497 1 d476439d497.htm FINAL PROSPECTUS SUPPLEMENT Final Prospectus Supplement
Table of Contents

Filed Pursuant to Rule 497
File No. 333-180267

 

PROSPECTUS SUPPLEMENT

(to Prospectus dated July 27, 2012)

Fifth Street Finance Corp.

$75,000,000

6.125% Senior Notes due 2028

We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940. We are managed by Fifth Street Management LLC.

We are offering $75,000,000 in aggregate principal amount of 6.125% senior notes due 2028, or the “Notes.” The Notes will mature on April 30, 2028. We will pay interest on the Notes on January 30, April 30, July 30 and October 30 of each year, beginning on April 30, 2013. In our sole discretion, we may redeem the Notes in whole or in part at any time or from time to time on or after April 30, 2018, at the redemption price set forth under “Specific Terms of the Notes and the Offering—Optional redemption” in this prospectus supplement. The Notes will be issued in minimum denominations of $25 and integral multiples of $25 in excess thereof.

The Notes will be our direct senior unsecured obligations and rank pari passu with all outstanding and future unsecured unsubordinated indebtedness issued by Fifth Street Finance Corp.

We intend to list the Notes on the NASDAQ Global Select Market, and expect trading in the Notes on NASDAQ to begin within 30 days of the original issue date under the symbol “FSCFL.” The Notes are expected to trade “flat,” which means that purchasers will not pay, and sellers will not receive, any accrued and unpaid interest on the Notes that is not reflected in the trading price. Currently, there is no public market for the Notes.

An investment in the Notes involves a high degree of risk and should be considered highly speculative. See “Supplementary Risk Factors” beginning on page S-8 in this prospectus supplement and “Risk Factors” beginning on page 15 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in our Notes.

This prospectus supplement and the accompanying prospectus contain important information about us that a prospective investor should know before investing in the Notes. Please read this prospectus supplement and the accompanying prospectus before investing and keep them for future reference. We file periodic reports, current reports, proxy statements and other information with the Securities and Exchange Commission. This information is available free of charge by contacting us at 10 Bank Street, 12th Floor, White Plains, New York 10606 or by telephone at (914) 286-6800 or on our website at www.fifthstreetfinance.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus. The Securities and Exchange Commission also maintains a website at www.sec.gov that contains information about us.

 

     Per Note     Total  

Public offering price

     100.0   $ 75,000,000   

Sales load (underwriting discount)

     3.0   $ 2,250,000   

Proceeds, before expenses, to us(1)

     97.0   $ 72,750,000   

 

(1) We estimate that we will incur approximately $300,000 of expenses relating to this offering, resulting in net proceeds, after sales load (underwriting discount) and expenses, to us of approximately $72,450,000.

We have granted the underwriters an overallotment option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to an additional $11,250,000 aggregate principal amount of Notes solely to cover overallotments, if any. If the underwriters exercise this option in full, the total public offering price will be $86,250,000, the total sales load (underwriting discount) paid by us will be $2,587,500, and the net proceeds before expenses will be $83,662,500.

THE NOTES ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF A BANK AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Delivery of the Notes in book-entry form only through The Depository Trust Company will be made on or about April 4, 2013.

 

Keefe, Bruyette & Woods

  Deutsche Bank Securities   Raymond James   RBC Capital Markets
                        A Stifel Company      

Barclays

JMP Securities   Oppenheimer & Co.   Sterne Agee   Wunderlich Securities

The date of this prospectus supplement is March 27, 2013.


Table of Contents

TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT

 

ABOUT THIS PROSPECTUS SUPPLEMENT

     S-iii   

PROSPECTUS SUPPLEMENT SUMMARY

     S-1   

SPECIFIC TERMS OF THE NOTES AND THE OFFERING

     S-4   

SUPPLEMENTARY RISK FACTORS

     S-8   

USE OF PROCEEDS

     S-12   

CAPITALIZATION

     S-13   

SELECTED FINANCIAL AND OTHER DATA

     S-14   

RATIOS OF EARNINGS TO FIXED CHARGES

     S-15   

SENIOR SECURITIES

     S-16   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

     S-17   

MANAGEMENT

     S-49   

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

     S-59   

UNDERWRITING

     S-63   

LEGAL MATTERS

     S-66   

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     S-66   

AVAILABLE INFORMATION

     S-66   

INDEX TO FINANCIAL STATEMENTS

     S-67   

 

PROSPECTUS

 

  

PROSPECTUS SUMMARY

     1   

THE OFFERING

     7   

FEES AND EXPENSES

     12   

SELECTED FINANCIAL AND OTHER DATA

     14   

RISK FACTORS

     15   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     34   

USE OF PROCEEDS

     35   

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

     36   

RATIOS OF EARNINGS TO FIXED CHARGES

     38   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

     39   

SENIOR SECURITIES

     70   

BUSINESS

     71   

PORTFOLIO COMPANIES

     83   

MANAGEMENT

     89   

PORTFOLIO MANAGEMENT

     98   

INVESTMENT ADVISORY AGREEMENT

     100   

ADMINISTRATION AGREEMENT

     107   

LICENSE AGREEMENT

     107   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     108   

CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS

     109   

DIVIDEND REINVESTMENT PLAN

     111   

DESCRIPTION OF OUR CAPITAL STOCK

     112   

DESCRIPTION OF OUR DEBT SECURITIES

     115   

DESCRIPTION OF OUR WARRANTS

     127   

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

     129   

REGULATION

     137   

 

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PLAN OF DISTRIBUTION

     142   

CUSTODIAN, TRANSFER AND DISTRIBUTION PAYING AGENT AND REGISTRAR

     144   

BROKERAGE ALLOCATION AND OTHER PRACTICES

     144   

LEGAL MATTERS

     144   

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     144   

CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     144   

AVAILABLE INFORMATION

     145   

PRIVACY NOTICE

     145   

INDEX TO FINANCIAL STATEMENTS

     F-1   

 

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ABOUT THIS PROSPECTUS SUPPLEMENT

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. Neither we nor the underwriters have authorized any other person to provide you with different information from that contained in this prospectus supplement or the accompanying prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. Neither this prospectus supplement nor the accompanying prospectus constitutes an offer to sell, or a solicitation of an offer to buy, the Notes by any person in any jurisdiction where it is unlawful for that person to make such an offer or solicitation or to any person in any jurisdiction to whom it is unlawful to make such an offer or solicitation. The information contained in this prospectus supplement and the accompanying prospectus is complete and accurate only as of their respective dates, regardless of the time of their delivery or sale of the Notes. Our financial condition, results of operations and prospects may have changed since those dates. To the extent required by law, we will amend or supplement the information contained in this prospectus supplement and the accompanying prospectus to reflect any material changes to such information subsequent to the date of this prospectus supplement and the accompanying prospectus and prior to the completion of any offering pursuant to this prospectus supplement and the accompanying prospectus.

This document is in two parts. The first part is this prospectus supplement, which describes the terms of the Notes and this offering and also adds to and updates information contained in the accompanying prospectus. The second part is the accompanying prospectus, which gives more general information and disclosure. To the extent the information contained in this prospectus supplement differs from or is additional to the information contained in the accompanying prospectus, you should rely only on the information contained in this prospectus supplement. You should read this prospectus supplement and the accompanying prospectus together with the additional information described under the heading “Available Information” before investing in the Notes.

Forward-Looking Statements

Information contained in this prospectus supplement and the accompanying prospectus may contain forward-looking statements. In addition, forward-looking statements can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. The matters described in “Supplementary Risk Factors” in this prospectus supplement, and in “Risk Factors” in the accompanying prospectus, and certain other factors noted throughout this prospectus supplement and the accompanying prospectus constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements. The forward-looking statements contained in this prospectus supplement and the accompanying prospectus are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, or the Securities Act. For a list of factors that could affect these forward-looking statements, see “Supplementary Risk Factors” in this prospectus supplement, and “Risk Factors” and “Special Note Regarding Forward-Looking Statements” in the accompanying prospectus.

 

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PROSPECTUS SUPPLEMENT SUMMARY

This summary highlights some of the information in this prospectus supplement and the accompanying prospectus. It is not complete and may not contain all of the information that is important to you. To understand the terms of the Notes offered pursuant to this prospectus supplement and the accompanying prospectus, you should read the entire prospectus supplement and the accompanying prospectus carefully. Together, these documents describe the specific terms of the Notes we are offering. Except as otherwise noted, all information in this prospectus supplement and the accompanying prospectus assumes no exercise of the underwriters’ overallotment option.

We commenced operations on February 15, 2007 as Fifth Street Mezzanine Partners III, L.P., a Delaware limited partnership. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp., a Delaware corporation. Unless otherwise noted, the terms “we,” “us,” “our,” the “Company” and “Fifth Street” refer to Fifth Street Mezzanine Partners III, L.P. prior to the merger date and Fifth Street Finance Corp. on and after the merger date. In addition, the terms “Fifth Street Management” and “investment adviser” refer to Fifth Street Management LLC, our external investment adviser.

Fifth Street Finance Corp.

We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We define small and mid-sized companies as those with annual revenues between $25 million and $250 million. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments. We are externally managed and advised by Fifth Street Management. Fifth Street Management is an affiliate of Fifth Street Capital LLC, a private investment firm founded and managed by our chief executive officer, and Fifth Street Management’s managing partner, Leonard M. Tannenbaum, who has led the investment of over $2.8 billion in small and mid-sized companies, including the investments made by Fifth Street, since 1998.

Our investments generally range in size from $10 million to $100 million and are principally in the form of first lien, second lien and subordinated debt investments, which may also include an equity component. We invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “high yield” or “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. As of December 31, 2012, 56.7% of our debt portfolio at fair value consisted of debt securities for which issuers were not required to make principal payments until the maturity of such debt securities, which could result in a substantial loss to us if such issuers are unable to refinance or repay their debt at maturity. Although our focus could change, we are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940, or the 1940 Act. As a business development company, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our investments through borrowings. However, as a business development company, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment

 

 

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outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of December 31, 2012, we had a debt to equity ratio (excluding SBA debentures) of 0.39x (i.e., one dollar of equity for each $0.39 of non-SBA debt outstanding).

We have also elected to be treated and have qualified, and we intend to continue to qualify, for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or realized net capital gains that we distribute to our stockholders if we meet certain source-of-income, distribution and asset diversification requirements.

In addition, we maintain two wholly-owned subsidiaries that are licensed as small business investment companies, or SBICs, and regulated by the Small Business Administration, or the SBA. The SBIC licenses allow us, through our wholly-owned subsidiaries, to issue SBA-guaranteed debentures. We received exemptive relief from the Securities and Exchange Commission, or SEC, to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act.

The following diagram depicts our organizational structure:

 

LOGO

 

 

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Our Corporate Information

Our principal executive offices are located at 10 Bank Street, 12th Floor, White Plains, NY 10606 and our telephone number is (914) 286-6800. We maintain a website on the Internet at www.fifthstreetfinance.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus and you should not consider information contained on our website to be part of this prospectus supplement or the accompanying prospectus.

Recent Developments

On March 19, 2013, we amended our Restated Certificate of Incorporation to increase the number of our authorized shares of common stock from 150,000,000 to 250,000,000 shares.

In March 2013, the SBA fixed the interest rate on approximately $32 million of one of our SBIC subsidiary’s outstanding debentures at a rate of 2.351% per annum for 10 years, plus SBA fees. As a result, the $182 million of SBA-guaranteed debentures held by our SBIC subsidiaries carry a weighted average interest rate of 3.355%.

As of March 26, 2013, we had $90.5 million of outstanding borrowings under our $150 million secured credit facility, or the Wells Fargo facility, with Wells Fargo Bank, National Association, successor to Wachovia Bank, N.A.; $150.0 million of outstanding borrowings under our $425 million secured syndicated revolving credit facility, or the ING facility, with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent; and $40.0 million of outstanding borrowings under our $200 million secured credit facility with Sumitomo Mitsui Banking Corporation, or the Sumitomo facility.

 

 

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SPECIFIC TERMS OF THE NOTES AND THE OFFERING

This prospectus supplement sets forth certain terms of the Notes that we are offering pursuant to this prospectus supplement and supplements the accompanying prospectus that is attached to the back of this prospectus supplement. This section outlines the specific legal and financial terms of the Notes. You should read this section together with the more general description of the Notes in the accompanying prospectus under the heading “Description of Our Debt Securities” before investing in the Notes. Capitalized terms used in this prospectus supplement and not otherwise defined shall have the meanings ascribed to them in the accompanying prospectus or in the indenture governing the Notes.

 

Issuer

Fifth Street Finance Corp.

 

Title of the securities

6.125% Senior Notes due 2028

 

Initial aggregate principal amount being offered

$75,000,000

 

Overallotment option

The underwriters may also purchase from us up to an additional $11,250,000 aggregate principal amount of Notes solely to cover overallotments, if any, within 30 days of the date of this prospectus supplement.

 

Initial public offering price

100% of the aggregate principal amount.

 

Principal payable at maturity

100% of the aggregate principal amount; the principal amount of each Note will be payable on its stated maturity date at the office of the Paying Agent, Registrar and Transfer Agent for the Notes or at such other office in New York City as we may designate.

 

Type of Note

Fixed rate note

 

Listing

We intend to list the Notes on the NASDAQ Global Select Market within 30 days of the original issue date under the symbol “FSCFL.”

 

Interest rate

6.125% per year

 

Day count basis

360-day year of twelve 30-day months

 

Original issue date

April 4, 2013

 

Stated maturity date

April 30, 2028

 

Date interest starts accruing

April 4, 2013

 

Interest payment dates

Each January 30, April 30, July 30, and October 30, commencing

April 30, 2013. If an interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue as a result of such delayed payment.

 

Interest periods

The initial interest period will be the period from and including April 4, 2013, to, but excluding, the initial interest payment date, and the subsequent interest periods will be the periods from and including an interest payment date to, but excluding, the next interest payment date or the stated maturity date, as the case may be.

 

 

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Regular record dates for interest

Each January 15, April 15, July 15 and October 15.

 

Specified currency

U.S. Dollars

 

Place of payment

New York City

 

Ranking of Notes

The Notes will be our direct unsecured obligations and will rank:

 

   

pari passu with our other outstanding and future senior unsecured indebtedness, including without limitation, the $115.0 million of 5.375% Convertible Senior Notes due 2016 (the “Convertible Notes”) and $75.0 million of 5.875% Senior Notes due 2024 (the “2024 Notes”) outstanding as of March 26, 2013;

 

   

senior to any of our future indebtedness that expressly provides it is subordinated to the Notes;

 

   

effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, the $280.5 million of borrowings under our credit facilities and $181.8 million of SBA-guaranteed debentures outstanding as of March 26, 2013; and

 

   

structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including without limitation, the indebtedness of Fifth Street Funding, LLC, Fifth Street Funding II, LLC and our SBIC subsidiaries.

 

Denominations

We will issue the Notes in denominations of $25 and integral multiples of $25 in excess thereof.

 

Business day

Each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which banking institutions in New York City are authorized or required by law or executive order to close.

 

Optional redemption

The Notes may be redeemed in whole or in part at any time or from time to time at our option on or after April 30, 2018, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption.

 

  You may be prevented from exchanging or transferring the Notes when they are subject to redemption. In case any Notes are to be redeemed in part only, the redemption notice will provide that, upon surrender of such Note, you will receive, without a charge, a new Note or Notes of authorized denominations representing the principal amount of your remaining unredeemed Notes.

 

 

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  Any exercise of our option to redeem the Notes will be done in compliance with the Investment Company Act of 1940, as amended, and the rules, regulations and interpretations promulgated thereunder, which we collectively refer to as the 1940 Act, to the extent applicable.

 

  If we redeem only some of the Notes, the Trustee or DTC, as applicable, will determine the method for selection of the particular Notes to be redeemed, in accordance with the indenture governing the Notes, and in accordance with the rules of any national securities exchange or quotation system on which the Notes are listed. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease to accrue on the Notes called for redemption.

 

Sinking fund

The Notes will not be subject to any sinking fund.

 

Repayment at option of Holders

Holders will not have the option to have the Notes repaid prior to the stated maturity date.

 

Defeasance and covenant defeasance

The Notes are subject to defeasance by us.

 

  The Notes are subject to covenant defeasance by us.

 

  Under the ING facility, we currently would be prohibited from defeasing the Notes or effecting covenant defeasance under the Notes.

 

Form of Notes

The Notes will be represented by global securities that will be deposited and registered in the name of The Depository Trust Company, or DTC, or its nominee. Except in limited circumstances, you will not receive certificates for the Notes. Beneficial interests in the Notes will be represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC. Investors may elect to hold interests in the Notes through either DTC, if they are a participant, or indirectly through organizations which are participants in DTC.

 

Trustee, Paying Agent, Registrar and Transfer Agent

Deutsche Bank Trust Company Americas

 

 

Other covenants

In addition to the covenants described in the prospectus attached to this prospectus supplement, the following covenants shall apply to the Notes:

 

   

We agree that for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the U.S. Securities and Exchange Commission (the “SEC”). Currently, these provisions generally prohibit us from

 

 

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making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings. See “Supplementary Risk Factors—Risks Relating to Our Business and Structure—Pending legislation may allow us to incur additional leverage.”

 

   

If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934 to file any periodic reports with the SEC, we agree to furnish to holders of the Notes and the Trustee, for the period of time during which the Notes are outstanding, our audited annual consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements will be prepared, in all material respects, in accordance with applicable United States generally accepted accounting principles.

