1
EXHIBIT 13
SELECTED CONSOLIDATED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1997* 1996 1995 1994 1993
DIVIDENDS AND DISTRIBUTIONS
Total tax distributions $85,678 $57,398 $47,920 $39,947 $29,722
Total tax distributions per common share:
Ordinary income $0.79 $0.89 $0.86 $0.70 $0.44
Net capital gains 0.62 0.34 0.23 0.22 0.30
Return of capital 0.13 -- -- 0.02 --
Special undistributed earnings distribution 0.17 -- -- -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total tax distributions per common share $1.71 $1.23 $1.09 $0.94 $0.74
=================================================================================================================================
OPERATIONS
Total interest and related portfolio income $97,405 $84,937 $68,817 $52,155 $37,668
Total expenses excluding merger expenses $46,180 $37,361 $27,274 $21,585 $18,004
Merger expenses $5,159 -- -- -- --
Portfolio income before realized and
unrealized gains (losses) $46,066 $47,576 $41,543 $30,570 $19,664
Net realized gains (losses) $10,704 $19,155 $12,000 $6,236 $(2,569)
Net unrealized gains (losses) $7,209 $(7,412) $9,266 $(2,244) $2,039
Total net realized and unrealized gains (losses) $17,913 $11,743 $21,266 $3,992 $(530)
Net increase in net assets resulting
from operations $61,304 $54,947 $60,479 $33,890 $18,963
Basic earnings per common share $1.24 $1.19 $1.38 $0.80 $0.46
Diluted earnings per common share $1.24 $1.17 $1.37 $0.79 $0.46
Basic earnings per common share excluding
merger expenses $1.35 $1.19 $1.38 $0.80 $0.46
Weighted average common shares outstanding 49,218 46,172 43,697 42,463 40,466
BALANCE SHEET
Portfolio at value $697,021 $607,368 $528,483 $443,316 $334,193
Portfolio at cost $690,720 $613,276 $526,979 $451,078 $339,711
Total assets $807,775 $713,360 $605,434 $501,817 $435,268
Total debt outstanding $347,663 $274,997 $200,339 $130,236 $69,800
Preferred stock issued to SBA $7,000 $7,000 $7,000 $7,000 $7,000
Shareholders' equity $420,060 $402,134 $367,192 $344,043 $342,904
Shareholders' equity per common share $8.07 $8.34 $8.26 $8.02 $8.11
Common share market value at end of year** $22.25 $15.25 $13.25 $10.38 $15.75
Common shares outstanding at end of year 52,047 48,238 44,479 42,890 42,306
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.
*IN 1997, 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.
**THE STOCK PRICES INDICATED ARE THOSE OF ALLIED CAPITAL LENDING CORPORATION,
THE SURVIVING COMPANY IN THE MERGER OF THE FIVE ALLIED CAPITAL COMPANIES,
WHICH WAS COMPLETED ON DECEMBER 31, 1997.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS
The information contained in this section should be read in conjunction with
the Company's 1997 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.
THE MERGER
On December 31, 1997, Allied Capital Corporation ("Allied I"), Allied Capital
Corporation II ("Allied II"), Allied Capital Commercial Corporation ("Allied
Commercial"), and Allied Capital Advisers, Inc. ("Advisers"), (each an
"Acquired Company" and collectively the "Acquired Companies") merged with and
into Allied Capital Lending Corporation ("Allied Lending") (collectively with
the Acquired Companies, the "Companies") pursuant to an Agreement and Plan of
Merger, dated as of August 14, 1997, as amended and restated as of September
19, 1997 in a stock-for-stock exchange (the "Merger"). Immediately following
the Merger, Allied Lending changed its name to Allied Capital Corporation
("ACC" or the "Company").
The Merger was effected through a conversion of each share of Acquired
Company common stock into the number of shares of Allied Lending common stock
determined pursuant to the following exchange ratios: Allied I--1.07 shares;
Allied II--1.40 shares; Allied Commercial--1.60 shares; and Advisers--0.31
shares. Allied Lending's common stock outstanding prior to the Merger continues
to be outstanding, and was not converted or changed in the Merger. On December
31, 1997, subsequent to the exchange of shares, the Company had 52,047,318
shares outstanding.
The Merger was treated as a tax-free reorganization under Section 368
(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). For
federal income tax purposes, the Acquired Companies carried forward the
historical cost basis of their assets and liabilities to the surviving entity
(ACC). For financial reporting purposes, the Acquired Companies also carried
forward the historical cost basis of their respective assets and liabilities at
the time the Merger was effected. The consolidated financial statements reflect
the operations of ACC with all periods restated as if the Companies had merged
as of the beginning of the earliest period presented.
Prior to the Merger, Allied I owned approximately 16% of Allied Lending's
total shares outstanding. These shares were distributed to the Allied I
shareholders in a dividend immediately prior to the Merger at a rate of
0.107448 shares of Allied Lending for each share of Allied I held on the record
date. For financial reporting purposes, Allied I's ownership of Allied Lending
has been eliminated for all periods presented. The Company is now an internally
managed business development company, as defined in the Investment Company Act
of 1940, as amended, and is a registered investment adviser pursuant to the
Investment Advisers Act of 1940.
THE PORTFOLIO
The Company's primary business is investing in and lending to primarily private
small and medium-sized businesses using three types of financing: mezzanine
finance, commercial real
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3
MANAGEMENT'S DISCUSSION AND ANALYSIS
estate finance, and 7(a) lending. In addition, the Company also earns advisory
fees from the management of certain private funds.
The earnings of the Company depend primarily on the level of interest and
related portfolio income and net realized and unrealized gain income earned on
these three investment types after deducting interest paid on borrowed capital
and operating expenses. Interest income results from the stated interest rate
paid on a loan, the amortization of loan origination points, and the
amortization of any market discount arising from purchased loans. The level of
interest income is directly related to the balance of the investment portfolio
multiplied by the effective yield on the portfolio. The Company's ability to
generate interest income is dependent on economic, regulatory and competitive
factors that influence interest rates, loan originations, and the Company's
ability to secure financing for its investment activities.
The Company's portfolio is managed in three parts: mezzanine loans, debt
securities and equity interests; commercial mortgage loans; and 7(a) loans. The
graphs included in this section indicate for the past three years, the
composition of the portfolio, loan origination volume and loan repayment
history, and realized and unrealized gains (losses) arising from the portfolio.
The total portfolio at value was $697.0 million, $607.4 million, and $528.5
million at December 31, 1997, 1996, and 1995, respectively, which represented a
15% increase in the total portfolio for each of the years ended December 31,
1997 and 1996.
Mezzanine loans, debt securities and equity interests were $207.7 million,
$191.2 million and $205.2 million at December 31, 1997, 1996, and 1995,
respectively. The effective yield on the mezzanine portfolio was 12.6% and
13.2% at December 31, 1997 and 1996, respectively. Mezzanine loan originations
were $66.7 million and $66.2 million for 1997 and 1996, respectively. During
the two years ended December 31, 1997, mezzanine loan repayments and sales of
equity interests were approximately equal to originations, which kept the level
of the portfolio relatively constant. Prior to the Merger, mezzanine loan
originations were made through Allied I and Allied II, which originated small
($2 million - $9 million) mezzanine loans in order to maintain appropriate
portfolio diversity for regulated investment company purposes. Pursuant to the
terms of a Securities and Exchange Commission exemptive order, Allied I and
Allied II loan originations were made pursuant to a co-investment formula,
based on relative total assets, which required identical terms for each loan
originated. As a result, Allied I and Allied II were unable to originate larger
loans or price loans based on their own capital structures. These
inefficiencies limited the ability of Allied I and Allied II to compete
effectively in the marketplace.
1997
Commercial Mortgage Loans 56%
Mezzanine Investments 25%
7(a) Loans 5%
Cash and Other Assets 14%
1996
Commercial Mortgage Loans 52%
Mezzanine Investments 27%
7(a) Loans 6%
Cash and Other Assets 15%
1995
Commercial Mortgage Loans 46%
Mezzanine Investments 34%
7(a) Loans 7%
Cash and Other Assets 13%
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Subsequent to the Merger, the Company's larger overall portfolio size
enables the Company to compete for larger mezzanine loans while maintaining
adequate diversity within the portfolio. As a result, the Company is actively
pursuing mezzanine loans in sizes ranging from $5 million to $20 million. The
Company is also able to price its mezzanine loans using a single capital
structure, which should enable the Company to price its loans more
competitively. The Company believes that these post-Merger strategies will
enable the Company to increase mezzanine loan originations in 1998.
Commercial mortgage loans were $446.3 million, $373.7 million, and $277.3
million at December 31, 1997, 1996 and 1995, respectively, which represented a
19% and 35% increase in the total portfolio for the years ended December 31,
1997 and 1996. Commercial mortgage loan originations were $249.0 million and
$176.3 million for 1997 and 1996, respectively. Commercial mortgage loan
originations grew by 41% and 58% in 1997 and 1996, respectively. Commercial
mortgage loan repayments were $154.5 million and $87.5 million for 1997 and
1996, respectively. The weighted average current stated interest rate on the
commercial real estate portfolio at December 31, 1997 and 1996 was 9.6% and
10.3%, respectively. The weighted yield on the commercial real estate portfolio
was 11.4% and 13.4% at December 31, 1997 and 1996, respectively.
The Company experienced a high rate of commercial mortgage loan repayments
in 1997 as many loans that had been purchased in earlier years and originated
without substantial prepayment prohibitions, repaid due to a favorable interest
rate environment. The Company now generally originates its commercial real
estate loans to require prepayment premiums, which generally take the form of a
fixed percentage of the loan amount that declines as the loan matures. At
December 31, 1997, 53% of the commercial real estate portfolio required payment
of some premium upon early repayment, or prohibited repayment for a specified
period of time.
Realized and Unrealized Gains (Losses)
(In Millions)
1995 1996 1997
REALIZED GAINS $12.000 $19.155 $10.704
UNREALIZED GAINS (LOSSES) $9.266 $-7.412 $7.209
Investment Originations and Repayments
(In Millions)
1995 1996 1997
ORIGINATIONS $216.2 $283.3 $364.9
REPAYMENTS $111.7 $179.3 $233.0
The effective yield on the commercial mortgage loan portfolio is
higher than the stated interest rate due to the amortization of market discount
on purchased loans. At December 31, 1997 and 1996, unamortized market and
original issue discount was $28.0 million and $37.1 million, respectively. The
Company generally prices its commercial mortgage loans based on a fixed spread
over comparable U.S. Treasury rates given the term of the loan. During 1997,
interest rates on U.S. Treasury bonds declined significantly, and the spreads
charged by commercial real estate lenders in the marketplace narrowed. As a
result, the Company's pricing was affected. Because of the Company's defined
niche as an enterprise value real estate lender, however, ACC experienced only
a minimal decline in the overall interest rates on loans originated in 1997.
Commercial mortgage loans originated in 1997 had an average stated interest
rate of 9.6% as compared to 10.0% for loans originated in 1996.
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5
MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company will continue to aggressively originate commercial mortgage loans
but may increasingly sell loans that are originated at interest rates that do
not meet the Company's overall portfolio strategy.
