SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarter Ended September 30, 1999.
/ / Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number: 814-00149
AMERICAN CAPITAL STRATEGIES, LTD.
(Exact name of registrant as specified in its charter)
Delaware 52-145-1377
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2 Bethesda Metro Center, 14th Floor
Bethesda, Maryland 20814
(Address of principal executive office)
(301) 951-6122
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes |X|. No |_|.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. The number of shares
of the issuer's Common Stock, $.01 par value, outstanding as of November 10,
1999 was 18,223,789.
AMERICAN CAPITAL STRATEGIES, LTD.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheets as of September 30, 1999 and December 31, 1998.................................1
Schedules of Investments as of September 30, 1999 and December 31, 1998.......................2
Statements of Operations for the three and nine months ended
September 30, 1999 and 1998..........................................................5
Statement of Shareholders' Equity for the nine months ended
September 30, 1999 and 1998..........................................................6
Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998..........................................................7
Financial Highlights for the nine months ended
September 30, 1999 and 1998..........................................................8
Notes to Financial Statements.................................................................9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation
Overview......................................................................................13
Results of Operations.........................................................................14
Financial Condition, Liquidity and Capital Resources..........................................16
Portfolio Credit Quality......................................................................17
Impact of the Year 2000.......................................................................17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................19
Item 2. Changes in Securities......................................................................19
Item 3. Defaults upon Senior Securities............................................................19
Item 4. Submission of Matters to a Vote of Security Holders........................................19
Item 5. Other Information..........................................................................19
Item 6. Exhibits and Reports on Form 8-K...........................................................19
Signature..............................................................................................20
i
PART I. FINANCIAL INFORMATION
AMERICAN CAPITAL STRATEGIES, LTD.
BALANCE SHEETS
(Unaudited)
(In thousands except per share data)
September 30, December 31,
1999 1998
------------- ------------
Assets
Investments at fair value (cost of $256,577 and $252,718, respectively) $ 264,921 $ 254,983
Cash and cash equivalents 45,186 6,149
Investment in unconsolidated operating subsidiary 5,233 6,386
Due from unconsolidated operating subsidiary 2,345 778
Interest receivable 3,082 1,561
Notes Receivable from employees 1,269 --
Other 4,198 162
--------- ---------
Total assets $ 326,234 $ 270,019
========= =========
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 255 $ 126
Accrued dividends payable 7,572 1,222
Notes payable -- 85,948
Revolving credit facility 69,840 30,000
--------- ---------
Total liabilities 77,667 117,296
Shareholders' equity:
Undesignated preferred stock, $0.01 par value, 5,000 shares authorized,
0 issued and outstanding -- --
Common stock, $.01 par value, 70,000 shares authorized, and 18,215 and
11,081 issued and outstanding, respectively 182 111
Capital in excess of par value 257,331 145,245
Notes receivable from sale of common stock (22,746) (300)
Undistributed (distributions in excess of) net realized earnings (60) (116)
Unrealized appreciation of investments 13,860 7,783
--------- ---------
Total shareholders' equity 248,567 152,723
--------- ---------
Total liabilities and shareholders' equity $ 326,234 $ 270,019
========= =========
See accompanying notes.
1
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1999
(Unaudited)
(In thousands except per share data)
Industry Cost Fair Value
-------- ---- ----------
Senior Debt--12.08%
- -------------------
BIW Connector Systems, LLC Manufacturing $ 3,404 $ 3,404
Chance Coach, Inc. (2) Bus Manufacturer 1,125 1,125
JAG Industries, Inc. (2) Manufacturing 1,200 1,200
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Euro-Caribe, Inc. (2) Meat Processing 6,705 6,705
Patriot Medical Technologies, Inc. (2) Repair Services 3,250 3,250
Tube City Olympic of Ohio, Inc. Mill Services 9,700 9,700
MBT International Inc. Musical Instrument Distributor 4,500 4,500
Caswell-Massey Holdings Corp. Toiletries 2,000 2,000
--------- ---------
Subtotal 32,634 32,634
Subordinated Debt--66.25%
- -------------------------
BIW Connector Systems, LLC. Manufacturing 6,799 6,799
Westwind Group Holdings, Inc. Restaurant 2,970 2,970
JAG Industries, Inc. (2) Manufacturing 2,371 2,371
Specialty Transportation Services, Inc. Waste Hauler 462 462
Chance Coach, Inc. (2) Bus Manufacturer 7,389 7,389
The L.A. Studios, Inc. Audio Production 2,448 2,448
Decorative Surfaces International, Inc. (2) Decorative Paper & Vinyl Mfg. 5,574 5,574
New Piper Aircraft, Inc. Aircraft Manufacturing 17,979 17,979
Electrolux, LLC Vacuum Cleaner 7,726 7,726
Cycle Gear, Inc. Motor Cycle Accessories 2,254 2,254
Confluence Holdings Corp. Canoes & Kayaks 8,783 8,783
Euro-Caribe, Inc. (2) Meat Processing 8,954 8,954
ConStar International, Inc. Electrical 18,867 18,867
Centennial Broadcasting, Inc. Radio Stations 16,465 16,465
Lion Brewery, Inc. (2) Malt Beverages 5,967 5,967
Auxi-Health, Inc. Home Health Care 10,110 10,110
Patriot Medical Technologies, Inc. (2) Repair Services 2,483 2,483
Tube City, Inc. . Mill Services 5,924 5,924
Erie County Plastics Corporation Molded Plastic Manufacturing 8,844 8,844
Aeriform Corporation Packaged Industrial Gas 7,637 7,637
MBT International, Inc. (2) Musical Instrument Distributor 6,764 6,764
Dixie Trucking Company, Inc. (2) Overnight Shorthaul Delivery 4,060 4,060
Caswell-Massey Holdings Corp. Toiletries 1,664 1,664
Transcore Holdings, Inc. (2) Transportation Services 5,387 5,387
The Inca Group (2) Manufacturing 11,097 11,097
--------- ---------
Subtotal 178,978 178,978
Convertible Preferred Stock--2.58%
- ----------------------------------
Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,687
Decorative Surfaces International, Inc. (2) prime rate
plus 4% dividend convertible into 2.9% of Co. Decorative Paper & Vinyl Mfg. 727 727
Patriot Medical Technologies, Inc. (2) 8% dividend convertible
into 16.9% of Co. Repair Services 1,000 1,000