 

Modification to Events of Default

The following event of default, as described in the accompanying prospectus, will not apply to the Notes:

 

   

Any class of debt securities has an asset coverage, as such term is defined in the 1940 Act, of less than 100 per centum on the last business day of each of twenty-four consecutive calendar months.

 

Global Clearance and Settlement Procedures

Interests in the Notes will trade in DTC’s Same Day Funds Settlement System, and any permitted secondary market trading activity in such Notes will, therefore, be required by DTC to be settled in immediately available funds. None of the issuer, the Trustee or the paying agent will have any responsibility for the performance by DTC or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations.

 

Use of Proceeds

The net proceeds we receive from the sale of the $75,000,000 aggregate principal amount of Notes in this offering will be $72,450,000 (or $83,362,500 if the underwriters fully exercise their overallotment option), after deducting the underwriting discounts and commissions of $2,250,000 (or $2,587,500 if the underwriters fully exercise their overallotment option) payable by us and estimated offering expenses of approximately $300,000 payable by us.

 

  We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. However, through reborrowing under our credit facilities, we intend to make investments in small and mid-sized companies (including investments made through our SBIC subsidiaries) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus. See “Use of Proceeds.”

 

 

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SUPPLEMENTARY RISK FACTORS

Investing in the Notes involves a high degree of risk. In addition to the other information contained in this prospectus supplement and the accompanying prospectus, you should carefully consider the following supplementary risk factors together with the risk factors set forth in the accompanying prospectus before making an investment in the Notes. The risks set out below and in the accompanying prospectus are not the only risks we face. Additional risks and uncertainties not presently known to us might also impair our operations and performance. If any of the events described herein or in the accompanying prospectus occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, our net asset value and the market price of the Notes could decline, and you may lose part or all of your investment.

Risks Relating to the Notes

The Notes will be unsecured and therefore will be effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future.

The Notes will not be secured by any of our assets or any of the assets of our subsidiaries. As a result, the Notes are effectively subordinated to any secured indebtedness we or our subsidiaries have currently incurred and may incur in the future (or any indebtedness that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness and the secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Notes. As of March 26, 2013, we had $90.5 million of outstanding borrowings under our Wells Fargo facility, $150.0 million of outstanding borrowings under our ING facility, $40.0 million of outstanding borrowings under our Sumitomo facility and $181.8 million of outstanding SBA-guaranteed debentures.

The Notes will be structurally subordinated to the indebtedness and other liabilities of our subsidiaries.

The Notes are obligations exclusively of Fifth Street Finance Corp. and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the Notes and the Notes are not required to be guaranteed by any subsidiaries we may acquire or create in the future. A portion of the indebtedness required to be consolidated on our balance sheet is held through our SBIC subsidiaries. The assets of such subsidiaries are not directly available to satisfy the claims of our creditors, including holders of the Notes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources” in this prospectus supplement and in the accompanying prospectus for more detail on the SBA-guaranteed debentures.

Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors (including trade creditors) and holders of preferred stock, if any, of our subsidiaries will have priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders of the Notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our subsidiaries, our claims would still be effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, the Notes will be structurally subordinated to all indebtedness and other liabilities (including trade payables) of any of our subsidiaries and any subsidiaries that we may in the future acquire or establish as financing vehicles or otherwise. As of March 26, 2013, we had $90.5 million borrowings outstanding under our Wells Fargo facility, $40.0 million of borrowings outstanding under our Sumitomo facility and $181.8 million of indebtedness outstanding incurred by our SBIC subsidiaries. All of such indebtedness would be structurally senior to the Notes. In addition, our subsidiaries may incur substantial additional indebtedness in the future, all of which would be structurally senior to the Notes.

 

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The indenture under which the Notes will be issued will contain limited protection for holders of the Notes.

The indenture under which the Notes will be issued offers limited protection to holders of the Notes. The terms of the indenture and the Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on your investment in the Notes. In particular, the terms of the indenture and the Notes will not place any restrictions on our or our subsidiaries’ ability to:

 

   

issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to the Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the SEC (currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings);

 

   

pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the Notes, including subordinated indebtedness;

 

   

sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);

 

   

enter into transactions with affiliates;

 

   

create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;

 

   

make investments; or

 

   

create restrictions on the payment of dividends or other amounts to us from our subsidiaries.

In addition, the indenture will not require us to offer to purchase the Notes in connection with a change of control or any other event.

Furthermore, the terms of the indenture and the Notes do not protect holders of the Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow or liquidity.

Our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by the terms of the Notes may have important consequences for you as a holder of the Notes, including making it more difficult for us to satisfy our obligations with respect to the Notes or negatively affecting the trading value of the Notes.

Certain of our current debt instruments include more protections for their holders than the indenture and the Notes. See “Risk Factors — Risks Relating to Our Business and Structure — Substantially all of our assets are subject to security interests under secured credit facilities or claims of the SBA with respect to our SBA-guaranteed debentures and if we default on our obligations thereunder, we may suffer adverse consequences, including the lenders and/or the SBA foreclosing on our assets” in the accompanying prospectus. In addition, other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for and trading levels and prices of the Notes.

 

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There is no existing trading market for the Notes and, even if NASDAQ approves the listing of the Notes, an active trading market for the Notes may not develop, which could limit your ability to sell the Notes or affect the market price of the Notes.

The Notes will be a new issue of debt securities for which there initially will not be a trading market. We intend to list the Notes on the NASDAQ Global Select Market within 30 days of the original issue date under the symbol “FSCFL.” However, there is no assurance that the Notes will be approved for listing on NASDAQ. Moreover, even if the listing of the Notes is approved, we cannot provide any assurances that an active trading market will develop for the Notes or that you will be able to sell your Notes. If the Notes are traded after their initial issuance, they may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial condition, performance and prospects and other factors. The underwriters have advised us that they may make a market in the Notes, but they are not obligated to do so. The underwriters may discontinue any market-making in the Notes at any time at their sole discretion. Accordingly, we cannot assure you that the Notes will be approved for listing on NASDAQ, that a liquid trading market will develop for the Notes, that you will be able to sell your Notes at a particular time or that the price you receive when you sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the Notes for an indefinite period of time.

If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.

Any default under the agreements governing our indebtedness, including a default under the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes and our 2024 Notes or other indebtedness to which we may be a party that is not waived by the required lenders or holders, and the remedies sought by the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the Notes and substantially decrease the market value of the Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Wells Fargo facility, the ING facility, the Sumitomo facility or other debt we may incur in the future could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to seek to obtain waivers from the required lenders under the Wells Fargo facility, the ING facility, or the Sumitomo facility or the required holders of our Convertible Notes or our 2024 Notes or other debt that we may incur in the future to avoid being in default. If we breach our covenants under the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes or our 2024 Notes or other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders. If this occurs, we would be in default and our lenders or debt holders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations, including the lenders under the Wells Fargo facility, the ING facility, or the Sumitomo facility, could proceed against the collateral securing the debt. Because the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes and our 2024 Notes have, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness thereunder or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due. See “Description of Our Debt Securities” in the accompanying prospectus.

Risks Relating to Our Business and Structure

Pending legislation may allow us to incur additional leverage.

As a BDC, under the 1940 Act we generally are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt

 

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may not exceed 50% of the value of our assets). We have agreed in a covenant in the indenture governing the Notes not to violate this section of the 1940 Act, whether or not we continue to be subject to such provision, but giving effect, in either case, to any exemptive relief granted to us by the SEC. Recent legislation introduced in the U.S. House of Representatives, if passed, would modify this section of the 1940 Act and increase the amount of debt that BDCs may incur by modifying the asset coverage percentage from 200% to 150%. In addition, recent legislation introduced in the U.S. Senate would modify SBA regulations in a manner that may permit us to incur additional SBA leverage. As a result, we may be able to incur additional indebtedness in the future and therefore your risk of an investment in the Notes may increase.

 

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USE OF PROCEEDS

The net proceeds from our sale of the $75,000,000 aggregate principal amount of Notes in this offering will be $72,450,000 (or $83,362,500 if the underwriters fully exercise their overallotment option), after deducting the underwriting discounts and commissions of $2,250,000 (or $2,587,500 if the underwriters fully exercise their overallotment option) payable by us and estimated offering expenses of approximately $300,000 payable by us.

We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. However, through reborrowing under our credit facilities, we intend to make investments in small and mid-sized companies (including investments made through our SBIC subsidiaries) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus. As of March 26, 2013, we had $90.5 million outstanding under the Wells Fargo facility. The Wells Fargo facility has a maturity date of April 25, 2016 and bears interest at a rate of LIBOR (1-month) plus 2.75% per annum with no LIBOR floor. As of March 26, 2013, we had $150.0 million outstanding under the ING facility. The ING facility has a maturity date of November 30, 2016 and bears interest at a rate of LIBOR (1, 2, 3 or 6-month, at our option) plus 2.75% per annum with no LIBOR floor, or, if we do not maintain our current credit rating, LIBOR plus 3.25% per annum with no LIBOR floor. As of March 26, 2013, we had $40.0 million outstanding under the Sumitomo facility. The Sumitomo facility bears interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor, permits us to make new borrowings until September 16, 2014, matures on September 16, 2018 and includes an option for a one-year extension.

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2012:

 

   

on an actual basis; and

 

   

on an as adjusted basis to reflect the sale of $75,000,000 aggregate principal amount of Notes in this offering (assuming no exercise of the overallotment option), after deducting the underwriting discounts and commissions of $2,250,000 payable by us and estimated offering expenses of approximately $300,000 payable by us.

 

     As of December 31, 2012
(unaudited)
 
(amounts in thousands)        Actual             As Adjusted      

Cash and cash equivalents

   $ 37,438      $ 37,483   
  

 

 

   

 

 

 

Long-term debt, including current maturities:

    

Credit facilities payable

   $ 218,000      $ 145,550 (1) 

Convertible Notes payable

     115,000        115,000   

SBA debentures payable

     181,750       
181,750
  

2024 Notes payable

     75,000        75,000   

Notes offered hereby

            75,000   
  

 

 

   

 

 

 

Total long-term debt

     589,750        592,300   

Net assets:

    

Common stock, $0.01 par value (150,000 shares authorized; 105,943 shares outstanding) (2)

     1,059        1,059   

Additional paid-in-capital

     1,171,963        1,171,963   

Net unrealized appreciation on investments

     10,658        10,658   

Net realized loss on investments and interest rate swap

     (127,436     (127,436

Accumulated overdistributed net investment income

     (9,365     (9,365
  

 

 

   

 

 

 

Total net assets

     1,046,879        1,046,879   
  

 

 

   

 

 

 

Total capitalization

   $ 1,636,629      $ 1,639,179   
  

 

 

   

 

 

 

 

(1) We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. As of March 26, 2013, we had credit facilities payable in the amount of $280.5 million due to net borrowings under our credit facilities in the amount of $62.5 million subsequent to December 31, 2012. This table has not been adjusted to reflect such net borrowings.

 

(2) On March 19, 2013, we amended our Restated Certificate of Incorporation to increase the number of our authorized shares of common stock from 150,000,000 to 250,000,000 shares. This table has not been updated to reflect this amendment.

 

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SELECTED FINANCIAL AND OTHER DATA

The following selected financial data should be read together with our Consolidated Financial Statements and the related notes and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this prospectus supplement and the accompanying prospectus. The financial information as of and for the fiscal years ended September 30, 2008, 2009, 2010, 2011 and 2012, set forth below was derived from our audited Consolidated Financial Statements and related notes. The financial information as of and for the three months ended December 31, 2012 and 2011 was derived from our unaudited financial statements and related notes. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The historical financial information below may not be indicative of our future performance. Our results for the interim period may not be indicative of our results for the full year.

 

    As of and for the
Three Months Ended
    As of and for the Year Ended  

(dollars in thousands, except
per share amounts)

  December 31,
2012
    December 31,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2010
    September 30,
2009
    September 30,
2008
 

Statement of Operations data:

             

Total investment income

  $ 51,783      $ 39,497      $ 165,116      $ 125,165      $ 70,538      $ 49,828      $ 33,219   

Base management fee, net

    8,046        5,741        23,799        19,656        9,275        5,889        4,258   

Incentive fee

    6,639        5,247        22,011        16,782        10,756        7,841        4,118   

All other expenses

    10,542        8,825        32,882        23,080        7,483        4,736        4,699   

Gain on extinguishment of convertible senior notes

    —          1,305        1,571        1,480        —          —          —     

Net investment income

    26,556        20,989        88,005        67,127        43,024        31,362        20,144   

Unrealized appreciation (depreciation) on interest rate swap

    —          —                 773        (773     —          —     

Realized loss on interest rate swap

    —          —                 (1,335     —          —          —     

Unrealized appreciation (depreciation) on investments

    (9,339     5,833        55,974        (7,299     (1,054     (10,795     (16,948

Realized gain (loss) on investments

    626        (16,638     64,578        (29,059     (18,781     (14,373     62   

Net increase in partners’ capital/net assets resulting from operations

    17,843        10,184        79,401        30,207        22,416        6,194        3,258   

Per share data:

             

Net asset value per common share at period end

  $ 9.88      $ 9.89      $ 9.92      $ 10.07      $ 10.43      $ 10.84      $ 13.02   

Market price at period end

    10.42        9.57        10.98        9.32        11.14        10.93        10.05   

Net investment income

    0.28        0.29        1.11        1.05        0.95        1.27        1.29   

Net realized and unrealized loss on investments and interest rate swap

    (0.09     (0.15     (0.11     (0.58     (0.46     (1.02     (1.08

Net increase in partners’ capital/net assets resulting from operations

    0.37        0.44        1.00        0.47        0.49        0.25        0.21   

Dividends paid per share

    (0.29     (0.32     1.18        1.28        0.99        1.20        0.61   

Balance Sheet data at period end:

             

Total investments at fair value

  $ 1,580,448      $ 1,119,898      $ 1,288,108      $ 1,119,837      $ 563,821      $ 299,611      $ 273,759   

Cash and cash equivalents

    37,438        70,336        74,393        67,644        76,765        113,205        22,906   

Other assets

    145        432        26,501        22,236        11,340        3,071        2,484   

Total assets

    1,646,684        1,218,472        1,389,002        1,209,717        651,926        415,887        299,149   

Total liabilities

    599,805        502,807        485,432        481,090        82,754        5,331        4,813   

Total net assets

    1,046,879        715,665        903,570        728,627        569,172        410,556        294,336   

Other data:

             

Weighted average yield on debt investments(1)

    12.0     12.3     12.0     12.4     14.0     15.7     16.2

Number of investments at period end

    92        67        78        65        38        28        24   

(1) Weighted average yield is calculated based upon our debt investments at the end of the period.

 

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RATIOS OF EARNINGS TO FIXED CHARGES

The following table contains our ratio of earnings to fixed charges for the periods indicated, computed as set forth below. You should read these ratios of earnings to fixed charges in connection with our Consolidated Financial Statements, including the notes to those statements, included in this prospectus. Although our earnings have generally increased over time, our ratios of earnings to fixed charges have generally decreased since September 30, 2010 due to greater levels of borrowing.

 

     For The Three
Months Ended
December 31,

2012
     For The Year
Ended
September 30,
2012
     For The  Year
Ended

September 30,
2011
     For The Year
Ended
September 30,
2010
     For The Year
Ended
September 30,
2009
     For The Year
Ended
September 30,
2008
 

Earnings to Fixed Charges(1)

     3.49         4.42         3.00         12.65         10.74         4.55   

 

(1) Earnings include net realized and unrealized gains or losses. Net realized and unrealized gains or losses can vary substantially from period to period.

For purposes of computing the ratios of earnings to fixed charges, earnings represent net increase in net assets resulting from operations plus (or minus) income tax expense (benefit) including excise tax expense plus fixed charges. Fixed charges include interest and credit facility fees and amortization of debt issuance costs.

 

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SENIOR SECURITIES

(dollar amounts in thousands, except per share data)

Information about our senior securities (including debt securities and other indebtedness) is shown in the following table as of December 31, 2012 and as of the fiscal years ended September 30, 2011 and 2012. We had no senior securities outstanding as of September 30 of any prior fiscal years. The report of our independent registered public accounting firm, PricewaterhouseCoopers LLP, on the information provided as of the fiscal years ended September 30, 2011 and 2012 will be included as an exhibit to the registration statement of which this prospectus supplement is a part.

 

Class and Year

   Total Amount
Outstanding
Exclusive of
Treasury
Securities(1)
     Asset
Coverage
Per Unit(2)
     Involuntary
Liquidating
Preference
Per Unit(3)
     Average
Market Value
Per Unit
 

ING Facility

           

Fiscal 2011

   $ 133,500       $ 3,328       $        N/A   

Fiscal 2012

     141,000         3,857                N/A   

Fiscal 2013 (as of December 31, 2012, unaudited)

     135,000         3,566                 N/A   

Wells Fargo Facility

           

Fiscal 2011

   $ 39,524       $ 3,328       $        N/A   

Fiscal 2012

     60,251         3,857                N/A   

Fiscal 2013 (as of December 31, 2012, unaudited)

     83,000         3,566                 N/A   

Sumitomo Facility

           

Fiscal 2011

   $ 5,000       $ 3,328       $        N/A   

Fiscal 2012

                          N/A   

Fiscal 2013 (as of December 31, 2012, unaudited)

                             N/A   

Convertible Notes

           

Fiscal 2011

   $ 135,000       $ 3,328       $        N/A   

Fiscal 2012

     115,000         3,857                N/A   

Fiscal 2013 (as of December 31, 2012, unaudited)

     115,000         3,566                 N/A   

2024 Notes

           

Fiscal 2013 (as of December 31, 2012, unaudited)

     75,000         3,566               $ 954.80   

 

 

(1) Total amount of each class of senior securities outstanding at the end of the period presented, in thousands.

