the maturity by one year.
MASTER LOAN AND SECURITY AGREEMENT. The Company has a facility to borrow
up to $100 million using certain commercial mortgage loans as collateral. The
agreement generally requires interest-only payments with all principal due at
maturity. The agreement charges interest at LIBOR plus 1.0%. The facility
matures in October 2000.
EQUITY CAPITAL AND DIVIDENDS
The Company raises debt and equity capital for continued investment in
growing businesses. Because the Company is a RIC, it distributes its income and
requires external capital for growth. Because the Company is a business
development company, it is limited in the amount of debt capital it may use to
fund its growth, since it is generally required to maintain a ratio of 200% of
total assets to total borrowings, or approximately 1 to 1 debt to equity
capital.
To support its growth during 1999, the Company raised $168.9 million in new
equity capital primarily through the sale of shares from its shelf registration
statement. At December 31, 1999, total shareholders' equity had increased to
$667.5 million. The Company issues new equity only in cases where attractive
investment opportunities have been identified, thus resulting in accretive
growth for existing shareholders.
The Company's Board has established a dividend policy for 2000 to review
the dividend rate quarterly, and to adjust the quarterly dividend rate
throughout the year as the Company's earnings momentum builds. In 1999, the
Board had established a dividend policy of level quarterly dividends of $0.40
per share, for an annual total distribution of $1.60 per share to approximate
annual taxable income. The Board changed its dividend policy for 2000 because of
the Company's significant portfolio growth and continued growth in ordinary
taxable income.
As a result of growth in ordinary taxable income combined with the
increased size and diversity of the Company's portfolio and its projected future
capital gains, the Company's Board of Directors will continue to evaluate
whether to retain or distribute capital gains as they occur. The new policy will
allow the Company to continue to distribute some capital gains, but will also
allow the Company to retain gains that exceed a normal capital gains
distribution level, and therefore avoid any unusual spike in dividends in any
one year. The new policy also enables the Board to selectively retain gains to
support future growth.
The Company plans to maintain a strategy of financing its operations,
dividend requirements and future investments with cash from operations, through
borrowings under short- or long-term credit facilities, through asset sales, or
through obtaining new equity capital. The Company will utilize its short-term
credit facilities only as a means to bridge to long-term financing. The Company
evaluates its interest rate exposure on an ongoing basis. The Company manages
interest rate risk through a diversified borrowing base and a matched-funding
policy. A diversified borrowing base consists of short- and long-term debt with
a variable or fixed rate. The matched-funding policy states that floating rate
assets generally be financed with similar term floating-rate liabilities and
fixed-rate assets
26
generally be financed with similar term fixed-rate liabilities. To the extent
deemed necessary, the Company may hedge variable and short-term interest rate
exposure through interest rate swaps or other techniques. At December 31, 1999,
the Company's debt to equity ratio was less than 1 to 1. Approximately 82% of
the Company's debt had a fixed interest rate, and the Company's weighted average
cost of funds was 7.9% at December 31, 1999. There are no significant maturities
of long-term debt until 2003. The Company believes that it has access to capital
sufficient to fund its ongoing investment and operating activities, and from
which to pay dividends.
The "Year 2000 problem" refers to the inability of many computers,
computer-based systems, related software, and other electronics to process dates
accurately during the Year 2000 and beyond. The Company's Year 2000 readiness
plan focused on three main areas: the Company's information technology and other
operating systems, critical service providers, and portfolio companies. As of
March 1, 2000, we have not experienced any business disruption as a result of
the Year 2000 problem. Although Year 2000 problems may not become evident until
long after January 1, 2000, based on our Year 2000 readiness and our experience
at the end of 1999 and early 2000, we also do not expect significant Year 2000
related business disruptions in the future.
INVESTMENT CONSIDERATIONS
INVESTING IN PRIVATE COMPANIES INVOLVES A HIGH DEGREE OF RISK. Our
portfolio consists primarily of long-term loans to and investments in private
companies. There is generally no publicly available information about these
companies, and we rely significantly on the diligence of our employees and
agents to obtain information in connection with the Company's investment
decisions. In addition, some smaller businesses have narrower product lines and
market shares than their competition, and may be more vulnerable to customer
preferences, market conditions or economic downturns, which may adversely effect
the return on, or the recovery of, our investment in such businesses.
Investments in private businesses, therefore, involve a high degree of business
and financial risk, which can result in substantial losses and accordingly
should be considered speculative.
OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS. We primarily invest in and
lend to companies that may have limited financial resources and that may be
unable to obtain financing from traditional sources. Numerous factors may affect
a borrower's ability to repay its loan, including the failure to meet its
business plan, a downturn in its industry or negative economic conditions.
Deterioration in a borrower's financial condition and prospects may be
accompanied by deterioration in the collateral for the loan. We make unsecured,
subordinated loans or invest in equity securities, which may involve a higher
degree of repayment risk.
OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID. We acquire most of our
investments directly from private companies. The majority of the investments in
our portfolio will be subject to restrictions on resale or otherwise have no
established trading market. The illiquidity of most of our portfolio may
adversely affect our ability to dispose of loans and securities at times when it
may be advantageous for us to liquidate such investments.
WE INVEST IN NON-INVESTMENT GRADE CMBS. The commercial mortgage-backed
securities ("CMBS") in which we invest are non-investment grade, which means
that nationally recognized statistical rating organizations rate them below the
top four investment-grade rating categories (e.g., "AAA" through "BBB").
Non-investment grade securities usually provide a higher yield than do
investment-grade bonds, but with the
27
higher return comes greater risk. Non-investment grade securities are considered
speculative, and their capacity to pay principal and interest in accordance with
the terms of their issue is not ensured. Therefore, the non-investment grade
CMBS tend to be less liquid, may have a higher risk of default and may be more
difficult to value.
OUR PORTFOLIO IS RECORDED AT FAIR VALUE AS DETERMINED BY THE BOARD OF
DIRECTORS. Pursuant to the requirements of the Investment Company Act of 1940
("1940 Act"), the Board of Directors is required to value each asset quarterly,
and we are required to carry our portfolio at fair value as determined by the
Board of Directors. Since there is typically no public market for the loans and
equity securities of the companies in which we make investments, our Board of
Directors estimates the fair value of these loans and equity securities pursuant
to a written valuation policy and a consistently applied valuation process.
Unlike banks, we are not permitted to provide a general reserve for anticipated
loan losses; we are instead required by the 1940 Act to specifically value each
individual investment and record an unrealized loss for an asset that we believe
has become impaired. We adjust quarterly the valuation of our portfolio to
reflect the Board of Directors' estimate of the current realizable value of each
investment in our portfolio. Without a readily ascertainable market value, the
estimated value of our portfolio of loans and equity securities may differ
significantly from the values that would be placed on the portfolio if there
existed a ready market for the loans and equity securities. Any changes in
estimated value are recorded in the Company's statement of operations as "Net
unrealized gains (losses)."
WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY. We
borrow from, and issue senior debt securities to, banks, insurance companies and
other lenders. Lenders of these senior securities have fixed dollar claims on
our consolidated assets that are superior to the claims of our common
shareholders. Borrowings, also known as leverage, magnify the potential for gain
or loss on amounts invested and, therefore, increase the risks associated with
investing in our securities. If the value of our consolidated assets increases,
then leveraging would cause the net asset value attributable to the Company's
common stock to increase more sharply than it would have had we not leveraged.
Conversely, if the value of our consolidated assets decreases, leveraging would
cause net asset value to decline more sharply than it otherwise would have had
we not leveraged. Similarly, any increase in our consolidated income in excess
of consolidated interest payable on the borrowed funds would cause our net
income to increase more than it would without the leverage, while any decrease
in our consolidated income would cause net income to decline more sharply than
it would have had we not borrowed. Such a decline could negatively affect our
ability to make common stock dividend payments, and, if asset coverage for a
class of senior security representing indebtedness declines to less than 200%,
we may be required to sell a portion of our investments when it is
disadvantageous to do so. Leverage is generally considered a speculative
investment technique.
As of December 31, 1999, the Company's asset coverage for indebtedness was
228%. Our ability to achieve our investment objective may depend in part on our
continued ability to maintain a leveraged capital structure by borrowing from
banks or other lenders on favorable terms. There can be no assurance that we
will be able to maintain such leverage. At December 31, 1999, the Company had
$592.9 million of outstanding indebtedness, bearing a weighted annual interest
cost of 7.9%. In order for us to cover annual interest payments on indebtedness,
we must achieve annual returns on our portfolio of at least 3.7%.
28
CHANGES IN INTEREST RATES MAY AFFECT OUR COST OF CAPITAL. Because we
borrow money to make investments, our income is dependent upon the difference
between the rate at which we borrow funds and the rate at which we invest these
funds. In periods of sharply rising interest rates, our cost of funds would
increase, which would reduce our portfolio income before net realized and
unrealized gains. However, there would be no effect on the return, if any, that
could be generated from our equity interests. We use a combination of long-term
and short-term borrowings and equity capital to finance our investing
activities. Investments originated for sale generally carry variable rates and
are financed with short-term variable rate debt. Our long-term fixed-rate
investments are financed with long-term fixed-rate debt and equity. We may use
interest rate risk management techniques in an effort to limit our exposure to
interest rate fluctuations. Such techniques may include various interest rate
hedging activities to the extent permitted by the 1940 Act. There can be no
assurance that a significant change in market interest rates will not have a
material adverse effect on our portfolio income.
BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL
CAPITAL. We will continue to need capital to fund incremental growth in our
investments. Historically, we have borrowed from financial institutions and have
issued equity securities. A reduction in the availability of funds from
financial institutions could limit our ability to grow. We must distribute at
least 90% of our taxable net operating income excluding net realized long-term
capital gains to our stockholders to maintain our regulated investment company
("RIC") status. As a result such earnings will not be available to fund
investment originations. We expect to continue to borrow from financial
institutions and sell additional equity securities. If we fail to obtain funds
from such sources or from other sources to fund our investments, it could limit
our ability to grow, which could have a material adverse effect on the value of
the Company's common stock. In addition, as a business development company
("BDC"), we are generally required to maintain a ratio of at least 200% of total
assets to total borrowings, which may restrict our ability to borrow in certain
circumstances.
OUR PORTFOLIO MAY NOT PRODUCE CAPITAL GAINS. Private finance investments
are typically structured as debt securities with a relatively high fixed rate of
interest and with an equity feature such as conversion rights, warrants or
options. As a result, private finance investments generate interest income from
the time they are made, and may also produce a realized gain from an
accompanying equity feature. We cannot be sure that our portfolio will generate
a current return or capital gains.
LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS
AND INCOME AVAILABLE FOR DIVIDENDS. We have operated the Company so as to
qualify to be taxed as a RIC under Subchapter M of the Code. If we meet certain
diversification and distribution requirements, the Company qualifies for
pass-through tax treatment. The Company would cease to qualify for pass-through
tax treatment if it were unable to comply with these requirements, or if it
ceased to qualify as a BDC under the 1940 Act. We also could be subject to a 4%
excise tax (and, in certain cases, corporate level income tax) if we fail to
make certain distributions. If the Company fails to qualify as a RIC, the
Company would become subject to federal income tax as if it were an ordinary
corporation, which would substantially reduce our net assets and the amount of
income available for distribution to our shareholders.
WE OPERATE IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES. We
compete for investments with many other companies and individuals, some of whom
have greater resources than we do. Increased competition would make it more
difficult for us to
29
purchase or originate investments at attractive prices. As a result of this
competition, sometimes we may be precluded from making otherwise attractive
investments.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT. We are regulated by the
Commission and the SBA. In addition, changes in the laws or regulations that
govern BDCs, RICs, real estate investment trusts ("REITs"), SBICs and SBLCs may
significantly affect our business. Laws and regulations may be changed from time
to time, and the interpretations of the relevant laws and regulations also are
subject to change. Any change in the law or regulations that govern our business
could have a material impact on the Company or its operations.
QUARTERLY RESULTS MAY FLUCTUATE. The Company's quarterly operating results
could fluctuate due to a number of factors. These factors include, among others,
variations in the investment origination volume, variation in timing of
prepayments, variations in and the timing of the recognition of realized and
unrealized gains or losses, the degree to which we encounter competition in our
markets and general economic conditions. As a result of these factors, you
should not rely on quarterly results to be indicative of the Company's
performance in future quarters.
30
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
---------------------
1999 1998
(IN THOUSANDS, EXCEPT NUMBER OF SHARE AMOUNTS) ---------- --------
ASSETS
Portfolio at value:
Private finance (cost: 1999-$639,171;
1998-$382,488)....................................... $ 647,040 $388,554
Commercial real estate finance (cost: 1999-$522,022;
1998-$356,039)....................................... 520,029 354,980
Small business finance (cost: 1999-$61,708;
1998-$64,952)........................................ 61,428 63,585
---------- --------
Total portfolio at value.......................... 1,228,497 807,119
---------- --------
Cash and cash equivalents................................... 18,155 25,075
Other assets................................................ 43,386 23,885
---------- --------
Total assets...................................... $1,290,038 $856,079
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable and debentures.......................... $ 487,350 $233,350
Revolving credit facilities........................... 105,500 101,000
Accounts payable and other liabilities................ 22,675 21,671
Dividends and distributions payable................... -- 1,700
---------- --------
Total liabilities................................. 615,525 357,721
---------- --------
Commitments and Contingencies
Preferred stock............................................. 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares
authorized; 65,930,360 and 56,729,502 issued and
outstanding at December 31, 1999 and 1998,
respectively......................................... 6 6
Additional paid-in capital............................ 699,149 526,824
Common stock held in deferred compensation trust
(516,779 shares and 810,456 shares at December 31,
1999 and 1998, respectively)......................... (6,218) (13,190)
Notes receivable from sale of common stock............ (29,461) (23,735)
Net unrealized appreciation on portfolio.............. 4,517 2,380
Distributions in excess of earnings................... (480) (927)
---------- --------
Total shareholders' equity........................ 667,513 491,358
---------- --------
Total liabilities and shareholders' equity........ $1,290,038 $856,079
========== ========
The accompanying notes are an integral part of these consolidated financial
statements.
31
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) --------- --------- ---------
Interest and related portfolio income:
Interest.............................................. $119,772 $ 79,921 $86,882
Premiums from loan dispositions....................... 14,284 5,949 7,277
Post-Merger gain on securitization of commercial
mortgage loans...................................... -- 14,812 --
Investment advisory fees and other income............. 7,084 6,056 3,246
-------- -------- -------
Total interest and related portfolio income....... 141,140 106,738 97,405
-------- -------- -------
Expenses:
Interest.............................................. 34,860 20,694 26,952
Employee.............................................. 16,136 11,829 10,258
Administrative........................................ 12,350 11,921 8,970
Merger................................................ -- -- 5,159
-------- -------- -------
Total operating expenses.......................... 63,346 44,444 51,339
-------- -------- -------
Formula and cut-off awards............................ 6,753 7,049 --
-------- -------- -------
Portfolio income before net realized and unrealized gains... 71,041 55,245 46,066
-------- -------- -------
Net realized and unrealized gains:
Net realized gains.................................... 25,391 22,541 10,704
Net unrealized gains.................................. 2,138 1,079 7,209
-------- -------- -------
Total net realized and unrealized gains........... 27,529 23,620 17,913
-------- -------- -------
Income before minority interests and income taxes........... 98,570 78,865 63,979
-------- -------- -------
Minority interests.......................................... -- -- 1,231
Income tax expense.......................................... -- 787 1,444
-------- -------- -------
Net increase in net assets resulting from operations........ $ 98,570 $ 78,078 $61,304
======== ======== =======
Basic earnings per common share............................. $ 1.64 $ 1.50 $ 1.24
======== ======== =======
Diluted earnings per common share........................... $ 1.64 $ 1.50 $ 1.24
======== ======== =======
Weighted average common shares outstanding -- basic......... 59,877 51,941 49,218
======== ======== =======
Weighted average common shares outstanding -- diluted....... 60,044 51,974 49,251
======== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
32
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) --------- --------- ---------
Operations:
Portfolio income before realized and unrealized
gains................................................ $ 71,041 $ 55,245 $ 46,066
Net realized gains..................................... 25,391 22,541 10,704
Net unrealized gains................................... 2,138 1,079 7,209
Minority interests and income tax expense.............. -- (787) (2,675)
-------- -------- --------
Net increase in net assets resulting from
operations...................................... 98,570 78,078 61,304
-------- -------- --------
Shareholder distributions:
Common stock dividends................................. (97,941) (75,087) (85,678)
Preferred stock dividends.............................. (230) (230) (220)
-------- -------- --------
Net decrease in net assets resulting from
shareholder distributions....................... (98,171) (75,317) (85,898)
-------- -------- --------
Capital share transactions:
Sale of common stock................................... 164,269 69,675 --
Net (increase) decrease in notes receivable from sale
of common stock...................................... (5,725) 5,576 (14,120)
Issuance of common stock upon the exercise of stock
options.............................................. 5,920 221 28,426
Issuance of common stock in lieu of cash
distributions........................................ 4,610 6,184 26,612
Net decrease (increase) in common stock held in
deferred compensation trust.......................... 6,972 (13,190) --
Other.................................................. (290) 71 1,602
-------- -------- --------
Net increase in net assets resulting from capital
share transactions.............................. 175,756 68,537 42,520
-------- -------- --------
Total increase in net assets...................... $176,155 $ 71,298 $ 17,926
======== ======== ========
Net assets at beginning of year............................. $491,358 $420,060 $402,134
-------- -------- --------
Net assets at end of year................................... $667,513 $491,358 $420,060
-------- -------- --------
Net asset value per common share............................ $ 10.20 $ 8.79 $ 8.07
-------- -------- --------
Common shares outstanding at end of year.................... 65,414 55,919 52,047
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
33
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
(IN THOUSANDS) --------- --------- ---------
Cash flows from operating activities:
Net increase in net assets resulting from operations..... $ 98,570 $ 78,078 $ 61,304
Adjustments
Net unrealized gains.................................. (2,138) (1,079) (7,209)
Post-Merger gain on securitization of commercial
mortgages........................................... -- (14,812) --
Depreciation and amortization......................... 788 702 450
Amortization of loan discounts and fees............... (10,674) (6,032) (10,804)
Deferred income taxes................................. -- -- 1,087
Minority interests.................................... -- -- 1,231
Changes in other assets and liabilities............... (8,712) 11,998 12,881
--------- --------- ---------
Net cash provided by operating activities........... 77,834 68,855 58,940
--------- --------- ---------
Cash flows from investing activities:
Portfolio investments.................................... (751,871) (524,530) (364,942)
Repayments of investment principal....................... 145,706 138,081 233,005
Proceeds from loan sales................................. 198,368 81,013 53,912
Proceeds from securitization of commercial mortgages..... -- 223,401 --
Net redemption (purchase) of U.S. government
securities............................................ -- 11,091 (10,301)
Collections of notes receivable from sale of common
stock................................................. 195 5,591 6,534
Other investing activities............................... (1,754) (2,539) (182)
--------- --------- ---------
Net cash used in investing activities............... (409,356) (67,892) (81,974)
--------- --------- ---------
Cash flows from financing activities:
Sale of common stock..................................... 164,269 69,896 8,615
Purchase of common stock by deferred compensation
trust................................................. -- (19,431) --
Common dividends and distributions paid.................. (95,031) (69,536) (58,194)
Special undistributed earnings distribution paid......... -- (8,848) --
Preferred stock dividends paid........................... (230) (450) (220)
Net borrowings under (payments on) notes payable and
debentures............................................ 254,000 (69,471) 78,923
Net borrowings under (payments on) revolving lines of
credit................................................ 4,500 56,158 (6,257)
Other financing activities............................... (2,906) (4,643) (1,237)
--------- --------- ---------
Net cash provided by (used in) financing
activities....................................... 324,602 (46,325) 21,630
--------- --------- ---------
Net decrease in cash and cash equivalents.................. $ (6,920) $ (45,362) $ (1,404)
--------- --------- ---------
Cash and cash equivalents at beginning of year............. $ 25,075 $ 70,437 $ 71,841
--------- --------- ---------
Cash and cash equivalents at end of year................... $ 18,155 $ 25,075 $ 70,437
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
34
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS
PRIVATE FINANCE DECEMBER 31, 1999
PORTFOLIO COMPANY -------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------------- --------------------------------------------- -------- --------
ACE Products, Inc. Debt Securities $ 13,386 $ 13,386
- -----------------------------------------------------------------------------------------------------------
Acme Paging, L.P. Debt Securities 6,618 6,618
Partnership Interest 1,456 2,100
- -----------------------------------------------------------------------------------------------------------
Allied Office Products Debt Securities 9,905 9,905
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc. Warrants 125 125
- -----------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -----------------------------------------------------------------------------------------------------------
Aurora Communications, LLC Loans 13,370 13,370
Equity Interest 1,500 1,500
- -----------------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 11,959 11,959
Warrants 1,180 1,180
- -----------------------------------------------------------------------------------------------------------
Bakery Chef, Inc. Loans 10,967 10,967
- -----------------------------------------------------------------------------------------------------------
CampGroup, LLC Debt Securities 2,491 2,491
Warrants 220 220
- -----------------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- -----------------------------------------------------------------------------------------------------------
Celebrities, Inc. Loan 310 310
Warrants 12 212
- -----------------------------------------------------------------------------------------------------------
Convenience Corporation of America Debt Securities 8,355 2,738
Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc. Debt Securities 3,460 3,460
Warrants -- 538
- -----------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 6,957 6,957
Debt Securities 4,942 4,942
Warrants -- --
Options -- --
- -----------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 5,817 5,817
Resources, LLC Options 87 87
- -----------------------------------------------------------------------------------------------------------
Coverall North America Loan 9,298 9,298
- -----------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 --