The 7(a) loan portfolio was $40.7 million, $42.1 million, and $43.3 million
at December 31, 1997, 1996 and 1995, respectively. 7(a) loan originations were
$ 49.2 million and $40.8 million for 1997 and 1996, respectively. Sales of the
guaranteed portions of 7(a) loan originations were $43.4 million and $25.0
million for 1997 and 1996, respectively. 7(a) loans are originated with
variable interest rates priced at spreads ranging from 1.75% to 2.75% over the
prime lending rate.
Prior to the Merger, 7(a) loan originations were conducted through Allied
Lending, which had a consolidated equity base of approximately $40 million.
Because of its relatively small equity base, the Company's cost of debt capital
was expensive and required the Company to price its 7(a) loans at a level that
was, in many cases, above market. Because of the Company's increased equity
base, ACC has reevaluated its pricing strategy and can offer 7(a) loans at
lower prices, and believes that this should increase loan origination activity
in 1998. Also, effective January 1, 1998, the Company is no longer required to
hold the guaranteed portion of its 7(a) loans originated for 90 days before
selling, which also lowers its costs associated with this loan origination
program.
RESULTS OF OPERATIONS
Net increase in net assets resulting from operations ("NIA") was $61.3 million,
or $1.24 per share, $54.9 million, or $1.19 per share, and $60.5 million, or
$1.38 per share, for the years ended December 31, 1997, 1996, and 1995,
respectively. 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. For 1997, NIA was significantly
impacted by certain one-time, non-recurring expenses related to the Merger,
which totaled approximately $5.2 million. Without these one-time, merger
expenses, NIA would have been $66.5 million, or $1.35 per share, for 1997, a
13% increase over 1996 earnings per share.
Total interest and related portfolio income was $97.4 million, $84.9
million, and $68.8 million for the years ended December 31, 1997, 1996, and
1995, 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 sales, prepayment premiums, and advisory fee and other
income.
Interest income totaled $86.9 million, $77.5 million, and $61.6 million for
the years ended December 31, 1997, 1996 and 1995, respectively. Interest income
increased 12% and 26% for 1997 and 1996, respectively. The increase in interest
income earned results primarily from increases in the amount of loans
outstanding during the periods presented. The Company's loan portfolio
increased by 13% to $654.9 million at December 31, 1997 from $580.9 million at
December 31, 1996, and the loan portfolio increased by 17% in 1996 from $495.3
million at December 31, 1995. The Company's total loan originations of $364.9
million for 1997 represented a 29% increase over loan originations of $283.3
million for 1996, and a 31% increase of loan originations of $216.2 million for
1995. In addition, the weighted average yield on the total loan portfolio at
December 31, 1997 was 11.7%, as compared to 13.1% at December 31, 1996. The
Company also earns interest on cash and government securities which totaled
$81.5 million, $71.8 million, and $49.0 million at December 31, 1997, 1996 and
1995, respectively. The Company for the past three years has earned
approximately 4% to 5% on its temporary cash and government securities.
Net premiums from loan sales were $3.2 million, $2.6 million, and $2.1
million for the years ended December 31, 1997, 1996 and 1995, respectively.
This premium income results primarily from the cash gain on the sale of the
guaranteed portion of the Company's 7(a) loans into the secondary market, less
the costs associated with originating the loans sold. Typically, the Company
receives cash premiums on loan sales net of origination costs ranging from 4%
to 6% of the face amount of each loan sold.
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
Prepayment premiums were $4.0 million, $1.7 million, and $0.7 million for
the years ended December 31, 1997, 1996 and 1995, respectively. Commercial
mortgage loan repayments of $154.5 million in 1997 were primarily responsible
for the large level of prepayment premiums experienced in 1997. The expected
maturity of mezzanine or commercial real estate loans ranges from five to ten
years. While it is the Company's intention to retain its borrowers for the full
expected life of the loan, it is not unusual for ACC'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 the borrower's balance sheet
strengthens, or as more favorable interest rates become available.
Investment advisory fees are received from the private funds managed by ACC.
Three of the Company's private managed funds are in liquidation, and are
actively distributing fund assets to their investors. In January 1998, the
Company entered into an investment advisory agreement with Kreditanstalt fur
Wiederaufbau (KfW), the state-owned public development bank of Germany, to
manage a fund of approximately DM 160 million. For its services related to
sourcing, structuring, investing, monitoring and disposing of its investments
in small, German businesses, ACC will receive a 3% per annum fee on total
committed capital, payable quarterly.
Other income, which was $2.3 million, $1.5 million and $2.5 million, for the
years ended December 31, 1997, 1996, and 1995, respectively, includes rental
income from the Company's fully leased commercial office building located in
northern Virginia and income from foreclosure properties.
Total expenses were $51.3 million ($46.1 million without Merger expenses),
$37.4 million, and $27.3 million for the years ended December 31, 1997, 1996,
and 1995, respectively. Operating expenses include interest on indebtedness,
salaries and employee benefits, legal and accounting expenses, and other
general and administrative expenses.
The Company's single largest expense is interest on indebtedness, which
totaled $26.9 million, $20.3 million, and $12.4 million for the years ended
December 31, 1997, 1996, and 1995, respectively. The increase in interest
expense was 33% and 64% for 1997 and 1996, respectively, and is attributable to
increased borrowings by the Company and its subsidiaries under various credit
facilities to fund new loan originations. The Company's total borrowings were
$347.7 million at December 31, 1997, $275.0 million at December 31, 1996, and
$200.3 million at December 31, 1995. Total borrowings increased by 26% and 37%
in 1997 and 1996, respectively. The Company's weighted average interest cost on
outstanding borrowings at December 31, 1997, 1996 and 1995 was 7.3%, 7.6%, and
7.6%, respectively.
Salaries and employee benefits totaled $10.3 million, $8.8 million, and $8.0
million for the years ended December 31, 1997, 1996, and 1995, respectively.
Total employees were 80, 66, and 74 at December 31, 1997, 1996 and 1995,
respectively. The increase in salaries and benefits reflects the increase in
total employees, combined with wage increases, and the experience level of
employees hired. The Company was an active recruiter in 1997 for experienced
investment and operational personnel and the Company will continue to actively
recruit and hire new professionals in 1998 to support anticipated portfolio
growth. In conjunction with the Merger, the Company established two award
programs. See Note 12 to the Company's 1997 Consolidated Financial Statements.
Legal and accounting expenses totaled $2.3 million, $1.6 million and $1.2
million for the years ended December 31, 1997, 1996, and 1995, respectively.
Legal and accounting expenses include the cost of corporate legal matters,
portfolio workout expenses, and routine accounting and auditing fees. The legal
and accounting expenses for 1997 include a one-time charge of $0.2 million
related to the settlement of a litigation matter associated with one portfolio
company. Legal and accounting expenses increased in 1997 because of this
one-time charge and various restructuring matters.
General and administrative expenses include the lease for the Company's
headquarters in Washington, DC, leases established in 1997 for the Company's
new offices in Chicago and San Francisco, travel costs, stock record expenses,
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7
MANAGEMENT'S DISCUSSION AND ANALYSIS
directors' fees, and various other expenses. General and administrative
expenses totaled $6.7 million, $6.7 million, and $5.7 million, respectively,
for the years ended December 31, 1997, 1996, and 1995. During 1997 and 1996,
the Company did not experience any significant increases in general and
administrative expenses. The Company intends to move its Washington, DC office
to larger office space in mid-1998. The Company is increasing the size of its
Washington, DC headquarters by approximately 10,000 square feet in order to
accommodate its recent and future anticipated increases in headcount. Annual
rent expense is expected to increase by approximately $0.6 million, annually.
Merger expenses totaled $5.2 million, and 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.
Total expenses excluding interest on indebtedness and merger expenses
represented approximately 2.5%, 2.6% and 2.7% of the Company's average assets
for the years ended December 31, 1997, 1996 and 1995, respectively.
Net realized gains were $10.7 million, $19.2 million, and $12.0 million for
the years ended December 31, 1997, 1996, and 1995, respectively. These gains
resulted from the sale of equity securities associated with certain mezzanine
loans and the realization of unamortized discount resulting from the payoff of
mezzanine and commercial mortgage loans, offset by losses on investments.
Realized gains totaled $15.8 million, $30.4 million and $16.7 million, and
realized losses totaled $5.1 million, $11.3 million, and $4.7 million for the
years ended December 31, 1997, 1996, and 1995, respectively. Realized gains
for 1997 resulted from the liquidation of securities from 83 portfolio
relationships, and ranged in size from less than $100 to $2.6 million, with an
average size of $188,000.
The Company recorded net unrealized gains of $7.2 million for the year ended
December 31, 1997, representing an increase in the Board of Directors'
valuation of the Company's assets over their aggregate cost as compared to the
prior period. Included as a component of the $7.2 million was a $5.0 million
write-down of interest rate swap agreements. For the year ended December 31,
1996, the Company recorded net unrealized losses of $7.4 million, as the
Company sold an unusual volume of equity securities that had previously been
recorded at appreciated values. When a sale is consummated, a realized gain is
recorded and a corresponding unrealized loss is also recorded to reflect that
the appreciated asset has been sold. For the year ended December 31, 1995, net
unrealized gains were $9.3 million.
The Company incurred income tax expense of $1.4 million, $1.9 million, and
$1.8 million, respectively, for the years ended December 31, 1997, 1996 and
1995 resulting from the operations of Advisers. In conjunction with the Merger,
Advisers' operations as an investment adviser to certain private funds were
assumed by the Company. Because ACC 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 and realized capital gains, to
the extent that such income and gains are distributed to shareholders. The
Company will be required to pay a tax on any assets previously owned by
Advisers that are subsequently sold.
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 to shareholders at least 90% of its
investment company taxable income annually. 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.
During 1997, 1996 and 1995, Allied I, Allied II, Allied Commercial and
Allied Lending declared dividends to their shareholders representing all of
each companies' ordinary taxable income, taxable net capital gains, and in the
case of Allied I in 1997, a partial return of capital resulting from the
distribution of Allied I's ownership of Allied Lending's shares. Tax
distributions differ from NIA due to timing differences in the recognition of
income and expenses, returns of capital and unrealized appreciation which is
not included in
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
taxable income. Total tax distributions declared were $85.7 million, $57.4
million and $47.9 million for 1997, 1996 and 1995, respectively. On a per share
basis, exchange adjusted for the Merger and including exchange-adjusted shares
of Advisers for which no tax distributions had been declared, for the three
years ended December 31, 1997, 1996, and 1995, tax distributions were $1.71,
$1.23, and $1.09 respectively.
Included in 1997 tax distributions was $18 million, or $0.34 per share,
representing a non-cash dividend of the shares of Allied Lending held in Allied
I's portfolio. Allied I declared and paid a dividend equal to 0.107448 shares
of Allied Lending for each share of Allied I held on the record date for such
dividend. These shares had a market value of $21.25 per share on December 30,
1997, the distribution date.
Also included in 1997 tax distributions was a special, one-time dividend
equal to $8.8 million or $0.17 per share representing all of the retained
earnings and profits of the Acquired Companies at December 31, 1997. The
special dividend was declared in conjunction with the Merger in order for the
Company to maintain its RIC status.
Certain of the Company's credit facilities limit the Company's ability to
declare dividends if the Company has defaulted under certain provisions of the
credit agreement.