 

(2) The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by total senior securities representing indebtedness. This asset coverage ratio is multiplied by $1,000 to determine the “Asset Coverage Per Unit.”

 

(3) The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The “—” indicates information that the SEC expressly does not require to be disclosed for certain types of senior securities.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in connection with our Consolidated Financial Statements and the notes thereto included in this prospectus supplement.

The information in this section contains forward-looking statements that involve risks and uncertainties. Please see “Supplementary Risk Factors” in this prospectus supplement and “Risk Factors” and “Special Note Regarding Forward-Looking Statements” in the accompanying prospectus for a discussion of the uncertainties, risks and assumptions associated with these statements.

All amounts are in thousands, except share and per share amounts, percentages and as otherwise indicated.

Overview

We are a specialty finance company that lends to and invests in small and mid-sized companies primarily in connection with investments by private equity sponsors. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.

We were formed as a Delaware limited partnership (Fifth Street Mezzanine Partners III, L.P.) on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp. At the time of the merger, all outstanding partnership interests in Fifth Street Mezzanine Partners III, L.P. were exchanged for 12,480,972 shares of common stock in Fifth Street Finance Corp.

Our Consolidated Financial Statements prior to January 2, 2008 reflect our operations as a Delaware limited partnership (Fifth Street Mezzanine Partners III, L.P.) prior to our merger with and into a corporation (Fifth Street Finance Corp.).

On June 17, 2008, we completed an initial public offering of 10,000,000 shares of our common stock at the offering price of $14.12 per share. Our stock was listed on the New York Stock Exchange until November 28, 2011 when we transferred the listing to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.”

Current Market Conditions

Since mid-2007, the global financial markets have experienced stress, volatility, illiquidity and disruption. This turmoil appears to have peaked in the fall of 2008, resulting in several major financial institutions becoming insolvent, being acquired, or receiving government assistance. While the turmoil in the financial markets appears to have abated somewhat, the global economy continues to experience economic uncertainty. Economic uncertainty impacts our business in many ways, including changing spreads, structures and purchase multiples as well as the overall supply of investment capital.

Despite the economic uncertainty, our deal pipeline remains robust, with high quality transactions backed by private equity sponsors in small to mid-sized companies. As always, we remain cautious in selecting new investment opportunities, and will only deploy capital in deals which we believe are consistent with our disciplined philosophy of pursuing superior risk-adjusted returns.

As evidenced by our recent investment activities, we expect to grow the investment portfolio by strategically investing in small and mid-sized companies when and where appropriate. Although we believe that we currently have sufficient capital available to fund investments, a prolonged period of market disruptions may cause us to reduce the volume of loans we originate and/or fund, which could have an adverse effect on our

 

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business, financial condition and results of operations. In this regard, because our common stock has at times traded at a price below our then current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

Critical Accounting Policies

Basis of Presentation

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the Consolidated Financial Statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

Investment Valuation

We are required to report our investments that are not publicly traded or for which current market values are not readily available at fair value. The fair value is deemed to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

In accordance with authoritative accounting guidance, we perform detailed valuations of our debt and equity investments on an individual basis, using market, income, and bond yield approaches as appropriate. In general, we utilize a bond yield method for the majority of our investments, as long as it is appropriate. If, in our judgment, the bond yield approach is not appropriate, we may use the market approach, income approach, or, in certain cases, an alternative methodology potentially including an asset liquidation or expected recovery model.

Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.

Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), cash flows, net income or revenues. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.

Under the income approach, we generally prepare and analyze discounted cash flow models based on our projections of the future free cash flows of the business.

Our Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of our investments:

 

   

The quarterly valuation process begins with each portfolio company or investment being initially valued by our finance department;

 

   

Preliminary valuations are then reviewed and discussed with principals of the investment adviser;

 

   

Separately, independent valuation firms engaged by our Board of Directors prepare preliminary valuations on a selected basis and submit the reports to us;

 

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Our finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;

 

   

Our finance department prepares a valuation report for the Audit Committee of our Board of Directors;

 

   

The Audit Committee of our Board of Directors is apprised of the preliminary valuations of the independent valuation firms;

 

   

The Audit Committee of our Board of Directors reviews the preliminary valuations, and our finance department responds and supplements the preliminary valuations to reflect any comments provided by the Audit Committee;

 

   

The Audit Committee of our Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in our portfolio; and

 

   

Our Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith.

The fair value of all of our investments at December 31, 2012, and September 30, 2012, was determined by our Board of Directors. Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and a consistently applied valuation process.

We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued over the course of each fiscal year. The percentages of our portfolio, at fair value, valued by independent valuation firms by period were as follows:

 

For the quarter ended December 31, 2007

     91.9

For the quarter ended March 31, 2008

     92.1

For the quarter ended June 30, 2008

     91.7

For the quarter ended September 30, 2008

     92.8

For the quarter ended December 31, 2008

     100.0

For the quarter ended March 31, 2009

     88.7 %

For the quarter ended June 30, 2009

     92.1 %(1) 

For the quarter ended September 30, 2009

     28.1

For the quarter ended December 31, 2009

     17.2 %(2) 

For the quarter ended March 31, 2010

     26.9

For the quarter ended June 30, 2010

     53.1

For the quarter ended September 30, 2010

     61.8

For the quarter ended December 31, 2010

     73.9

For the quarter ended March 31, 2011

     82.0

For the quarter ended June 30, 2011

     82.9

For the quarter ended September 30, 2011

     91.2

For the quarter ended December 31, 2011

     89.1

For the quarter ended March 31, 2012

     87.3

For the quarter ended June 30, 2012

     84.3

For the quarter ended September 30, 2012

     79.6

For the quarter ended December 31, 2012

     79.5

 

(1) 96.0% excluding our investment in IZI Medical Products, Inc., which closed on June 30, 2009 and therefore was not valued by an independent valuation firm during such period

 

(2) 24.8% excluding four investments that closed in December 2009 and therefore were not valued by an independent valuation firm during such period

 

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As of December 31, 2012 and September 30, 2012, approximately 96.0% and 92.7%, respectively, of our total assets represented investments in portfolio companies valued at fair value.

Revenue Recognition

Interest and Dividend Income

Interest income, adjusted for accretion of original issue discount, or OID, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We stop accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.

Fee Income

We receive a variety of fees in the ordinary course of business. Certain fees, such as loan origination fees, if any, are capitalized and amortized in accordance with ASC 310-20 Nonrefundable Fees and Other Costs . In accordance with ASC 820, the net unearned fee income balance is netted against the cost and fair value of the respective investments. Other fees, such as servicing, advisory and structuring fees, are classified as fee income and recognized as they are earned.

We have also structured exit fees across certain of our portfolio investments to be received upon the future exit of those investments. Exit fees are payable upon the exit of a debt security. These fees are to be paid to us upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan, or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan. As of December 31, 2012, we had structured $6.6 million in aggregate exit fees across eight portfolio investments upon the future exit of those investments.

Payment-in-Kind (PIK) Interest

Our loans typically contain contractual PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We generally cease accruing PIK interest if there is insufficient value to support the accrual or if we do not expect the portfolio company to be able to pay all principal and interest due. Our decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; our assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by us in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, we determine whether to cease accruing PIK interest on a loan or debt security. Our determination to cease accruing PIK interest on a loan or debt security is generally made well before our full write-down of such loan or debt security. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest.

For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required

 

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to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments” in the accompanying prospectus. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest. The accrual of PIK interest on our debt investments increases the recorded cost basis of these investments in our consolidated financial statements and, as a result, increases the cost basis of these investments for purposes of computing the capital gains incentive fee payable by us to our investment adviser.

To maintain our status as a RIC, PIK income must be paid out to our stockholders in the form of dividends even though we have not yet collected the cash and may never collect the cash relating to the PIK interest. Accumulated PIK interest was $16.8 million and represented 1.1% of the fair value of our portfolio of investments as of December 31, 2012 and $18.4 million or 1.4% as of September 30, 2012. The net increase in loan balances as a result of contracted PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

Portfolio Composition

Our investments principally consist of loans, purchased equity investments and equity grants in privately-held companies. Our loans are typically secured by a first, second or subordinated lien on the assets of the portfolio company and generally have terms of up to six years (but an expected average life of between three and four years). We are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection. The mix may change over time based on market conditions and management’s view of where the best risk adjusted returns are available.

A summary of the composition of our investment portfolio at cost and fair value as a percentage of total investments is shown in the following tables:

 

     December 31,
2012
    September 30,
2012
 

Cost:

    

First lien debt

     62.27     70.06

Second lien debt

     15.93        10.71   

Subordinated debt

     18.75        15.92   

Purchased equity

     2.54        2.72   

Equity grants

     0.30        0.37   

Limited partnership interests

     0.21        0.22   
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

 

     December 31,
2012
    September 30,
2012
 

Fair value:

    

First lien debt

     61.98     70.06

Second lien debt

     15.50        10.35   

Subordinated debt

     18.89        15.95   

Purchased equity

     3.02        3.00   

Equity grants

     0.40        0.43   

Limited partnership interests

     0.21        0.21   
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

 

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The industry composition of our portfolio at cost and fair value as a percentage of total investments were as follows:

 

     December 31,
2012
    September 30,
2012
 

Cost:

    

Healthcare services

     13.28     13.32

Education services

     9.40        7.81   

Diversified support services

     9.16        8.78   

IT consulting & other services

     7.02        3.55   

Internet software & services

     6.88        5.81   

Healthcare equipment

     5.25        6.53   

Oil & gas equipment services

     4.97        4.75   

Advertising

     3.77        4.23   

Leisure products

     3.53        4.38   

Leisure facilities

     3.00        2.34   

Construction and engineering

     2.93        3.65   

Diversified financial services

     2.56        3.03   

Pharmaceuticals

     2.46        3.18   

Electronic equipment & instruments

     2.33        2.85   

Apparel, accessories & luxury goods

     2.29        2.99   

Human resources & employment services

     2.17        1.53   

Specialty stores

     2.10        2.60   

Auto parts & equipment

     2.08        0.08   

Household products

     1.86        2.34   

Home improvement retail

     1.84        2.24   

Integrated telecommunication services

     1.40        2.52   

Environmental & facilities services

     1.34        1.66   

Distributors

     1.23        1.51   

Air freight and logistics

     1.21        1.49   

Food distributors

     1.14        1.43   

Industrial machinery

     1.06        1.66   

Restaurants

     0.89        1.51   

Research & consulting services

     0.83        1.09   

Security & alarm services

     0.83        0.00   

Construction materials

     0.45        0.55   

Consumer finance

     0.31        0.00   

Multi-sector holdings

     0.19        0.21   

Application software

     0.18        0.00   

Building products

     0.05        0.06   

Movies & entertainment

     0.01        0.02   

Electronic manufacturing services

     0.00        0.30   
  

 

 

   

 

 

 

Total

     100.00 %     100.00
  

 

 

   

 

 

 

 

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     December 31,
2012
    September 30,
2012
 

Fair Value:

    

Healthcare services

     13.38     13.58

Education services

     9.39        7.71   

Diversified support services

     9.22        8.77   

Internet software & services

     7.19        6.15   

IT consulting & other services

     7.04        3.55   

Healthcare equipment

     5.27        6.53   

Oil & gas equipment services

     5.05        4.82   

Advertising

     3.77        4.20   

Leisure products

     3.62        4.38   

Construction & engineering

     3.20        3.88   

Leisure facilities

     2.98        2.36   

Diversified financial services

     2.60        3.05   

Pharmaceuticals

     2.50        3.18   

Electronic equipment & instruments

     2.32        2.82   

Apparel, accessories & luxury goods

     2.32        2.98   

Human resources & employment services

     2.21        1.57   

Specialty stores

     2.14        2.65   

Auto parts & equipment

     2.13        0.12   

Household products

     1.85        2.32   

Home improvement retail

     1.80        2.19   

Integrated telecommunication services

     1.43        2.55   

Distributors

     1.28        1.56   

Industrial machinery

     1.11        1.69   

Food distributors

     0.96        1.43   

Restaurants

     0.91        1.51   

Research & consulting services

     0.85        1.10   

Security & alarm services

     0.82        0.00   

Air freight & logistics

     0.78        1.24   

Environmental & facilities services

     0.63        0.95   

Construction materials

     0.46        0.56   

Consumer finance

     0.32        0.00   

Multi-sector holdings

     0.21        0.22   

Application software

     0.19        0.00   

Building products

     0.05        0.06   

Movies & entertainment

     0.02        0.02   

Electronic manufacturing services

     0.00        0.30   
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

Portfolio Asset Quality

We employ a ranking system to assess and monitor the credit risk of our investment portfolio. We rank all investments on a scale from 1 to 5. The system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loan, and other factors considered relevant to making a credit judgment. We have determined that there should be an individual ranking assigned to each tranche of securities in the same portfolio company where appropriate. This may arise when the perceived risk of loss on the investment varies significantly between tranches due to their respective seniority in the capital structure.

 

   

Investment Ranking 1 is used for investments that are performing above expectations and/or a capital gain is expected.

 

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Investment Ranking 2 is used for investments that are performing substantially within our expectations, and whose risks remain neutral or favorable compared to the potential risk at the time of the original investment. All new investments are initially ranked 2.

 

   

Investment Ranking 3 is used for investments that are performing below our expectations and that require closer monitoring, but where we expect no loss of investment return (interest and/or dividends) or principal. Companies with a ranking of 3 may be out of compliance with financial covenants.

 

   

Investment Ranking 4 is used for investments that are performing below our expectations and for which risk has increased materially since the original investment. We expect some loss of investment return, but no loss of principal.

 

   

Investment Ranking 5 is used for investments that are performing substantially below our expectations and whose risks have increased substantially since the original investment. Investments with a ranking of 5 are those for which some loss of principal is expected.

The following table shows the distribution of our investments on the 1 to 5 investment ranking scale at fair value as of December 31, 2012 and September 30, 2012:

 

Investment Ranking

   December 31, 2012     September 30, 2012  
   Fair Value      % of Portfolio     Leverage Ratio     Fair Value      % of Portfolio     Leverage Ratio  

1

   $ 196,930         12.46     2.72      $ 68,685         5.33     2.72   

2

     1,345,195         85.11        4.18        1,212,993         94.17        3.96   

3

     37,251         2.36        NM (1)     3,193         0.25        NM (1)

4

                                            

5

     1,072         0.07        NM (1)     3,237         0.25        NM (1)
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 1,580,448         100.00     4.05      $ 1,288,108         100.00     3.89   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) Due to operating performance this ratio is not measurable.

We may from time to time modify the payment terms of our investments, either in response to current economic conditions and their impact on certain of our portfolio companies or in accordance with tier pricing provisions in certain loan agreements. As of December 31, 2012, we had modified the payment terms of our investments in 14 portfolio companies. Such modified terms may include increased PIK interest provisions and reduced cash interest rates. These modifications, and any future modifications to our loan agreements, may limit the amount of interest income that we recognize from the modified investments, which may, in turn, limit our ability to make distributions to our stockholders.

Loans and Debt Securities on Non-Accrual Status

As of December 31, 2012, we had stopped accruing PIK interest on two investments. As of December 31, 2011, we had stopped accruing cash and/or PIK interest and original issue discount (“OID”) on four investments, including three that had not paid all of their scheduled cash interest payments for the period ended December 31, 2011.

The percentages of our portfolio investments at cost and fair value by accrual status for the periods ended December 31, 2012, September 30, 2012 and December 31, 2011 were as follows:

 

    December 31, 2012     September 30, 2012     December 31, 2011  
    Cost     % of
Portfolio
    Fair
Value
    % of
Portfolio
    Cost     % of
Portfolio
    Fair
Value
    % of
Portfolio
    Cost     % of
Portfolio
    Fair
Value
    %
of
Portfolio
 

Accrual

  $ 1,551,741        98.83 %   $ 1,579,376        99.93   $ 1,256,265        99.04   $ 1,284,872        99.75   $ 1,112,527        96.71   $ 1,109,720        99.09

PIK non-accrual

    18,427        1.17        1,072        0.07        12,224        0.96        3,236        0.25        15,636        1.36        4,007        0.36   

Cash non-accrual(1)

                                                            22,256        1.93        6,171        0.55   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,570,168        100.00 %   $ 1,580,448        100.00   $ 1,268,489        100.00   $ 1,288,108        100.00   $ 1,150,419        100.00   $ 1,119,898        100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Cash non-accrual status is inclusive of PIK and other noncash income, where applicable.

 

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The non-accrual status of our portfolio investments as of December 31, 2012, September 30, 2012, and December 31, 2011 was as follows:

 

     December 31, 2012      September 30, 2012      December 31, 2011  

Coll Materials Group LLC

     PIK non-accrual         PIK non-accrual           

Lighting by Gregory, LLC(1)

                     Cash non-accrual   

O’Currance, Inc.(1)

                     Cash non-accrual   

Repechage Investments Limited(1)

                     Cash non-accrual   

Rail Acquisition Corp.(1)

                     PIK non-accrual   

Trans-Trade, Inc. – Term Loan B

     PIK non-accrual                   

 

(1) We no longer hold this investment as of December 31, 2012.