- -----------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 --
- -----------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 29
- -----------------------------------------------------------------------------------------------------------
Directory Investment Corporation Common Stock (470 shares) -- --
- -----------------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (34 shares) -- --
Series B Common Stock (6 shares) 8 --
Series C Common Stock (10 shares) 22 --
- -----------------------------------------------------------------------------------------------------------
Drilltec Patents & Technologies Loan 10,911 8,755
Company, Inc. Debt Securities 786 786
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
35
PRIVATE FINANCE DECEMBER 31, 1999
PORTFOLIO COMPANY -------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------------- --------------------------------------------- -------- --------
EDM Consulting, LLC Debt Securities $ 1,875 $ 343
Common Stock (100 shares) 250 --
- -----------------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Loans 306 306
- -----------------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -----------------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 --
- -----------------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) 500 500
Common Stock (2,500 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Executive Greetings, Inc. Debt Securities 15,825 15,825
Warrants 360 360
- -----------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Company Debt Securities 5,753 5,753
Warrants 280 3,628
- -----------------------------------------------------------------------------------------------------------
FTI Consulting, Inc. (1) Debt Securities 12,053 12,053
Warrants 970 970
- -----------------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,740 30,740
Communications, LLC Options -- 750
- -----------------------------------------------------------------------------------------------------------
Garden Ridge Corporation Debt Securities 26,537 26,537
Preferred Stock (1,130 shares) 1,130 1,130
Common Stock (471 shares) 613 613
- -----------------------------------------------------------------------------------------------------------
Genesis Worldwide, Inc. (1) Loan 1,328 1,328
Common Stock (41,644 shares) 214 81
- -----------------------------------------------------------------------------------------------------------
Genoa Mine Acquisition Corporation Loan 108 108
- -----------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,742 15,742
Warrants 525 1,000
- -----------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- 154
- -----------------------------------------------------------------------------------------------------------
Global Communications, LLC Loans 2,526 2,526
Debt Securities 1,733 1,733
Equity Interest 6,867 6,867
Options 1,639 1,639
- -----------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 840
Archery, LLC Convertible Debentures 2,248 2,008
- -----------------------------------------------------------------------------------------------------------
Grant Broadcasting Systems II Debt Securities 5,200 5,200
Warrants 87 5,226
- -----------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,177 9,177
Warrants -- 2,500
- -----------------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- -----------------------------------------------------------------------------------------------------------
Icon International, Inc. Series A Preferred Stock (13,720 shares) 1,334 1,334
Series B Preferred Stock (11,987 shares) 1,166 1,166
- -----------------------------------------------------------------------------------------------------------
J3 Technology Services Corporation Debt Securities 7,841 7,841
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
36
PRIVATE FINANCE DECEMBER 31, 1999
PORTFOLIO COMPANY -------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------------- --------------------------------------------- -------- --------
Jakel, Inc. Loan $ 18,174 $ 18,174
- -----------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,134 2,134
Warrants 74 74
- -----------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 3,502 3,502
Warrants 324 4,100
- -----------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Warrants 348 3,495
Equity Interest 4 9
- -----------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,318 6,318
Warrants 96 600
- -----------------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,665 7,665
Warrants 348 348
- -----------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,439 3,439
Common Stock (64,535 shares) 142 142
- -----------------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High-Yield Senior Secured Debt 15,150 14,150
- -----------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred 359 213
Stock (26,000 shares)
- -----------------------------------------------------------------------------------------------------------
Master Plan, Inc. Common Stock (156 shares) 42 3,042
- -----------------------------------------------------------------------------------------------------------
MedAssets.com, Inc. Debt Securities 3,793 3,793
Series B Convertible 2,049 2,049
Preferred Stock (227,665 shares)
Warrants 136 136
- -----------------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,938 2,938
- -----------------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, LLC Loan 11,109 11,109
- -----------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 7 7
Debt Securities 1,823 243
Common Stock (33,333 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Morton Industrial Group (1) Common Stock (5,835 shares) 241 20
- -----------------------------------------------------------------------------------------------------------
MVL Group Debt Securities 13,989 13,989
Warrants 651 651
- -----------------------------------------------------------------------------------------------------------
Net-Tel Communications, Inc. Debt Securities 9,426 9,426
Series B Convertible 5,000 5,000
Preferred Stock (647 shares)
Warrants 500 500
- -----------------------------------------------------------------------------------------------------------
Nobel Learning Communities, Inc. (1) Debt Securities 9,492 9,492
Series D Convertible 2,000 2,000
Preferred Stock (265,957 shares)
Warrants 575 575
- -----------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, L.P. Debt Securities 384 384
- -----------------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,922 10,922
Warrants 900 900
- -----------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
37
PRIVATE FINANCE DECEMBER 31, 1999
PORTFOLIO COMPANY -------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------------- --------------------------------------------- -------- --------
Old Mill Holdings, Inc. Debt Securities $ 140 --
- -----------------------------------------------------------------------------------------------------------
Opinion Research Corporation (1) Debt Securities 13,896 $ 13,896
Warrants 996 996
- -----------------------------------------------------------------------------------------------------------
Outsource Partners, Inc. Debt Securities 23,802 23,802
Warrants 826 826
- -----------------------------------------------------------------------------------------------------------
Panera Bread Company (1) Warrants 227 271
- -----------------------------------------------------------------------------------------------------------
Physician Specialty Corporation Debt Securities 14,388 14,388
Redeemable Preferred 850 850
Stock (850 shares)
Convertible Preferred 150 150
Stock (97,411 shares)
Warrants 476 476
- -----------------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Loan 1,300 1,300
Debt Securities 4,591 2,591
Common Stock (208,000 shares) 59 3
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Polaris Pool Systems, Inc. Debt Securities 6,395 6,395
Warrants 1,050 1,050
- -----------------------------------------------------------------------------------------------------------
Powell Plant Farms, Inc. Loan 15,031 15,031
- -----------------------------------------------------------------------------------------------------------
Progressive International Corporation Debt Securities 3,940 3,940
Preferred Stock (500 shares) 500 500
Common Stock (197 shares) 13 13
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,978 9,978
Warrants 395 395
- -----------------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred 993 136
Stock (1,000 shares)
- -----------------------------------------------------------------------------------------------------------
Soff-Cut Holdings, Inc. Debt Securities 8,140 8,140
Warrants 446 446
Preferred Stock (300 shares) 300 300
Common Stock (2,000 shares) 200 200
- -----------------------------------------------------------------------------------------------------------
Southwest PCS, L.P. Debt Securities 6,364 6,364
Options 1,000 2,000
- -----------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 469 360
Common Stock (6,208 shares) 25 18
- -----------------------------------------------------------------------------------------------------------
SunStates Refrigerated Services, Inc. Loans 6,130 4,641
Debt Securities 2,445 1,316
- -----------------------------------------------------------------------------------------------------------
Sure-Tel, Inc. Preferred Stock (1,116,902 shares) 3,108 3,108
Warrants 662 662
Options -- --
- -----------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,674 11,674
Options 266 266
- -----------------------------------------------------------------------------------------------------------
Teknekron Infoswitch Corporation Debt Securities 13,863 13,863
Warrants 900 900
- -----------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.
38
PRIVATE FINANCE DECEMBER 31, 1999
PORTFOLIO COMPANY -------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------------- --------------------------------------------- -------- --------
Total Foam, Inc. Debt Securities $ 1,528 $ 135
Common Stock (910 shares) 57 --
- -----------------------------------------------------------------------------------------------------------
Tubbs Snowshoe Company, LLC Debt Securities 3,886 3,886
Warrants 54 54
Equity Interests 500 500
- -----------------------------------------------------------------------------------------------------------
United Pet Group Debt Securities 4,938 4,938
Warrants 15 15
- -----------------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,694 3,694
Warrants 360 1,010
- -----------------------------------------------------------------------------------------------------------
Wildwood Designs, Inc. Loan 1,167 1,167
- -----------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company Warrants 24 322
- -----------------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,390 12,390
- -----------------------------------------------------------------------------------------------------------
Woodstream Corporation Debt Securities 8,000 8,000
Equity Interests 1,700 1,700
Warrants -- --
- -----------------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Corporation Debt Securities 15,113 15,113
Preferred Stock (100 shares) 3,700 3,700
Common Stock (99 shares) 100 4,100
- -----------------------------------------------------------------------------------------------------------
Total private finance (91 investments) $639,171 $647,040
- -----------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
INTEREST NUMBER OF -------------------
(IN THOUSANDS, EXCEPT NUMBER OF LOANS) RATE RANGES LOANS COST VALUE
- ------------------------------------------- ---------------- --------- -------- --------
COMMERCIAL MORTGAGE-BACKED SECURITIES
Commercial Mortgage Loans Up to 6.99% 5 $ 1,422 $ 1,422
7.00%- 8.99% 15 71,619 71,595
9.00%-10.99% 41 39,415 39,623
11.00%-12.99% 30 25,016 25,175
13.00%-14.99% 12 15,207 15,230
15.00% and above 3 1,088 1,064
- -----------------------------------------------------------------------------------------------
Total commercial mortgage loans 106 153,767 154,109
- -----------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
39
DECEMBER 31, 1999
STATED -------------------
INTEREST FACE COST VALUE
-------- ------ ------- ------
Purchased CMBS
Mortgage Capital Funding, Series 1998-MC3 5.5% $ 61,302 $ 29,141 $ 29,141
Morgan Stanley Capital I, Series 1999-RM1 6.4% 71,640 35,453 35,453
COMM 1999-1 5.7% 105,010 54,166 54,166
Morgan Stanley Capital I, Series 1999-FNV1 6.1% 49,486 24,505 24,505
DLJ Commercial Mortgage Trust 1999-CG2 6.1% 96,622 44,288 44,288
Commercial Mortgage Acceptance Corp., Series
1999-C1 6.8% 50,449 28,115 28,115
LB Commercial Mortgage Trust, Series 1999-C2 6.7% 42,391 20,054 20,054
Chase Commercial Mortgage Securities Corp.,
Series 1999-2 6.5% 43,046 20,121 20,121
FUNB CMT, Series 1999-C4 6.5% 49,288 21,851 21,851
- --------------------------------------------------------------------------------------------------
Total purchased CMBS $569,234 $ 277,694 $ 277,694
- --------------------------------------------------------------------------------------------------
Residual CMBS 76,374 76,374
- --------------------------------------------------------------------------------------------------
Residual Interest Spread 6,882 5,382
- --------------------------------------------------------------------------------------------------
Real Estate Owned 7,305 6,470
- --------------------------------------------------------------------------------------------------
Total commercial real estate finance $ 522,022 $ 520,029
- --------------------------------------------------------------------------------------------------
Small business finance $ 61,708 $ 61,428
- --------------------------------------------------------------------------------------------------
Total portfolio at value $1,222,901 $1,228,497
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
40
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
Allied Capital Corporation, a Maryland corporation, is a closed-end
management investment company that has elected to be regulated as a business
development company ("BDC") under the Investment Company Act of 1940 ("1940
Act"). Allied Capital Corporation has two wholly owned subsidiaries that have
also elected to be regulated as BDCs. Allied Investment Corporation ("Allied
Investment") is licensed under the Small Business Investment Act of 1958 as a
Small Business Investment Company ("SBIC"). Allied Capital SBLC Corporation
("Allied SBLC") is licensed by the Small Business Administration ("SBA") as a
Small Business Lending Company and is a participant in the SBA Section 7(a)
Guaranteed Loan Program. In addition, the Company has a real estate investment
trust subsidiary, Allied Capital REIT, Inc. ("Allied REIT") and several single-
member limited liability companies established primarily to hold real estate
properties.