MBT International, Inc. (2) convertible into 53.1% of Co. Musical Instrument Distributor 2,250 2,250
Transcore Holdings, Inc. (2) 8% dividend convertible
into 1.24% of Co. Transportation Service 300 300
--------- ---------
Subtotal 6,277 6,964
2
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1999
(Unaudited)
(In thousands except per share data)
Industry Cost Fair Value
-------- ---- ----------
Common Stock and Membership Interest Warrants(1)--14.77%
- --------------------------------------------------------
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 451
Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 244
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 429
Specialty Transportation Services, Inc. up to 40% of Co. Waste Hauler 694 1,500
Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 5,656
The L.A. Studios, Inc. 17% of Co. Audio Production 902 802
Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 6,804
New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,884
Cycle Gear, Inc. 16.5% of Co. Motor Cycle Accessories 374 374
Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,217
Euro-Caribe, Inc. (2) 37% of Co. Meat Processing 1,110 1,046
ConStar International, Inc. 17.5% of Co. Electrical 3,914 3,914
Lion Brewery, Inc. (2) 54% of Co. Malt Beverages 675 1,397
Auxi Health, Inc. 20% of Co. Home Health Care 2,599 2,599
Patriot Medical Technologies, Inc. (2) 17% of Co. Repair Services 612 612
Tube City, Inc. 14.75% of Co. Mill Services 2,523 2,523
Erie County Plastics Corporation 8% of Co. Molded Plastic Manufacturing 1,170 1,170
MBT International, Inc. (2) 30.6% of Co. Musical Instrument Distributor 846 846
Dixie Trucking Company, Inc. (2) 32% of Co. Overnight Shorthaul Delivery 141 141
Caswell-Massey Holdings Corp. 24% of Co. Toiletries 552 552
Transcore Holdings, Inc. (2) 30.6% of Co. Transportation Services 1,694 1,694
The Inca Group (2) 66.5% of Co. Manufacturing 3,060 3,060
--------- ---------
Subtotal 34,535 39,915
Common Stock and Membership Interests(1) - 2.45%
- ------------------------------------------------
Specialty Transportation Services, Inc. 9.1% of Co. Waste Hauler $ 500 $ 1,500
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,687
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 957
Confluence Holdings Corp. 0.7% of Co. Canoes & Kayaks 45 17
ConStar International, Inc. 2.8% of Co. Electrical 616 616
The Inca Group (2) 18.5% of Co. Manufacturing 850 850
--------- ---------
Subtotal 4,153 6,627
--------- ---------
Subtotal--non-publicly traded securities--98.13% 256,577 265,118
Interest Rate Basis Swap Agreements--(0.07)%
- --------------------------------------------
No. of Contracts Notional Amount Expiration Date Receive Rate Pay Rate
- ---------------- --------------- --------------- ------------ --------
4 $ 61,325 4/10/04 Floating Floating $ -- $ (197)
--------- ---------
Total Investments 256,577 264,921
Investment in Unconsolidated Operating Subsidiary--1.94%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)100% of Co. Investment Banking 403 5,233
--------- ---------
Totals $ 256,980 $ 270,154
========= =========
(1) Non-income producing
(2) Affiliate
See accompanying notes.
3
AMERICAN CAPITAL STRATEGIES, LTD.
SCHEDULE OF INVESTMENTS
DECEMBER 31, 1998
(Unaudited)
(In thousands except per share data)
Industry Cost Fair Value
-------- ---- ----------
Senior Debt--9.47%
- ------------------
Four S Baking Company (2) Baking $ 1,266 $ 1,266
BIW Connector Systems, LLC Manufacturing 3,404 3,404
Chance Coach, Inc. (2) Bus Manufacturer 1,286 1,286
JAG Industries, Inc. (2) Manufacturing 1,200 1,200
Confluence Holdings Corp. Canoes & Kayaks 9,675 9,675
Cycle Gear, Inc. Motor Cycle Accessories 750 750
Euro-Caribe, Inc. (2) Meat Processing 7,181 7,181
--------- ---------
Subtotal 24,762 24,762
Subordinated Debt--41.37%
- -------------------------
Four S Baking Company (2) Baking 1,588 1,588
BIW Connector Systems, LLC. Manufacturing 6,710 6,710
Westwind Group Holdings, Inc. Restaurant 2,932 2,932
JAG Industries, Inc. (2) Manufacturing 2,335 2,335
Specialty Transportation Services, Inc. (2) Waste Hauler 7,368 7,368
Chance Coach, Inc. (2) Bus Manufacturer 7,060 7,060
The L.A. Studios, Inc. Audio Production 2,393 2,393
Decorative Surfaces International, Inc. (2) Decorative Paper & Vinyl Mfg. 10,490 10,490
New Piper Aircraft, Inc. Aircraft Manufacturing 17,858 17,858
Electrolux, LLC Vacuum Cleaner 7,264 7,264
Cycle Gear, Inc. Motor Cycle Accessories 633 633
Confluence Holdings Corp. Canoes & Kayaks 4,701 4,701
Euro-Caribe, Inc. (2) Meat Processing 8,905 8,905
Starcom Holdings, Inc. Electrical 12,839 12,839
Centennial Broadcasting, Inc. Radio Stations 15,040 15,040
--------- ---------
Subtotal 108,116 108,116
Convertible Preferred Stock--2.10%
- ----------------------------------
Four S Baking Company (2) 15% dividend convertible into 10.89% of Co. Baking 2,756 2,756
Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,079
Decorative Surfaces International, Inc. (2) prime rate
plus 4% dividend convertible into 2.9% of Co. Decorative Paper & Vinyl Mfg. 646 646
--------- ---------
Subtotal 5,402 5,481
Common Stock and Membership Interests Warrants(1)--8.43%
- --------------------------------------------------------
Four S Baking Company (2) 3.26% of Co. Baking 462 600
BIW Connector Systems, LLC 8% of LLC Manufacturing 652 540
Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 421
JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 465
Specialty Transportation Services, Inc. (2) Up to 39.1% of Co. Waste Hauler 694 784
Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 4,543
The L.A. Studios, Inc. 17% of Co. Audio Production 902 857
Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 5,596
New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,231
Cycle Gear, Inc. 16.5% of Co. Motor Cycle Accessories 374 374
Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,319
Euro-Caribe, Inc. (2) 37% of Co. Meat Processing 1,110 1,110
Starcom Holdings, Inc. 17.5% of Co. Electrical 3,171 3,171
--------- ---------
Subtotal 20,382 22,011
Common Stock and Membership Interests(1) - 1.78%
- ------------------------------------------------
Four-S Baking Company (2) 5.5% of Co. Baking 966 1,004
Specialty Transportation Services, Inc. (2) 9.1% of Co. Waste Hauler 500 784
Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,131
Electrolux, LLC 2.5% of Co. Vacuum Cleaner 246 246
ConStar International, Inc. 2.8% Electrical 500 500
--------- ---------
Subtotal 4,108 4,665
--------- ---------
Subtotal--non-publicly traded securities--63.15% 162,770 165,035
Government Securities--34.41%
- -----------------------------
FHLB Discount Note due 1/4/99 89,948 89,948
--------- ---------
Total Investments 252,718 254,983
Investment in Unconsolidated Operating Subsidiary--2.44%
- --------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. Investment Banking 403 6,386
--------- ---------
Totals $ 256,980 $ 270,154
========= =========
(1) Non-income producing
(2) Affiliate
See accompanying notes.