Income non-accrual amounts for the three months ended December 31, 2012 and December 31, 2011 and the year ended September 30, 2012 were as follows:

 

     Three months  ended
December 31, 2012
     Three months  ended
December 31, 2011
     Year ended
September 30, 2012
 

Cash interest income

   $       $ 1,190       $ 3,068   

PIK interest income

     424         828         4,198   

OID income

             90         96   
  

 

 

    

 

 

    

 

 

 

Total

   $ 424       $ 2,108       $ 7,362   
  

 

 

    

 

 

    

 

 

 

Discussion and Analysis of Results and Operations

Results of Operations

The principal measure of our financial performance is the net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income is the difference between our income from interest, dividends, fees, and other investment income and total expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Net unrealized appreciation (depreciation) is the net change in the fair value of our investment portfolio.

Comparison of three months ended December 31, 2012 and December 31, 2011

Total Investment Income

Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, servicing fees, unused fees, amendment fees, advisory fees, structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.

Total investment income for the three months ended December 31, 2012 and December 31, 2011 was $51.8 million and $39.5 million, respectively. For the three months ended December 31, 2012, this amount primarily consisted of $38.6 million of interest income from portfolio investments (which included $3.7 million of PIK interest) and $12.8 million of fee income. For the three months ended December 31, 2011, this amount primarily consisted of $33.5 million of interest income from portfolio investments (which included $3.4 million of PIK interest) and $6.0 million of fee income.

The increase in our total investment income for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of 19 debt investments in our portfolio and fee

 

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income related to investment activity, partially offset by amortization repayments received on our debt investments and a decrease in the weighted average yield on our debt investments from 12.3% to 12.0% during the year-over-year period.

Expenses

Expenses for the three months ended December 31, 2012 and December 31, 2011 were $25.2 million and $19.8 million, respectively. Expenses increased for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 by $5.4 million. This was due primarily to increases in:

 

   

Base management fee, which was attributable to a 41.1% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;

 

   

Incentive fee, which was attributable to a 26.5% increase in pre-incentive fee net investment income for the year-over-year period; and

 

   

Interest expense, which was attributable to a 10.4% increase in weighted average debt outstanding for the year-over-year period.

Gain on Extinguishment of Convertible Senior Notes

During the three months ended December 31, 2012, we did not repurchase any of our unsecured convertible senior notes (“Convertible Notes”) in the open market. During the three months ended December 31, 2011, we repurchased $10.5 million in principal amount of our Convertible Notes in the open market and surrendered them to the trustee for cancellation. The aggregate purchase price of these Convertible Notes was $8.9 million because they were trading at a discount due to what we believe were volatile market conditions. As such, we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded for the three months ended December 31, 2011 was $1.3 million. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such fees. This type of net gain, and corresponding income incentive fee, may occur again in the future. Any repurchase of our 2024 Notes at a discount will be treated in a similar manner.

Net Investment Income

As a result of the $12.3 million increase in total investment income as compared to the $1.3 million decrease in the gain on extinguishment of debt and the $5.4 million increase in total expenses, net investment income for the three months ended December 31, 2012 reflected a $5.6 million, or 26.5%, increase compared to the three months ended December 31, 2011.

Realized Gain (Loss) on Investments

Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

 

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During the three months ended December 31, 2012, we recorded investment realization events, including the following:

 

   

In October, 2012, we received a cash payment of $4.2 million from Rail Acquisition Corp. in full satisfaction of all obligations related to the revolving loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In October 2012, we received a cash payment of $5.4 million from Bojangles in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In October 2012, we received a cash payment of $21.9 million from Blue Coat Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In October 2012, we received a cash payment of $9.9 million from Insight Pharmaceuticals LLC in full satisfaction of all obligations related to the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In November 2012, we received a cash payment of $8.5 million from SolutionSet, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction; and

 

   

During the three months ended December 31, 2012, we received cash payments of $33.7 million in connection with partial sales of debt investments in the open market and recorded a net realized gain of $0.6 million.

During the three months ended December 31, 2011, we recorded investment realization events, including the following:

 

   

In November 2011, we recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on our investment in Premier Trailer Leasing, Inc.;

 

   

In November 2011, we received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and we received an additional $1.3 million proceeds from our equity investment, realizing a gain of $0.8 million;

 

   

In December 2011, we received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In December 2011, we received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In December 2011, we received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In December 2011, we sold $4.0 million of our $10.0 million debt investment in Bojangles and no realized gain or loss was recorded on this transaction; and

 

   

In December 2011, we sold $2.0 million of our $11.5 million debt investment in US Collections, Inc. and no realized gain or loss was recorded on this transaction.

 

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Net Unrealized Appreciation (Depreciation) on Investments

Net unrealized appreciation or depreciation is the net change in the fair value of our investments during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

During the three months ended December 31, 2012, we recorded net unrealized depreciation of $9.3 million. This consisted of $13.1 million of net unrealized depreciation on debt investments and $0.8 million of net reclassifications to realized gains on debt and equity investments (resulting in unrealized depreciation), offset by $4.6 million of net unrealized appreciation on equity investments. During the three months ended December 31, 2011, we recorded net unrealized appreciation of $5.8 million. This consisted of $1.3 million of net unrealized appreciation on equity investments and $17.1 million of net reclassifications to realized losses on debt and equity investments (resulting in unrealized appreciation), offset by $12.6 million of net unrealized depreciation on debt investments.

Comparison of Years ended September 30, 2012 and September 30, 2011

Total Investment Income

Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, administrative fees, unused fees, amendment fees, advisory fees, structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.

Total investment income for the years ended September 30, 2012 and September 30, 2011 was $165.1 million and $125.2 million, respectively. For the year ended September 30, 2012, this amount primarily consisted of $133.2 million of interest income from portfolio investments (which included $13.8 million of PIK interest) and $31.7 million of fee income. For the year ended September 30, 2011, this amount primarily consisted of $108.3 million of interest income from portfolio investments (which included $13.7 million of PIK interest) and $16.7 million of fee income.

The increase in our total investment income for the year ended September 30, 2012 as compared to the year ended September 30, 2011 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of eight debt investments in our portfolio and fees related to debt payoffs, partially offset by amortization repayments received on our debt investments and a decrease in the weighted average yield of our debt investments from 12.4% to 12.0% during the year-over-year period.

Expenses

Expenses for the years ended September 30, 2012 and September 30, 2011 were $78.7 million and $59.5 million, respectively. Expenses increased for the year ended September 30, 2012 as compared to the year ended September 30, 2011 by $19.2 million. This was due primarily to increases in:

 

   

Base management fee, which was attributable to a 15.0% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;

 

   

Incentive fee, which was attributable to a 31.1% increase in pre-incentive fee net investment income for the year-over-year period; and

 

   

Interest expense, which was attributable to a 70.2% increase in weighted average debt outstanding for the year-over-year period.

Gain on Extinguishment of Convertible Senior Notes

During the years ended September 30, 2012 and September 30, 2011, we repurchased $20.0 million and $17.0 million in principal amount, respectively, of our unsecured convertible senior notes (“Convertible Notes”)

 

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in the open market and surrendered them to the trustee for cancellation. The aggregate purchase price of these Convertible Notes was $17.9 million and $15.1 million in 2012 and 2011, respectively, because they were trading at a discount due to what we believe were volatile market conditions. As such, we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded for the years ended September 30, 2012 and September 30, 2011 was $1.6 million and $1.5 million, respectively. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such fees. This type of net gain, and corresponding income incentive fee, may occur again in the future.

Net Investment Income

As a result of the $39.9 million increase in total investment income and the $0.1 million increase in the gain on extinguishment of debt, as compared to the $19.2 million increase in total expenses, net investment income for the year ended September 30, 2012 reflected a $20.9 million, or 31.1%, increase compared to the year ended September 30, 2011.

Realized Gain (Loss) on Investments and Interest Rate Swap

Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and interest rate swaps and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

During the year ended September 30, 2012, we recorded investment realization events, including the following:

 

   

In November 2011, we recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on our investment in Premier Trailer Leasing, Inc.;

 

   

In November 2011, we received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and we received an additional $1.3 million proceeds from our equity investment, realizing a gain of $0.8 million;

 

   

In December 2011, we received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In December 2011, we received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In December 2011, we received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

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In January 2012, we received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In February 2012, we received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and we recorded a realized loss in the amount of $10.7 million on this transaction;

 

   

In February 2012, we received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In March 2012, we received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In March 2012, we received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In March 2012, we received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In March 2012, we received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In May 2012, we received a cash payment of $28.9 million from JTC Education, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In May 2012, we received a cash payment of $6.1 million from Fitness Edge, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In June 2012, we received a cash payment of $20.2 million from Caregiver Services, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In July 2012, we received a cash payment of $1.0 million from Best Vinyl Fence & Deck, LLC. The Term Loan B debt investment was exited below par and we recorded a realized loss in the amount of $3.3 million on this transaction;

 

   

In July 2012, we received a cash payment of $8.7 million from Pacific Architects & Engineers, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In August 2012, we restructured our investment in Traffic Control & Safety Corp. As part of the restructuring, we exchanged cash and our debt and equity securities for debt and equity securities in the successor entity, Statewide Holdings, Inc., and recorded a realized loss in the amount of $10.9 million on this transaction;

 

   

In August 2012, we received a cash payment of $18.0 million from Stackpole Powertrain International ULC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In September 2012, we received a cash payment of $0.1 million in connection with the exit of our investment in Lighting by Gregory, LLC. The investment was exited below par and we recorded a realized loss in the amount of $5.3 million on this transaction;

 

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In September 2012, we received total consideration of $0.6 million in connection with the exit of our investment in Repechage Investments Limited. The investment was exited below par and we recorded a realized loss in the amount of $3.6 million on this transaction; and

 

   

In September 2012, we received total consideration of $1.8 million in connection with the sale of our Rail Acquisition Corp. term loan investment. The debt investment was exited below par and we recorded a realized loss in the amount of $13.9 million on this transaction. The proceeds related to this sale had not yet been received as of September 30, 2012 and are recorded as receivables from unsettled transactions in the Consolidated Statement of Assets and Liabilities.

During the year ended September 30, 2011, we recorded investment realization events, including the following:

 

   

In October 2010, we received a cash payment of $8.7 million from Goldco, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In November 2010, we received a cash payment of $11.0 million from TBA Global, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In November 2010, we restructured our investment in Vanguard Vinyl, Inc. The restructuring resulted in a realized loss in the amount of $1.7 million;

 

   

In December 2010, we restructured our investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a realized loss in the amount of $3.9 million;

 

   

In December 2010, we received a cash payment of $25.3 million from Boot Barn in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In December 2010, we received a cash payment of $11.7 million from Western Emulsions, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

 

   

In December 2010, we restructured our investment in Lighting by Gregory, LLC. The restructuring resulted in a realized loss in the amount of $7.8 million;

 

   

In March 2011, we received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a realized loss in the amount of $0.3 million;

 

   

In March and April 2011, we received cash payments totaling $1.1 million from MK Network, LLC as part of a settlement of the loan agreement. In April 2011, we recorded a realized loss on this investment in the amount of $14.1 million;

 

   

In July 2011, we received a cash payment of $7.3 million from Filet of Chicken in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

 

   

In July 2011, we received a cash payment of $19.8 million from Cenegenics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

 

   

In August 2011, we terminated our interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation;

 

 

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In September 2011, we received a cash payment of $19.1 million from Flatout, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction; and

 

   

In September 2011, we received a cash payment of $0.1 million in connection with the sale of our investment in CPAC, Inc. We recorded a realized loss on this investment in the amount of $1.0 million.

Net Unrealized Appreciation (Depreciation) on Investments and Interest Rate Swap

Net unrealized appreciation or depreciation is the net change in the fair value of our investments and interest rate swap during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

During the year ended September 30, 2012, we recorded net unrealized appreciation of $56.0 million. This consisted of $66.6 million of net reclassifications of net unrealized depreciation to realized losses on our investments (resulting in unrealized appreciation) and $0.1 million of net unrealized appreciation on equity investments, offset by $10.7 million of net unrealized depreciation on debt investments. During the year ended September 30, 2011, we recorded net unrealized depreciation of $6.5 million. This consisted of $34.6 million of net unrealized depreciation on debt investments, offset by $25.6 million of net reclassifications of net unrealized depreciation to realized losses on our investments and interest rate swaps (resulting in unrealized appreciation) and $2.5 million of net unrealized appreciation on equity investments.

Financial Condition, Liquidity and Capital Resources

Cash Flows

We have a number of alternatives available to fund the growth of our investment portfolio and our operations, including, but not limited to, raising equity, increasing debt and funding from operational cash flow. Additionally, we may reduce investment size by syndicating a portion of any given transaction. We intend to fund our future distribution obligations through operating cash flow or with funds obtained through future equity and debt offerings or credit facilities, as we deem appropriate.

For the three months ended December 31, 2012, we experienced a net decrease in cash and cash equivalents of $37.0 million. During that period, we used $280.1 million of cash in operating activities, primarily for the funding of $398.8 million of investments and net revolvers, partially offset by $103.2 million of principal payments, PIK payments and sale proceeds received and $26.6 million of net investment income. During the same period, cash provided by financing activities was $243.1 million, primarily consisting of $151.7 million of proceeds from issuances of our common stock, $31.8 million of net borrowings of SBA debentures, $16.7 million of net borrowings under our credit facilities and $75.0 million of proceeds from the issuance of senior unsecured notes, partially offset by $25.9 million of cash dividends paid, $0.5 million of offering costs paid and $5.7 million of deferred financing costs paid.

For the three months ended December 31, 2011, we experienced a net increase in cash and cash equivalents of $2.7 million. During that period, we had $4.0 million of cash provided by operating activities, primarily from $79.0 million of principal payments, PIK payments and sale proceeds received and $21.0 million of net investment income, offset by the funding of $84.5 million of investments and net revolvers. During the same period cash used by financing activities was $1.3 million, primarily consisting of $23.1 million of cash dividends paid, $8.9 million of net repurchases of our convertible senior notes, $0.3 million of offering costs paid and $0.2 million of deferred financing costs paid, partially offset by $31.2 million of net borrowings under our credit facilities.

For the year ended September 30, 2012, we experienced a net increase in cash and cash equivalents of $6.7 million. During that period, we used $90.2 million of cash in operating activities, primarily for the funding of $530.9 million of investments and net revolvers, partially offset by $376.5 million of principal and PIK

 

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payments received and $88.0 million of net investment income. During the same period, cash provided by financing activities was $97.0 million, primarily consisting of $188.7 million of proceeds from issuances of our common stock and $23.2 million of net borrowings under our credit facilities, partially offset by $91.9 million of cash dividends paid, $17.9 million of net repurchases of our Convertible Notes, $1.1 million of offering costs paid and $4.0 million of deferred financing costs paid.

As of December 31, 2012, we had $37.4 million in cash and cash equivalents, portfolio investments (at fair value) of $1.58 billion, $8.6 million of interest and fees receivable, $181.8 million of SBA debentures payable, $218.0 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable, $75.0 million of 2024 Notes payable and unfunded commitments of $114.0 million.

As of September 30, 2012, we had $74.4 million in cash and cash equivalents, portfolio investments (at fair value) of $1.29 billion, $7.7 million of interest and fees receivable, $150.0 million of SBA debentures payable, $201.3 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable and unfunded commitments of $102.5 million.

Other Sources of Liquidity

We intend to continue to generate cash primarily from cash flows from operations, including interest earned, future borrowings and future offerings of securities. In the future, we may also securitize a portion of our investments in first and second lien senior loans or unsecured debt or other assets. To securitize loans, we would likely create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. We would then sell interests in the subsidiary on a non-recourse basis to purchasers and we would retain all or a portion of the equity in the subsidiary. Our primary use of funds is investments in our targeted asset classes and cash distributions to holders of our common stock.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, because our common stock has at times traded at a price below our then-current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. See “Regulated Investment Company Status and Dividends” below. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

Also, as a business development company, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. As of December 31, 2012, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment

 

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portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.

Significant Capital Transactions That Have Occurred Since October 1, 2011

The following table reflects the dividend distributions per share that our Board of Directors has declared, including shares issued under our DRIP, on our common stock since October 1, 2011:

 

Date Declared

 

Record

Date

   

Payment Date

    Amount per
Share
    Cash
Distribution
    DRIP Shares
Issued
    DRIP Shares
Value
 

November 10, 2011

    January 13, 2012        January 31, 2012      $ 0.0958      $ 6.6 million        29,902 (1)    $ 0.3 million   

November 10, 2011

    February 15, 2012        February 29, 2012        0.0958        7.4 million        45,071        0.4 million   

November 10, 2011

    March 15, 2012        March 30, 2012        0.0958        7.5 million        41,807 (1)      0.4 million   

February 7, 2012

    April 13, 2012        April 30, 2012        0.0958        7.4 million        48,328 (1)      0.5 million   

February 7, 2012

    May 15, 2012        May 31, 2012        0.0958        7.4 million        47,877 (1)      0.5 million   

February 7, 2012

    June 15, 2012        June 29, 2012        0.0958        7.5 million        41,499        0.4 million   

May 7, 2012

    July 13, 2012        July 31, 2012        0.0958        7.4 million        49,217        0.5 million   

May 7, 2012

    August 15, 2012        August 31, 2012        0.0958        7.5 million        41,359        0.4 million   

May 7, 2012

    September 14, 2012        September 28, 2012        0.0958        8.3 million        43,952        0.5 million   

August 6, 2012

    October 15, 2012        October 31, 2012        0.0958        8.2 million        51,754        0.5 million   

August 6, 2012

    November 15, 2012        November 30, 2012        0.0958        8.2 million        53,335        0.5 million   

August 6, 2012

    December 14, 2012        December 28, 2012        0.0958        9.5 million        64,680        0.6 million   

August 6, 2012

    January 15, 2013        January 31, 2013        0.0958        9.5 million        61,782        0.6 million   

August 6, 2012

    February 15, 2013        February 28, 2013        0.0958         

January 14, 2013

    March 15, 2013        March 29, 2013        0.0958         

January 14, 2013

    April 15, 2013        April 30, 2013        0.0958         

January 14, 2013

    May 15, 2013        May 31, 2013        0.0958         

 

(1) Shares were purchased on the open market and distributed.