Allied Capital Corporation and its subsidiaries, collectively, are
hereinafter referred to as the "Company."
The investment objective of the Company is to achieve current income and
capital gains. In order to achieve this objective, the Company invests primarily
in private, small and middle-market companies in a variety of industries and in
diverse geographic locations in the United States.
On December 31, 1997, Allied Capital Corporation, Allied Capital
Corporation II, Allied Capital Commercial Corporation, and Allied Capital
Advisers ("Advisers") merged with and into Allied Capital Lending Corporation
("Allied Lending") (each a "Predecessor Company" and collectively the
"Predecessor Companies") in a stock-for-stock exchange (the "Merger").
Immediately following the Merger, Allied Lending changed its name to Allied
Capital Corporation.
The consolidated financial statements reflect the operations of the
Company, with the year ended December 31, 1997 restated as if the Predecessor
Companies had merged as of the beginning of the year.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly owned or majority owned subsidiaries. All intercompany accounts
and transactions have been eliminated in consolidation. Certain
reclassifications have been made to the 1998 and 1997 balances to conform with
the 1999 financial statement presentation. The consolidated financial statements
for 1997 and prior periods have been restated to include the accounts of the
Predecessor Companies. Transaction fees and expenses related to the Merger were
expensed in the fourth quarter of 1997.
VALUATION OF PORTFOLIO INVESTMENTS
Portfolio assets are carried at fair value as determined by the Board of
Directors under the Company's valuation policy.
41
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
LOANS AND DEBT SECURITIES
The values of loans and debt securities are considered to be amounts that
could be realized in the normal course of business, which generally anticipates
the Company holding the loan to maturity and realizing the face value of the
loan. For loans and debt securities, value normally corresponds to cost unless
the borrower's condition or external factors lead to a determination of value at
a lower amount.
Interest income is recorded on the accrual basis to the extent that such
amounts are expected to be collected. Loan origination fees, original issue
discount and market discount are amortized into interest income using the
effective interest method. Yields on loans and debt securities are computed on
these investments at value.
EQUITY SECURITIES
Equity interests in portfolio companies for which there is no public market
are valued based on various factors including a history of positive cash flow
from operations, the market value of comparable publicly traded companies, and
other pertinent factors such as recent offers to purchase a portfolio company's
securities or other liquidation events. The determined values are generally
discounted to account for liquidity issues and minority control positions.
The Company's equity interests in public companies that carry certain
restrictions on sale are typically valued at a discount from the public market
value of the security at the balance sheet date. Restricted and unrestricted
publicly traded stocks may also be valued at a discount due to the investment
size or market liquidity concerns.
COMMERCIAL MORTGAGE-BACKED SECURITIES ("CMBS")
CMBS consists of purchased commercial mortgage-backed securities
("Purchased CMBS"), residual interest in a mortgage securitization ("Residual
CMBS") and residual interest spread.
PURCHASED CMBS
The Purchased CMBS is carried at fair value. The Company recognizes income
from the amortization of original issue discount using the effective interest
method, using the anticipated yield over the projected life of the investment.
Yields are revised when there are changes in estimates of future credit losses,
actual losses incurred, and actual and estimated prepayment speeds. Changes in
estimated yield are currently recognized as an adjustment to the estimated yield
over the remaining life of the Purchased CMBS. The Company recognizes unrealized
depreciation on its Purchased CMBS whenever it determines that the value of its
Purchased CMBS is less than the cost basis.
RESIDUAL CMBS
The Company values its residual interest in securitization and recognizes
income using the same accounting policies used for the Purchased CMBS.
42
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
RESIDUAL INTEREST SPREAD
Residual interest spread is carried at fair value based on discounted
estimated future cash flows. The Company recognizes income from the residual
interest spread using the effective interest method. At each reporting date, the
effective yield is recalculated and used to recognize income until the next
reporting date.
NET REALIZED AND UNREALIZED GAINS
Realized gains or losses are measured by the difference between the net
proceeds from the sale and the cost basis of the investment without regard to
unrealized gains or losses previously recognized, and include investments
charged off during the year, net of recoveries. Unrealized gains or losses
reflect the change in portfolio investment values during the reporting period.
DEFERRED FINANCING COSTS
Financing costs are based on actual costs incurred in obtaining financing
and are deferred and amortized as part of interest expense over the term of the
related debt instrument.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company may or may not use derivative financial instruments to reduce
interest rate risk. The Company has established policies and procedures for risk
assessment and the approval, reporting and monitoring of derivative financial
instrument activities. The Company does not hold or issue derivative financial
instruments for trading purposes.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash in banks and all highly liquid
investments with original maturities of three months or less.
DIVIDENDS TO SHAREHOLDERS
Dividends to shareholders are recorded on the record date.
FEDERAL AND STATE INCOME TAXES
The Company and its wholly owned subsidiaries intend to comply with the
requirements of the Internal Revenue Code ("Code") that are applicable to
regulated investment companies ("RIC") and real estate investment trusts
("REIT"). The Company and its wholly owned subsidiaries intend to annually
distribute or retain through a deemed distribution all of their taxable income
to shareholders; therefore, the Company has made no provision for income taxes.
With the exception of Advisers, the Predecessor Companies qualified as a
RIC or a REIT; however, Advisers was a corporation subject to federal and state
income taxes. Income tax expense reported on the consolidated statement of
operations relates to the operations of Advisers for all periods presented.
43
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
PER SHARE INFORMATION
Basic earnings per share is calculated using the weighted average number of
shares outstanding for the period presented. Diluted earnings per share reflects
the potential dilution that could occur if options to issue common stock were
exercised into common stock. Earnings per share is computed after subtracting
dividends on preferred shares.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles 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 the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from these estimates.
NOTE 3. PORTFOLIO
The Company's investment operations are conducted in three primary areas:
private finance, commercial real estate finance, and small business finance.
PRIVATE FINANCE
At December 31, 1999 and 1998, the private finance portfolio consisted of
the following:
1999 1998
--------------------------- ---------------------------
COST VALUE YIELD COST VALUE YIELD
-------- -------- ----- -------- -------- -----
(IN THOUSANDS)
Loans and debt securities............... $578,570 $559,746 14.2% $354,870 $339,163 14.6%
Equity interests........................ 60,601 87,294 27,618 49,391
-------- -------- -------- --------
Total......................... $639,171 $647,040 $382,488 $388,554
======== ======== ======== ========
Private finance investments are generally structured as loans and debt
securities that carry a relatively high fixed rate of interest, which may be
combined with equity features, such as conversion privileges, or warrants or
options to purchase a portion of the portfolio company's equity at a nominal
price.
Debt securities would typically have a maturity of five to ten years, with
interest-only payments in the early years and payments of both principal and
interest in the later years, although debt maturities and principal amortization
schedules vary.
Equity interests consist primarily of securities issued by privately owned
companies and may be subject to restrictions on their resale or otherwise
illiquid. Equity securities generally do not produce a current return, but are
held for investment appreciation and ultimate gain on sale.
At December 31, 1999 and 1998, approximately 98% of the Company's private
finance loan portfolio was composed of fixed interest rate loans. At December
31, 1999 and 1998, loans and debt securities with a value of $34,560,000 and
$5,459,000, respectively, were not accruing interest.
44
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PORTFOLIO, CONTINUED
The geographic and industry compositions of the private finance portfolio
at December 31, 1999 and 1998 were as follows:
1999 1998
---- ----
GEOGRAPHIC REGION
Southeast................................................... 27% 23%
Midwest..................................................... 26 27
Mid-Atlantic................................................ 23 28
West........................................................ 11 11
Northeast................................................... 9 4
International............................................... 4 7
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Business Services........................................... 32% 15%
Consumer Products........................................... 19 25
Telecommunications.......................................... 13 14
Industrial Products......................................... 11 8
Retail...................................................... 8 9
Broadcasting................................................ 6 9
Education................................................... 5 8
Other....................................................... 6 12
--- ---
Total............................................. 100% 100%
=== ===
COMMERCIAL REAL ESTATE FINANCE
At December 31, 1999 and 1998, the commercial real estate finance portfolio
consisted of the following:
1999 1998
--------------------------- ---------------------------
COST VALUE YIELD COST VALUE YIELD
-------- -------- ----- -------- -------- -----
(IN THOUSANDS)
Loans........................... $153,767 $154,109 9.4% $232,745 $233,186 10.4%
CMBS............................ 360,950 359,450 13.5% 115,174 113,674 11.2%
REO............................. 7,305 6,470 8,120 8,120
-------- -------- -------- --------
Total................. $522,022 $520,029 $356,039 $354,980
======== ======== ======== ========
LOANS
The commercial mortgage loan portfolio contains loans that were originated
by the Company or were purchased from third-party sellers.
At December 31, 1999 and 1998, approximately 81% and 19%, and 68% and 32%
of the Company's commercial mortgage loan portfolio was composed of fixed and
adjustable interest rate
45
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PORTFOLIO, CONTINUED
loans, respectively. As of December 31, 1999 and 1998, loans with a value of
$8,334,000 and $5,436,000, respectively, were not accruing interest.