4
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except per share data)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
Operating income:
Interest and dividend income $ 8,414 $ 4,090 $ 20,758 $ 9,931
Loan fees 729 672 2,060 1,806
-------- -------- -------- --------
Total operating income 9,143 4,762 22,818 11,737
Operating expenses:
Salaries and benefits 411 250 909 628
General, administrative and other 382 246 1,035 682
Interest 1,349 -- 3,245 --
-------- -------- -------- --------
Total operating expenses 2,142 496 5,189 1,310
Operating income before equity in loss of
unconsolidated operating subsidiary 7,001 4,266 17,629 10,427
Equity in loss of unconsolidated operating
subsidiary (337) (366) (1,153) (154)
-------- -------- -------- --------
Net operating income 6,664 3,900 16,476 10,273
Net realized gain on investments -- -- 867 --
Increase in unrealized appreciation of investments 3,570 924 6,077 943
-------- -------- -------- --------
Net increase in shareholders' equity resulting
from operations $ 10,234 $ 4,824 $ 23,420 $ 11,216
======== ======== ======== ========
Net operating income per share:
Basic $ 0.45 $ 0.35 $ 1.33 $ 0.93
Diluted $ 0.43 $ 0.34 $ 1.28 $ 0.89
Earnings per common share:
Basic $ 0.69 $ 0.44 $ 1.89 $ 1.01
Diluted $ 0.66 $ 0.42 $ 1.81 $ 0.97
Weighted average shares of Basic 14,869 11,070 12,395 11,069
Common stock outstanding Diluted 15,619 11,461 12,920 11,544
See accompanying notes.
5
AMERICAN CAPITAL STRATEGIES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands except per share data)
(Distributions
Notes in excess of)
Capital in Receivable Net Realized Unrealized Total
Common Stock Excess of From Sale of Undistributed Appreciation Shareholders'
Shares Amount Par Value Common Stock Earnings of Investments Equity
------ ------ --------- ------------ ------------- -------------- ------
Balance at December 31, 1997 11,069 $ 111 $ 144,940 $ -- $ (55) $ 5,656 $ 150,652
Issuance of common stock under
the 1997 Stock Option Plan 8 -- 96 -- -- -- 96
Net increase in shareholders'
equity resulting from -- -- -- -- 10,273 943 11,216
operations
Distributions -- -- -- -- (9,522) -- (9,522)
------ --------- --------- --------- --------- --------- ---------
Balance at September 30, 1998 11,077 $ 111 $ 145,036 $ -- $ 696 $ 6,599 $ 152,442
====== ========= ========= ========= ========= ========= =========
Balance at December 31, 1998 11,081 $ 111 $ 145,245 $ (300) $ (116) $ 7,783 $ 152,723
Issuance of common stock 5,605 56 89,150 89,206
Issuance of common stock under
the 1997 Stock Option Plan 1,499 15 22,431 -- -- -- 22,446
Issue of common stock under the
Dividend Reinvestment Plan 20 -- 339 -- -- -- 339
Issuance of restricted stock 10 -- 166 -- -- -- 166
Issuance of notes receivable
from sale of common stock -- -- -- (22,446) -- -- (22,446)
Net increase in shareholders'
equity resulting from -- -- -- -- 17,343 6,077 23,420
operations
Distributions -- -- -- -- (17,287) -- (17,287)
------ --------- --------- --------- --------- --------- ---------
Balance at September 30, 1999 18,215 $ 182 $ 257,331 $ (22,746) $ (60) $ 13,860 $ 248,567
====== ========= ========= ========= ========= ========= =========
See accompanying notes.
6
AMERICAN CAPITAL STRATEGIES, LTD.
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands except per share data)
Nine Months Nine Months
Ended Ended
September 30, September 30,
1999 1998
------------- -------------
Operating activities
Net increase in shareholders' equity resulting from operations $ 23,420 $ 11,216
Adjustments to reconcile net increase in shareholders' equity resulting
from operations to net cash provided by operating activities:
Unrealized appreciation of investments (6,077) (943)
Net realized gain on investments (867) --
Net amortization of securities -- (1,347)
Accretion of loan discounts (1,613) (563)
Amortization of deferred finance costs 554 --
Increase in interest receivable (1,521) (1,291)
Increase in accrued payment-in-kind dividend and interest (2,068) --
(Increase) decrease in due from unconsolidated subsidiary (1,567) 833
Increase (decrease) in other assets (2,579) 26
Increase in accounts payable and accrued liabilities 129 91
Equity in loss of unconsolidated operating subsidiary 1,153 154
--------- ---------
Net cash provided by operating activities 8,964 8,176
Investing activities
Proceeds from sale or maturity of investments 28,885 161,580
Principal repayments 26,092 1,313
Purchase of investments (122,338) (91,337)
Issuance of employee notes receivable (1,269) --
Purchase of securities (12,900) (117,308)
--------- ---------
Net cash used in investing activities (81,530) (45,752)
Financing activities
Drawings on revolving credit facilities, net 39,840 --
Proceeds from notes payable -- 45,037
Repayments of notes payable (5,000) --
Increase in deferred financing costs (2,011) --
Issuance of common stock 89,372 96
Distributions paid (10,598) (9,522)
--------- ---------
Net cash provided by financing activities 111,603 35,611
--------- ---------
Net increase (decrease) in cash and cash equivalents 39,037 (1,965)
Cash and cash equivalents at beginning of period 6,149 8,862
--------- ---------
Cash and cash equivalents at end of period $ 45,186 $ 6,897
========= =========
Non-cash financing activities:
- ------------------------------
Issuance of common stock in conjunction with dividend reinvestment $ 339 $ --
Notes receivable issued in exchange for common stock 22,446 --
Net repayment of margin borrowings through sale of securities 80,948 --
See accompanying notes.