The following table reflects share transactions that occurred from October 1, 2010 through December 31, 2012:

 

Date

  

Transaction

  Shares      Share Price     Gross Proceeds  

December 2010

   At-the-market offering     429,110       $ 11.87 (1)    $ 5.1 million   

February 4, 2011

   Public offering(2)     11,500,000         12.65        145.5 million   

June 24, 2011

   Public offering(3)     5,558,469         11.72        65.1 million   

January 26, 2012

   Public offering     10,000,000         10.07        100.7 million   

September 14, 2012

   Public offering(3)     8,451,486         10.79        91.2 million   

December 2012

   Public offering(3)     14,725,000         10.68        157.3 million   

 

(1) Average offering price
(2) Includes the underwriters’ full exercise of their over-allotment option
(3) Includes the underwriters’ partial exercise of their over-allotment option

Borrowings

Through wholly-owned subsidiaries, we sought and obtained two licenses from the SBA to operate SBIC subsidiaries. In this regard, on February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. (“FSMP IV”), received a license, effective February 1, 2010, from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Act of 1958. On May 15, 2012, our wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. (“FSMP V”), received a license, effective May 10, 2012, from the SBA to operate as an SBIC. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

 

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The SBIC licenses allow our SBIC subsidiaries to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.

SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when they have at least $112.5 million in regulatory capital. As of December 31, 2012, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $133.6 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:

 

Rate Fix Date

   Debenture
Amount
     Fixed
Interest
Rate
    SBA
Annual
Charge
 

September 2010

   $ 73,000            3.215        0.285

March 2011

     65,300            4.084        0.285

September 2011

     11,700            2.877        0.285

As of December 31, 2012, FSMP V had $37.5 million in regulatory capital and $31.8 million in SBA-guaranteed debentures outstanding, which had a fair value of $21.3 million and do not yet have a locked interest rate. For the three months ended December 31, 2012 and 2011, we recorded interest expense of $1.6 million and $1.6 million, respectively, related to the SBA-guaranteed debentures of both subsidiaries.

We have received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $225 million more than we would otherwise be able to absent the receipt of this exemptive relief.

On November 16, 2009, we and Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote special purpose subsidiary (“Funding”), entered into a Loan and Servicing Agreement (“Wells Agreement”) with respect to a three-year credit facility (“Wells Fargo facility”) with Wells Fargo Bank, National Association (“Wells Fargo”), as successor to Wachovia Bank, National Association (“Wachovia”), Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time, in the amount of $50 million, with an accordion feature which allowed for potential future expansion of the facility up to $100 million. The facility bore interest at LIBOR plus 4.0% per annum and had a maturity date of November 16, 2012.

On May 26, 2010, we amended the Wells Fargo facility to expand the borrowing capacity under that facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility from $50 million to $100 million, with an accordion feature that allows for potential future expansion of that facility from a total of $100 million up to a total of $150 million. In addition, the interest rate of the Wells Fargo facility was reduced from LIBOR plus 4% per annum to LIBOR plus 3.5% per annum, with no LIBOR floor, and the maturity date of the facility was extended from November 16, 2012 to May 26, 2013.

On November 5, 2010, we amended the Wells Fargo facility to, among other things, provide for the issuance from time to time of letters of credit for the benefit of our portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million. On February 28, 2011, we amended the Wells Fargo facility to, among other things, (i) reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, (ii) extend the period during which we may make new

 

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borrowings under the facility to February 25, 2013, and (iii) extend the maturity date of the facility to February 25, 2014. The facility may be extended for up to two additional years upon the mutual consent of Wells Fargo and each of the lender parties thereto.

On November 30, 2011, we amended the Wells Fargo facility to, among other things, reduce the interest rate to LIBOR (1-month) plus 2.75% per annum, with no LIBOR floor.

On April 23, 2012, we amended the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which we may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

In connection with the Wells Fargo facility, we concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which we will sell to Funding certain loan assets we have originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which we pledged all of our equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.

The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Wells Fargo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or us to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.

The Wells Fargo facility is secured by all of the assets of Funding, and all of our equity interest in Funding. We use the Wells Fargo facility to fund a portion of our loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of December 31, 2012, we had $83.0 million of borrowings outstanding under the Wells Fargo facility, which had a fair value of $83.0 million. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.039% for the three months ended December 31, 2012. For the three months ended December 31, 2012 and December 31, 2011, we recorded interest expense of $0.8 million and $0.7 million, respectively related to the Wells Fargo facility.

On May 27, 2010, we entered into a three-year secured syndicated revolving credit facility (“ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allowed for us to borrow money at a rate of either (i) LIBOR plus 3.5% per annum or (ii) 2.5% per annum plus an alternate base rate based on the greatest of the Prime Rate, Federal Funds Rate plus 0.5% per annum or LIBOR plus 1% per annum, and had a maturity date of May 27, 2013. The ING facility also allows us to request letters of credit from ING Capital LLC, as the issuing bank. The initial commitment under the ING facility was $90 million, and the ING facility included an accordion feature that allowed for potential future expansion of the facility up to a total of $150 million.

The ING facility is secured by substantially all of our assets, as well as the assets of our wholly-owned subsidiary, FSFC Holdings, Inc., and our indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC,

 

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subject to certain exclusions for, among other things, equity interests in any of our SBIC subsidiaries and equity interests in Funding and Fifth Street Funding II, LLC as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and us. None of our SBIC subsidiaries, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

On February 22, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion up to a total of $300 million and the maturity date was extended to February 22, 2014. On July 8, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $230 million and increase the accordion feature to allow for potential future expansion up to a total of $350 million. In addition, the ING facility’s interest rate was reduced to LIBOR plus 3.0% per annum, with no LIBOR floor, when the facility is drawn more than 35%. Otherwise, the interest rate will be LIBOR plus 3.25% per annum, with no LIBOR floor. On February 29, 2012, we amended the ING facility to, among other things, (i) extend the period during which we may make and repay borrowings under the ING facility to February 27, 2015, (ii) extend the maturity date to February 29, 2016, and (iii) increase the accordion feature to allow for potential future expansion up to a total of $450 million.

On November 30, 2012, we amended our existing $230 million ING facility to, among other things: (i) increase the borrowing capacity of the facility to $380 million, (ii) add five new banks to the syndicate group, (iii) increase the accordion feature of the facility to $600 million, (iv) reduce the interest rate to LIBOR (1-, 2-, 3- or 6-month, at our option) plus 2.75% per annum, with no LIBOR floor, assuming we maintain our current credit rating, (v) extend the period during which we may make and repay borrowings to November 30, 2015, and (vi) extend the maturity date to November 30, 2016. During December 2012 and January 2013, additional lenders were added to the ING facility and the borrowing capacity increased to $425 million. With the addition of the new lenders, the ING facility syndicate group now includes 12 lenders.

Pursuant to the ING Security Agreement, FSFC Holdings, Inc. and Fifth Street Fund of Funds LLC guaranteed the obligations under the ING Security Agreement, including our obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, we pledged our entire equity interest in FSFC Holdings, Inc. and FSFC Holdings, Inc. pledged its entire equity interest in Fifth Street Fund of Funds LLC to the collateral agent pursuant to the terms of the ING Security Agreement.

The ING Credit Agreement and related agreements governing the ING facility required FSFC Holdings, Inc., Fifth Street Fund of Funds LLC and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) agree to comply with various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by us to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the ING facility at any particular time or at all. As of December 31, 2012, we had $135.0 million of borrowings outstanding under the ING facility, which had a fair value of $135.0 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of 3.684% for the three months ended December 31, 2012. For the three months ended December 31, 2012 and December 31, 2011, we recorded interest expense of $1.7 million and $1.4 million, respectively, related to the ING facility.

 

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On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto, in the amount of $200 million. The Sumitomo facility bears interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor, permits us to make new borrowings until September 16, 2014, matures on September 16, 2018 and includes an option for a one-year extension.

In connection with the Sumitomo facility, we concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which we will sell to Funding II certain loan assets we have originated or acquired, or will originate or acquire.

The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or us to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of December 31, 2012, we had no borrowings outstanding under the Sumitomo facility. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 3.805% for the three months ended December 31, 2012. For the three months ended December 31, 2012 and December 31, 2011, we recorded interest expense of $0.4 million and $0.2 million, respectively, related to the Sumitomo facility.

As of December 31, 2012, except for assets that were funded through our SBIC subsidiaries, substantially all of our assets were pledged as collateral under the Wells Fargo facility, ING facility or the Sumitomo facility. With respect to the assets funded through our SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over our stockholders.

 

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The following table describes significant financial covenants with which we must comply under each of our credit facilities on a quarterly basis. The Sumitomo facility does not require us to comply with significant financial covenants.

 

Facility

 

Financial Covenant

 

Description

 

Target Value

 

Reported Value (1)

Wells Fargo facility

  Minimum shareholders’ equity (inclusive of affiliates)   Net assets shall not be less than $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 25, 2011   $636 million   $904 million
  Minimum shareholders’ equity (exclusive of affiliates)   Net assets exclusive of affiliates other than Funding shall not be less than $250 million   $250 million   $682 million
  Asset coverage ratio   Asset coverage ratio shall not be less than 2.00:1   2.00:1   3.86:1

ING facility

  Minimum shareholders’ equity   Net assets shall not be less than the greater of (a) 40% of total assets; and (b) $675 million plus 50% of the aggregate net proceeds of all sales of equity interests after November 30, 2012   $751 million   $904 million
  Asset coverage ratio   Asset coverage ratio shall not be less than 2.10:1   2.10:1   3.86:1
  Interest coverage ratio   Interest coverage ratio shall not be less than 2.50:1   2.50:1   4.95:1

 

(1) As contractually required, we report financial covenants based on the last filed quarterly or annual report, in this case our Form 10-K for the year ended September 30, 2012. We were also in compliance with all financial covenants under these credit facilities based on the financial information contained in our Form 10-Q for the quarter ended December 31, 2012.

We and our SBIC subsidiaries are also subject to certain regulatory requirements relating to our borrowings. For a discussion of such requirements, see “Regulation — Business Development Company Regulations” and “— Small Business Investment Company Regulations” in the accompanying prospectus.

 

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The following table reflects material credit facility and SBA debenture transactions that have occurred since October 1, 2010. Amounts available and drawn are as of December 31, 2012.

 

Facility

 

Date

 

Transaction

 

Total

Facility

Amount

 

Upfront

fee Paid

 

Total
Facility

Availability

  

Amount

Drawn

 

Remaining

Availability

 

Interest Rate

Wells Fargo facility

  11/16/2009   Entered into credit facility   $50 million   $0.8 million          LIBOR + 4.00%
  5/26/2010   Expanded credit facility   100 million   0.9 million          LIBOR + 3.50%
  2/28/2011   Amended credit facility   100 million   0.4 million          LIBOR + 3.00%
  11/30/2011   Amended credit facility   100 million            LIBOR + 2.75%
  4/23/2012   Amended credit facility   150 million   1.2 million   $99 million(1)    $83 million   $16 million   LIBOR + 2.75%

ING facility

  5/27/2010   Entered into credit facility   90 million   0.8 million          LIBOR + 3.50%
  2/22/2011   Expanded credit facility   215 million   1.6 million          LIBOR + 3.50%
  7/8/2011   Expanded credit facility   230 million   0.4 million          LIBOR + 3.00%/3.25%(2)
  2/29/2012   Amended credit facility   230 million   1.5 million          LIBOR + 3.00%/3.25%(2)
  11/30/2012   Amended credit facility   385 million   2.2 million  

385 million

   135 million   250 million   LIBOR + 2.75%(3)

SBA

  2/16/2010   Received capital commitment   75 million   2.6 million         
  9/21/2010   Received capital commitment   150 million   2.6 million         
  7/23/2012   Received capital commitment   225 million   1.5 million   225 million    182 million   43 million   3.567%(4)

Sumitomo facility

  9/16/2011   Entered into credit facility   200 million   2.5 million   68 million(1)      68 million   LIBOR + 2.25%

 

(1) Availability to increase upon our decision to further collateralize the facility.
(2) LIBOR plus 3.0% when the facility is drawn more than 35%. Otherwise, LIBOR plus 3.25%.
(3) Assuming we maintain our current credit rating.
(4) Weighted average interest rate of 3.567% (excludes the SBA annual charge of 0.285%) on $150 million of debentures; the remainder do not yet have a locked interest rate.

On April 12, 2011, we issued $152 million unsecured convertible senior notes (“Convertible Notes”), including $2 million issued to Leonard M. Tannenbaum, our Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between us and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”).

The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per annum payable semiannually in arrears on April 1 and October 1 of each year, commencing on October 1, 2011. The Convertible Notes are our senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles.

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when our shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, we will deliver shares of our common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of our common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115.0 million Convertible Notes outstanding at December 31, 2012 is 7,790,273. If we deliver shares of common stock upon a conversion

 

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at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our Convertible Notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

We may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect to us, holders of the Convertible Notes may require us to repurchase for cash all or part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.

The Indenture contains certain covenants, including covenants requiring us to provide financial information to the holders of the Convertible Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture.

For the three months ended December 31, 2012 and December 31, 2011, we recorded interest expense of $1.7 million and $1.9 million, respectively, related to the Convertible Notes.

We may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any Convertible Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the Indenture. During the three months ended December 31, 2012, we did not repurchase any of the Convertible Notes in the open market. During the three months ended December 31, 2011, we repurchased $10.5 million in principal amount of the Convertible Notes in the open market for an aggregate purchase price of $8.9 million and surrendered them to the Trustee for cancellation.

As of December 31, 2012, there were $115.0 million Convertible Notes outstanding, which had a fair value of $117.0 million.

On October 18, 2012, we issued $75.0 million in aggregate principal amount of our 5.875% 2024 Notes for net proceeds of approximately $72.8 million after deducting underwriting commissions of $2.2 million.

The 2024 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the first supplemental indenture, dated October 18, 2012 (collectively, the “2024 Notes Indenture”), between us and the Trustee. The 2024 Notes are our senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 2024 Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the 2024 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 5.875% per annum, beginning January 30, 2013. The 2024 Notes mature on October 30, 2024 and may be redeemed in whole or in part at any time or from time to time at our option on or after October 30, 2017. On November 1, 2012, we listed the 2024 Notes on the New York Stock Exchange under the trading symbol “FSCE” with a par value of $25.00 per share.

The 2024 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, as well as

 

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covenants requiring us to provide financial information to the holders of the 2024 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2024 Notes Indenture. We may repurchase the 2024 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2024 Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any 2024 Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the 2024 Notes Indenture. During the three months ended December 31, 2012, we did not repurchase any of the 2024 Notes in the open market.

For the three months ended December 31, 2012, we recorded interest expense of $1.0 million related to the 2024 Notes.

As of December 31, 2012, there were $75.0 million 2024 Notes outstanding, which had a fair value of $71.6 million.

Interest expense for the three months ended December 31, 2012 and December 31, 2011 was $7.2 million and $5.7 million, respectively. Interest expense for the year ended September 30, 2012 was $23.2 million.

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of December 31, 2012, our only off-balance sheet arrangements consisted of $114.0 million of unfunded commitments, which was comprised of $104.3 million to provide debt financing to certain of our portfolio companies and $9.7 million related to unfunded limited partnership interests. As of September 30, 2012, our only off-balance sheet arrangements consisted of $102.5 million, which was comprised of $94.3 million to provide debt financing to certain of our portfolio companies and $8.2 million related to unfunded limited partnership interests. Such commitments are subject to our portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on our Consolidated Statement of Assets and Liabilities.

 

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A summary of the composition of unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of December 31, 2012 and September 30, 2012 is shown in the table below:

 

     December 31, 2012      September 30, 2012  

Welocalize, Inc.

   $ 10,000       $ 10,000   

Deltek, Inc.

     10,000           

Yeti Acquisition, LLC

     7,500         7,500   

Refac Optical Group

     5,500         5,500   

I Drive Safely, LLC

     5,000         5,000   

Traffic Solutions Holdings, Inc.

     5,000         5,000   

Titan Fitness, LLC

     5,000         3,500   

First American Payment Systems, LP

     5,000           

Reliance Communications, LLC

     5,000           

Teaching Strategies, LLC

     4,500           

InvestRx Corporation

     4,300         5,000   

Phoenix Brands Merger Sub LLC

     4,286         4,071   

Enhanced Recovery Company, LLC

     4,000         4,000   

World 50, Inc.

     4,000         4,000   

Cardon Healthcare Network, LLC

     3,000         3,000   

Discovery Practice Management, Inc.

     2,700         2,600   

Drugtest, Inc.

     2,500         4,000   

Charter Brokerage, LLC

     2,400         7,353   

Olson + Co., Inc.

     2,105         2,105   

Mansell Group, Inc.

     2,000         2,000   

Physicians Pharmacy Alliance, Inc.

     2,000         2,000   

Riverside Fund V, LP (limited partnership interest)

     2,000         2,000   

Beecken Petty O’Keefe Fund IV, LP (limited partnership interest)

     2,000           

Miche Bag, LLC

     1,518         3,500   

Tegra Medical, LLC

     1,500         1,500   

Ansira Partners, Inc.

     1,190         1,190   

Milestone Partners IV, LP (limited partnership interest)

     1,105         1,343   

Garretson Firm Resolution Group, Inc.

     1,063           

BMC Acquisition, Inc.