The geographic composition and the property types securing the commercial
mortgage loan portfolio at December 31, 1999 and 1998 were as follows:
1999 1998
---- ----
GEOGRAPHIC REGION
Mid-Atlantic................................................ 32% 37%
Southeast................................................... 31 26
West........................................................ 25 24
Midwest..................................................... 9 9
Northeast................................................... 3 4
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Hospitality................................................. 42% 47%
Office...................................................... 24 20
Retail...................................................... 11 14
Recreation.................................................. 8 7
Other....................................................... 15 12
--- ---
Total............................................. 100% 100%
=== ===
CMBS
At December 31,1999 and 1998, the CMBS portfolio consisted of the
following:
1999 1998
------------------- -------------------
COST VALUE COST VALUE
-------- -------- -------- --------
(IN THOUSANDS)
Purchased CMBS.............................. $277,694 $277,694 $ 32,221 $ 32,221
Residual CMBS............................... 76,374 76,374 70,771 70,771
Residual interest spread.................... 6,882 5,382 12,182 10,682
-------- -------- -------- --------
Total............................. $360,950 $359,450 $115,174 $113,674
======== ======== ======== ========
PURCHASED CMBS
The Company has Purchased CMBS bonds with a face amount of $569,234,000 and
a cost of $277,694,000, with the difference representing original issue
discount. As of December 31, 1999 and 1998, the estimated yield to maturity on
the Purchased CMBS was approximately 14.6% and 15%, respectively. The Company's
yield on its Purchased CMBS is based upon a number of assumptions that are
subject to certain business and economic uncertainties and contingencies.
Examples include the timing and magnitude of credit losses on the mortgage loans
underlying the Purchased CMBS that are a result of the general condition of the
real estate market (including competition for tenants and their related credit
quality) and changes in market rental rates. At December 31, 1999 and 1998,
46
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PORTFOLIO, CONTINUED
the yield on the Purchased CMBS portfolio was computed assuming a 1% loss
estimate for its entire underlying collateral mortgage pool. As these
uncertainties and contingencies are difficult to predict and are subject to
future events which may alter these assumptions, no assurance can be given that
the anticipated yields to maturity will be achieved.
The non-investment grade and unrated tranches of the Purchased CMBS bonds
are junior in priority for payment of principal to the more senior tranches of
the related commercial securitization. Cash flow from the underlying mortgages
generally is allocated first to the senior tranches, with the most senior
tranches having a priority right to the cash flow. Then, any remaining cash flow
is allocated, generally, among the other tranches in order of their relative
seniority. To the extent there are defaults and unrecoverable losses on the
underlying mortgages resulting in reduced cash flows, the subordinate tranche
will bear this loss first.
The underlying rating classes of the Purchased CMBS is as follows:
1999 1998
--------------------- --------------------
PERCENTAGE PERCENTAGE
VALUE OF TOTAL VALUE OF TOTAL
-------- ---------- ------- ----------
(IN THOUSANDS)
BB........................................... $ 41,091 14.8% $ 4,109 12.8%
BB-.......................................... 46,692 16.8 4,269 13.2
B+........................................... 41,765 15.0 -- --
B............................................ 64,830 23.4 13,133 40.8
B-........................................... 40,995 14.8 4,711 14.6
CCC.......................................... 6,506 2.3 -- --
Unrated...................................... 35,815 12.9 5,999 18.6
-------- ----- ------- -----
Total.............................. $277,694 100.0% $32,221 100.0%
======== ===== ======= =====
RESIDUAL CMBS AND RESIDUAL INTEREST SPREAD
The Residual CMBS primarily consists of a retained interest from a
post-Merger asset securitization whereby bonds were sold in three classes rated
"AAA," "AA" and "A."
The Company sold $295 million of loans, and received cash proceeds, net of
costs, of approximately $223 million. The Company retained a trust certificate
for its residual interest in the loan pool sold, and will receive interest
income from this Residual CMBS as well as the Residual Interest Spread from the
interest earned on the loans sold less the interest paid on the bonds over the
life of the bonds.
As a result of this securitization, the Company recorded a gain of $14.8
million, net of the costs of the securitization and the cost of settlement of
interest rate swaps. As of December 31, 1999 and 1998, the mortgage loan pool
had an approximate weighted average stated interest rate of 9.3% and 9.4%,
respectively. The three bond classes sold had an aggregate weighted average
interest rate of 6.5% and 6.4% as of December 31, 1999 and 1998, respectively.
The value of the Residual CMBS was determined using a discount rate equal to the
average interest rate of the underlying mortgage loans. The value of the
residual interest spread was determined based on a constant prepayment rate of
7% and a discount rate of 14%.
47
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PORTFOLIO, CONTINUED
The geographic composition and the property types of the underlying
mortgage loan pools securing the CMBS at December 31, 1999 and 1998 were as
follows:
1999 1998
---- ----
GEOGRAPHIC REGION
West........................................................ 32% 18%
Mid-Atlantic................................................ 23 32
Midwest..................................................... 21 20
Southeast................................................... 20 24
Northeast................................................... 4 6
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Retail...................................................... 33% 32%
Housing..................................................... 29 13
Office...................................................... 20 21
Hospitality................................................. 9 23
Other....................................................... 9 11
--- ---
Total............................................. 100% 100%
=== ===
SMALL BUSINESS FINANCE
At December 31,1999 and 1998, the small business finance portfolio
consisted of the following:
1999 1998
----------------- -----------------
COST VALUE COST VALUE
------- ------- ------- -------
(IN THOUSANDS)
7(a) loans...................................... $43,246 $43,000 $57,652 $56,285
Residual interest in loans sold................. 4,036 4,036 -- --
Residual interest spread........................ 14,046 14,046 7,250 7,250
REO............................................. 380 346 50 50
------- ------- ------- -------
Total................................. $61,708 $61,428 $64,952 $63,585
======= ======= ======= =======
The Company, through its wholly owned subsidiary, Allied SBLC, participates
in the SBA's Section 7(a) Guaranteed Loan Program ("7(a) loans").
Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA will
guarantee 80% of any qualified loan up to $100,000 regardless of maturity, and
75% of any such loan over $100,000 regardless of maturity, to a maximum
guarantee of $750,000 for any one borrower. SBA regulations define qualified
small businesses generally as businesses with no more than $5 million in annual
sales or no more than 500 employees.
The Company charges interest on the 7(a) loans at a variable rate,
typically 1.75% to 2.75% above the prime rate, as published in The Wall Street
Journal or other financial newspaper, adjusted monthly. All loans are payable in
equal monthly installments of principal and interest from the date on which the
loan was made to its maturity.
48
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PORTFOLIO, CONTINUED
As permitted by SBA regulations, the Company sells to investors, without
recourse, 100% of the guaranteed portion of its 7(a) loans while retaining the
right to service 100% of such loans. Additionally, the Company sells up to a 90%
interest in the unguaranteed portion of its 7(a) loans through a structured
finance agreement with a commercial paper conduit.
In 1999, the Company sold $36,387,000 of the unguaranteed portion of 7(a)
loans into the facility. The Company received $35,500,000 in proceeds and
retained a subordinated interest valued at $4,036,000. The Company recognized a
premium from the loan sale of $4,106,000, which includes the value of the
retained residual interest spread.
As of December 31, 1999 and 1998, 7(a) loans with a value of $5,562,000 and
$5,806,000, respectively, were not accruing interest.
As of December 31,1999 and 1998, 7(a) loans include a balance of
$7,667,000 and $3,229,000, respectively, that is guaranteed by the SBA.
NOTE 4. DEBT
At December 31, 1999 and 1998, the Company had the following debt:
1999 1998
------------------- -------------------
FACILITY AMOUNT FACILITY AMOUNT
AMOUNT DRAWN AMOUNT DRAWN
-------- -------- -------- --------
(IN THOUSANDS)
Notes payable and debentures:
Unsecured long-term notes payable......... $419,000 $419,000 $180,000 $180,000
SBA debentures............................ 74,650 62,650 74,650 47,650
OPIC loan................................. 5,700 5,700 5,700 5,700
-------- -------- -------- --------
Total notes payable and
debentures...................... 499,350 487,350 260,350 233,350
======== ======== ======== ========
Revolving credit facilities:
Revolving line of credit.................. 340,000 82,000 200,000 95,000
Master loan and security agreement........ 100,000 23,500 250,000 6,000
-------- -------- -------- --------
Total revolving credit
facilities...................... 440,000 105,500 450,000 101,000
-------- -------- -------- --------
Total..................................... $939,350 $592,850 $710,350 $334,350
======== ======== ======== ========
NOTES PAYABLE AND DEBENTURES
UNSECURED LONG-TERM NOTES PAYABLE
In June 1998, May 1999 and November 1999, the Company issued unsecured
long-term notes to private institutional investors. The notes require
semi-annual interest payments until maturity and have terms of five or seven
years. The weighted average interest rate on the notes was 7.6% and 7.2% at
December 31, 1999 and 1998, respectively. The notes may be prepaid in whole or
in part together with an interest premium, as stipulated in the note agreement.
49
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. DEBT, CONTINUED
SBA DEBENTURES
At December 31, 1999 and 1998, the Company had debentures payable to the
SBA with terms of ten years and at interest rates ranging from 6.6% to 9.6%. The
debentures require semi-annual interest-only payments with all principal due
upon maturity. The SBA debentures are subject to prepayment penalties if paid
prior to maturity.
Scheduled future maturities of notes payable and debentures at December 31,
1999 are as follows:
YEAR AMOUNT MATURING
---- ---------------
(IN THOUSANDS)
2000........................................................ $ 17,300
2001........................................................ 9,350
2002........................................................ --
2003........................................................ 140,000
2004........................................................ 221,000
Thereafter.................................................. 99,700
--------
Total............................................. $487,350
========
REVOLVING CREDIT FACILITIES
REVOLVING LINE OF CREDIT
In May 1999, the Company increased its unsecured revolving line of credit
to $340,000,000 from $315,000,000. The facility bears interest at the London
Interbank Offer Rate ("LIBOR") plus 1.25% and adjusts at the beginning of each
new interest period, usually every thirty days. The interest rates were 7.7% and
6.9% at December 31, 1999 and December 31, 1998, respectively, and the facility
requires a commitment fee equal to 0.25% of the committed amount. The new line
expires in March 2001. The line of credit requires monthly interest payments and
all principal is due upon its expiration. In January 2000, the Company increased
its unsecured revolving line of credit to $360,000,000.
MASTER LOAN AND SECURITY AGREEMENT
The Company has a facility to borrow up to $100,000,000, using certain
commercial mortgage loans as collateral. The Company pledges commercial mortgage
loans as collateral for the facility such that the amount borrowed is
approximately equal to 80% of the value of the collateral pledged. The agreement
generally requires interest-only payments with all principal due at maturity.
Principal may be repaid at any time without penalty. The agreement bears
interest at the one-month LIBOR plus 1.0%, and adjusts daily, or 6.8% and 6.6%
at December 31, 1999 and 1998, respectively. The agreement matures on October
27, 2000.
The average debt outstanding on the revolving credit facilities was
$123,860,000 and $73,836,000 for the years ended December 31, 1999 and 1998,
respectively. The maximum amount borrowed under these facilities and the
weighted average interest rate for the years ended December 31, 1999 and 1998,
were $199,392,000 and $135,000,000, and 6.5% and 6.7%, respectively.