The weighted average common shares outstanding were 49.2 million, 46.2
million, and 43.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The increases in the weighted average shares reflect the exercise
of employee stock options to purchase shares of the Company, the issuance of
shares pursuant to a dividend reinvestment plan, the issuance of new shares
pursuant to two separate rights offerings, and the exchange of shares pursuant
to the Merger. Allied I's ownership of Allied Lending during the periods
presented has been eliminated in the consolidation.
NIA, as a percentage of average shareholders' equity was 15%, 14%, and 17%
for 1997, 1996, and 1995, respectively. NIA, excluding Merger expenses, as a
percentage of average shareholders' equity for 1997 was 16%.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $81.5 million in cash and government
securities. ACC 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.
Prior to the Merger, certain of the Companies had excess cash resources
while other of the Companies were borrowers on credit facilities. In
conjunction with the Merger, the Company has used excess cash for new
investments and in its operations. The Company continues to maintain excess
cash in its SBIC and SSBIC licensed subsidiaries. This cash may not be
withdrawn from the subsidiaries because it supports the long-term borrowings of
those subsidiaries, and such borrowings carry substantial prepayment penalties.
The cash has not been invested due to a lack of quality investment
opportunities, primarily for the SSBIC subsidiary. The Company is currently
working with the SBA to restructure its SBIC and SSBIC licensees so that the
excess cash may be effectively used. There can be no assurance that this
restructuring will be achieved.
Debt to Equity Ratios
(in Millions)
55% 68% 83%
1995 1996 1997
DEBT $ 200.3 $ 275.0 $ 347.7
EQUITY $ 367.2 $ 402.1 $ 420.1
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MANAGEMENT'S DISCUSSION AND ANALYSIS
CREDIT FACILITIES. At Merger, ACC and its subsidiaries had several credit
facilities with an aggregate borrowing capability of $674.3 million primarily
with banks, investment banks, the SBA and an insurance company. Amounts
outstanding under all of the credit facilities totaled $347.7 million, $275.0
million, and $200.3 million at December 31, 1997, 1996, and 1995, respectively.
The weighted average interest rate on these facilities was 7.3%, 7.6%, and
7.6% during 1997, 1996 and 1995, respectively.
Weighted Average Cost of Funds
7.63% 7.59% 7.32%
1995 1996 1997
In January 1998, the Company began to restructure its credit facilities, and
obtained a committed $150 million unsecured revolving credit facility with
three banks. This facility has an 18-month term, a stated interest rate equal
to the 30-, 60- or 90-day LIBOR plus 125 basis points, and the amount borrowed
is tied to a borrowing base formula generally equal to 50% of the Company's
portfolio not securing other credit facilities. The Company is currently
negotiating to increase this facility to $200 million, but there can be no
assurance that such an increase will be achieved.
The Company maintains two secured credit facilities for the short-term
finance of its commercial mortgage loans with two investment banks. The
facilities provide for an aggregate availability of $500 million, of which $200
million is committed. The facilities expire in August 1998 and January 1999,
respectively. The facilities bear interest at an interest rate equal to 100 to
113 basis points over the 30-day LIBOR. The Company generally uses the
facilities to warehouse its commercial mortgage loans pending securitization or
sale.
Subsequent to year-end, including the commercial mortgage loan warehouse
facilities and the new $150 million unsecured line of credit, the Company has
$350 million in committed short-term credit facilities.
At December 31, 1997, through its SBIC and SSBIC subsidiaries, the Company
had $54.3 million in debentures issued to the SBA. These debentures have
interest rates ranging from 6.87% to 9.80% and mature over the next 8 years. In
addition, the Company's SSBIC subsidiary had $7.0 million in preferred stock
issued to the SBA, with a 3.1% stated dividend amount. During 1997, Congress
increased the maximum borrowing amount available to an SBIC to $101.0 million,
and the Company intends to continue to borrow under the SBIC program as the
situation warrants.
ASSET SECURITIZATION. Subsequent to year-end on January 28, 1998, the Company,
in conjunction with BMI, completed a $239 million commercial mortgage-backed
bond offering though Allied Capital Commercial Mortgage Trust 1998-1. The bonds
were sold in a private placement of three bond classes rated "AAA", "AA" and
"A" by Standard & Poor's Ratings Services and Fitch IBCA, Inc. The bonds are
secured by the issuer's direct and indirect interests in a pool of 97 mortgage
loans with an aggregate balance of $310 million. The Company contributed
approximately 95%, or $295 million, of the total assets securitized. The
Company retained the balance of the assets not sold, which approximated 23% of
the assets sold, and will recognize income from this residual over the life of
the pool. The mortgage loan pool had an approximate weighted average stated
interest rate of 9.6%. The three bond classes sold have an aggregate weighted
average interest rate of approximately 6.38%. The Company will account for the
sale in accordance with FASB 125.
FUTURE DEBT OR EQUITY OFFERINGS. The Company will continue to secure additional
debt and equity capital, and is in the process of obtaining unsecured long-term
debt to permanently finance its long-term lending operations. The terms of this
debt placement cannot yet be determined and will be dependent on interest rate
and other market conditions, and there can be no assurance that such long-term
debt may be available to the Company on terms it deems acceptable.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company's cash flow from operations was $58.9 million, $45.2 million and
$47.3 million for 1997, 1996 and 1995, respectively. The Company plans to
maintain a strategy of financing its operations, dividend requirements and
future investments with cash from operations, long-term debt, asset
securitizations or through use of its equity capital. The Company will utilize
its short-term credit facilities only as a means to bridge to long-term
financing. The Company plans to hedge variable and short-term interest rate
exposure. The Company believes that it has access to capital sufficient to fund
its ongoing investment and operating activities, and from which to pay
dividends.
As a BDC, the Company is generally required to maintain a ratio of 200% of
total assets to total borrowings. As a result of this requirement, the Company
may complete, either in public or private transactions, one or more equity
offerings in 1998 and in future years. There can be no assurance that such
sales of equity, if undertaken, would be favorably received by the market.
YEAR 2000. The Company has reviewed its exposure to the risks associated with
the Year 2000 issue, and has determined that there is no material risk of
business interruption as a result of computer errors or inefficiencies. The
Company exclusively uses purchased software and has been informed by its
vendors that the software will be Year 2000 compatible; however, there is no
assurance that such software will indeed address all Year 2000 compatibility
issues. The Company is currently assessing the risk that its portfolio
companies may have regarding this issue. For all new loans originated, the
Company includes in its documentation a Year 2000 compatibility assessment,
and will monitor particular portfolio companies as needed.
FINANCIAL OBJECTIVES. The merged Company has set forth certain financial
objectives that it intends to use in allocating its resources and in selecting
new investment opportunities. Management's goal is to increase NIA annually by
15% to 20% and to provide for a ratio of NIA to average shareholders' equity of
18%. Management believes that the Company will be able to achieve these goals
over the next three to five years. Factors that may impede the achievement of
these objectives include those described in the Investment Considerations
section of this Management's Discussion and Analysis, and also include other
factors such as changes in the economy, competitive and market conditions, and
future business decisions.
NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. Statement of Financial Accounting
Standards Nos. 130 and 131, "Reporting Comprehensive Income" and "Disclosures
about Segments of an Enterprise and Related Information," respectively, were
issued in June 1997. SFAS 130 requires that certain financial activity
typically disclosed in shareholders' equity be reported in the financial
statements as an adjustment to net income in determining comprehensive income.
SFAS 131 requires the reporting of selected segmented information in quarterly
and annual reports. The Company does not anticipate any material financial
impact from the implementation of SFAS Nos. 130 and 131.
INVESTMENT CONSIDERATIONS
Risks of Default. ACC invests in and lends to small businesses. Loans to small
businesses involve a high risk of default, and generally are not rated by any
nationally recognized statistical rating organization. Small businesses usually
have narrower product lines and smaller market shares than larger companies and
therefore may be more vulnerable to competitors' actions and market conditions,
as well as general economic downturns. These businesses typically depend for
their success on the management talents and efforts of one person or a small
group of persons whose death, disability or resignation would adversely affect
the business. Because these businesses frequently have highly leveraged
capital structures, reduced cash flows resulting from adverse competitive
developments, a shift in customer preferences or an economic downturn can
severely affect the return on, or the recovery of, the Company's investments in
such businesses.
23
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
Loss of Pass-Through Tax Treatment. The Company would cease to qualify for
pass-through tax treatment under Subchapter M if it is unable to comply with
the diversification or distribution requirements contained in Subchapter M of
the Code, or if it ceases to qualify as a BDC. The Company also could be
subject to a 4% excise tax (and, in certain cases, corporate level income tax)
if it fails to make certain distributions. The lack of Subchapter M tax
treatment could have a material adverse effect on the total return, if any,
obtainable from an investment in the Company.
Risks of Leverage. ACC borrows funds from, and issues senior debt securities
to, banks and other lenders. Lenders of these senior securities have fixed
dollar claims on the Company's consolidated assets which are superior to the
claims of the Company's shareholders. If the value of the Company's
consolidated assets increases, then such leveraging techniques would cause the
net asset value attributable to the Company's common stock to increase more
sharply than it would have had the techniques not been utilized. Conversely, a
decrease in the value of the Company's consolidated assets would cause net
asset value to decline more sharply than it otherwise would if the senior funds
had not been borrowed. Similarly, any increase in the Company's consolidated
income in excess of consolidated interest payable on the borrowed funds would
cause its net income to increase more than it would without the leverage, while
any decrease in its consolidated income would cause net income to decline more
sharply than it would had the funds not been borrowed. Such a decline could
negatively affect the Company's ability to make common stock dividend payments,
and, if asset coverage for a class of senior security representing indebtedness
declines to less than 200%, the Company may be required to sell a portion of
its investments when it is disadvantageous to do so. Leverage is generally
considered a speculative investment technique. The ability of the Company to
achieve its investment objective may depend in part on its continued ability to
maintain a leveraged capital structure by borrowing from banks or other lenders
on favorable terms, and there can be no assurance that such leverage can be
maintained.
Competition. Many entities and individuals compete for investments similar
to those made by the Company, some of whom have greater resources than ACC.
Increased competition would make it more difficult for the Company to purchase
or originate loans at attractive prices. As a result of this competition, ACC
from time to time may be precluded from making otherwise attractive investments
on terms considered to be prudent in light of the risks assumed.
Long-Term Character of Investments. It is expected that mezzanine loans will
generally yield a current return from the time they are made, but also will
generally produce a realized gain from an accompanying equity feature after
approximately three to eight years. There can be no assurance that capital
gains will actually be achieved.
Illiquidity of Investments. The Company acquires securities directly from
issuers in private transactions, and the major portion of such investments is
subject to restrictions on resale or is otherwise illiquid. In particular,
there is usually no established trading market in which such securities could
be sold. In addition, equity securities generally cannot be sold to the public
without registration under the Securities Act of 1933 which involves delay,
uncertainty and expense.
Government Regulations. The Company is subject to regulation by the
Securities and Exchange Commission and the Small Business Administration. In
addition, the Company's business may be significantly impacted by changes in
the laws or regulations that govern BDCs, RICs, REITs, SBICs, SSBICs and SBLCs.
Laws and regulations may be changed from time to time and the interpretations
of the relevant law and regulations is also subject to change. Any change in
the laws or regulations that govern the Company could have a material impact on
the Company or its operations.