     1,050         900   

Psilos Group Partners IV, LP (limited partnership interest)

     1,000         1,000   

CPASS Acquisition Company

     1,000         1,000   

Bunker Hill Capital II (QP), LP (limited partnership interest)

     915         934   

ACON Equity Partners III, LP (limited partnership interest)

     758         753   

HealthDrive Corporation

     750         750   

Riverlake Equity Partners II, LP (limited partnership interest)

     638         760   

RCP Direct, LP (limited partnership interest)

     539         615   

Advanced Pain Management

     400         400   

Baird Capital Partners V, LP (limited partnership interest)

     391         513   

Riverside Fund IV, LP (limited partnership interest)

     351         323   

Specialty Bakers, LLC

             750   

Eagle Hospital Physicians, Inc.

             1,400   

Rail Acquisition Corp.

             6,165   

Saddleback Fence and Vinyl Products, Inc.

             100   
  

 

 

    

 

 

 

Total

   $ 113,959       $ 102,525   
  

 

 

    

 

 

 

 

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Contractual Obligations

The following table reflects information pertaining to debt outstanding under the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes and our 2024 Notes:

 

      Debt Outstanding
as of  September 30,
2012
     Debt Outstanding
as of  December 31,
2012
     Weighted average  debt
outstanding for the
three months ended
December 31, 2012
     Maximum  debt
outstanding
for the three
months ended

December 31,
2012
 

SBA debentures

   $ 150,000       $ 181,750       $ 156,052       $ 181,750   

Wells Fargo facility

     60,251         83,000         60,809       $ 96,166   

ING facility

     141,000         135,000         85,793       $ 141,000   

Sumitomo facility

                     5,728       $ 67,000   

Convertible senior notes

     115,000         115,000         115,000       $ 115,000   

Senior unsecured notes

             75,000         60,326       $ 75,000   
  

 

 

    

 

 

    

 

 

    

Total debt

   $ 466,251       $ 589,750       $ 483,708       $ 589,750   
  

 

 

    

 

 

    

 

 

    

The following table reflects our contractual obligations arising from the SBA debentures, the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes and our 2024 Notes:

 

     Payments due by period as of December 31, 2012  
     Total      < 1 year      1-3 years      3-5 years      > 5 years  

SBA debentures

   $ 181,750       $       $       $       $ 181,750   

Interest due on SBA debentures

     52,807         6,113         12,489         12,506         21,699   

Wells Fargo facility

     83,000                         83,000           

Interest due on Wells Fargo facility

     8,148         2,456         4,911         781           

ING facility

     135,000                         135,000           

Interest due on ING facility

     15,867         4,050         8,100         3,717           

Sumitomo facility

                                       

Interest due on Sumitomo facility

                                       

Convertible Notes

     115,000                         115,000           

Interest due on Convertible Notes

     20,102         6,181         12,363         1,558           

2024 Notes

     75,000                                 75,000   

Interest due on 2024 Notes

     52,163         4,406         8,813         8,813         30,131   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 738,837       $ 23,206       $ 46,676       $ 360,375       $ 308,580   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Regulated Investment Company Status and Dividends

We elected, effective as of January 2, 2008, to be treated and have qualified, and we intend to continue to qualify, as a RIC under Subchapter M of the Code. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

 

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To maintain RIC tax treatment, we must, among other things, timely distribute, with respect to each taxable year, at least 90% of our investment company taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distribution requirements of our taxable income on a calendar year basis (e.g., calendar year 2012). We anticipate timely distribution of our taxable income within the tax rules; however, we incurred a de minimis U.S. federal excise tax for calendar years 2009 and 2010. We did not incur a federal excise tax for calendar year 2011 and do not expect to incur a federal excise tax for the calendar year 2012. We may incur a federal excise tax in future years.

We intend to timely distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, we are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to enable us to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility could, under certain circumstances, restrict Fifth Street Funding, LLC from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders for federal income tax purposes.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in our credit facilities. If we do not distribute a certain percentage of our taxable income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

Related Party Transactions

We have entered into an investment advisory agreement with Fifth Street Management LLC, our investment adviser. Fifth Street Management LLC is controlled by Leonard M. Tannenbaum, its managing member and the

 

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chairman of our Board of Directors and our chief executive officer. Pursuant to the investment advisory agreement, fees payable to our investment adviser will be equal to (a) a base management fee of 2.0% of the value of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents, and (b) an incentive fee based on our performance. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee. The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three months ended December 31, 2012 and December 31, 2011, we incurred fees of $14.7 million and $11.0 million, respectively, under the investment advisory agreement.

Pursuant to the administration agreement with FSC, Inc., which is controlled by Mr. Tannenbaum, FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will pay FSC, Inc. our allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and chief compliance officer and their respective staffs. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. Although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three months ended December 31, 2012 and December 31, 2011, we have incurred expenses of $1.6 million and $1.1 million, respectively, under the administration agreement.

We have also entered into a license agreement with Fifth Street Capital LLC pursuant to which Fifth Street Capital LLC has agreed to grant us a non-exclusive, royalty-free license to use the name “Fifth Street.” Under this agreement, we will have a right to use the “Fifth Street” name, for so long as Fifth Street Management LLC or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we will have no legal right to the “Fifth Street” name. Fifth Street Capital LLC is controlled by Mr. Tannenbaum, its managing member.

Recent Developments

During December 2012 and January 2013, additional lenders were added to the ING facility and our borrowing capacity increased to $425 million. With the addition of the new lenders, the ING facility syndicate group now includes 12 lenders.

On January 14, 2013, our Board of Directors declared the following dividends:

 

   

$0.0958 per share, payable on March 29, 2013 to stockholders of record on March 15, 2013;

 

   

$0.0958 per share, payable on April 30, 2013 to stockholders of record on April 15, 2013; and

 

   

$0.0958 per share, payable on May 31, 2013 to stockholders of record on May 15, 2013.

Effective January 15, 2013, our Board of Directors increased its size to eight members and appointed Ivelin M. Dimitrov, our Chief Investment Officer, to the Board for a one-year term to serve until our 2014 Annual Meeting of Stockholders.

 

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Recently Issued Accounting Standards

See Note 2 to the Consolidated Financial Statements for a description of recent accounting pronouncements, including the expected dates of adoption and the anticipated impact on the Consolidated Financial Statements.

Quantitative and Qualitative Disclosures about Market Risk

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent our debt investments include floating interest rates. In addition, our investments are carried at fair value as determined in good faith by our Board of Directors in accordance with the 1940 Act (See “— Critical Accounting Policies — Investment Valuation”). Our valuation methodology utilizes discount rates in part in valuing our investments, and changes in those discount rates may have an impact on the valuation of our investments.

As of December 31, 2012, 70.8% of our debt investment portfolio (at fair value) and 70.2% of our debt investment portfolio (at cost) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of December 31, 2012 and September 30, 2012 was as follows:

 

     December 31, 2012     September 30, 2012  
     Fair Value      % of Floating
Rate  Portfolio
    Fair Value      % of Floating
Rate  Portfolio
 

Under 1%

   $ 68,159         6.32   $ 72,609         8.35

1% to under 2%

     771,946         71.63        554,315         63.72   

2% to under 3%

     112,764         10.46        111,262         12.79   

3% to under 4%

     124,871         11.59        131,686         15.14   

4% and over

                              
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,077,740         100.00   $ 869,872         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Based on our Consolidated Statement of Assets and Liabilities as of December 31, 2012, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investment and capital structure.

 

Basis point increase(1)

   Interest
income
     Interest
expense
    Net  increase
(decrease)
 

100

   $ 700       $ (2,200 )   $ (1,500

200

     6,500         (4,400 )     2,100   

300

     16,400         (6,500 )     9,900   

400

     27,200         (8,700 )     18,500   

500

     38,000         (10,900 )     27,100   

 

(1) A decline in interest rates would not have a material impact on our Consolidated Financial Statements.

 

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We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of December 31, 2012 and September 30, 2012:

 

     December 31, 2012      September 30, 2012  
     Interest Bearing
Cash and
Investments
     Borrowings      Interest Bearing
Cash and
Investments
     Borrowings  

Money market rate

   $ 37,438       $       $ 74,393       $   

Prime rate

     31,550                 6,832         60,000   

LIBOR

           

30 day

     32,552         218,000         32,753         141,251   

90 day

     1,013,013                 822,867           

Fixed rate

     457,474         371,750         377,522         265,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,572,027       $ 589,750       $ 1,314,367       $ 466,251   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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MANAGEMENT

Our business and affairs are managed under the direction of our Board of Directors. Our Board of Directors appoints our officers, who serve at the discretion of the Board of Directors. The responsibilities of the Board of Directors include, among other things, the oversight of our investment activities, the quarterly valuation of our assets, oversight of our financing arrangements and corporate governance activities. The Board of Directors has an Audit Committee, a Nominating and Corporate Governance Committee and a Compensation Committee, and may establish additional committees from time to time as necessary.

Board of Directors and Executive Officers

Our Board of Directors consists of eight members, five of whom are classified under applicable NASDAQ corporate governance regulations by our Board of Directors as “independent” directors and under Section 2(a)(19) of the 1940 Act as non-interested persons. Pursuant to our restated certificate of incorporation, our Board of Directors is divided into three classes. Each class of directors will hold office for a three-year term. At each annual meeting of our stockholders, the successors to the class of directors whose terms expire at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. Each director will hold office for the term to which he or she is elected and until his or her successor is duly elected and qualifies. Our restated certificate of incorporation also gives our Board of Directors sole authority to appoint directors to fill vacancies that are created either through an increase in the number of directors or due to the resignation, removal or death of any director.

Directors

Information regarding our Board of Directors is set forth below. We have divided the directors into two groups — independent directors and interested directors. Interested directors are “interested persons” of Fifth Street Finance Corp. as defined in Section 2(a)(19) of the 1940 Act.

The address for each director is c/o Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606.

 

Name

   Age      Director
Since
     Expiration of
Term
 

Independent Directors

        

Brian S. Dunn

     41         2007         2014   

Richard P. Dutkiewicz

     57         2010         2016   

Byron J. Haney

     52         2007         2014   

Frank C. Meyer

     69         2007         2016   

Douglas F. Ray

     45         2007         2016   

Interested Directors

        

Leonard M. Tannenbaum

     41         2007         2015   

Bernard D. Berman

     42         2009         2015   

Ivelin M. Dimitrov

     34         2013         2014   

Executive Officers

The following persons serve as our executive officers in the following capacities:

 

Name

   Age     

Position(s) Held

Leonard M. Tannenbaum

     41       Chief Executive Officer

Bernard D. Berman

     42       President, Chief Compliance Officer and Secretary

Alexander C. Frank

     55       Chief Financial Officer

Ivelin M. Dimitrov

     34       Chief Investment Officer

The address for each executive officer is c/o Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606.

 

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Biographical Information

Independent Directors

 

   

Brian S. Dunn.    Mr. Dunn has been a member of our Board of Directors since December 2007. Mr. Dunn has over 17 years of marketing, logistical and entrepreneurial experience. He founded and turned around direct marketing divisions for several consumer-oriented companies. Currently, he manages Little White Dog, Inc., a marketing firm that he founded. Mr. Dunn was the marketing director and chief operating officer for Lipenwald, Inc., a direct marketing company that markets collectibles and mass merchandise from June 2006 until May 2011. Lipenwald filed for bankruptcy in July 2011. Prior to Lipenwald, from February 2001 to June 2006, he was sole proprietor of BSD Trading/Consulting. Mr. Dunn graduated from the Wharton School of the University of Pennsylvania with a B.S. in Economics.

Mr. Dunn’s executive experience brings extensive business, entrepreneurial and marketing expertise to his Board service with our Company. His experience as a marketing executive for several consumer-oriented companies provides guidance to our investor relations efforts. Mr. Dunn’s many experiences also make him skilled in leading committees requiring substantive expertise, including his role as chairman of the Board’s Nominating and Corporate Governance Committee. Mr. Dunn’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing business development companies. The foregoing qualifications led to our conclusion that Mr. Dunn should serve as a member of our Board.

 

   

Richard P. Dutkiewicz.    Mr. Dutkiewicz has been a member of our Board of Directors since February 2010. He has served as a managing director at Capital Insight, LLC, a private investment bank, since March 2013. Previously, he was an independent financial and management consultant affiliated with Exxodus Capital Partners. From April 2010 to March 2012, Mr. Dutkiewicz was the executive vice president and chief financial officer of Real Mex Restaurants, Inc., which filed for bankruptcy in October 2011. Mr. Dutkiewicz previously served as chief financial officer of Einstein Noah Restaurant Group, Inc. from October 2003 to April 2010. From May 2003 to October 2003, Mr. Dutkiewicz was vice president-information technology of Sirenza Microdevices, Inc. In May 2003, Sirenza Microdevices, Inc. acquired Vari-L Company, Inc. From January 2001 to May 2003, Mr. Dutkiewicz was vice president-finance, and chief financial officer of Vari-L Company, Inc. From April 1995 to January 2001, Mr. Dutkiewicz was vice president-finance, chief financial officer, secretary and treasurer of Coleman Natural Products, Inc., located in Denver, Colorado. Mr. Dutkiewicz’s previous experience includes senior financial management positions at Tetrad Corporation, MicroLithics Corporation and various divisions of United Technologies Corporation. Mr. Dutkiewicz began his career as an Audit Manager at KPMG LLP. Mr. Dutkiewicz received a B.B.A. degree from Loyola University of Chicago. Mr. Dutkiewicz currently serves on the Board of Directors of Motor Sport Country Club Holdings, Inc., which sells balancing technology for rotating devices in the automotive industry.

Through his prior experiences as a vice president and chief financial officer at several public companies, including executive vice president and chief financial officer of Real Mex Restaurants, Inc. and chief financial officer of Einstein Noah Restaurant Group, Inc., Mr. Dutkiewicz brings business expertise, finance and audit skills to his Board service with our Company. Mr. Dutkiewicz’s expertise, experience and skills closely align with our operations, and his prior investment experience with managing public companies facilitates an in-depth understanding of our investment business. Moreover, Mr. Dutkiewicz’s knowledge of financial and accounting matters qualify him as the Board’s Audit Committee Financial Expert and chairman of the Audit Committee. The foregoing qualifications led to our conclusion that Mr. Dutkiewicz should serve as a member of our Board.

 

   

Byron J. Haney.    Mr. Haney has been a member of our Board of Directors since December 2007. From October 2010 through October 2011, Mr. Haney served as a principal of Duggan Asset Management, L.L.C. where he was director of research. Prior to that, he served as chief operating officer of VSO Capital Management from March 2010 to October 2010. From 1994 until 2009, Mr. Haney worked for Resurgence Asset Management LLC, during which time he most recently served as managing director

 

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and chief investment officer. Mr. Haney previously served on the Board of Directors of Sterling Chemicals, Inc., and Furniture.com. Mr. Haney has more than 25 years of business experience, including having served as chief financial officer of a private retail store chain and as an auditor with Touche Ross & Co., a predecessor of Deloitte & Touche LLP. Mr. Haney earned his B.S. in Business Administration from the University of California at Berkeley and his M.B.A. from the Wharton School of the University of Pennsylvania.

Through his extensive experiences as a senior executive, Mr. Haney brings business expertise, finance and risk assessment skills to his Board service with our Company. In addition, Mr. Haney’s past experience as an auditor greatly benefits our oversight of our quarterly and annual financial reporting obligations. Mr. Haney’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing business development companies. The foregoing qualifications led to our conclusion that Mr. Haney should serve as a member of our Board.

 

   

Frank C. Meyer.    Mr. Meyer has been a member of our Board of Directors since December 2007. Mr. Meyer is a private investor who was chairman of Glenwood Capital Investments, LLC, an investment adviser specializing in hedge funds, which he founded in January of 1988 and from which he resigned in January of 2004. As of October of 2000, Glenwood has been a wholly-owned subsidiary of the Man Group, PLC, an investment adviser based in England specializing in alternative investment strategies. Since leaving Glenwood in 2004, Mr. Meyer has focused on serving as a director for various companies. During his career, Mr. Meyer has served as an outside director for several companies, including Quality Systems, Inc. (a public company specializing in software for medical and dental professionals), Bernard Technologies, Inc. (a firm specializing in development of industrial processes using chlorine dioxide), and Centurion Trust Company of Arizona (where he served as a non-executive chairman until its purchase by GE Financial). Currently, he is on the Board of Directors of Einstein Noah Restaurant Group, Inc., a firm operating in the quick casual segment of the restaurant industry, and United Capital Financial Partners, Inc., a firm that converts transaction-oriented brokers into fee-based financial planners. He is also on the Board of Directors of three investment funds run by Ferox Capital Management, Limited, an investment manager based in the United Kingdom that specializes in convertible bonds. Mr. Meyer received his B.A. and M.B.A. from the University of Chicago.

Mr. Meyer’s extensive investment experiences within the financial advisory industry provides our Company with broad and diverse knowledge concerning general business trends and the capital markets. Mr. Meyer’s experience and skills closely align with our business, and his lending and credit experience facilitates an in-depth understanding of risk associated with the structuring of investments. Mr. Meyer’s board related experiences makes him skilled in leading committees requiring substantive expertise. In addition, Mr. Meyer’s risk management expertise and credit related experience also qualify him to serve as a member of our Audit Committee. Mr. Meyer’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing business development companies. The foregoing qualifications led to our conclusion that Mr. Meyer should serve as a member of our Board.