50
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. INCOME TAXES
For the years ended December 31, 1999, 1998 and 1997, the Company's
effective tax rate was 0.0%, 1.0% and 2.3%, respectively.
For the year ended December 31, 1998, the Company incurred income tax
expense of $787,000, which resulted from the realization of a taxable net
built-in gain associated with property owned by Advisers prior to the Merger.
For the year ended December 31, 1997, the Company's income was subject to
federal and state taxes related to the income generated by the pre-Merger
operations of Advisers.
NOTE 6. PREFERRED STOCK
Allied Investment has outstanding a total of 60,000 shares of $100 par
value, 3% cumulative preferred stock and 10,000 shares of $100 par value, 4%
redeemable cumulative preferred stock issued to the SBA pursuant to Section
303(c) of the Small Business Investment Act of 1958, as amended. The 3%
cumulative preferred stock does not have a required redemption date. Allied
Investment has the option to redeem in whole or in part the preferred stock by
paying the SBA the par value of such securities and any dividends accumulated
and unpaid to the date of redemption. The 4% redeemable cumulative preferred
stock has a required redemption date in June 2005.
NOTE 7. SHAREHOLDERS' EQUITY
Sale of common stock in 1999 and 1998 was as follows:
1999 1998
-------- -------
(IN THOUSANDS)
Number of common shares..................................... 8,659 4,367
Gross proceeds.............................................. $172,539 $73,736
Less costs including underwriting fees...................... (8,270) (4,061)
-------- -------
Net proceeds.............................................. $164,269 $69,675
======== =======
The Company has a dividend reinvestment plan, whereby the Company may buy
shares of its common stock in the open market or issue new shares in order to
satisfy dividend reinvestment requests. If the Company issues new shares, the
issue price is equal to the average of the closing sale prices reported for the
Company's common stock for the five consecutive days immediately prior to the
dividend payment date.
Dividend reinvestment plan activity for 1999, 1998 and 1997 was as follows:
1999 1998 1997
------- ------- -------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Shares issued............................................... 233 241 551
Average price per share..................................... $19.43 $20.35 $15.67
51
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. EARNINGS PER COMMON SHARE
1999 1998 1997
------- ------- -------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net increase in net assets resulting from operations........ $98,570 $78,078 $61,304
Less preferred stock dividends.............................. (230) (230) (220)
------- ------- -------
Income available to common shareholders..................... $98,340 $77,848 $61,084
======= ======= =======
Basic shares outstanding.................................... 59,877 51,941 49,218
Options outstanding to officers............................. 167 33 33
------- ------- -------
Diluted shares outstanding.................................. 60,044 51,974 49,251
======= ======= =======
BASIC EARNINGS PER COMMON SHARE............................. $ 1.64 $ 1.50 $ 1.24
======= ======= =======
DILUTED EARNINGS PER COMMON SHARE........................... $ 1.64 $ 1.50 $ 1.24
======= ======= =======
NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN, 401(K) PLAN AND DEFERRED COMPENSATION
PLAN
The Company had an employee stock ownership plan ("ESOP"). Pursuant to the
ESOP, the Company was obligated to contribute 5% of each eligible participant's
total cash compensation for the year to a plan account on the participant's
behalf, which vested over a two-year period. ESOP contributions were used to
purchase shares of the Company's common stock.
As of December 31, 1999 and 1998, the ESOP held 303,210 shares and 282,500
shares, respectively, of the Company's common stock, all of which had been
allocated to participants' accounts. The plan is funded annually and the total
ESOP contribution expense for the years ended December 31, 1999, 1998, and 1997
was $641,000, $489,000 and $351,000, respectively, net of forfeitures of $4,100,
$4,000, and $0, respectively. In 1999, the Company established a 401(k) plan
(see below) and elected to terminate the ESOP Plan in 2000. During 2000, the
ESOP assets will be transferred into the 401(k) plan.
The Company has a 401(k) retirement investment plan, which is open to all
of its employees. The employees may elect voluntary wage deferrals ranging from
0% to 15% of taxable compensation for the year. In 2000, the Company will begin
making contributions to the 401(k) plan under the same terms that ESOP
contributions were made.
The Company also has a deferred compensation plan (the "DC Plan"). Eligible
participants in the DC Plan may elect to defer some of their compensation and
have such compensation credited to a participant account. All amounts credited
to a participant's account shall be credited solely for purposes of accounting
and computation and remain assets of the Company and subject to the claims of
the Company's general creditors. Amounts credited to participants under the DC
Plan are at all times 100% vested and non-forfeitable except for amounts
credited to participants' accounts related to the Formula Award (see Note 11). A
participant's account shall become distributable upon his or her separation from
service, retirement, disability, death or at a future determined date. All DC
Plan accounts will be distributed in the event of a change of control of the
Company or in the event of the Company's insolvency. Amounts deferred by
participants under the DC Plan are funded to a trust, the trustee of which
administers the DC Plan on behalf of the Company.
52
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. STOCK OPTION PLAN
In conjunction with the Merger, all stock option plans that existed for
Allied Lending and the Predecessor Companies before the Merger ("Old Plans")
were cancelled on December 31, 1997, and at a special meeting of shareholders on
November 26, 1997, the Company's shareholders approved a new stock option plan
("Option Plan") for the Company to be effected post-Merger.
THE OPTION PLAN
The purpose of the Option Plan is to provide officers and non-officer
directors of the Company with additional incentives. Options may be granted from
time to time on up to 6,250,000 shares, which represents approximately 10% of
the outstanding shares as of December 31, 1999.
Options are exercisable at a price equal to the fair market value of the
shares on the day the option is granted. Each option states the period or
periods of time within which the option may be exercised by the optionee, which
may not exceed ten years from the date the option is granted.
All rights to exercise options terminate 60 days after an optionee ceases
to be (i) a non-officer director, (ii) both an officer and a director, if such
optionee serves in both capacities, or (iii) an officer (if such officer is not
also a director) of the Company for any cause other than death or total and
permanent disability. In the event of a change of control of the Company, all
outstanding options will become fully vested and exercisable as of the change of
control.
Information with respect to options granted, exercised and forfeited under
the Option Plan for the years ended December 31, 1999 and 1998 is as follows:
WEIGHTED
AVERAGE
OPTION PRICE
SHARES PER SHARE
------ ------------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Options outstanding at January 1, 1998...................... -- $ --
Granted..................................................... 5,190 20.16
Exercised................................................... (10) 21.38
Forfeited................................................... (66) 21.38
----- ------
Options outstanding at December 31, 1998.................... 5,114 $20.14
Granted..................................................... 1,288 19.75
Exercised................................................... (318) 19.07
Forfeited................................................... (195) 20.00
----- ------
Options outstanding at December 31,1999..................... 5,889 $20.12
===== ======
OLD PLAN ACTIVITY
During 1997, the Predecessor Companies granted 1,474,000 options under the
Old Plans at exercise prices ranging from $9.53 to $22.58 per share. Total
shares issued pursuant to the exercise of stock options totaled 2,395,000 during
1997.
53
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. STOCK OPTION PLAN, CONTINUED
NOTES RECEIVABLE FROM THE SALE OF COMMON STOCK
The Company provides loans to officers for the exercise of options. The
loans have varying terms not exceeding ten years, bear interest at the
applicable federal interest rate in effect at the date of issue and have been
recorded as a reduction to shareholders' equity. For the years ended December
31, 1999, 1998 and 1997, the Company had outstanding loans to officers of
$29,461,000, $23,735,000, and $29,611,000, respectively. Officers with
outstanding loans repaid principal of $195,000, $5,591,000, and $6,534,000 for
the years ended December 31, 1999, 1998 and 1997, respectively. The Company
recognized interest income from these loans of $1,539,000, $1,600,000, and
$1,031,000, respectively, during these same periods.
The following table summarizes information about stock options outstanding
at December 31, 1999:
TOTAL WEIGHTED AVERAGE TOTAL
RANGE OF NUMBER REMAINING WEIGHTED NUMBER WEIGHTED
EXERCISE OUTSTANDING CONTRACTUAL LIFE AVERAGE EXERCISABLE AVERAGE
PRICES AT 12/31/99 (YEARS) EXERCISE PRICE AT 12/31/99 EXERCISE PRICE
-------- ----------- ---------------- -------------- ------------ --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND YEARS)
$15.19-$17.75.......... 774 9.75 $17.25 154 $16.92
$17.88................. 1,196 8.94 $17.88 265 $17.88
$18.50-$19.94.......... 238 9.26 $19.55 55 $19.50
$21.38................. 3,157 8.02 $21.38 1,045 $21.38
$22.00-$22.50.......... 524 9.65 $22.16 170 $22.11
----- ---- ------ ----- ------
$15.19-$22.50.......... 5,889 8.63 $20.12 1,689 $20.43
===== ==== ====== ===== ======
The Company accounts for its stock options as required by the Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," and
no compensation cost has been recognized. Had compensation cost for the plan
been determined consistent with SFAS No. 123 "Accounting for Stock Based
Compensation," the Company's net increase in net assets resulting from
operations and basic and diluted earnings per common share would have been
reduced to the following pro forma amounts:
1999 1998 1997
-------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net increase in net assets resulting from
operations:
As reported.................................. $98,570 $78,078 $61,304
Pro forma.................................... $94,510 $72,684 $60,656
Basic earnings per common share:
As reported.................................. $1.64 $1.50 $1.24
Pro forma.................................... $1.58 $1.39 $1.23
Diluted earnings per common share:
As reported.................................. $1.64 $1.50 $1.24
Pro forma.................................... $1.57 $1.39 $1.23
Pro forma expenses are based on the underlying value of the options granted
by the Company and the Predecessor Companies. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model, with the following weighted average assumptions for
54
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. STOCK OPTION PLAN, CONTINUED
grants: risk-free interest rate of 5.9%, 5.0% and 5.7% for 1999, 1998 and 1997,
respectively; expected life of approximately five years for all options granted;
expected volatility of 37%, 35% and 35% for 1999, 1998 and 1997, respectively.
NOTE 11. CUT-OFF AWARD AND FORMULA AWARD
The Predecessor Companies' existing stock option plans were canceled and
the Company established a cut-off dollar amount for all existing, but unvested
options as of the date of the Merger (the "Cut-off Award"). The Cut-off Award
was computed for each unvested option as of the Merger date. The Cut-off Award
was equal to the difference between the market price on August 14, 1997 (the
Merger announcement date) of the shares of stock underlying the option less the
exercise price of the option. The Cut-off Award was payable for each unvested
option upon the future vesting date of that option. The Cut-off Award was
designed to cap the appreciated value in unvested options at the Merger
announcement date, in order to set the foundation to balance option awards upon
the Merger. The Cut-off Award approximated $2.9 million in the aggregate and has
been expensed as the Cut-off Award vests. For the years ended December 31, 1999
and 1998, $532,000 and $807,000, respectively, of the Cut-off Award vested.