7
AMERICAN CAPITAL STRATEGIES, LTD.
FINANCIAL HIGHLIGHTS
(Unaudited)
(In thousands except per share data)
Nine Months Ended Nine Months Ended
September 30, 1999 September 30, 1998
------------------ ------------------
Per Share Data(1)
Net asset value at beginning of the period $ 13.80 $ 13.61
Net operating income 1.33 0.93
Increase in unrealized appreciation on investments 0.56 0.08
--------- ---------
Net increase in shareholders' equity from operations $ 1.89 $ 1.01
Issuance of common stock 0.71 --
Dividends declared (1.27) (0.86)
Effect of Dilution from exercise of stock options (1.49) --
--------- ---------
Net asset value at end of period $ 13.64 $ 13.76
Per share market value at beginning of period $ 17.250 $ 18.125
Per share market value at end of period $ 18.500 $ 16.188
Total return (2) 14.62% (5.94)%
Shares outstanding at end of period 18,215 11,077
Ratio/Supplemental Data
Net assets at end of period $ 248,508 $ 152,442
Ratio of operating expenses to average net assets 2.59% 0.86%
Ratio of net operating income to average net assets 8.24% 6.78%
(1) Basic per share data.
(2) Amounts were not annualized for the results of the nine month periods ended
September 30, 1999 and 1998.
See accompanying notes.
8
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
Note 1. Unaudited Interim Financial Statements
Interim financial statements of American Capital Strategies, Ltd. (the
"Company") are prepared in accordance with generally accepted accounting
principles ("GAAP") for the interim financial information and pursuant to the
requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain disclosures accompanying annual financial statements
prepared in accordance with GAAP are omitted. In the opinion of management, all
adjustments, consisting solely of normal recurring accruals, necessary for the
fair presentation of financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results that ultimately may be achieved for the year. The interim
financial statements and notes thereto should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K/A for
the year ended December 31, 1998, as filed with the Securities and Exchange
Commission.
Use of Estimates in 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, liabilities, revenues
and expenses and disclosure of contingent assets and liabilities. Actual results
could differ from those estimates.
Note 2. Organization
American Capital Strategies, Ltd., a Delaware corporation (the
"Company"), was incorporated in 1986 to provide financial advisory services to
and invest in middle market companies. On August 29, 1997, the Company completed
an initial public offering ("IPO") of 10,382,437 shares of common stock ("Common
Stock"), and became a non-diversified closed end investment company that has
elected to be treated as a business development company ("BDC") under the
Investment Company Act of 1940, as amended ("1940 Act"). On October 1, 1997, the
Company began operations so as to qualify to be taxed as a regulated investment
company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the
Internal Revenue Code of 1986 as amended (the "Code"). As contemplated by these
transactions, the Company materially changed its business plan and format from
structuring and arranging financing for buyout transactions on a fee for
services basis to primarily being a lender to and investor in middle market
companies. The Company's investment objectives are to achieve current income
from the collection of interest and dividends, as well as long-term growth in
its shareholders' equity through appreciation in value of the Company's equity
interests. The Company provides financial advisory services to businesses
through ACS Capital Investments Corporation ("CIC"), a wholly-owned subsidiary.
The Company is headquartered in Bethesda, Maryland, and has offices in New York,
Boston, Pittsburgh, San Francisco, Chicago, and Dallas.
Note 3. Investment in Unconsolidated Operating Subsidiary
As discussed in Note 2, CIC is an operating subsidiary of the Company
and is accounted for under the equity method effective October 1, 1997. The
investment in CIC is carried at fair value as determined by the Board of
Directors.
Condensed financial information for CIC is as follows:
September 30, 1999 December 31, 1998
------------------ -----------------
Assets
Investments in portfolio companies, at fair value $10,365 $10,837
Other assets, net 2,399 1,359
------- -------
Total assets $12,764 $12,196
======= =======
Liabilities and Shareholder's Equity
Deferred income taxes $ 2,205 $ 2,921
Due to parent 2,390 778
Other liabilities 2,936 2,111
Shareholder's equity 5,233 6,386
------- -------
Total liabilities and shareholder's equity $12,764 $12,196
======= =======
9
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
Operating income $ 1,528 $ 901 $ 3,543 $ 4,782
Operating expense 2,257 1,628 6,082 5,090
------- ------- ------- -------
Net operating loss (729) (727) (2,539) (308)
Realized gains on investments -- -- 925 --
Increase (decrease) in unrealized
appreciation of investments 186 187 (246) 57
Other income 206 174 707 97
------- ------- ------- -------
Net loss $ (337) $ (366) $(1,153) $ (154)
======= ======= ======= =======
Note 4. Notes Payable
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility; on September 17, 1999, the facility was increased to a maximum
of $125,000. In connection with the closing, the Company established ACS Funding
Trust I (the "Trust"), an affiliated business trust and contributed or sold to
the Trust approximately $157,000 in loans. The Company subsequently contributed
an additional $55 million in loans to the Trust. Subject to the continued
satisfaction of certain conditions, the Company will remain servicer of the
loans. Simultaneously with the initial contribution, the Trust entered into a
loan agreement with First Union Capital Markets Corp., as deal agent, and
certain other parties providing for loans in an amount up to 50% of the eligible
loan balance subject to certain concentration limits. The term of the facility
is two years and interest on borrowings will be charged at LIBOR plus 2.50%. The
full amount of principal is due at the end of the term and interest is payable
monthly. The transfer of assets to the Trust and the related borrowings by the
Trust have been treated as a financing arrangement by the Company under
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." As of
September 30, 1999, the Company has $69,840 of borrowings outstanding under this
facility.
Due to the short term of the borrowings, the fair value of the notes
payable approximates cost.