 

   

Douglas F. Ray.    Mr. Ray has been a member of our Board of Directors since December 2007. Since August 1995, Mr. Ray has worked for Seavest Inc., a private investment and wealth management firm based in White Plains, New York. He currently serves as the president of Seavest Inc. Mr. Ray has more than 15 years experience acquiring, developing, financing and managing a diverse portfolio of real estate investments, including three healthcare properties funds. Mr. Ray previously served on the Board of Directors of Nat Nast, Inc., a luxury men’s apparel company. Prior to joining Seavest, Mr. Ray worked in Washington, D.C. on the staff of U.S. Senator Arlen Specter and as a research analyst with the Republican National Committee. Mr. Ray holds a B.A. from the University of Pittsburgh.

Through his broad experience as an officer and director of several companies, in addition to skills acquired with firms engaged in investment banking, banking and financial services, Mr. Ray brings to our Company extensive financial and risk assessment abilities. Mr. Ray’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing

 

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business development companies. Mr. Ray’s expertise and experience also qualify him to serve as chairman of the Compensation Committee. The foregoing qualifications led to our conclusion that Mr. Ray should serve as a member of our Board.

Interested Directors

 

   

Leonard M. Tannenbaum, CFA.    Mr. Tannenbaum has been our chief executive officer since October 2007 and the chairman of our Board of Directors since December 2007, and was our president from October 2007 through February 2010. He is also the managing partner of our investment adviser and serves on its investment committee. Since founding his first private investment firm in 1998, Mr. Tannenbaum has founded a number of private investment firms, including Fifth Street Capital LLC, and he has served as managing member of each firm. Prior to launching his first firm, Mr. Tannenbaum gained extensive small-company experience as an equity analyst for Merrill Lynch. In addition to serving on our Board of Directors, Mr. Tannenbaum currently serves on the Board of Directors of several private Greenlight Capital affiliated entities and has previously served on the Boards of Directors of several other public companies, including Einstein Noah Restaurant Group, Inc., Assisted Living Concepts, Inc. and WesTower Communications, Inc. Mr. Tannenbaum has also served on four audit committees and five compensation committees, of which he has acted as chairperson for one of such audit committees and four of such compensation committees. Mr. Tannenbaum graduated from the Wharton School of the University of Pennsylvania, where he received a B.S. in Economics. Subsequent to his undergraduate degree from the University of Pennsylvania, Mr. Tannenbaum received an M.B.A. in Finance from the Wharton School as part of the Submatriculation Program. He is a holder of the Chartered Financial Analyst designation and he is also a member of the Young Presidents’ Organization.

Through his broad experience as an officer and director of several private and public companies, in addition to skills acquired with firms engaged in investment banking and financial services, Mr. Tannenbaum brings to our Company a unique business expertise and knowledge of private equity financing as well as extensive financial and risk assessment abilities. Mr. Tannenbaum’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing business development companies. Mr. Tannenbaum’s positions as chief executive officer of our Company, managing partner of our investment adviser and member of its investment committee provides the Board with a direct line of communication to, and direct knowledge of the operations of, our Company and our investment adviser, respectively. The foregoing qualifications led to our conclusion that Mr. Tannenbaum should serve as a member of our Board.

 

   

Bernard D. Berman.    Mr. Berman has been a member of our Board of Directors since February 2009. He has also been our president since February 2010, our chief compliance officer since April 2009 and our secretary since October 2007. Mr. Berman is also a partner of our investment adviser and serves on its investment committee. Mr. Berman is responsible for the operations of our Company. He also currently serves as chairman of the Board of Directors of Traffic Solutions Holdings, Inc. (formerly known as Statewide Holdings, Inc.). Prior to joining Fifth Street in 2004, Mr. Berman was a corporate attorney from 1995 to 2004, during which time he negotiated and structured a variety of investment transactions. Mr. Berman graduated from Boston College Law School. He received a B.S. in Finance from Lehigh University.

Mr. Berman’s prior position as a corporate attorney allows him to bring to the Board and our Company the benefit of his experience negotiating and structuring various investment transactions as well as an understanding of the legal, business, compliance and regulatory issues facing business development companies. Mr. Berman’s previous service on the Board also provides him with a specific understanding of our Company and its operations. The foregoing qualifications led to our conclusion that Mr. Berman should serve as a member of our Board.

 

   

Ivelin M. Dimitrov, CFA.    Mr. Dimitrov has been a member of our Board of Directors since January 2013 and our chief investment officer and the chief investment officer of our investment adviser since August 2011, and served as co-chief investment officer for these entities since November 2010 and June

 

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2010, respectively. He is also a partner of our investment adviser and serves on its investment committee. Mr. Dimitrov has over seven years of experience structuring middle market transactions. Mr. Dimitrov joined our investment adviser in May 2005 and is responsible for the credit underwriting of our investment portfolio, overseeing risk analysis and investment approvals. Mr. Dimitrov leads the tactical asset allocation decisions for the portfolio, shifting exposures between asset classes and industries, as well as managing interest rate risk. He is also responsible for the recruitment and development of the investment adviser’s investment team. He has substantial experience in financial analysis, valuation and investment research. Mr. Dimitrov graduated from the Carroll Graduate School of Management at Boston College with an M.S. in Finance and has a B.S. in Business Administration from the University of Maine. He is also a holder of the Chartered Financial Analyst designation and has completed CFA Institute’s Investment Management Workshop at Harvard Business School.

Mr. Dimitrov brings to our Company substantial experience in financial analysis, underwriting, valuation and investment research. Mr. Dimitrov’s position as our chief investment officer and the chief investment officer of our investment adviser provides the Board with a direct line of communication to, and direct knowledge of the operations of, our Company and our investment adviser, respectively. The foregoing qualifications led to our conclusion that Mr. Dimitrov should serve as a member of our Board.

Executive Officer Who Is Not A Director

 

   

Alexander C. Frank.    Mr. Frank has been our chief financial officer since September 2011. Prior to joining the Company, he served as a managing director and chief financial officer of Chilton Investment Company LLC, a global investment management firm, from September 2008 to March 2011. Mr. Frank was responsible for finance and operations infrastructure. Prior to that, Mr. Frank spent over 22 years at Morgan Stanley, having served as global head of institutional operations, global corporate controller and chief financial officer of U.S. broker/dealer operations and global treasurer. In his roles, he oversaw various securities infrastructure services, creating efficiencies throughout the organization, and managed all aspects of the internal and external financial control and reporting functions. He also oversaw the firm’s financing, capital planning, cash management and rating agency functions. Mr. Frank began his career in audit and tax accounting at Arthur Andersen LLP before joining Morgan Stanley in 1985. He received an M.B.A. from the University of Michigan and a B.A. from Dartmouth College.

Board Leadership Structure

Our Board of Directors monitors and performs an oversight role with respect to our business and affairs, including with respect to investment practices and performance, compliance with regulatory requirements and the services, expenses and performance of service providers to us. Among other things, our Board of Directors approves the appointment of our investment adviser and our officers, reviews and monitors the services and activities performed by our investment adviser and our executive officers and approves the engagement, and reviews the performance of, our independent registered public accounting firm.

Under our Amended and Restated By-laws, our Board of Directors may designate a chairman to preside over the meetings of the Board of Directors and meetings of the stockholders and to perform such other duties as may be assigned to him by the Board of Directors. We do not have a fixed policy as to whether the chairman of the Board of Directors should be an independent director and believe that we should maintain the flexibility to select the chairman and reorganize the leadership structure, from time to time, based on the criteria that is in our best interests and the best interests of our stockholders at such times. Our Board of Directors has established corporate governance procedures to guard against, among other things, an improperly constituted Board. Pursuant to our Corporate Governance Policy, whenever the chairman of the Board is not an independent director, the chairman of the Nominating and Corporate Governance Committee will act as the presiding independent director at meetings of the “Non-Management Directors” (which will include the independent directors and other directors who are not officers of the company even though they may have another relationship to the company or its management that prevents them from being independent directors).

 

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Presently, Mr. Tannenbaum serves as the chairman of our Board of Directors and he is also our chief executive officer. We believe that Mr. Tannenbaum’s history with our company, familiarity with its investment platform, and extensive knowledge of the financial services industry qualify him to serve as the chairman of our Board of Directors. We believe that we are best served through this existing leadership structure, as Mr. Tannenbaum’s relationship with our investment adviser provides an effective bridge and encourages an open dialogue between management and our Board of Directors, ensuring that these groups act with a common purpose.

Our Board of Directors does not currently have a designated lead independent director. We are aware of the potential conflicts that may arise when a non-independent director is chairman of the Board of Directors, but believe these potential conflicts are offset by our strong corporate governance practices. Our corporate governance practices include regular meetings of the independent directors in executive session without the presence of interested directors and management, the establishment of Audit and Nominating and Corporate Governance Committees comprised solely of independent directors and the appointment of a chief compliance officer, with whom the independent directors meet without the presence of interested directors and other members of management with in executive session, for administering our compliance policies and procedures. While certain non-management members of our Board of Directors currently participate on the boards of directors of other public companies, we do not view their participation as excessive or as interfering with their duties on our Board of Directors.

Board’s Role In Risk Oversight

Our Board of Directors performs its risk oversight function primarily through (i) its three committees, which report to the entire Board of Directors and are comprised solely of independent directors, and (ii) active monitoring of our chief compliance officer and our compliance policies and procedures.

As described below in more detail, the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee assist the Board of Directors in fulfilling its risk oversight responsibilities. The Audit Committee’s risk oversight responsibilities include overseeing the company’s accounting and financial reporting processes, the company’s systems of internal controls regarding finance and accounting, and audits of the company’s financial statements, as well as the establishment of guidelines and making recommendations to our Board of Directors regarding the valuation of our loans and investments. The Compensation Committee’s risk oversight responsibilities include reviewing and approving the reimbursement by the company of the compensation of the company’s chief financial officer and his staff, and the staff of the company’s chief compliance officer. The Nominating and Corporate Governance Committee’s risk oversight responsibilities include selecting, researching and nominating directors for election by our stockholders, developing and recommending to the Board of Directors a set of corporate governance principles and overseeing the evaluation of the Board of Directors and our management.

Our Board of Directors also performs its risk oversight responsibilities with the assistance of the company’s chief compliance officer. The Board of Directors annually reviews a written report from the chief compliance officer discussing the adequacy and effectiveness of the compliance policies and procedures of the company and its service providers. The chief compliance officer’s annual report addresses at a minimum (i) the operation of the compliance policies and procedures of the company since the last report; (ii) any material changes to such policies and procedures since the last report; (iii) any recommendations for material changes to such policies and procedures as a result of the chief compliance officer’s annual review; and (iv) any compliance matter that has occurred since the date of the last report about which the Board of Directors would reasonably need to know to oversee our compliance activities and risks. In addition, the chief compliance officer meets in executive session with the independent directors.

We believe that the role of our Board of Directors in risk oversight is effective and appropriate given the extensive regulation to which we are already subject as a BDC. As a BDC, we are required to comply with certain regulatory requirements that control the levels of risk in our business and operations. For example, we are limited in our ability to enter into transactions with our affiliates, including investing in any portfolio company in which one of our affiliates currently has an investment.

 

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Committees of the Board of Directors

Our Board of Directors met nine times during fiscal year 2012. Each director attended at least 75% of the total number of meetings of the Board and committees on which the director served that were held while the director was a member. Our Board of Directors has established the committees described below. Our Corporate Governance Policy, Code of Business Conduct and Ethics, our and our investment adviser’s Code of Ethics as required by the 1940 Act and our Board Committee charters are available at our corporate governance webpage at http://ir.fifthstreetfinance.com/governance.cfm and are also available to any stockholder who requests them by writing to our secretary, Bernard Berman, at Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606, Attention: Corporate Secretary.

Audit Committee

The Audit Committee is responsible for selecting, engaging and discharging our independent accountants, reviewing the plans, scope and results of the audit engagement with our independent accountants, approving professional services provided by our independent accountants (including compensation therefore), reviewing the independence of our independent accountants and reviewing the adequacy of our internal control over financial reporting, as well as establishing guidelines and making recommendations to our Board regarding the valuation of our loans and investments. Effective December 1, 2012, the Board eliminated the Valuation Committee and merged its responsibilities into the Audit Committee. The members of the Audit Committee are Messrs. Dunn, Dutkiewicz, Haney, Meyer and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Dutkiewicz serves as the chairman of the Audit Committee. Our Board of Directors has determined that Mr. Dutkiewicz is an “audit committee financial expert” as defined under SEC rules. The Audit Committee met eight times during the 2012 fiscal year.

Nominating and Corporate Governance Committee

The Nominating and Corporate Governance Committee is responsible for determining criteria for service on the Board, identifying, researching and nominating directors for election by our stockholders, selecting nominees to fill vacancies on our Board or a committee of the Board, developing and recommending to the Board a set of corporate governance principles and overseeing the self-evaluation of the Board and its committees and evaluation of our management. The Nominating and Corporate Governance Committee considers nominees properly recommended by our stockholders. The members of the Nominating and Corporate Governance Committee are Messrs. Dunn, Dutkiewicz, Haney, Meyer and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Dunn serves as the chairman of the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee met one time during the 2012 fiscal year.

The Nominating and Corporate Governance Committee will consider qualified director nominees recommended by stockholders when such recommendations are submitted in accordance with our Amended and Restated By-laws and any other applicable law, rule or regulation regarding director nominations. Stockholders may submit candidates for nomination for our Board of Directors by writing to: Board of Directors, Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606. When submitting a nomination to us for consideration, a stockholder must provide certain information about each person whom the stockholder proposes to nominate for election as a director, including: (i) the name, age, business address and residence address of the person; (ii) the principal occupation or employment of the person; (iii) the class or series and number of shares of our capital stock owned beneficially or of record by the persons; and (iv) any other information relating to the person that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act, and the rules and regulations promulgated thereunder. Such notice must be accompanied by the proposed nominee’s written consent to be named as a nominee and to serve as a director if elected.

 

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In evaluating director nominees, the Nominating and Corporate Governance Committee considers the following facts:

 

   

the appropriate size and composition of our Board;

 

   

our needs with respect to the particular talents and experience of our directors;

 

   

the knowledge, skills and experience of nominees in light of prevailing business conditions and the knowledge, skills and experience already possessed by other members of our Board;

 

   

the capacity and desire to serve as a member of our Board of Directors and to represent the balanced, best interests of our stockholders as a whole;

 

   

experience with accounting rules and practices; and

 

   

the desire to balance the considerable benefit of continuity with the periodic addition of the fresh perspective provided by new members.

The Nominating and Corporate Governance Committee’s goal is to assemble a board of directors that brings us a variety of perspectives and skills derived from high quality business and professional experience.

Other than the foregoing, there are no stated minimum criteria for director nominees, although the Nominating and Corporate Governance Committee may also consider such other factors as it may deem are in our best interests and those of our stockholders. The Nominating and Corporate Governance Committee also believes it appropriate for certain key members of our management to participate as members of the Board. The Nominating and Corporate Governance Committee does not assign specific weights to particular criteria and no particular criterion is necessarily applicable to all prospective nominees. We believe that the backgrounds and qualifications of the directors, considered as a group, should provide a significant composite mix of experience, knowledge and abilities that will allow the Board to fulfill its responsibilities. Our Board does not have a specific diversity policy, but considers diversity of race, religion, national origin, gender, sexual orientation, disability, cultural background and professional experiences in evaluating candidates for Board membership.

The Nominating and Corporate Governance Committee identifies nominees by first evaluating the current members of the Board willing to continue in service. Current members of the Board with skills and experience that are relevant to our business and who are willing to continue in service are considered for re-nomination, balancing the value of continuity of service by existing members of the Board with that of obtaining a new perspective. If any member of the Board does not wish to continue in service or if the Nominating and Corporate Governance Committee or the Board decides not to re-nominate a member for re-election, the Nominating and Corporate Governance Committee identifies the desired skills and experience of a new nominee in light of the criteria above. Current members of the Nominating and Corporate Governance Committee and Board are polled for suggestions as to individuals meeting the criteria of the Nominating and Corporate Governance Committee. Research may also be performed to identify qualified individuals. We have not engaged third parties to identify or evaluate or assist in identifying potential nominees to the Board.

Valuation Committee

Effective December 1, 2012, the Board eliminated the Valuation Committee and merged its responsibilities into the Audit Committee. Prior to its elimination, the Valuation Committee established guidelines and made recommendations to our Board regarding the valuation of our loans and investments. The Valuation Committee met on six occasions during the 2012 fiscal year.

Compensation Committee

The Compensation Committee is responsible for reviewing and approving the reimbursement by us of the compensation of our chief financial officer and his staff, and the staff of our chief compliance officer. The current members of the Compensation Committee are Messrs. Dunn, Meyer and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Ray serves as the chairman of the Compensation Committee. As discussed below,

 

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currently, none of our executive officers are directly compensated by us. The Compensation Committee did not meet during the 2012 fiscal year.

Executive Compensation

Compensation of Directors

The following table sets forth compensation of our directors for the year ended September 30, 2012.

 

Name

   Fees Earned or
Paid in Cash(1)(2)
     Total  

Interested Directors

     

Bernard D. Berman

               

Leonard M. Tannenbaum

               

Ivelin M. Dimitrov(3)

               

Name

   Fees Earned or
Paid in Cash(1)(2)
     Total  

Independent Directors

     

Brian S. Dunn

   $ 112,000       $ 112,000   

Richard P. Dutkiewicz

   $ 90,000       $ 90,000   

Byron J. Haney

   $ 125,000       $ 125,000   

Frank C. Meyer

   $ 117,000       $ 117,000   

Douglas F. Ray

   $ 104,000       $ 104,000   

 

 

(1) For a discussion of the independent directors’ compensation, see below.