12
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
(in thousands, except number of shares) 1997 1996
ASSETS
Portfolio at value:
Commercial mortgage loans (cost: 1997-$446,114; 1996-$373,378) $446,342 $373,695
Mezzanine loans and debt securities (cost: 1997-$181,184; 1996-$178,664) 167,842 165,086
Small Business Administration 7(a) loans: (cost: 1997-$41,103; 1996-$42,351) 40,709 42,131
Equity interests in portfolio companies (cost: 1997-$20,050; 1996-$18,521) 39,906 26,134
Other portfolio assets (cost: 1997-$2,269; 1996-$362) 2,222 322
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio at value 697,021 607,368
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 70,437 71,841
U.S. government securities 11,091 --
Other assets 29,226 34,151
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total assets $807,775 $713,360
===================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable $308,821 $229,898
Revolving lines of credit 38,842 45,099
Accounts payable and accrued expenses 18,189 14,662
Dividends and distributions payable 9,068 8,197
Other liabilities 5,795 6,370
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
380,715 304,226
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies
Preferred stock issued to Small Business Administration 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares authorized;
52,047,318 and 48,237,621 issued and outstanding
at December 31, 1997 and 1996, respectively 5 5
Additional paid-in capital 451,044 417,670
Notes receivable from sale of common stock (29,611) (15,491)
Net unrealized appreciation (depreciation) on portfolio 1,301 (5,908)
Undistributed (distributions in excess of) earnings (2,679) 5,858
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 420,060 402,134
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $807,775 $713,360
===================================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
25
13
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1997 1996 1995
INTEREST AND RELATED PORTFOLIO INCOME
Interest $86,882 $77,541 $61,550
Net premiums from loan sales 3,241 2,563 2,090
Prepayment premiums 4,036 1,678 706
Investment advisory fees 993 1,667 2,009
Other income 2,253 1,488 2,462
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total interest and related portfolio income 97,405 84,937 68,817
===================================================================================================================================
EXPENSES
Interest on indebtedness 26,952 20,298 12,355
Salaries and employee benefits 10,258 8,774 8,031
Legal and accounting 2,262 1,605 1,167
General and administrative 6,708 6,684 5,721
Merger 5,159 -- --
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------------
Total expenses 51,339 37,361 27,274
===================================================================================================================================
Portfolio income before realized and unrealized gains 46,066 47,576 41,543
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAINS
Net realized gains 10,704 19,155 12,000
Net unrealized gains (losses) 7,209 (7,412) 9,266
===================================================================================================================================
Total net realized and unrealized gains 17,913 11,743 21,266
===================================================================================================================================
Income before minority interests and income taxes 63,979 59,319 62,809
Minority interests 1,231 2,427 546
Income tax expense 1,444 1,945 1,784
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations $61,304 $54,947 $60,479
===================================================================================================================================
Basic earnings per common share $1.24 $1.19 $1.38
===================================================================================================================================
Diluted earnings per common share $1.24 $1.17 $1.37
===================================================================================================================================
Weighted average common shares outstanding 49,218 46,172 43,697
===================================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
14
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1997 1996 1995
OPERATIONS
Portfolio income before realized and unrealized gains $46,066 $47,576 $41,543
Net realized gains 10,704 19,155 12,000
Net unrealized gains (losses) 7,209 (7,412) 9,266
Minority interests and income tax expense (2,675) (4,372) (2,330)
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 61,304 54,947 60,479
===================================================================================================================================
SHAREHOLDER DISTRIBUTIONS
Portfolio income (38,751) (39,030) (37,296)
Excess of portfolio income (605) (2,533) (451)
Net capital gains (15,172) (11,546) (9,799)
Excess of net capital gains -- -- (374)
Return of capital (22,302) (4,289) --
Undistributed earnings (8,848) -- --
Preferred stock dividend (220) (220) (220)
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net decrease in net assets resulting from
shareholder distributions (85,898) (57,618) (48,140)
===================================================================================================================================
CAPITAL SHARE TRANSACTIONS
Sale of common stock -- 22,365 1,156
Net increase in notes receivable from sale of common stock (14,120) (8,176) (3,526)
Issuance of common stock upon the exercise of stock options 28,426 12,176 5,310
Issuance of common stock in lieu of cash distributions 26,612 11,986 7,506
Other 1,602 (738) 364
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from
capital share transactions 42,520 37,613 10,810
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Total increase in net assets $17,926 $34,942 $23,149
===================================================================================================================================
Net assets at beginning of year $402,134 $367,192 $344,043
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net assets at end of year $420,060 $402,134 $367,192
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net asset value per common share $8.07 $8.34 $8.26
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Common shares outstanding at end of year 52,047 48,238 44,479
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
27
15
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting from operations $61,304 $54,947 $60,479
Adjustments
Net unrealized (gains) losses (7,209) 7,412 (9,266)
Depreciation and amortization 450 393 319
Amortization of loan discounts and fees (10,804) (9,027) (6,841)
Deferred income taxes 1,087 (381) (174)
Minority interests 1,231 2,427 546
Amortization of deferred financing costs 957 693 72
Changes in other assets and liabilities 11,924 (11,299) 2,173
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 58,940 45,165 47,308
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in small business concerns (364,942) (283,295) (216,175)
Collections of investment principal 233,005 179,292 111,731
Proceeds from the sale of loans 53,912 27,715 29,726
Net (purchase) redemption of U.S. government securities (10,301) -- 35,061
Collections of notes receivable from sale of common stock 6,534 2,199 1,038
Other investing activities (182) 2,635 2,357
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (81,974) (71,454) (36,262)
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 8,615 24,166 1,074
Common dividends and distributions paid (58,194) (47,089) (36,265)
Preferred stock dividends (220) (220) (220)
Net borrowings under (payments on) debentures
and notes payable 78,923 (35,202) 85,636
Net borrowings under (payments on) revolving
lines of credit (6,257) 110,460 (11,812)
Net payments on government securities available for sale -- -- (23,210)
Other financing activities (1,237) (3,029) 364
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 21,630 49,086 15,567
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents $(1,404) $22,797 $26,613
===================================================================================================================================
Cash and cash equivalents at beginning of year $71,841 $49,044 $22,431
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $70,437 $71,841 $49,044
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
16
CONSOLIDATED STATEMENT OF INVESTMENTS
DECEMBER 31, 1997
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
Acme Paging, L.P. Debt Securities $5,993 $5,993
Equity Interest 1,456 2,600
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
AGPAL Broadcasting, Inc. Debt Securities 928 928
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
American Barbecue & Grill Loans 1,499 1,499
Debt Securities 2,250 2,250
Warrants 125 125
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 713 713
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
ARS, Inc. Debt Securities 9,723 9,723
Warrants 171 171
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc. (1) Debt Securities 7,355 7,355
Warrants 227 234
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc. (1) Common Stock (342,938 shares) 330 1,547
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Broadcast Holdings, Inc. Debt Securities 2,696 2,696
Warrants -- 1,054
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Calendar Broadcasting, Inc. Debt Securities 3,780 3,780
Warrants 144 144
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 365 365
Warrants 12 12
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,983 253
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,776 1,776
Common Stock (220 shares) 1 --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Chungsan Corporation Loan 78 78
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Convenience Corporation of America Loans 1,226 1,226
Debt Securities 8,370 6,245
Class A Preferred Stock (22,797 shares) 265 --
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc. Debt Securities 3,440 3,440
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Debt Securities 3,140 3,140
Equity Interest 700 700
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 1,440
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 760
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Directory Investment Corporation Common Stock (470 shares) -- 83
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (1,031 shares) -- 862
Series B Common Stock (188 shares) 235 157
Series C Common Stock (292 shares) 656 245
Series A Preferred Stock (214 shares) 307 192
Series B Preferred Stock (175 shares) 931 158
Series C Preferred Stock (58 shares) 58 52
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
DMI Furniture, Inc. (1) Convertible Preferred Stock (199,920 shares) 500 982
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 36 4
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS
AND EQUITY INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
29
17
CONSOLIDATED STATEMENT OF INVESTMENTS
DECEMBER 31, 1997
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans $ 30 $ 30
Debt Securities 1,875 428
Equity Interest -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Warrants -- 585
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 1,000
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 65 65
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Ex Terra Funding, LLC Loan 1,960 1,960
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Company Debt Securities 5,653 5,653
Warrants 280 280
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loan 200 200
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Gibson Guitar Corp. Debt Securities 14,475 14,475
Warrants 525 525
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Archery, LLC Loans 550 550
Debt Securities 2,248 2,248
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 7,866 7,866
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Han Hie Loan 518 518
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 262 262
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Herr-Voss Industries, Inc. Debt Securities 9,500 9,500
Common Stock (132,507 shares) 1,050 1,050
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
HFC Acquisition Sub I, Inc. Loans 232 232
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 128 128
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
JR Industries, Inc. Debt Securities 2,343 2,343
Warrants 74 74
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,630 4,630
Warrants 323 2,099
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 800 800
Debt Securities 2,784 2,784
Warrants 348 2,350
Equity Interest 40 40
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,250 6,250
Warrants 96 96
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Kjellberg's Incorporated Loan 3,146 3,146
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Kurlancheek Loan 311 311
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Labor Ready, Inc. (1) Common Stock (247,863 shares) 1,477 4,308
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,370 3,370
Common Stock (60,000 shares) 100 100
Warrants -- --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 235 235
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 360 214
Warrants 200 --
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
Magic Auto Loan 17 17
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
MidSouth Data Systems, Inc. Debt Securities 7,550 7,550
Warrants 348 348
- - - - - - - - - - - - - -----------------------------------------------------------------------------------------------------------------------------------
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS
AND EQUITY INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
18
CONSOLIDATED STATEMENT OF INVESTMENTS
DECEMBER 31, 1997
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities $ 326 $ 326
Warrants -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Mihadas Loan 290 290
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
MLX/SinterMet Corp. (1) Common Stock (5,835 shares) 241 109
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 33 33
Debt Securities 1,822 219
Common Stock (33,333 shares) -- --
Warrants -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Radio City Mobil Home Park Loan 1,361 1,361
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Nobel Education Dynamics, Inc. (1) Preferred Stock (265,957 shares) 2,000 2,000
Warrants -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 30 30
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, L.P. Debt Securities 483 483
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 106 106
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 1,115 888
Warrants 77 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
OMA, Inc. Loans 1,931 1,931
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 323 323
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Peerless Group, Inc. (1) Common Stock (379,475 shares) 17 1,405
Warrants 4 667
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
David Peters Loan 169 55
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loans 107 107
Preferred Stock (276 shares) 160 175
Common Stock (36 shares) -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Debt Securities 5,669 5,669
Common Stock (248,000 shares) 71 336
Warrants -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Quality Software Products Holdings, PLC (1) Common Stock (94,479 shares) 901 344
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 341 341
Debt Securities 9,951 9,951
Common Stock (1,430 shares) -- --
Warrants -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Randhawa Brothers Enterprises, Inc. Loans 217 217
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
R-Tex Decoratives Company, Inc. Debt Securities 1,513 1,170
Warrants 58 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 112 112
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Saturn Chemicals, Inc. Loan -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
SerpCo., Inc. Loan 182 182
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Spa Lending Corporation Series A Preferred Stock (5,826 shares) 420 322
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
SunStates Refrigerated Services, Inc. Loans 1,557 68
Debt Securities 4,262 1,486
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,582 129
Common Stock (910 shares) 57 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
University Village Mobile Homes Loan 157 157
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Vidon, Inc. Loans 262 262
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS AND EQUITY
INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
31
19
CONSOLIDATED STATEMENT OF INVESTMENTS
DECEMBER 31, 1997
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares and investments)
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Waterview Limited Partnership Equity Interest $ -- $ 3,050
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Weathertech Distributing Company, Inc. Loans 291 291
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
West Virginia Radio Corporation of Clarksburg, Inc. Debt Securities 962 962
Warrants 400 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
William R. Dye Loan 270 270
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company Loans 720 720
Debt Securities 308 308
Warrants 24 24
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Z-Spanish Radio Network, Inc. Loans 11,636 11,636
Debt Securities 750 750
Warrants 6 6
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and
equity interests in portfolio companies (89 investments) $ 201,234 $ 207,748
=================================================================================================================================
INTEREST NUMBER OF
RATE RANGES INVESTMENTS COST VALUE
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 6 $ 6,129 $ 6,129
7.00%-8.99% 49 108,313 108,313
9.00%-10.99% 156 259,203 259,221
11.00%-12.99% 72 61,681 61,891
13.00%-14.99% 7 7,294 7,294
15.00% and above 1 3,494 3,494
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total commercial mortgage loans 291 $ 446,114 $ 446,342
=================================================================================================================================
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 10 $ 111 $ 111
7.00-8.99% 16 192 107
9.00-10.99% 24 2,636 2,673
11.00-12.99% 378 38,072 37,739
13.00-14.99% 4 92 79
15.00% and above 0 0 0
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 432 $ 41,103 $ 40,709
=================================================================================================================================
Other portfolio assets 7 $ 2,269 $ 2,222
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------------------
Total portfolio at value 819 $ 690,720 $ 697,021
=================================================================================================================================
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS
AND EQUITY INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. MERGER
On December 31, 1997, Allied Capital Corporation ("Allied I"), Allied Capital
Corporation II ("Allied II"), Allied Capital Commercial Corporation ("Allied
Commercial"), and Allied Capital Advisers, Inc. ("Advisers"), (each an
"Acquired Company" and collectively the "Acquired Companies") merged with and
into Allied Capital Lending Corporation ("Allied Lending") pursuant to an
Agreement and Plan of Merger, dated as of August 14, 1997, as amended and
restated as of September 19, 1997 in a stock-for-stock exchange (the "Merger").