Note 5. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three and nine months ended September 30, 1999 and
1998.
10
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
Numerator for basic and diluted net
increase in shareholders'
equity resulting from
operations $10,234 $ 4,824 $23,420 $11,216
Denominator for basic-weighted
average shares 14,869 11,070 12,395 11,069
Employee stock options 70 304 185 359
Contingently issuable shares 598 -- 268 --
Warrants 82 87 72 116
------- ------- ------- -------
Dilutive potential shares 750 391 525 475
Denominator for diluted 15,619 11,461 12,920 11,544
------- ------- ------- -------
Basic earnings per share $ 0.69 $ 0.44 $ 1.89 $ 1.01
Diluted earnings per share $ 0.66 $ 0.42 $ 1.81 $ 0.97
Note 6. Realized Gain on Investments
During March, 1999, the Company sold its investment in Four S Baking
Company ("Four S"). The Company's investment included senior debt, subordinated
debt, preferred stock, common stock and common stock warrants. The Company
received $7.2 million in total proceeds from the sale and recognized a net
realized gain of $316. The realized gain was comprised of a $331 realization of
unamortized loan discounts on the subordinated debt and a net loss of $15 on the
common stock and warrants. In addition, the Company earned prepayment fees of
$87 from the early repayment of the senior and subordinated debt. In conjunction
with the sale, the Company also recorded $177 of unrealized depreciation to
reverse previously recorded unrealized appreciation.
During June, 1999, the Company received a prepayment of subordinated
debt from Specialty Transportation Services, Inc. ("STS") in the amount of
$7,500. In conjunction with the repayment, the Company received prepayment fees
of $225 and recognized a realized gain of $551 from the realization of
unamortized original issue discount. At September 30, 1999, the Company's
subordinated debt investment in STS was $462. (See Note 10)
Note 7. Interest Rate Risk Management
The Company enters into interest rate swap agreements with major banks
as part of its strategy to manage interest rate risks and to fulfill its
obligation under the terms of its debt funding facility. The Company uses
interest rate swap agreements for hedging and risk management only and not for
speculative purposes. During the nine months ended September 30, 1999, the
Company entered into four interest rate basis swap agreements with an aggregate
notional amount of $61,325. Pursuant to these swap agreements, the Company pays
a variable rate equal to the prime lending rate (8.25% at September 30, 1999)
and receives a weighted average rate of the 30-day LIBOR (5.38% at September 30,
1999) plus 2.70%. The swaps have a remaining weighted average maturity of more
than four years. At September 30, 1999, the fair value of the interest rate
basis swap agreements represented a liability of $197.
11
AMERICAN CAPITAL STRATEGIES, LTD.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(In thousands except per share data)
Note 8. Related Party Transactions
The Company has provided loans to employees, including the three
executive officers discussed below, for the exercise of options under the 1997
Stock Option Plan. The loans require the current payment of interest at the
applicable federal interest rate in effect at the date of issue, have varying
terms not exceeding nine years and have been recorded as a reduction of
shareholders' equity. The loans are evidenced by full recourse notes that are
due upon termination of employment and the shares of common stock purchased with
the proceeds of the loan are posted as collateral. During the nine months ended
September 30, 1999, the Company issued $23,715 in loans to employees for the
exercise of options. The Company recognized interest income from these loans of
$265 and $314 during the three and nine months ended September 30, 1999.
In addition to the above, the Company entered into agreements to
purchase split dollar life insurance for three executive officers. The aggregate
cost of the split dollar life insurance is $2,638. The cost to the Company will
generally be amortized over a period equal to ten years as long as each
executive officer continues employment. During the period the loans are
outstanding, the Company will have a collateral interest in the cash value and
death benefit of these policies as additional security for the loans.
Additionally, as long as the policy premium is not fully amortized, the Company
will have a collateral interest in such items generally equal to the unamortized
cost of the policies. In the event of an individual's termination of employment
with the Company prior to the end of such ten year period, or, his election not
to be bound by non compete agreements, such individual must reimburse the
company the unamortized cost of his policy.
Note 9. Capital Transactions
On August 11, 1999, the Company issued 5,000 shares of common stock for
an aggregate purchase price of $85,000 and granted the underwriters the option
to purchase up to 750 additional shares of common stock within thirty days for
an aggregate purchase price of $12,750. The net proceeds from the sale of the
5,000 shares of common stock were $79,512. On September 10, 1999, the
underwriters' exercised their option to acquire 605 shares from the Company. The
net proceeds from the issuance of the 605 shares of common stock were $9,694.
The Company used the proceeds from the offerings to repay outstanding borrowings
under its revolving debt funding facility.
Note 10. Subsequent Events
During October 1999, the Company sold its investments in STS. The
Company received $3,000 for its common stock and common stock warrants. In
addition, STS repaid the $500 of subordinated debt owned by the Company. As a
result of these transactions, the Company recorded a realized gain of $1,806 on
the sale of the common stock and warrants and $38 on the early repayment of the
subordinated debt. In addition, STS paid CIC $1,000 in fees for the termination
of an investment banking agreement and paid the Company $15 in prepayment
penalties.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(In thousands except per share data)
All statements contained herein that are not historical facts
including, but not limited to, statements regarding anticipated activity are
forward looking in nature and involve a number of risks and uncertainties.
Actual results may differ materially. Among the factors that could cause actual
results to differ materially are the following: changes in the economic
conditions in which the Company operates negatively impacting the financial
resources of the Company; certain of the Company's competitors with
substantially greater financial resources than the Company reducing the number
of suitable investment opportunities offered to the Company or reducing the
yield necessary to consummate the investment; increased costs related to
compliance with laws, including environmental laws; general business and
economic conditions and other risk factors described in the Company's reports
filed from time to time with the Securities and Exchange Commission. The Company
cautions readers not to place undue reliance on any such forward looking
statements, which statements are made pursuant to the Private Securities
Litigation Reform Act of 1995 and, as such, speak only as of the date made.
The following analysis of the financial condition and results of
operations of the Company should be read in conjunction with the Company's
financial statements and the notes thereto, included elsewhere in this report
and in the Company's annual report on Form 10-K/A for the year ended December
31, 1998.