The Formula Award was established to compensate employees from the point
when their unvested options would cease to appreciate in value (the Merger
announcement date), up until the time at which they would be able to receive
option awards in ACC post-merger. In the aggregate, the Formula Award equaled 6%
of the difference between an amount equal to the combined aggregated market
capitalizations of the Predecessor Companies as of the close of the market on
the day before the Merger date (December 30, 1997), less an amount equal to the
combined aggregate market capitalizations of Allied Lending and the Predecessor
Companies as of the close of the market on the Merger announcement date.
Advisers' compensation committee allocated the Formula Award to individual
officers on December 30, 1997. The amount of the Formula Award as computed at
December 30, 1997 was $18,994,000. This amount was contributed to the Company's
deferred compensation trust under the DC Plan (see Note 9) and was used to
purchase shares of the Company's stock (included in common stock held in
deferred compensation trust). The Formula Award vests equally in three
installments on December 31, 1998, 1999 and 2000; provided, however, that such
Formula Award vests immediately upon a change in control of the Company. The
Formula Award has been expensed in each year in which it vests. For the years
ended December 31, 1999 and 1998, $6,221,000 and $6,241,000, respectively, was
expensed as a result of the Formula Award. At December 31, 1999 and 1998, the
liability related to the Formula Award was $6,221,000 and $6,241,000,
respectively, and has been included in common stock held in deferred
compensation trust. Vested Formula Awards are distributable to recipients at the
Company's discretion, however, sale of the Company's stock by the recipients is
restricted. Unvested Formula Awards are forfeited upon a recipient's separation
from service and the related Company stock is retired. During 1999 and 1998,
$61,000 and $270,000, respectively, of the Formula Award was forfeited.
On January 3, 2000 and January 4, 1999, the Company distributed shares of
the Company's common stock with a value of $4,274,000 and $4,062,000,
respectively, representing the portion of the Formula Award that vested during
the previous year.
55
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. DIVIDENDS AND DISTRIBUTIONS
For the years ended December 31, 1999, 1998 and 1997, the Company declared
the following distributions:
1999 1998 1997
------------------- ------------------- -------------------
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- --------- ------- --------- ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
First quarter......................... $23,286 $0.40 $18,025 $0.35 $14,347 $0.30
Second quarter........................ 23,746 0.40 17,966 0.35 14,795 0.30
Third quarter......................... 24,768 0.40 17,976 0.35 15,548 0.31
Fourth quarter........................ 26,141 0.40 19,444 0.35 31,022 0.61
Annual extra distribution............. -- -- 1,676 0.03 1,118 0.02
Special undistributed earnings
distribution........................ -- -- -- -- 8,848 0.17
------- ----- ------- ----- ------- -----
Total distributions to common
shareholders........................ $97,941 $1.60 $75,087 $1.43 $85,678 $1.71
======= ===== ======= ===== ======= =====
For income tax purposes, distributions for 1999, 1998 and 1997 were
composed of the following:
1999 1998 1997
------------------- ------------------- -------------------
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- --------- ------- --------- ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Ordinary income....................... $76,948 $1.26 $49,397 $0.94 $39,356 $0.79
Long-term capital gains............... 20,993 0.34 25,690 0.49 31,037 0.62
Return of capital (tax)............... -- -- -- -- 6,437 0.13
------- ----- ------- ----- ------- -----
Total distributions before special
distribution........................ 97,941 1.60 75,087 1.43 76,830 1.54
------- ----- ------- ----- ------- -----
Special undistributed earnings
distribution........................ -- -- -- 8,848 0.17
Total distributions to common
shareholders........................ $97,941 $1.60 $75,087 $1.43 $85,678 $1.71
======= ===== ======= ===== ======= =====
56
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. DIVIDENDS AND DISTRIBUTIONS, CONTINUED
The following table summarizes the differences between financial statement
net income and taxable income for the years ended December 31, 1999, 1998 and
1997:
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
Financial statement net income............................ $98,570 $78,078 $61,304
Adjustments:
Net unrealized gains................................. (2,138) (1,079) (7,209)
Amortization of discount............................. 129 2,207 (1,124)
Post-Merger gain on securitization of commercial
mortgage loans..................................... -- (14,812) --
Interest income from securitized commercial mortgage
loans.............................................. 4,640 4,910 --
Gains from disposition of portfolio assets........... (4,547) 1,177 17,890
Expenses not deductible for tax:
Merger expenses................................. -- -- 5,159
Formula award................................... 2,158 6,242 --
Other........................................... 1,053 1,393 853
Other................................................ (1,492) (3,816) (9,050)
Income tax expense................................... -- 787 1,444
------- ------- -------
Taxable income....................................... $98,373 $75,087 $69,267
======= ======= =======
NOTE 13. CONCENTRATIONS OF CREDIT RISK
The Company places its cash with financial institutions and, at times, cash
held in checking accounts in financial institutions may be in excess of the
Federal Deposit Insurance Corporation insured limit. At December 31, 1999 and
1998, cash and cash equivalents consisted of the following:
1999 1998
------- -------
(IN THOUSANDS)
Cash and cash equivalents................................... $24,419 $31,833
Less escrows held........................................... (6,264) (6,758)
------- -------
Total cash and cash equivalents................... $18,155 $25,075
======= =======
NOTE 14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
During 1999, 1998 and 1997, the Company paid $21,092,000, $21,708,000 and
$26,874,000, respectively, for interest and income taxes. During 1999, 1998 and
1997, the Company's non-cash financing activities totaled $10,241,000,
$6,237,000 and $48,207,000, respectively, related primarily to common stock
issuance resulting from stock option exercises and dividend reinvestment shares
issued. During 1999, 1998 and 1997, the Company's non-cash investing activities
totaled $19,320,000, $1,265,000 and $12,022,000, respectively.
57
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15. SELECTED QUARTERLY DATA (UNAUDITED)
1999
-----------------------------------------
QTR 1 QTR 2 QTR 3 QTR 4
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total interest and related portfolio income............. $27,678 $33,186 $37,998 $42,278
Portfolio income before realized and unrealized gains... $13,830 $16,619 $19,273 $21,319
Net increase in net assets resulting from operations.... $18,580 $22,121 $26,944 $30,925
Basic earnings per common share......................... $ 0.33 $ 0.38 $ 0.44 $ 0.49
Diluted earnings per common share....................... $ 0.33 $ 0.38 $ 0.44 $ 0.49
1998
-------------------------------------
QTR 1 QTR 2 QTR 3 QTR 4
------- ------- ------- -------
Total interest and related portfolio income............. $36,897 $21,321 $22,546 $25,974
Portfolio income before realized and unrealized gains... $24,920 $ 9,148 $ 9,401 $11,776
Net increase in net assets resulting from operations.... $32,065 $14,476 $14,906 $16,631
Basic earnings per common share......................... $ 0.62 $ 0.28 $ 0.29 $ 0.31
Diluted earnings per common share....................... $ 0.61 $ 0.28 $ 0.29 $ 0.31
58
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1999
-------------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
CAPITAL INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
---------- ---------- ------- ------- ------------ ------------
(IN THOUSANDS)
ASSETS
Portfolio at value:
Private finance.................... $ 513,835 $133,205 $ -- $ -- $ -- $ 647,040
Commercial real estate finance..... 422,514 4,530 -- 92,985 -- 520,029
Small business finance............. -- -- 61,428 -- -- 61,428
Investments in subsidiaries........ 162,161 -- -- -- (162,161) --
---------- -------- ------- ------- --------- ----------
Total portfolio at value...... 1,098,510 137,735 61,428 92,985 (162,161) 1,228,497
---------- -------- ------- ------- --------- ----------
Cash and cash equivalents.............. 10,198 3,361 2,256 2,340 -- 18,155
Intercompany notes and receivables..... 77,748 682 618 4 (79,052) --
Other assets........................... 35,113 2,771 4,299 1,203 -- 43,386
---------- -------- ------- ------- --------- ----------
Total assets.................. $1,221,569 $144,549 $68,601 $96,532 $(241,213) $1,290,038
========== ======== ======= ======= ========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable and debentures....... $ 424,700 $ 62,650 $ -- $ -- $ -- $ 487,350
Revolving credit facilities........ 105,500 -- -- -- -- 105,500
Accounts payable and other
liabilities...................... 19,476 794 2,202 203 -- 22,675
Dividends and distributions
payable.......................... -- 6,131 7,791 3,861 (17,783) --
Intercompany notes and payables.... 4,380 9,500 38,664 8,726 (61,270) --
---------- -------- ------- ------- --------- ----------
Total liabilities............. 554,056 79,075 48,657 12,790 (79,053) 615,525
---------- -------- ------- ------- --------- ----------
Commitments and Contingencies
Preferred stock........................ -- 7,000 -- -- -- 7,000
Shareholders' Equity:
Common stock....................... 6 -- -- 1 (1) 6
Additional paid-in capital......... 699,149 36,673 17,643 81,129 (135,445) 699,149
Common stock held in deferred
compensation trust............... (6,218) -- -- -- -- (6,218)
Notes receivable from sale of
common stock..................... (29,461) -- -- -- -- (29,461)
Net unrealized appreciation
(depreciation) on portfolio...... 4,517 2,056 (970) (2,415) 1,329 4,517
Undistributed (distributions in
excess of) earnings.............. (480) 19,745 3,271 5,027 (28,043) (480)
---------- -------- ------- ------- --------- ----------
Total shareholders' equity.... 667,513 58,474 19,944 83,742 (162,160) 667,513
---------- -------- ------- ------- --------- ----------
Total liabilities and
shareholders' equity........ $1,221,569 $144,549 $68,601 $96,532 $(241,213) $1,290,038
========== ======== ======= ======= ========= ==========
The accompanying notes are an integral part of these consolidating financial
statements.