Immediately following the Merger, Allied Lending changed its name to Allied
Capital Corporation ("ACC" or the "Company").
The Merger was effected through a conversion of each share of Acquired
Company common stock into the number of shares of Allied Lending common stock
determined pursuant to the following exchange ratios: Allied I - 1.07 shares;
Allied II - 1.40 shares; Allied Commercial - 1.60 shares; and Advisers - 0.31
shares. Allied Lending's common stock outstanding prior to the Merger continues
to be outstanding, and was not converted or changed in the Merger. On December
31, 1997, subsequent to the exchange of shares, the Company had 52,047,318
shares outstanding.
The Merger was treated as a tax-free reorganization under Section 368
(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). For
federal income tax purposes, the Acquired Companies carried forward the
historical cost basis of their assets and liabilities to the surviving entity
(ACC). For financial reporting purposes, the Acquired Companies also carried
forward the historical cost basis of their respective assets and liabilities at
the time the Merger was effected. The consolidated financial statements reflect
the operations of ACC with all periods presented restated as if the Companies
had merged as of the beginning of the earliest period presented.
To facilitate the Merger, Allied Lending's charter was amended primarily to
effect: (a) an increase in the number of authorized shares of common stock, par
value one-tenth of one mil ($0.0001) per share, from 20,000,000 to 100,000,000
shares; and (b) a change in Allied Lending's name to "Allied Capital
Corporation."
Prior to the Merger, Allied I owned approximately 16 percent of Allied
Lending's total shares outstanding. These shares were distributed to the Allied
I shareholders in a dividend immediately prior to the Merger at a rate of
0.107448 shares of Allied Lending for each share of Allied I held on the record
date. For financial reporting purposes, Allied I's ownership of Allied Lending
has been eliminated for all periods presented.
NOTE 2. 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 three wholly owned subsidiaries that have also elected
to be regulated as BDCs. Allied Investment Corporation ("Allied Investment")
and Allied Capital Financial Corporation ("Allied Financial") are licensed
under the Small Business Investment Act of 1958 as a Small Business Investment
Company and a Specialized Small Business Investment Company, respectively.
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 to
these wholly owned subsidiaries, Allied Capital Corporation has established
several single-member limited liability companies primarily to hold real estate
properties.
Allied Capital Corporation and its subsidiaries, collectively, are
hereinafter referred to as the "Company" or "ACC."
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, growing businesses in a variety of industries and in
diverse geographic locations (primarily in the United States).
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements for the periods
presented have been restated to include the accounts of the Acquired Companies
and Allied Lending for all periods presented. Transaction fees and expenses
related to the Merger have been expensed in the 1997 results of operations. The
consolidated financial statements include the accounts of the Company or its
wholly
33
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
owned or majority owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation.
VALUATION OF PORTFOLIO INVESTMENTS. Portfolio investments are carried at fair
value, as determined by the board of directors under the Company's valuation
policy.
The values of loans and debt securities are based on the board of directors'
evaluation of the financial condition of the borrowers and/or the underlying
collateral. The values assigned are considered to be amounts which 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 debt securities and loans, value normally corresponds to cost unless the
borrower's condition or external factors lead to a determination of value at a
lower amount.
Equity interests in portfolio companies for which there is no public market
are valued based on various factors including history of positive cash flow
from operations, the market value of comparable publicly traded companies
(discounted for illiquidity), and other pertinent factors. The board of
directors also considers recent offers to purchase a portfolio company's
securities when valuing equity interests.
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. Other publicly traded stocks
may also be valued at a discount due to the investment size or market liquidity
concerns.
INTEREST INCOME. 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.
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 the valuation of the portfolio
investment during the reporting period.
DISTRIBUTIONS TO SHAREHOLDERS. Distributions to shareholders are recorded on
the record date.
FEDERAL AND STATE INCOME TAXES. With the exception of Advisers, the Acquired
Companies qualified as regulated investment companies ("RIC") or a real estate
investment trust ("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.
The Company and its wholly owned subsidiaries intend to comply with the
requirements of the Code that are applicable to RICs. The Company and its
wholly owned subsidiaries intend to distribute annually all of their taxable
income to shareholders; therefore, the Company has made no provision for
deferred taxes.
DERIVATIVE FINANCIAL INSTRUMENTS. The Company uses 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.
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.
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
securities to issue common stock were exercised into common stock.
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
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from these estimates.
NOTE 4. PORTFOLIO
The Company lends and invests in growing businesses through three primary
products: commercial mortgage loans, mezzanine loans and debt and equity
securities, and 7(a) loans.
MEZZANINE FINANCE. Mezzanine investments are generally structured as loans
that carry a relatively high fixed rate of interest, which may be combined with
equity features, such as conversion privileges, warrants or options to purchase
a portion of the portfolio company's equity at a nominal price. Such an
investment 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 loan maturities and principal
amortization schedules vary. At December 31, 1997, approximately 98 percent of
the Company's mezzanine loan portfolio was composed of fixed interest rate
loans. The weighted average yield on the mezzanine portfolio as of December 31,
1997 and 1996 equaled 12.6 percent and 13.2 percent, respectively. At December
31, 1997 and 1996, mezzanine loans and debt securities with a cost basis of
$13,661,000 and $16,648,000, respectively, were not accruing interest.
At December 31, 1997, approximately 29 percent, 27 percent, 17 percent, 13
percent and 8 percent of the Company's mezzanine portfolio was located in the
mid-atlantic, southeast, midwest, west, and northeast regions, respectively. In
addition, 6 percent of the mezzanine portfolio was located in other countries.
Loans to businesses in the industrial/manufacturing,
broadcasting/communications, retail/wholesale, and services industries equaled
approximately 43 percent, 26 percent, 15 percent, and 12 percent, respectively,
or 96 percent as of December 31, 1997.
Equity investments 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.
COMMERCIAL REAL ESTATE FINANCE. The commercial real estate portfolio contains
loans that were originated by the Company or were purchased from the Resolution
Trust Corporation, the Federal Deposit Insurance Corporation and other third
party sellers including life insurance companies and banks.
At December 31, 1997, approximately 73 percent and 27 percent of the
Company's commercial mortgage loan portfolio was composed of fixed and
adjustable interest rate loans, respectively. At December 31, 1997,
approximately 38 percent, 18 percent, 18 percent, 14 percent and 12 percent of
the Company's commercial real estate portfolio was located in the mid-atlantic,
midwest, west, southeast, and northeast regions, respectively. In addition,
commercial mortgage loans secured by hospitality, office, retail,
industrial/manufacturing and other properties equaled approximately 33 percent,
31 percent, 14 percent, 6 percent and 16 percent, respectively, of the
Company's portfolio at December 31, 1997.
The weighted average yield on the real estate portfolio as of December 31,
1997 and 1996 equaled 11.4 percent and 13.4 percent, respectively. As of
December 31, 1997 and 1996, loans with a cost basis of $11,987,000 and
$10,978,000, respectively, were not accuring interest.
As of December 31, 1997 and 1996, unamortized discount related to the real
estate portfolio was $27,954,000 and $37,124,000, respectively. Unamortized
discounts are considered in determining the fair value and are amortized into
income over the life of the loan.
SMALL BUSINESS LENDING. The Company, through its wholly owned subsidiary,
Allied SBLC participates in the SBA's Section 7(a) Guaranteed Loan Program.
Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA will
guarantee 80 percent of any qualified loan up to $100,000 regardless of
maturity, and 75 percent 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 and no more than 500 employees.
The Company charges interest on these loans at a variable rate, typically
1.75 percent to 2.75 percent 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
35
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on which the loan was made to its maturity. As of December 31, 1997,
approximately 92 percent of the Company's portfolio of 7(a) loans were variable
interest rate loans.
As permitted by SBA regulations, the Company sells to investors, without
recourse, the guaranteed portion of its loans while retaining the right to
service 100 percent of such loans.
As of December 31, 1997 and 1996, 7(a) loans with a cost basis of $4,346,000
and $3,734,000, respectively, were not accruing interest.
At December 31, 1997, approximately 36 percent, 29 percent, 18 percent, 10
percent, and 7 percent of the Company's 7(a) loan portfolio was located in the
midwest, mid-atlantic, southeast, northeast, and west regions, respectively. In
addition, loans to businesses in the hospitality, automotive services,
broadcasting/communications, restaurant/food services,
industrial/manufacturing, services, and retail/wholesale industries equaled 25
percent, 21 percent, 10 percent, 9 percent, 7 percent, 6 percent and 6 percent,
respectively, or 84 percent of the Company's portfolio as of December 31, 1997.