Overview
The Company's primary business is investing in and lending to
privately-owned businesses through investments in senior debt, subordinated debt
with detachable equity warrants, preferred stock, and common stock. The total
portfolio value of investments in non-publicly traded securities was $265,118
and $165,035 at September 30, 1999 and December 31, 1998, respectively. During
the three months ended September 30, 1999 (the "Third Quarter 1999"), the
Company originated investments totaling $48,384 and advanced $8,400 previously
committed under working capital facilities. During the nine months ended
September 30, 1999 (the "1999 YTD Period"), the Company originated investments
totaling $118,113 and advanced $4,275 previously committed under working capital
facilities. During the 1999 YTD Period, the Company also received repayments of
loans of $26.1 million and, in conjunction with the sale of one portfolio
company, the Company sold warrants of $0.6 million, common stock of $1.0
million, preferred stock of $2.9 million, and received repayment of senior and
subordinated debt of $2.8 million. As a result, the total portfolio increased by
61% from December 31, 1998 to September 30, 1999. The weighted average effective
interest rate on the investment portfolio was 13.8% and 13.0%, respectively, at
September 30, 1999 and December 31, 1998. A summary of the composition of the
Company's portfolio of non-publicly traded securities at September 30, 1999 and
December 31, 1998 is shown in the following table:
September 30, 1999 December 31, 1998
------------------ -----------------
Senior debt 12.3% 15.0%
Subordinated debt 67.5% 65.5%
Convertible preferred stock 2.6% 3.3%
Common stock warrants 15.1% 13.4%
Common stock 2.5% 2.8%
The Company expects its portfolio composition for the remainder of 1999
to be similar to its portfolio composition at September 30, 1999 and at December
31, 1998. The Company will continue to weight heavily its portfolio composition
toward investments in subordinated debt with detachable warrants.
13
The following table shows the portfolio composition by industry
grouping:
September 30, 1999 December 31, 1998
------------------ -----------------
Manufacturing 61.0% 66.1%
Health Care 4.8% --
Media 6.2% 9.1%
Construction 8.8% 10.0%
Wholesale & Retail 9.5% 7.4%
Transportation 2.9% 5.4%
Service 6.8% 2.0%
Management expects that the largest percentage of its investments will
continue to be in manufacturing companies, however, the Company intends to
continue to diversify its portfolio and will explore new investment
opportunities in a variety of industries.
Results of Operations
The Company's financial performance, as reflected in its Statements of
Operations, is composed of three primary elements. The first element is "Net
operating income," which is primarily the interest and dividends earned from
investing in debt and equity securities and the equity in earnings of its
unconsolidated operating subsidiary less the operating expenses of the Company.
The second element is "Change in unrealized appreciation of investments," which
is the net change in the estimated fair value of the Company's portfolio assets
at the end of the period compared with their estimated fair values at the
beginning of the period or their stated costs, as appropriate. The third element
is "Realized gain on investments," which reflects the difference between the
proceeds from a sale or maturity of a portfolio investment and the cost basis of
the investment. In addition, the Company operates so as to qualify to be taxed
as a RIC. As long as the Company qualifies as a RIC, it will be able to take a
deduction against its otherwise taxable income for certain dividends it pays,
allowing it to substantially reduce or eliminate its corporate-level tax
liability. As a result, the provisions for income taxes are expected to be
minimal.
As a RIC, the Company is required to account for investments in
operating subsidiaries under the equity method, regardless of ownership
interest. Accordingly, the Company's investment in CIC is presented on the
equity method and, consistent with the equity method of accounting, the
portfolio companies owned by CIC are not reported separately by the Company.
14
The operating results for the three and nine months ended September 30,
1999 and September 30, 1998 are as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1999 1998 1998
------------- ------------- ------------- -------------
Operating income $ 9,143 $ 4,762 $ 22,818 $ 11,737
Operating expenses 2,142 496 5,189 1,310
Equity in loss of unconsolidated
operating subsidiary
(337) (366) (1,153) (154)
-------- -------- -------- --------
Net operating income 6,664 3,900 16,476 10,273
Net realized gain on investments
-- -- 867 --
Increase in unrealized
appreciation of investments 3,570 924 6,077 943
-------- -------- -------- --------
Net increase in shareholders'
equity resulting from
operations $ 10,234 $ 4,824 $ 23,420 $ 11,216
======== ======== ======== ========
Total operating income for the Third Quarter 1999 and the 1999 YTD
Period increased $4,381, or 92%, and $11,081, or 94%, respectively, compared to
the three and nine months ended September 30, 1998 (the "Third Quarter 1998" and
the "1998 YTD Period"). The increase in operating income is a result of the
Company closing 21 investments in private companies totaling $161 million
between September 30, 1998 and September 30, 1999. For the Third Quarter 1999,
operating income consisted of $729 in loan fees, $8,060 in interest and
dividends on non-publicly traded securities and $354 in interest on government
agency securities, bank deposits, repurchase agreements and shareholder loans;
for the Third Quarter 1998, operating income consisted of $672 in loan fees,
$3,393 in interest and dividends on non-publicly traded securities and $697 in
interest on government agency securities, bank deposits and repurchase
agreements. For the 1999 YTD Period, operating income consisted of $2,060 in
loan fees, $20,193 in interest and dividends on non-publicly traded securities
and $565 in interest on government agency securities, bank deposits repurchase
agreements and shareholder loans; for the 1998 YTD Period, operating income
consisted of $1,806 in loan fees, $6,763 in interest and dividends on
non-publicly traded securities and $3,168 in interest on government agency
securities, bank deposits and repurchase agreements. As the Company increases
its investment portfolio of non-publicly traded securities, the interest and
dividends the Company realizes on these securities will also increase.
Operating expenses for the Third Quarter 1999 increased $1,646, or
332%, over the same period in 1998. For the 1999 YTD Period, operating expenses
increased $3,879, or 296% over the nine months ended September 30, 1999. The
increase for both periods is primarily due to the increase in interest expense
from $0 in the Third Quarter 1998 and the 1998 YTD Period to $1,349 and $3,245
for the three and nine months ended September 30, 1999, respectively. The
increase in interest expense resulted from the Company's $69.8 million in net
borrowings under credit facilities between September 30, 1998 and September 30,
1999. The weighted average interest rate on borrowings at September 30, 1999 was
7.9%. In addition operating expenses also increased for the 1999 YTD Period due
to the increase in salaries and benefits from $628 for the nine months ended
September 30, 1998 to $909 in 1999. The Company had 36 and 30 employees at
September 30, 1999 and 1998, respectively. The increase in salary and benefit
expense is directly attributable to the increase in the number of employees. The
Company intends to continue hiring new professionals in 1999 and 2000 to support
anticipated portfolio growth.