59
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
-----------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
CAPITAL INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
-------- ---------- ------- ------- ------------ ------------
(IN THOUSANDS)
Interest and Related Portfolio
Income
Interest................... $ 91,863 $11,465 $ 7,931 $ 8,513 $ -- $119,772
Intercompany interest...... 6,237 -- -- -- (6,237) --
Premiums from loan
dispositions............. 4,525 40 9,719 -- -- 14,284
Income from investments in
wholly owned
subsidiaries............. 34,761 -- -- -- (34,761) --
Investment advisory fees
and other income......... 6,574 423 318 (231) -- 7,084
-------- ------- ------- ------- -------- --------
Total interest and
related portfolio
income.............. 143,960 11,928 17,968 8,282 (40,998) 141,140
-------- ------- ------- ------- -------- --------
Expenses
Interest................... 30,765 4,074 6 15 -- 34,860
Intercompany interest...... -- 285 4,648 1,304 (6,237) --
Employee................... 16,136 -- -- -- -- 16,136
Administrative............. 11,000 56 878 416 -- 12,350
-------- ------- ------- ------- -------- --------
Total operating
expenses............ 57,901 4,415 5,532 1,735 (6,237) 63,346
-------- ------- ------- ------- -------- --------
Formula and cut-off
awards................... 6,753 -- -- -- -- 6,753
-------- ------- ------- ------- -------- --------
Portfolio income before net
realized and unrealized
gains......................... 79,306 7,513 12,436 6,547 (34,761) 71,041
-------- ------- ------- ------- -------- --------
Net Realized and Unrealized
Gains
Net realized gains
(losses)................. 17,126 9,667 (1,000) (402) -- 25,391
Net unrealized gains
(losses)................. 2,138 593 1,104 (915) (782) 2,138
-------- ------- ------- ------- -------- --------
Total net realized and
unrealized gains
(losses)............ 19,264 10,260 104 (1,317) (782) 27,529
-------- ------- ------- ------- -------- --------
Net increase in net assets
resulting from operations..... $ 98,570 $17,773 $12,540 $ 5,230 $(35,543) $ 98,570
======== ======= ======= ======= ======== ========
The accompanying notes are an integral part of these consolidating financial
statements.
60
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1999
--------------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
CAPITAL INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
--------- ---------- -------- -------- ------------ ------------
(IN THOUSANDS)
Cash Flows from Operating
Activities
Net increase in net assets
resulting from operations.... $ 98,570 $ 17,773 $ 12,540 $ 5,230 $(35,543) $ 98,570
Adjustments
Net unrealized (gains)
losses.................... (2,138) (593) (1,104) 915 782 (2,138)
Depreciation and
amortization.............. 788 -- -- -- -- 788
Amortization of loan
discounts and fees........ (9,079) (761) (834) -- -- (10,674)
Changes in other assets and
liabilities............... (8,344) (64) (1,642) 1,338 -- (8,712)
--------- -------- -------- -------- -------- ---------
Net cash provided by
operating activities.... 79,797 16,355 8,960 7,483 (34,761) 77,834
--------- -------- -------- -------- -------- ---------
Cash Flows from Investing
Activities
Portfolio investments........ (596,725) (67,022) (88,124) -- -- (751,871)
Repayments of investment
principal................. 91,851 26,012 6,719 21,124 -- 145,706
Proceeds from loan sales..... 104,706 -- 93,662 -- -- 198,368
Net change in intercompany
investments............... 10,389 9,705 (7,980) (21,280) 9,166 --
Collections of notes
receivable from sale of
common stock.............. 195 -- -- -- -- 195
Other investing activities... 4,805 574 (8,198) 1,065 -- (1,754)
--------- -------- -------- -------- -------- ---------
Net cash (used in)
provided by investing
activities.............. (384,779) (30,731) (3,921) 909 9,166 (409,356)
--------- -------- -------- -------- -------- ---------
Cash Flows from Financing
Activities
Sale of common stock......... 164,269 -- -- -- -- 164,269
Common dividends and
distributions paid........ (95,031) -- -- -- -- (95,031)
Dividends paid to parent
company................... -- (12,111) (5,559) (7,925) 25,595 --
Preferred stock dividends
paid...................... 40 (220) -- (50) -- (230)
Net borrowings under notes
payable and debentures.... 239,000 15,000 -- -- -- 254,000
Net borrowings under
revolving lines of
credit.................... 4,500 -- -- -- -- 4,500
Other financing activities... (2,906) -- -- -- -- (2,906)
--------- -------- -------- -------- -------- ---------
Net cash provided by (used
in) financing
activities.............. 309,872 2,669 (5,559) (7,975) 25,595 324,602
--------- -------- -------- -------- -------- ---------
Net increase (decrease) in cash and
cash equivalents................. $ 4,890 $(11,707) $ (520) $ 417 $ -- $ (6,920)
--------- -------- -------- -------- -------- ---------
Cash and cash equivalents at
beginning of year................ $ 5,308 $ 15,068 $ 2,776 $ 1,923 $ -- $ 25,075
--------- -------- -------- -------- -------- ---------
Cash and cash equivalents at end of
year............................. $ 10,198 $ 3,361 $ 2,256 $ 2,340 $ -- $ 18,155
========= ======== ======== ======== ======== =========
The accompanying notes are an integral part of these consolidated financial
statements.
61
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF ALLIED CAPITAL CORPORATION AND
SUBSIDIARIES:
We have audited the consolidated balance sheet of Allied Capital
Corporation and subsidiaries as of December 31, 1999 and 1998, including the
consolidated statement of investments as of December 31, 1999, and the related
consolidated statements of operations, changes in net assets and cash flows for
each of the three years in the period ended December 31, 1999. These
consolidated financial statements and supplementary consolidating financial
information referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and supplementary consolidating financial information
referred to below based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. These procedures
included physical counts of investments. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 3, the consolidated financial statements include
investments valued at $1,228,497,000 as of December 31, 1999 and $807,119,000 as
of December 31, 1998, (95 percent and 94 percent, respectively, of total assets)
whose values have been estimated by the board of directors in the absence of
readily ascertainable market values. We have reviewed the procedures used by the
board of directors in arriving at its estimate of value of such investments and
have inspected the underlying documentation, and in the circumstances we believe
the procedures are reasonable and the documentation appropriate. However,
because of the inherent uncertainty of valuation, the board of directors'
estimate of values may differ significantly from the values that would have been
used had a ready market existed for the investments, and the differences could
be material.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Allied
Capital Corporation and subsidiaries as of December 31, 1999 and 1998, and the
consolidated results of their operations, changes in net assets and cash flows
for each of the three years in the period then ended in conformity with
generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
consolidating balance sheet and related consolidating statements of operations
and cash flows are presented for purposes of additional analysis and are not a
required part of the basic financial statements. This information has been
subjected to the auditing procedures applied in our audit of the basic
consolidated financial statements and in our opinion, is fairly stated in all
material respects in relation to the basic financial statements taken as a
whole.
/s/ Arthur Anderson
Vienna, Virginia
February 14, 2000
62
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
BOARD OF DIRECTORS AND MANAGEMENT
Directors
WILLIAM L. WALTON(1,2)
Chairman and Chief Executive Officer,
Allied Capital Corporation
GEORGE C. WILLIAMS, JR.(1)
Chairman Emeritus, Allied Capital Corporation
BROOKS H. BROWNE(3,4)
President, Environmental Enterprises
Assistance Fund
JOHN D. FIRESTONE(3)
Partner, Secor Group
ANTHONY T. GARCIA(3)
General Manager, Breen Capital Group
LAWRENCE I. HEBERT(2)
Director and President, Perpetual Corporation
JOHN I. LEAHY(1,4)
President, Management and Marketing Associates
ROBERT E. LONG(1,3)
Managing Director, Goodwyn Long & Black
Investment Management, Inc.
WARREN K. MONTOURI(1)
Partner, Montouri & Roberson
GUY T. STEUART, II(2,4)
Director and President, Steuart Investment
Corporation
T. MURRAY TOOMEY, ESQ.(2)
Attorney at Law
LAURA W. VAN ROIJEN(2)
Private Real Estate Investor
Executive Management
WILLIAM L. WALTON
Chairman and Chief Executive Officer
GEORGE C. WILLIAMS, JR.
Chairman Emeritus
PHILIP A. MCNEILL
Managing Director
JOHN M. SCHEURER
Managing Director
JOAN M. SWEENEY
Managing Director
G. CABELL WILLIAMS, III
Managing Director
Principals
THOMAS H. AIKEN
KELLY A. ANDERSON
SCOTT S. BINDER
ARTHUR S. COOPER
DOUGLAS L. COOPER
TRICIA B. DANIELS
CHRISTINA L. DELDONNA
RICHARD E. FEARON, JR.
MICHAEL P. GAFFNEY
MICHAEL J. GRISIUS
SAMUEL B. GUREN
JOHN J. HALL, JR.
PATRICK J. HARRINGTON
ROBERT M. MONK
DIANE E. MURPHY
MARY E. OLSON
CARR T. PRESTON
PENNI F. ROLL
JAMES P. SHEVLIN
SUZANNE V. SPARROW
THOMAS H. WESTBROOK
(1) Executive Committee (2) Nominating Committee (3) Compensation Committee
(4) Audit Committee
63
[GRAPHIC] STOCKHOLDER INFORMATION
Corporate Headquarters
WASHINGTON, DC
1919 Pennsylvania Avenue, NW
Washington, DC 20006
Telephone: 202.331.1112
Fax: 202.659.2053
info@alliedcapital.com
www.alliedcapital.com
Please visit our web site for a complete listing of regional offers
nationwide.
Market Listing
Allied Capital Corporation common stock is listed on the Nasdaq National
Market under the trading symbol ALLC. The abbreviation often used in
newspaper stock listings is "AldCap." There were approximately 4,500
shareholders of record and 45,000 beneficial shareholders of the Company
as of December 31, 1999.
Stock Transfer Agent and Registrar
Investors with questions concerning account information, issuing new
certificates, replacing lost or stolen certificates, transferring
securities, participating in the Dividend Reinvestment Plan, dividend
payments, requesting payments, requesting direct deposit information or
processing a change of address should contact:
AMERICAN STOCK TRANSFER & TRUST COMPANY
40 Wall Street, 46th Floor
New York, NY 10005
Telephone: 800.937.5449 or 212.936.5100
www.amstock.com
Investor Relations Contact
SUZANNE V. SPARROW, PRINCIPAL
Toll free: 888.818.5298
ir@alliedcapital.com
Information Requests
Allied Capital Corporation's Annual Report on Form 10-K and all quarterly
reports on Form 10-Q, as filed with the Securities and Exchange Commission
will be provided without charge to shareholders upon written requests to
the Investor Relations Department at the Company's corporate
headquarters.
Independent Public Accountants
ARTHUR ANDERSEN LLP
Vienna, VA
Corporate Counsel
SUTHERLAND, ASBILL & BRENNAN LLP
Washington, DC
Annual Meeting of Stockholders
The Company's Annual Meeting of Stockholders will be held at 10:00 AM on
Tuesday, May 9, 2000, at the St. Regis Hotel, 923 16th Street, NW,
Washington DC.
All stockholders are welcome to attend.
QUARTERLY STOCK PRICES FOR 1999 AND 1998
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1999 1998
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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
High $20.25 $24.00 $23.81 $23.13 $27.69 $29.00 $24.81 $18.88
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Low $16.50 $17.00 $20.25 $16.75 $21.00 $21.75 $14.94 $12.50
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Close $18.38 $24.00 $22.44 $18.31 $27.69 $24.50 $17.75 $17.31
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