NOTE 5. DEBT
At December 31, 1997 and 1996, ACC had the following available credit
facilities:
INDEBTNESS, AS OF DECEMBER 31:
1997 1996
FACILITY AMOUNT FACILITY AMOUNT
(IN THOUSANDS) AMOUNT DRAWN AMOUNT DRAWN
Notes payable and debentures:
Master repurchase agreement $250,000 $202,705 $150,000 $85,775
Master loan and security agreement 250,000 23,116 -- --
Senior note payable 20,000 20,000 20,000 20,000
SBA debentures 54,300 54,300 61,300 61,300
OPIC loan 20,000 8,700 20,000 8,700
Bonds payable -- -- 54,123 54,123
- - - - - - - - - - - - - ----------------------------------------------------------------------------------------------------------
Total notes payable and debentures 594,300 308,821 305,423 229,898
==========================================================================================================
Revolving lines of credit 80,000 38,842 110,000 45,099
- - - - - - - - - - - - - ----------------------------------------------------------------------------------------------------------
Total Debt $674,300 $347,663 $415,423 $274,997
==========================================================================================================
MASTER REPURCHASE AGREEMENT. The Company and Business Mortgage Investors, Inc.
("BMI"), a private real estate investment trust that is co-managed by the
Company and another investment adviser, can borrow up to $250,000,000, of which
$100,000,000 is committed, through repurchase agreements using its 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 75 percent to 80 percent of the value of the collateral pledged. The
terms of the master repurchase agreement require interest only payments with
all principal due at maturity. The master repurchase agreement bears interest
at the one-month London Inter Bank Overnight Rate ("LIBOR") plus 1.13 percent,
or 6.8 percent and 6.7 percent at December 31, 1997 and 1996, respectively.
Average debt outstanding, maximum amount borrowed, and weighted average
interest rate charged on the master repurchase agreement for the years ended
December 31, 1997 and 1996 were $166,362,000 and $51,767,000, $209,591,000 and
$85,775,000, and 6.6 percent and 7.3 percent, respectively. The master
repurchase agreement matures on January 31, 1999.
MASTER LOAN AND SECURITY AGREEMENT. During 1997, the Company, again in
conjunction with BMI, established a facility to borrow up to $250,000,000, of
which $100,000,000 is committed, using its commercial mortgage loans as
collateral under the agreement. At December 31, 1997, the Company's recorded
investment in these loans pledged as collateral totaled $29,193,000, which
approximated their market value. The agreement generally requires interest only
payments with all principal due at
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
maturity. The agreement bears interest at the one-month LIBOR plus 1.0 percent,
or 6.7 percent, at December 31, 1997. Average debt outstanding, maximum amount
borrowed, and weighted average interest rate charged on this facility for the
year ended December 31, 1997 was $17,899,000, $23,116,000, and 6.7 percent,
respectively. The agreement matures on August 21, 1998.
SENIOR NOTE PAYABLE. The Company has a $20,000,000 unsecured senior note
payable to an insurance company. This note bears interest at a fixed rate of
9.15 percent, payable semi-annually. The note is scheduled to mature over a
five-year period commencing in 1998 with annual principal payments of
$4,000,000. The senior note payable is subject to a prepayment penalty if paid
prior to maturity.
SBA DEBENTURES. The Company has debentures totaling $54,300,000 payable to the
SBA, at interest rates ranging from 6.87 percent to 9.80 percent, with
scheduled maturity dates as follows: 1998 - $6,650,000; 1999 - $0; 2000 -
$17,300,000; 2001 - $9,350,000; 2002 - $0; and $21,000,000 thereafter. The
debentures require semi-annual interest-only payments with all principal due
upon maturity.
BONDS PAYABLE. Allied Commercial, through one of its subsidiaries, issued
$98,810,000 of 6.92 percent series 1995-C1 Commercial Mortgage Collateralized
Bonds during November 1995. The bonds were rated "AA" by Fitch Investors
Service, L.P. The bonds were repaid in full in November 1997.
OVERSEAS PRIVATE INVESTMENT CORPORATION (OPIC) LOAN. The Company has a loan
agreement with OPIC under which the Company may borrow up to $20,000,000 (loan
commitment) to provide financing for international projects involving
qualifying U.S. small businesses. Loans under this agreement bear interest at
the U.S. Treasury rate plus 0.5 percent for the applicable period of the
borrowing. In addition, OPIC is entitled to receive from the Company a
contingent fee at maturity of the loan equal to 5 percent of the return
generated by the OPIC-related investments in excess of 7 percent. There are no
required principal payments until the OPIC loans mature in January 2006. The
loan commitment expires on the earlier of the first date on which the amount of
the loans equal $20,000,000 or April 10, 1998. As of December 31, 1997, the
Company had $11,300,000 available under the loan agreement.
REVOLVING LINES OF CREDIT. At December 31, 1997, the Company had several
revolving lines of credit totaling $80,000,000 under which the Company had
outstanding borrowings totaling $38,842,000. At December 31, 1996, the Company
had several revolving lines of credit totaling $110,000,000, under which the
Company had outstanding borrowings totaling $45,099,000. The lines of credit
bear interest at rates ranging from LIBOR plus 1.35 percent to 2.5 percent. At
December 31, 1997 and 1996 the weighted average interest rate on the facilities
was 7.7 percent and 7.8 percent, respectively. The lines required various
commitment and other fees equal to 0.39 percent of the outstanding borrowings
at December 31, 1997.
Average debt outstanding, maximum amount borrowed, and weighted average
interest rate charged on the revolving lines of credit for the years ended
December 31, 1997 and 1996 were $30,033,000 and $28,216,000, $45,759,000, and
$45,099,000, and 8.1 percent and 8.2 percent, respectively.
On January 12, 1998, the Company repaid all of its previous unsecured
revolving lines of credit and entered into a new $150,000,000 unsecured
revolving line of credit. The new facility bears interest at LIBOR plus 1.25
percent and requires a commitment fee equal to 0.2 percent of the committed
amount, and a facility fee equal to 0.15 percent of the initial commitment. The
new line expires 18-months from its inception. The new line of credit requires
monthly payments of interest and all principal is due upon its expiration. The
amount borrowed is based upon a borrowing base formula generally equal to 50
percent of the Company's portfolio investments not securing other credit
facilities.
NOTE 6. INCOME TAXES
For the years ended December 31, 1997, 1996 and 1995, the Company's effective
tax rate was 2.3 percent, 3.5 percent and 2.9 percent, respectively.
The Company's income subject to federal and state taxes relates to the
income generated by the pre-Merger operations of Advisers. The income
generated by Allied Lending and the Acquired Companies (except Advisers) is not
subject to federal and state income taxes because these companies qualified as
regulated investment companies or a real estate investment trust.
37
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7. PREFERRED STOCK
As of December 31, 1997, Allied Financial had outstanding a total of 60,000
shares of $100 par value, 3 percent cumulative preferred stock and 10,000
shares of $100 par value, 4 percent 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 percent cumulative preferred stock does not have
a required redemption date. Allied Financial 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 percent redeemable cumulative preferred stock has a required redemption
date of June 4, 2005.
NOTE 8. SHAREHOLDERS' EQUITY
In 1996, the Company completed two non-transferable subscription rights
offerings to common shareholders. The Company issued 1,433,414 shares of
common stock pursuant to these offerings raising net proceeds to the Company of
$17,147,000, after costs including a 2.5 percent fee paid to eligible
broker/dealers.
In 1996, the Company also sold 400,000 shares of its common stock through an
underwriter in a registered offering for net proceeds of $5,218,000.
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 sales prices reported for
the Company's common stock for the five days on which trading in the shares
takes place immediately prior to the dividend payment date. During 1997 and
1996, the Company issued 550,971 and 913,206 shares, respectively, at an
average price of $15.67 and $13.13 per share, respectively.
NOTE 9. EARNINGS PER COMMON SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) PER
COMMON
SHARE
1997 INCOME SHARES AMOUNT
Net increase in net assets resulting from operations $61,304
Less: Preferred stock dividends (220)
-------
Income available to common shareholders $61,084
=======
BASIC EARNINGS PER COMMON SHARE 49,218 $ 1.24
=========
Options outstanding to officers 33
------
DILUTED EARNINGS PER COMMON SHARE 49,251 $ 1.24
====== =========
1996
Net increase in net assets resulting from operations $54,947
Less: Preferred stock dividends (220)
-------
Income available to common shareholders $54,727
=======
BASIC EARNINGS PER COMMON SHARE 46,172 $ 1.19
=========
Options outstanding to officers 561
------
DILUTED EARNINGS PER COMMON SHARE 46,733 $ 1.17
====== =========
1995
Net increase in net assets resulting from operations $60,479
Less: Preferred stock dividends (220)
-------
Income available to common shareholders $60,259
=======
BASIC EARNINGS PER COMMON SHARE 43,697 $ 1.38
=========
Options outstanding to officers 313
------
DILUTED EARNINGS PER COMMON SHARE 44,010 $ 1.37
====== =========
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basic earnings per common share was computed by dividing net increase in net
assets resulting from operations, after deducting preferred stock dividends, by
the weighted average number of common shares outstanding each year.
Diluted earnings per common share was computed by dividing net increase in
net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding plus
common shares issuable upon assumed exercise of stock options outstanding each
year.
NOTE 10. EMPLOYEE STOCK OWNERSHIP PLAN AND DEFERRED COMPENSATION PLAN
The Company has an employee stock ownership plan ("ESOP"). Pursuant to the
ESOP, the Company is obligated to contribute 5 percent of each eligible
participant's total cash compensation for the year to a plan account on the
participant's behalf, which vests over a two-year period. ESOP contributions
are used to purchase shares of ACC.
As of December 31, 1997, the ESOP held 433,047 shares 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, 1997, 1996 and 1995 was $351,000, $1,018,000 and $864,000
respectively, net of forfeitures of $0, $36,000 and $180,000 in 1997, 1996 and
1995, respectively.
The Company also has a deferred compensation plan (the "DC Plan"). Eligible
participants of 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 shall 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 percent vested and non-forfeitable
except for amounts credited to participants' accounts related to the Formula
Award (see Note 12). 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 ACC 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.
NOTE 11. STOCK OPTION PLAN
In conjunction with the Merger, all stock option plans that existed for Allied
Lending and the Acquired Companies before the Merger ("Existing 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
("ACC Plan") for the Company to be effected post-Merger.
THE ACC PLAN. The purpose of the ACC Plan is to provide officers and
non-officer directors of ACC with additional incentives. Options may be
granted from time to time on up to 6,250,000 shares which represents
approximately 12 percent of the outstanding shares as of December 31, 1997.
There were no options granted pursuant to the ACC Plan as of December 31, 1997.
Options will be exercisable at a price equal to the fair market value of the
shares on the day the option is granted. Each option will state 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 ACC for any cause other than death or total and permanent
disability. If an optionee dies or becomes totally and permanently disabled
before expiration of the options without fully exercising it, he or she or the
executors or administrators or legatees or distributees of the estate shall, as
may be provided at the time of the grant, have the right, within one year after
the optionee's death or total and permanent disability, to exercise the options
in whole or in part before the expiration of its term. In the event of a change
of control of ACC, all outstanding options will become fully vested and
exercisable as of the change of control. Subsequent to December 31, 1997, the
Company's compensation committee granted a total of
39
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3,407,000 options to officers of the Company under the ACC Plan. The options
awarded to officers were generally non-qualified stock options that vest over a
five-year period from the grant date. The stock options granted had an exercise
price equal to $21.38 per share.
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 of
shareholders' equity. For the years ended December 31, 1997, 1996 and 1995, the
Company had outstanding loans to officers of $29,611,000, $15,491,000, and
$7,315,000, respectively. Officers with outstanding loans repaid principal of
$6,534,000, $2,199,000 and $1,038,000 for the years ended December 31, 1997,
1996 and 1995, respectively. The Company recognized interest income from these
loans of $1,031,000, $529,000 and $276,000, respectively, during these same
periods.