Equity in loss of unconsolidated operating subsidiary, which represents
CIC's results, decreased from a loss of $366 for Third Quarter 1998 to a loss of
$337 for Third Quarter 1999. For the nine months ended September 30, 1999,
equity in loss of unconsolidated operating subsidiary decreased $999 from the
1998 YTD Period. For the three months ended September 30, 1999, CIC's results
included $1,528 of operating income, $2,257 of operating expenses, $186 of
unrealized appreciation of investments, and $206 in other income. For the three
months ended September 30, 1998, CIC's results included $901 of operating
income, $1,628 of
15
operating expenses, $187 of unrealized appreciation of investments, and $174 of
other income. For the 1999 YTD Period, CIC's results included $3,543 of
operating income, $6,082 of operating expenses, $925 of realized gains, $246 of
unrealized depreciation of investments, and $707 of other income. The realized
gain was a result of the sale of CIC's common stock investment in Four S Baking
Company and the unrealized depreciation was due to the reversal of previously
recorded unrealized appreciation of CIC's Four S Baking Company investment,
netted against unrealized gains on other investments. For the nine months ended
September 30, 1998, CIC recorded $4,782 in operating income, $5,090 in operating
expenses, $57 in unrealized appreciation of investments, and $97 of other
income. The decrease in CIC's earnings for the 1999 YTD Period was primarily
attributable to the lower investment banking fees generated during the Third
Quarter 1999 and the higher operating expenses resulting from the increase in
employees from 30 to 36, which resulted in a decrease in operating income of
$2,231 for the nine month period ended September 30, 1999.
During the 1999 YTD Period, the Company recorded a realized gain of
$551 from the prepayment of $7.5 million of subordinated debt by STS, and a
realized gain of $316 on the sale of its investment in Four S. Total proceeds
from the sale of the Four S securities, which included senior debt, subordinated
debt, preferred stock, common stock warrants, and common stock, were $7.2
million. The realized gains for the STS and Four S transactions were comprised
of the realization of unamortized loan discounts.
The increase in unrealized appreciation of investments is based on
portfolio asset valuations determined by the Company's Board of Directors. The
increase in unrealized appreciation of investments for the Third Quarter 1999
increased $2,646 over the Third Quarter 1998. The increase for Third Quarter
1999 was comprised of aggregate valuation increases of $4,090 at eight portfolio
companies and aggregate valuation decreases of $323 at seven portfolio companies
and $197 related to interest rate basis swaps used to manage interest rate risk.
The increase in unrealized appreciation for the 1999 YTD Period increased $5,134
due to aggregate valuation increases of $7,002 at six portfolio companies and
aggregate valuation decreases of $728 at seven portfolio companies and $197
related to interest rate basis swaps used to manage interest rate risk.
Financial Condition, Liquidity, and Capital Resources
At September 30, 1999, the Company had $45,186 in cash and cash
equivalents. In addition, the Company had outstanding debt secured by assets of
the Company of $69,840 in borrowings under credit facilities; the maximum amount
available under this facility is $125,000. During 1998, the Company's primary
source of funding was the proceeds received in connection with its IPO. The
Company completed investing the proceeds of its IPO during 1998 and began
funding its investments with proceeds from a line of credit and short term
borrowings. On August 11, 1999, the Company completed a fully underwritten
public offering of its common stock and received net proceeds of approximately
$79,500 in exchange for 5,000 common shares. On September 10, 1999, the Company
issued 605 shares of its common stock pursuant to the underwriter's
overallotment option granted on Auguest 11, 1999 and received net proceeds of
approximately $9,600.
As of March 31, 1999, the Company closed a maximum $100,000 debt
funding facility; this facility was increased to a $125,000 on September 17,
1999. In connection with the closing, the Company established ACS Funding Trust
I (the "Trust"), an affiliated business trust and contributed or sold to the
Trust approximately $157,000 in loans. The Company subsequently contributed an
additional $55,000 in loans to the Trust. Subject to the continuing satisfaction
of certain conditions, the Company will remain servicer of the loans.
Simultaneously with the initial contribution, the Trust entered into a loan
agreement with First Union Capital Markets Corp., as deal agent, and certain
other parties providing for loans in an amount up to 50% of the eligible loan
balance, subject to certain concentration limits. The term of the facility is
two years and interest on borrowings will be charged at LIBOR plus 2.50%. The
full amount of principal is due at the end of the term and interest is payable
monthly. The Company has used borrowings under this facility to repay debt and
to make investments in the debt and equity securities of middle market
companies; the Company intends to continue to use the facility to make
investments and for general working capital purposes. In order to manage
interest rate risk associated with the floating rate borrowings and fulfill its
obligations under the terms of its debt funding facility, the Company has
entered into interest rate basis swap agreements. The Company intends to use
derivative instruments for non-trading and non-speculative purposes only.
As a RIC, the Company is required to distribute annually 90% or more of
its net operating income and net realized short-term capital gains to
shareholders. In addition to the above noted equity offerings and borrowings,
the Company anticipates having to issue additional debt or equity to expand its
investments in middle market companies. The terms of the future debt and equity
issuances can not be determined and there can be no assurances that the debt or
equity markets will be available to the Company on terms it deems favorable.
16
Portfolio Credit Quality
The Company has implemented a system under which it grades all
investments on a scale of 1 to 4. This system is intended to reflect the
performance of the borrower's business, the collateral coverage of the loans and
other factors considered relevant. Under this system, management believes that
investments with a grade of 4 involve the least amount of risk in the Company's
portfolio. The borrower is performing above expectations and the trends and risk
factors are generally favorable. Management believes that investments graded 3
involve an acceptable level of risk that is similar to the risk at the time of
origination. The borrower is performing as expected and the risk factors are
neutral to favorable. All new investments are initially graded 3.