EXISTING PLAN ACTIVITY. During 1997, 1996 and 1995, Allied Lending and the
Acquired Companies granted 1,474,000, 866,000, and 1,505,000 options,
respectively, under the Existing 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, 1,051,000, and 576,000 during 1997, 1996 and 1995,
respectively.
The Company accounts for the ACC Plan 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 share would have been reduced to
the following pro forma amounts:
FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 1996 1995
Net increase in net assets resulting from operations:
As reported $61,304 $54,947 $60,479
Pro forma $60,656 $53,372 $58,931
Basic earnings per common share:
As reported $1.24 $1.19 $1.38
Pro forma $1.23 $1.16 $1.35
Diluted earnings per common share:
As reported $1.24 $1.17 $1.37
Pro forma $1.23 $1.14 $1.34
==============================================================================================
Pro forma expenses are based on the underlying value of the options granted by
the Company and the Acquired Companies. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model.
NOTE 12. CUT-OFF AWARD AND FORMULA AWARD
Allied Lending's and each Acquired Company's 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 is computed for each unvested option as of the Merger date. The
Cut-off Award is 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 is 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 approximates $2.9 million in the
aggregate.
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
percent of the difference between an amount equal to the combined aggregated
market capitalizations of Allied Lending and the Acquired Companies as of the
close of the market on the day before the Merger date (December 30, 1997), less
an amount equal to the
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
combined aggregate market capitalizations of Allied Lending and the Acquired
Companies as of the close of the market on the Merger announcement date (August
14, 1997). 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 approximated $19 million. The Formula Award will
vest 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 will be expensed in each year in
which it vests.
NOTE 13. INVESTMENT ADVISOR SERVICES
The Company has investment advisory agreements to manage the assets of certain
private companies. The investment advisory agreements are generally annual
agreements, and may be terminated at any time on 60 days' notice, without
penalty, by the managed companies.
NOTE 14. INTEREST RATE SWAPS
The Company uses interest rate swap agreements to protect against fluctuation
in interest costs on its variable rate short-term credit facilities. Amounts
paid or received on the settlement of interest rate swap agreements are
recognized as an adjustment to interest expense. As of December 31, 1997, the
Company had interest swap agreements with an aggregate notional amount of
$145,000,000. Pursuant to the swap agreements, the Company pays a weighted
average fixed rate equal to 6.8 percent and receives payments with a weighted
average variable rate equal to the 30-day LIBOR. The swap agreements have a
remaining weighted average maturity of approximately four years from December
31, 1997. As of December 31, 1997, the Company recorded an unrealized loss of
$5,000,000 related to the swap agreements in connection with the January 1998
asset securitization transaction.
NOTE 15. DIVIDENDS AND DISTRIBUTIONS
For the years ended December 31, 1997, 1996, and 1995, the Company declared
the following distributions:
1997 1996 1995
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
First quarter $14,347 $0.30 $11,158 $0.25 $8,855 $0.20
Second quarter 14,795 0.30 11,911 0.26 9,344 0.21
Third quarter 15,548 0.31 12,743 0.27 9,818 0.22
Fourth quarter 31,022 0.61 13,678 0.29 10,355 0.24
Annual extra distribution 1,118 0.02 7,908 0.16 9,548 0.22
Special undistributed earnings distribution 8,848 0.17 -- -- -- --
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------
Total distributions to common shareholders $85,678 $1.71 $57,398 $1.23 $47,920 $1.09
==================================================================================================================
For income tax purposes, distributions for 1997, 1996, and 1995 were comprised
of the following:
1997 1996 1995
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
Ordinary income $39,356 $0.79 $41,563 $0.89 $37,747 $0.86
Long-term capital gains 31,037 0.62 15,835 0.34 10,173 0.23
Return of capital (tax) 6,437 0.13 -- -- -- --
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------
Total distributions before special distribution 76,830 1.54 57,398 1.23 47,920 1.09
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------
Special undistributed earnings distribution 8,848 0.17 -- -- -- --
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------
Total distributions to common shareholders $85,678 $1.71 $57,398 $1.23 $47,920 $1.09
==================================================================================================================
41
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the differences between taxable income and
financial reporting income for the years ended December 31, 1997, 1996 and
1995:
(IN THOUSANDS) 1997 1996 1995
Financial statement net income $61,304 $54,947 $60,479
Adjustments
Amortization of discount (1,124) (2,779) (1,206)
Gains from disposition of portfolio assets 17,890 874 (904)
Net unrealized (gains) losses (7,209) 7,412 (9,266)
Expenses not deductible for tax:
Merger expenses 5,159 -- --
Other 853 2,306 1,176
Other (9,050) (1,372) 930
Income tax expense 1,444 1,945 1,784
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------
Taxable income $69,267 $63,333 $52,993
=============================================================================================
NOTE 16. COMMITMENTS AND CONTINGENCIES
The Company had commitments to fund loans to various prospective and existing
portfolio companies totaling $105,065,000 at December 31, 1997.
The Company is party to certain lawsuits in connection with its
business. While the outcome of these legal proceedings cannot at this time be
predicted with certainty, management does not expect that these proceedings
will have a material effect upon the financial condition of the Company.
NOTE 17. 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, cash and
cash equivalents consisted of the following:
(IN THOUSANDS) 1997 1996
Cash and cash equivalents $76,791 $75,744
Less escrows held (6,354) (3,903)
- - - - - - - - - - - - - ------------------------------------------------
Total $70,437 $71,841
================================================
NOTE 18. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
During 1997, 1996 and 1995, respectively, the Company paid $26,874,000,
$21,391,000 and $13,393,000 for interest and income taxes. During 1997, 1996
and 1995, respectively, the Company's non-cash financing activities totaled
$48,207,000, $22,361,000 and $15,756,000 related primarily to common stock
issuances resulting from stock option exercises and dividend reinvestment
shares issued. Additionally, during 1995, $18,062,000 in long-term debt was
consolidated from the minority interest in an asset securitization pool. During
1997, 1996 and 1995, respectively, the Company's non-cash investing activities
totaled $12,022,000, $2,004,000 and $23,490,000, relating to mortgage loans
consolidated from the minority interests in certain joint ventures.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19. SELECTED QUARTERLY DATA (UNAUDITED)
(in thousands, except per share amounts)
1997
QTR 1 QTR 2 QTR 3 QTR 4
Total interest and related portfolio income $21,399 $24,911 $25,111 $25,984
Portfolio income before realized and unrealized gains $11,968 $14,095 $12,093 $ 7,910
Net increase in net assets resulting from operations $12,646 $18,296 $17,146 $13,216
Basic earnings per common share $ 0.27 $ 0.35 $ 0.37 $ 0.25
Diluted earnings per common share $ 0.27 $ 0.35 $ 0.37 $ 0.25
1996
QTR 1 QTR 2 QTR 3 QTR 4
Total interest and related portfolio income $19,412 $20,866 $20,753 $23,906
Portfolio income before realized and unrealized gains $11,284 $11,665 $11,592 $13,035
Net increase in net assets resulting from operations $18,935 $11,090 $16,855 $ 8,067
Basic earnings per common share $ 0.42 $ 0.24 $ 0.35 $ 0.18
Diluted earnings per common share $ 0.42 $ 0.23 $ 0.34 $ 0.18
NOTE 20. SUBSEQUENT EVENT
LOAN SECURITIZATION. On January 30, 1998, the Company, in conjunction with BMI,
completed an asset securitization transaction whereby $239 million in
commercial mortgage-backed bonds were issued by Allied Capital Commercial
Mortgage Trust 1998-1. The bonds were sold in a private placement of three bond
classes rated "AAA," "AA" and "A" by Standard & Poor's Rating Services and
Fitch IBCA, Inc. The Company and BMI sold loans with an aggregate balance of
$310 million to secure the bonds. The Company contributed approximately 95
percent, or $295 million, of the total loans sold. The Company retained a trust
certificate representing the difference between the assets sold and the bond
proceeds received, or approximately 23% of the assets sold. The mortgage loans
sold had an approximate weighted average stated interest rate of 9.6 percent.
The three bond classes have an aggregate weighted average interest rate of
approximately 6.38 percent. The Company will account for the sale in accordance
with FASB 125.
43
31
CONSOLIDATING BALANCE SHEET
ALLIED ALLIED ALLIED
(IN THOUSANDS) ACC INVESTMENT FINANCIAL SBLC OTHERS
ASSETS
Portfolio at value:
Commercial mortgage loans $446,342 $ -- $ -- $ -- $ --
Mezzanine loans and debt securities 89,707 64,486 13,649 -- --
Small Business Administration 7(a) loans -- -- -- 40,709 --
Equity interests in portfolio companies 16,836 21,814 1,256 -- --
Investments in subsidiaries 67,293 -- -- -- --
Other portfolio assets 8 -- -- 43 2,171
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------
Total portfolio at value 620,186 86,300 14,905 40,752 2,171
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 25,958 26,024 16,397 1,593 465
U.S. government securities -- -- 11,091 -- --
Intercompany notes and receivables 56,167 8 -- 1,386 --
Other assets 13,809 2,425 761 8,696 3,535
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------
Total assets $716,120 $114,757 $43,154 $52,427 $6,171
=====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable $249,521 $40,183 $19,117 $ -- $ --
Revolving lines of credit 20,294 -- -- 18,548 --
Accounts payable and accrued expenses 12,040 3,961 152 1,828 208
Dividends and distributions payable 8,848 -- 220 -- --
Intercompany notes and payables 6,967 26,495 1,598 19,915 2,586
Other liabilities 4,591 816 226 162 --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------
302,261 71,455 21,313 40,453 2,794
=====================================================================================================================
Commitments and Contingencies
Preferred stock issued to Small
Business Administration -- -- 7,000 -- --
Shareholders' equity:
Common stock 5 -- -- -- 1
Additional paid-in capital 451,044 22,374 12,134 12,564 1,437
Notes receivable from sale of common
stock (29,611) -- -- -- --
Net unrealized appreciation
(depreciation) on portfolio 1,301 4,689 299 (394) --
Undistributed (distributions in
excess of) earnings (8,880) 16,239 2,408 (196) 1,939
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 413,859 43,302 14,841 11,974 3,377
=====================================================================================================================
Total liabilities and
shareholders' equity $716,120 $114,757 $43,154 $52,427 $6,171
=====================================================================================================================
DECEMBER 31, 1997
CONSOLIDATED
(IN THOUSANDS) ELIMINATIONS TOTAL
ASSETS
Portfolio at value:
Commercial mortgage loans $ -- $446,342
Mezzanine loans and debt securities -- 167,842
Small Business Administration 7(a) loans -- 40,709
Equity interests in portfolio companies -- 39,906
Investments in subsidiaries (67,293) --
Other portfolio assets -- 2,222
- - - - - - - - - - - - - --------------------------------------------------------------------------
Total portfolio at value (67,293) 697,021
- - - - - - - - - - - - - --------------------------------------------------------------------------
Cash and cash equivalents -- 70,437
U.S. government securities -- 11,091
Intercompany notes and receivables (57,561) --
Other assets -- 29,226
- - - - - - - - - - - - - --------------------------------------------------------------------------
Total assets $(124,854) $807,775
==========================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable $ -- $308,821
Revolving lines of credit -- 38,842
Accounts payable and accrued expenses -- 18,189
Dividends and distributions payable -- 9,068
Intercompany notes and payables (57,561) --
Other liabilities -- 5,795
- - - - - - - - - - - - - --------------------------------------------------------------------------
(57,561) 380,715
==========================================================================
Commitments and Contingencies
Preferred stock issued to Small
Business Administration -- 7,000
Shareholders' equity:
Common stock (1) 5
Additional paid-in capital (48,509) 451,044
Notes receivable from sale of common
stock -- (29,611)
Net unrealized appreciation
(depreciation) on portfolio (4,594) 1,301
Undistributed (distributions in
excess of) earnings (14,189) (2,679)
- - - - - - - - - - - - - --------------------------------------------------------------------------
Total shareholders' equity (67,293) 420,060
==========================================================================
Total liabilities and
shareholders' equity $(124,854) $807,775
==========================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
32
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
ALLIED ALLIED ALLIED CONSOLIDATED
(IN THOUSANDS) ACC INVESTMENT FINANCIAL SBLC OTHERS ELIMINATIONS TOTAL
INTEREST AND RELATED PORTFOLIO INCOME
Interest $57,067 $9,903 $3,637 $6,352 $9,923 $ -- $86,882
Interest income-intercompany 3,843 -- -- -- -- (3,843) --
Dividends from subsidiaries 22,960 -- -- -- -- (22,960) --
Net premiums from loan sales 170 -- -- 3,071 -- -- 3,241
Prepayment premiums 3,689 -- -- -- 347 -- 4,036
Investment advisory fees 15,439 -- -- -- -- (14,446) 993
Other income 663 107 -- -- 1,483 -- 2,253
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
Total interest and related
portfolio income 103,831 10,010 3,637 9,423 11,753 (41,249) 97,405
==============================================================================================================================
EXPENSES
Interest on indebtedness 16,950 3,897 1,781 1,511 2,813 -- 26,952
Interest on indebtedness-intercompany -- 1,555 -- 1,749 539 (3,843) --
Salaries and employee benefits 10,258 -- -- -- -- -- 10,258
Investment advisory fees 14,130 -- -- -- 316 (14,446) --
Legal and accounting 1,850 200 94 118 -- -- 2,262
General and administrative 5,677 157 (45) 113 806 -- 6,708
Merger 5,159 -- -- -- -- -- 5,159
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
Total expenses 54,024 5,809 1,830 3,491 4,474 (18,289) 51,339
==============================================================================================================================
Portfolio income before realized
and unrealized gains (losses) 49,807 4,201 1,807 5,932 7,279 (22,960) 46,066
==============================================================================================================================
NET REALIZED AND UNREALIZED GAINS
Net realized gains (losses) 6,777 3,104 (93) (132) 1,048 -- 10,704
Net unrealized gains (losses) 7,919 7,425 934 (711) -- (8,358) 7,209
- - - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
Total net realized and unrealized
gains (losses) 14,696 10,529 841 (843) 1,048 (8,358) 17,913
==============================================================================================================================
Income before minority interests and
income taxes 64,503 14,730 2,648 5,089 8,327 (31,318) 63,979
==============================================================================================================================
Minority interests -- -- -- -- 1,231 -- 1,231
Income tax expense 1,444 -- -- -- -- -- 1,444
==============================================================================================================================
Net increase in net assets resulting
from operations $63,059 $14,730 $2,648 $5,089 $7,096 $(31,318) $61,304
==============================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
45
33
CONSOLIDATING STATEMENT OF CASH FLOWS
ALLIED ALLIED ALLIED
(IN THOUSANDS) ACC INVESTMENT FINANCIAL SBLC
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting
from operations $63,060 $7,306 $1,714 $5,088
Adjustments
Net unrealized (gains) losses (7,920) -- -- 711
Depreciation and amortization 331 -- -- --
Amortization of loan discounts and fees (7,362) (314) (666) (505)
Deferred income taxes 1,087 -- -- --
Minority interests -- -- -- --
Amortization of deferred financing costs -- -- -- --
Changes in net assets and liabilities 656 3,475 658 (2,835)
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------
Net cash provided by
operating activities 49,852 10,467 1,706 2,459
=========================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in small business concerns (284,563) (20,949) (257) (49,231)
Collections of investment principal 143,470 26,396 12,544 8,117
Proceeds from the sale of loans 10,546 -- -- 43,366
Net (purchase) redemption of
U.S. government securities -- 254 (10,555) --
Collections (advances) under
intercompany notes (990) 1,500 -- (10)
Collections of notes receivable from
sale of common stock 6,534 -- -- --
Other investing activities (182) -- -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
investing activities (125,185) 7,201 1,732 2,242
=========================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 8,615 -- -- --
Purchase of common stock of subsidiaries (15,528) -- -- --
Common dividends and distributions paid (58,194) -- -- --
Dividends paid to parent company -- (6,321) (5,067) (5,995)
Preferred stock dividends -- -- (220) --
Net borrowings under (payments on) debentures
and notes payable 134,519 (5,000) (2,000) --
Net borrowings under revolving lines of credit (9,144) -- -- 2,887
Net payments on government securities
available for sale -- -- -- --
Other financing activities 10,800 -- -- --
- - - - - - - - - - - - - ---------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities 71,068 (11,321) (7,287) (3,108)
=========================================================================================================
Net increase (decrease) in cash and cash
equivalents $ (4,265) $ 6,347 $ (3,849) $1,593
=========================================================================================================
Cash and cash equivalents at beginning of year $30,223 $19,677 $20,247 --
=========================================================================================================
Cash and cash equivalents at end of year $25,958 $26,024 $16,398 $1,593
=========================================================================================================
FOR THE YEAR ENDED DECEMBER 31, 1997
CONSOLIDATED
(IN THOUSANDS) OTHERS ELIMINATIONS TOTAL
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting
from operations $7,096 $(22,960) $61,304
Adjustments
Net unrealized (gains) losses -- -- (7,209)
Depreciation and amortization 119 -- 450
Amortization of loan discounts and fees (1,957) -- (10,804)
Deferred income taxes -- -- 1,087
Minority interests 1,231 -- 1,231
Amortization of deferred financing costs 957 -- 957
Changes in net assets and liabilities 5,254 4,716 11,924
- - - - - - - - - - - - - -------------------------------------------------------------------------------------------
Net cash provided by
operating activities 12,700 (18,244) 58,940
===========================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in small business concerns (9,942) -- (364,942)
Collections of investment principal 42,478 -- 233,005
Proceeds from the sale of loans -- -- 53,912
Net (purchase) redemption of
U.S. government securities -- -- (10,301)
Collections (advances) under
intercompany notes (500) -- --
Collections of notes receivable from
sale of common stock -- -- 6,534
Other investing activities -- -- (182)
- - - - - - - - - - - - - -------------------------------------------------------------------------------------------
Net cash provided by (used in)
investing activities 32,036 -- (81,974)
===========================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock -- -- 8,615
Purchase of common stock of subsidiaries 15,528 -- --
Common dividends and distributions paid -- -- (58,194)
Dividends paid to parent company (861) 18,244 --
Preferred stock dividends -- -- (220)
Net borrowings under (payments on) debentures
and notes payable (48,596) -- 78,923
Net borrowings under revolving lines of credit -- -- (6,257)
Net payments on government securities
available for sale -- -- --
Other financing activities (12,037) -- (1,237)
- - - - - - - - - - - - - -------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities (45,966) 18,244 21,630
===========================================================================================
Net increase (decrease) in cash and cash
equivalents $(1,230) -- $(1,404)
===========================================================================================
Cash and cash equivalents at beginning of year $ 1,694 -- $71,841
===========================================================================================
Cash and cash equivalents at end of year $ 464 -- $70,437
===========================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
34
Report of Independent Public Accountants
To the Shareholders and Board of Directors
of Allied Capital Corporation and Subsidiaries:
We have audited the consolidated balance sheets of Allied Capital Corporation
and subsidiaries as of December 31, 1997 and 1996, including the consolidated
statement of investments as of December 31, 1997, 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, 1997. 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 the confirmation and 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.
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, 1997 and 1996, 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.
As discussed in Note 3, the consolidated financial statements include
investments valued at $697,021,000 as of December 31, 1997 and $607,368,000 as
of December 31, 1996, (86 percent and 85 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.
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 ANDERSEN LLP
Vienna, Virginia
February 20, 1998
47
35
SHAREHOLDER INFORMATION
CORPORATE OFFICES
WASHINGTON, DC--HEADQUARTERS
1666 K Street NW, 9th Floor
Washington, DC 20006
Telephone: 202.331.1112
Facsimile: 202.659.2053
Effective August 1998:
1919 Pennsylvania Avenue, NW
3rd Floor
Washington, DC 20006
CHICAGO
401 North Michigan Avenue, Suite 1620
Chicago, IL 60611
Telephone: 312.828.0330
Facsimile: 312.828.0909
SAN FRANCISCO
One Maritime Plaza, Suite 1750
San Francisco, CA 94111
Telephone: 415.399.2980
Facsimile: 415.986.8922
FRANKFURT, GERMANY
c/o Allied Capital Beteiligungsberatung GmbH
Ulmenstrasse 37
60325 Frankfurt
Telephone: +49 69 97 20 04 0
Facsimile: +49 69 97 20 04 15
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
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
212.936.5100 (outside the U.S.)
INVESTOR RELATIONS
Investors requiring information about the Company should contact:
SUZANNE V. SPARROW
PRINCIPAL, INVESTOR RELATIONS
Telephone: 888.818.5298
Facsimile: 202.659.2053
E-mail: ir@alliedcapital.com
MARKET LISTING
ALLIED CAPITAL CORPORATION common stock is quoted on the Nasdaq Stock 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 32,500 beneficial shareholders of the Company as of December 31, 1997.
FORM 10-K
ALLIED CAPITAL CORPORATION'S Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission, will be furnished without charge to
shareholders upon written request to the Investor Relations Department at the
Company's corporate headquarters. This information is also available on the
Company's Internet site at www.alliedcapital.com.
INDEPENDENT PUBLIC ACCOUNTANTS
ARTHUR ANDERSEN LLP
Vienna, VA
CORPORATE COUNSEL
SUTHERLAND, ASBILL & BRENNAN LLP
Washington, DC
ANNUAL MEETING OF SHAREHOLDERS
The Company's Annual Meeting of Shareholders will be held at 9:00 AM on May 14,
1998 at the Sheraton Carlton Hotel, 629 16th Street, NW, Washington, DC. All
shareholders are welcome to attend.
ALLIED CAPITAL CORPORATION
Annual Report 1997
STOCK PRICE: QUARTERLY, 1997 & 1996
1996 1997
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
High $ 15.000 $ 15.000 $ 15.375 $15.875 $ 17.000 $ 16.625 $ 16.750 $ 22.750
Low $ 12.750 $ 12.703 $ 13.125 $14.000 $ 14.875 $ 13.875 $ 14.500 $ 15.750
Close $ 14.500 $ 13.125 $ 14.625 $15.250 $ 16.250 $ 14.750 $ 16.000 $ 22.250
Quarterly Stock Price
The stock prices indicated are those of Allied Capital Lending Corporation, the
surviving company in the merger of the five Allied Capital companies, which was
completed on December 31, 1997.