Investments graded 2 involve a borrower performing below expectations
and the investment risk has increased since origination. The borrower may be out
of compliance with debt covenants, however, loan payments are not more than 120
days past due. For investments graded 2, the Company's management will increase
procedures to monitor the borrower and will write down the fair value of the
loan if it is deemed to be impaired. An investment grade of 1 indicates that the
borrower is performing materially below expectations and the loan risk has
substantially increased since origination. Some or all of the debt covenants are
out of compliance and payments are delinquent. Loans graded 1 are not
anticipated to be repaid in full and the Company will reduce the fair market
value of the loan to the amount it anticipates will be recovered.
To monitor and manage the investment portfolio risk, management tracks
the weighted average portfolio grade. The weighted average investment grade was
3.2, 3.1, 3.1 and 3.2 at September 30, 1999, June 30, 1999, March 31, 1999 and
December 31, 1998, respectively. In addition, all of the Company's outstanding
loans are performing and paying as agreed as of September 30, 1999. At September
30, June 30, and March 31, 1999 the Company's investment portfolio was graded as
follows:
September 30, 1999 June 30, 1999 March 31, 1999
------------------ ------------- --------------
Percentage Percentage Percentage
Investments at of Total Investments at of Total Investments at of Total
Grade Value Portfolio Value Portfolio Value Portfolio
----- ----- --------- ----- --------- ----- ---------
4 $ 48,696 18.4% $ 31,070 9.0% $ 30,709 16.8%
3 212,422 80.1% 181,820 84.6% 142,938 78.3%
2 4,000 1.5% 1,920 0.9% 8,851 4.9%
1 -- -- -- -- -- --
------- ----- ------- ----- -------- -----
265,118 100.0% 214,810 100.0% $182,498 100.0%
Impact of the Year 2000
The "Year 2000 Issue" is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruption of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities. The Company created a Year 2000 Compliance Committee to address the
Year 2000 compliance of the Company's information technology and non-information
technology systems, the systems of third parties, and the systems of the
portfolio companies. The Company has also engaged outside technology consultants
to assist with its Year 2000 project.
All of the software used by the Company in its information technology
systems is provided by outside vendors. The Company has taken an inventory of
all of its information technology systems and is in the process of obtaining
Year 2000 compliance designation from the vendors and internally conducting
compliance testing. Based on its assessment of its information technology
systems, management has identified the general ledger software package as the
significant system that is Year 2000 non-compliant. As such, the Company will
replace its accounting software with a new, Year 2000 compliant software
package. The new accounting software and all necessary modifications to other
information technology systems will be completed by November, 1999.
The Company has also evaluated the Year 2000 compliance of its
non-information technology systems, consisting of office equipment other than
computers and communications equipment. The Company has contacted the office
equipment vendors to obtain Year 2000 compliance designation. The Company has
completed the remediation, testing and implementation of these non-information
technology systems and believes there is not a material exposure.
17
The Company has contacted third parties that do not share information
systems with the Company ("external agents"). These third parties include the
Company's banks, landlords, utility companies, telecommunication providers and
other vendors. To date, the Company is not aware of any external agent Year 2000
issue that would materially impact the Company's results of operations,
liquidity, or capital resources. However, the Company has no means of ensuring
that external agents will be Year 2000 ready. The inability of external agents
to complete their Year 2000 resolution process in a timely fashion could
materially impact the Company. The effect of non-compliance by external agents
is not determinable.
The Company has also evaluated the Year 2000 readiness of its portfolio
companies. Since the summer of 1998, the Company has required that each
portfolio company expressly warrant in its loan agreement that it is or will be
Year 2000 compliant prior to December 31, 1999. The Company has also submitted
questionnaires to all of its portfolio companies acquired by the Company prior
to June 30, 1999 to determine their exposure to the Year 2000 problem and the
adequacy of their plans to address the issues. All of the portfolio companies
have responded to the questionnaire. For investments subsequent to June 30,
1999, the Company has performed Year 2000 readiness evaluations as part of its
due diligence process. Based on the correspondence received from the portfolio
companies and the due diligence procedures performed by the Company, management
believes that its portfolio companies have either no material exposure to the
Year 2000 issue or are adequately carrying out their plans to address their
exposure. The Company intends to make additional inquiriesof its portfolio
companies to determine if they have completed their compliance plan by November
1999.
The Company will continue to address any issues of Year 2000
non-compliance and further develop its contingency plan to mitigate business
interuptions in the event of systems failure in the Year 2000. The Company is
utilizing both internal and external resources to reprogram or replace, test,
and implement the software and other systems for Year 2000 modifications. The
Company estimates that the cost of its Year 2000 project will be less than $125.
This amount includes the cost of additional software, reviewing the portfolio
companies' readiness, and outside systems professionals working on the Company's
Year 2000 compliance.
The Company's plans to complete the Year 2000 modifications are based
on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability of certain
resources, estimates on the status of completion and the total expected costs.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Specific issues that
might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties. Significant
systems failures at the Company, a third party, or the portfolio companies could
have a materially adverse effect on the Company's business. While the Company
believes that its portfolio companies are adequately addressing the Year 2000
issue, no assurance can be given that some of its portfolio companies will not
suffer material adverse effects from Year 2000 issues. Management believes that
the most likely worst case Year 2000 scenario is a material decrease in interest
income and an impairment in the valuation of the Companies investment portfolio.
The magnitude of these material adverse effects on the portfolio companies and
the operating results and financial of the Company cannot be determined at this
time.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Company, nor any of the Company's subsidiaries, is
currently subject to any material litigation nor, to the Company's knowledge, is
any material litigation threatened against the Company or any subsidiary, other
than routine litigation and administrative proceedings arising in the ordinary
course of business. Such proceedings are not expected to have a material adverse
effect on the business, financial conditions, or results of operation of the
Company or any subsidiary.
Item 2. Changes in Securities
Not Applicable.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
Item 5. Other Information
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit
Number Description
- ------ -----------
10.1 Second Amended and Restated Employment Agreement of David J.
Gladstone
10.2 Stock Option Exercise Agreement with David J. Gladstone
10.3 Purchase Note by David J. Gladstone
10.4 Split Dollar Agreement with David J. Gladstone
27 Financial Data Schedule
(b) The registrant has not filed any reports on a Current Report on
Form 8-K during the quarter for which this report 10-Q is filed.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AMERICAN CAPITAL STRATEGIES, LTD.
By: /s/ John R. Erickson
-------------------------------
John R. Erickson
Vice President and
Chief Financial Officer
Date: November 15, 1999
20