 

(2) We do not maintain a stock or option plan, non-equity incentive plan or pension plan for our directors.

 

(3) Mr. Dimitrov was not a director during the year ended September 30, 2012.

For the fiscal year ended September 30, 2012, the independent directors received an annual retainer fee of (i) $20,000, payable once per year if an independent director not on any committee attends at least 75% of the meetings held during the previous year, (ii) $50,000, payable once per year if an independent director on one committee attends at least 75% of the meetings held the previous year, (iii) $65,000, payable once per year if an independent director on two committees attends at least 75% of the meetings held the previous year, and (iv) $75,000, payable once per year if an independent director on three committees attends at least 75% of the meetings held the previous year. In addition, the independent directors received $2,500 for each Board meeting in which the director attended in person and $1,000 for each Board meeting in which the director participated other than in person, and reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each Board meeting. The independent directors also received $1,000 for each Board committee meeting in which they attended in person and $500 for each Board committee meeting in which they participated other than in person, plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting not held concurrently with a Board meeting.

In addition, the chairman of the Audit Committee and the chairman of the Valuation Committee each received an annual retainer of $15,000, while the chairman of the Nominating and Corporate Governance Committee and the Compensation Committee each received an annual retainer of $5,000. No compensation was paid to directors who are interested persons of us as defined in the 1940 Act.

Effective as of October 1, 2012, the annual retainer fee received by the independent directors was amended to $85,000, payable once per year to independent directors that attend at least 75% of the meetings held the previous year.

 

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Compensation of Executive Officers

None of our executive officers receive direct compensation from us. The compensation of the principals and other investment professionals of our investment adviser are paid by our investment adviser. Compensation paid to our chief financial officer and other support personnel is set by our administrator, FSC, Inc., and is subject to reimbursement by us of an allocable portion of such compensation for services rendered to us. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. During fiscal year 2012, we reimbursed FSC, Inc. approximately $2.4 million for the allocable portion of compensation expenses incurred by FSC, Inc. on behalf of our chief financial officer and other support personnel, pursuant to the administration agreement with FSC, Inc.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of the material United States federal income tax considerations (and, in the case of a non-U.S. holder (as defined below), the material United States federal estate tax consequences) applicable to an investment in the Notes. This summary does not purport to be a complete description of the income and estate tax considerations applicable to such an investment. The discussion is based upon the Internal Revenue Code of 1986, as amended (the “Code”), Treasury Regulations, and administrative and judicial interpretations, each as of the date of this prospectus supplement and all of which are subject to change, potentially with retroactive effect. You should consult your own tax advisor with respect to tax considerations that pertain to your purchase of our Notes.

This discussion deals only with Notes held as capital assets within the meaning of Section 1221 of the Code and does not purport to deal with persons in special tax situations, such as financial institutions, insurance companies, controlled foreign corporations, passive foreign investment companies and regulated investment companies (and shareholders of such corporations), dealers in securities or currencies, traders in securities, former citizens of the United States, persons holding the Notes as a hedge against currency risks or as a position in a “straddle,” “hedge,” “constructive sale transaction” or “conversion transaction” for tax purposes, entities that are tax-exempt for United States federal income tax purposes, retirement plans, individual retirement accounts, tax-deferred accounts, persons subject to the alternative minimum tax, pass-through entities (including partnerships and entities and arrangements classified as partnerships for United States federal income tax purposes) and beneficial owners of pass-through entities, or persons whose functional currency is not the U.S. dollar. It also does not deal with beneficial owners of the Notes other than original purchasers of the Notes who acquire the Notes in this offering for a price equal to their original issue price (i.e., the first price at which a substantial amount of the Notes is sold other than to bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers). If you are considering purchasing the Notes, you should consult your own tax advisor concerning the application of the United States federal tax laws to you in light of your particular situation, as well as any consequences to you of purchasing, owning and disposing of the Notes under the laws of any other taxing jurisdiction.

For purposes of this discussion, the term “U.S. holder” means a beneficial owner of a Note that is, for United States federal income tax purposes, (i) an individual citizen or resident of the United States, (ii) a corporation or other entity treated as a corporation for United States federal income tax purposes, created or organized in or under the laws of the United States or of any political subdivision thereof, (iii) a trust (a) subject to the control of one or more United States persons and the primary supervision of a court in the United States, or (b) that existed on August 20, 1996 and has made a valid election (under applicable Treasury Regulations) to be treated as a domestic trust, or (iv) an estate the income of which is subject to United States federal income taxation regardless of its source. The term “non-U.S. holder” means a beneficial owner of a Note that is neither a U.S. holder nor a partnership (including an entity or arrangement treated as a partnership for U.S. federal income tax purposes). An individual may, subject to exceptions, be deemed to be a resident alien, as opposed to a non-resident alien, by, among other ways, being present in the United States (i) on at least 31 days in the calendar year, and (ii) for an aggregate of at least 183 days during a three-year period ending in the current calendar year, counting for such purposes all of the days present in the current year, one-third of the days present in the immediately preceding year, and one-sixth of the days present in the second preceding year. Resident aliens are subject to United States federal income tax as if they were United States citizens.

If a partnership (including an entity or arrangement treated as a partnership for U.S. federal income tax purposes) holds any Notes, the United States federal income tax treatment of a partner of the partnership generally will depend upon the status of the partner, the activities of the partnership and certain determinations made at the partner level. Partners of partnerships holding Notes should consult their own tax advisors.

Taxation of Note Holders

Under present law, we are of the opinion that the Notes will constitute indebtedness of us for United States federal income tax purposes, which the below discussion assumes. We intend to treat all payments made with respect to the Notes consistent with this characterization.

 

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Taxation of U.S. Holders.    Payments or accruals of interest on a Note generally will be taxable to a U.S. holder as ordinary interest income at the time they are received (actually or constructively) or accrued, in accordance with the U.S. holder’s regular method of tax accounting.

Upon the sale, exchange, redemption, retirement or other taxable disposition of a Note, a U.S. holder generally will recognize capital gain or loss equal to the difference between the amount realized on the sale, exchange, redemption, retirement or other taxable disposition (excluding amounts representing accrued and unpaid interest, which are treated as ordinary income to the extent not previously included in income) and the U.S. holder’s adjusted tax basis in the Note. A U.S. holder’s adjusted tax basis in a Note generally will equal the U.S. holder’s initial investment in the Note. Capital gain or loss generally will be long-term capital gain or loss if the Note was held for more than one year. Long-term capital gains recognized by individuals and certain other non-corporate U.S. holders generally are eligible for reduced rates of taxation. The distinction between capital gain or loss and ordinary income or loss is also important in other contexts; for example, for purposes of the limitations on a U.S. holder’s ability to offset capital losses against ordinary income.

After December 31, 2012, a tax of 3.8% will be imposed on certain “net investment income” (or “undistributed net investment income”, in the case of estates and trusts) received by taxpayers with adjusted gross income above certain threshold amounts. “Net investment income” as defined for United States federal Medicare contribution purposes generally includes interest payments and gain recognized from the sale or other disposition of the Notes. Tax-exempt trusts, which are not subject to income taxes generally, and foreign individuals will not be subject to this tax. U.S. holders should consult their own tax advisors regarding the effect, if any, of this tax on their ownership and disposition of the Notes.

Taxation of Non-U.S. Holders.    A non-U.S. holder generally will not be subject to United States federal income or withholding taxes on payments of principal or interest on a Note provided that (i) income on the Note is not effectively connected with the conduct by the non-U.S. holder of a trade or business within the United States, (ii) the non-U.S. holder is not a controlled foreign corporation related to the Company through stock ownership, (iii) in the case of interest income, the non-U.S. holder is not a bank receiving interest described in Section 881(c)(3)(A) of the Code, (iv) the non-U.S. holder does not own (directly or indirectly, actually or constructively) 10% or more of the total combined voting power of all classes of stock of the Company, and (v) the non-U.S. holder provides a statement in the year in which a payment occurs or in the preceding 3 years, on an Internal Revenue Service (IRS) Form W-8BEN (or other applicable form) signed under penalties of perjury that includes its name and address and certifies that the non-U.S. holder is the beneficial owner and is not a United States person in compliance with applicable requirements, or satisfies documentary evidence requirements for establishing that it is a non-U.S. holder.

A non-U.S. holder that is not exempt from tax under these rules generally will be subject to United States federal income tax withholding on payments of interest on the Notes at a rate of 30% unless (i) the income is effectively connected with the conduct of a United States trade or business, so long as the non-U.S. holder has provided an IRS Form W-8ECI or substantially similar substitute form stating that the interest on the Notes is effectively connected with the non-U.S. holder’s conduct of a trade or business in the U.S. in which case the interest will be subject to United States federal income tax on a net income basis as applicable to U.S. holders generally (unless an applicable income tax treaty provides otherwise), or (ii) an applicable income tax treaty provides for a lower rate of, or exemption from, withholding tax.

In the case of a non-U.S. holder that is a corporation and that receives income that is effectively connected with the conduct of a United States trade or business, such income may also be subject to a branch profits tax (which is generally imposed on a non-U.S. corporation on the actual or deemed repatriation from the United States of earnings and profits attributable to a United States trade or business) at a 30% rate. The branch profits tax may not apply (or may apply at a reduced rate) if the non-U.S. holder is a qualified resident of a country with which the United States has an income tax treaty.

 

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To claim the benefit of an income tax treaty or to claim exemption from withholding because income is effectively connected with a United States trade or business, the non-U.S. holder must timely provide the appropriate, properly executed IRS forms. The non-U.S. holder must inform the recipient of any changes on these forms within 30 days of such change. These forms may be required to be periodically updated. Also, a non-U.S. holder who is claiming the benefits of a treaty may be required to obtain a United States taxpayer identification number and to provide certain documentary evidence issued by foreign governmental authorities to prove residence in the foreign country.

Generally, a non-U.S. holder will not be subject to United States federal income or withholding taxes on any amount that constitutes capital gain upon the sale, exchange, redemption, retirement or other taxable disposition of a Note, provided that (i) the gain is not effectively connected with the conduct of a trade or business in the United States by the non-U.S. holder (and, if required by an applicable income tax treaty, is not attributable to a United States “permanent establishment” maintained by the non-U.S. holder) and (ii) that the non-U.S. holder is not an individual who is present in the U.S. for 183 days or more in the taxable year of the sale, exchange, or other taxable disposition and meets certain other conditions (unless such holder is eligible for relief under an applicable income tax treaty). Certain other exceptions may be applicable, and a non-U.S. holder should consult its tax advisor in this regard.

A Note that is held by an individual who, at the time of death, is not a citizen or resident of the United States (as specially defined for United States federal estate tax purposes) generally will not be subject to the United States federal estate tax, unless, at the time of death, (i) such individual directly or indirectly, actually or constructively, owns ten percent or more of the total combined voting power of all classes of our stock entitled to vote within the meaning of Section 871(h)(3) of the Code and the Treasury Regulations thereunder or (ii) such individual’s interest in the Notes is effectively connected with the individual’s conduct of a United States trade or business.

Information Reporting and Backup Withholding.    A U.S. holder (other than an “exempt recipient,” including a corporation and certain other persons who, when required, demonstrate their exempt status) may be subject to backup withholding at a rate of 28% on, and to information reporting requirements with respect to, payments of principal and interest on, and proceeds from the sale, exchange, redemption or retirement of, the Notes. In general, if a non-corporate U.S. holder subject to information reporting fails to furnish a correct taxpayer identification number or otherwise fails to comply with applicable backup withholding requirements, backup withholding at the applicable rate may apply.

The amount of interest we pay to a non-U.S. holder on the Notes will be reported to such non-U.S. Holder and to the IRS annually on an IRS Form 1042-S even if the non-U.S. holder is exempt from the 30% withholding tax described above. Copies of the information returns reporting those payments and the amounts withheld, if any, may also be made available to the tax authorities in the country where the non-U.S. holder is resident under provisions of an applicable income tax treaty or agreement.

In addition, backup withholding tax and certain other information reporting requirements apply to payments of principal and interest on, and proceeds from the sale, exchange, redemption or retirement of, the Notes held by a non-U.S. holder, unless an exemption applies. Backup withholding and information reporting will not apply to payments we make to a non-U.S. holder if such non-U.S. holder has provided to the applicable withholding agent under penalties of perjury the required certification of their non-U.S. person status as discussed above (and the applicable withholding agent does not have actual knowledge or reason to know that they are a U.S. person) or if the non-U.S. holder is an exempt recipient.

If a non-U.S. holder sells or redeems a Note through a U.S. broker or the U.S. office of a foreign broker, the proceeds from such sale or redemption will be subject to information reporting and backup withholding unless such non-U.S. holder provides a withholding certificate or other appropriate documentary evidence establishing that such non-U.S. holder is not a United States person to the broker and such broker does not have actual

 

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knowledge or reason to know that such non-U.S. holder is a United States person, or the non-U.S. holder is an exempt recipient eligible for an exemption from information reporting and backup withholding. If a non-U.S. holder sells or redeems a Note through the foreign office of a broker who is a United States person or has certain enumerated connections with the U.S., the proceeds from such sale or redemption will be subject to information reporting unless the non-U.S. holder provides to such broker a withholding certificate or other appropriate documentary evidence establishing that the non-U.S. holder is not a United States person and such broker does not have actual knowledge or reason to know that such evidence is false, or the non-U.S. holder is an exempt recipient eligible for an exemption from information reporting. In circumstances where information reporting by the foreign office of such a broker is required, backup withholding will be required only if the broker has actual knowledge that the non-U.S. holder is a United States person.

You should consult your tax advisor regarding the qualification for an exemption from backup withholding and information reporting and the procedures for obtaining such an exemption, if applicable. Any amounts withheld under the backup withholding rules from a payment to a beneficial owner generally would be allowed as a refund or a credit against such beneficial owner’s United States federal income tax provided the required information is timely furnished to the IRS.

You should consult your own tax advisor with respect to the particular tax consequences to you of an investment in the Notes, including the possible effect of any pending legislation or proposed regulations.

 

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UNDERWRITING

Keefe, Bruyette & Woods, Inc., Deutsche Bank Securities Inc., Raymond James & Associates, Inc. and RBC Capital Markets, LLC are acting as joint book-running managers of the offering and as representatives of the underwriters named below. Subject to the terms and conditions stated in the underwriting agreement dated March 27, 2013, each underwriter named below severally agrees to purchase aggregate principal amount of Notes indicated in the following table:

 

Underwriters

   Principal
Amount of Notes
 

Keefe, Bruyette & Woods, Inc.

   $ 13,687,500   

Deutsche Bank Securities Inc.

     13,687,500   

Raymond James & Associates, Inc.

     13,687,500   

RBC Capital Markets, LLC

     13,687,500   

Barclays Capital Inc.

     7,500,000   

JMP Securities LLC

     3,750,000   

Oppenheimer & Co. Inc.

     3,000,000   

Sterne, Agee & Leach, Inc.

     3,000,000   

Wunderlich Securities, Inc.

     3,000,000   
  

 

 

 

Total

   $ 75,000,000   
  

 

 

 

The underwriters are committed to take and pay for all of the Notes being offered, if any are purchased, other than the Notes covered by the option described below.

Overallotment Option

If the underwriters sell more Notes than the total number set forth in the table above, the underwriters have an option to buy up to an additional $11,250,000 aggregate principal amount of the Notes solely to cover overallotments, if any. They may exercise that option for 30 days. If any Notes are purchased pursuant to this option, the underwriters will severally purchase such Notes in approximately the same proportion as set forth in the table above.

Commissions and Discounts

The following table shows the per Note and total underwriting discounts and commissions to be paid by us to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters’ option to purchase additional Notes.

 

Paid by Fifth Street

   No
Exercise
    Full
Exercise
 

Per Note

     3.0     3.0

Total

   $ 2,250,000      $ 2,587,500   

Notes sold by the underwriters to the public will initially be offered at the public offering price set forth on the cover of this prospectus supplement and to certain dealers at a price less a concession not in excess of 1.5% of the aggregate principal amount of Notes. The underwriters may allow, and the dealers may reallow, a discount from the concession not in excess of 1.2% of the aggregate principal amount of the Notes to certain broker dealers. If all the Notes are not sold at the public offering price, the representative may change the offering price and the other selling terms. The offering of the Notes by the underwriters is subject to receipt and acceptance and subject to the underwriters’ right to reject any order in whole or in part.

We estimate that our share of the total expenses of the offering, excluding underwriting discounts, will be approximately $300,000.

 

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We have agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act.

Lock-up Agreement

We have agreed not to directly or indirectly sell, offer to sell, enter into any agreement to sell, or otherwise dispose of, any debt securities issued by the Company which are substantially similar to the Notes or securities convertible into such debt securities for a period of 30 days after the date of this prospectus supplement without first obtaining the prior written consent of Keefe, Bruyette & Woods, Inc., Deutsche Bank Securities Inc., Raymond James & Associates, Inc. and RBC Capital Markets, LLC.

Listing

The Notes are a new issue of securities with no established trading market. We intend to list the Notes on the NASDAQ Global Select Market and expect trading in the Notes on NASDAQ to begin within 30 days after the original issue date under the symbol “FSCFL.” Currently there is no public market for the Notes and we can provide no assurance that the Notes will be approved for listing on NASDAQ or that an active trading market will develop for the Notes.

We have been advised by the underwriters that they presently intend to make a market in the Notes after completion of the offering as permitted by applicable laws and regulations. The underwriters are not obligated, however, to make a market in the Notes and any such market-making may be discontinued at any time in the sole discretion of the underwriters without any notice. Accordingly, no assurance can be given as to the liquidity of, or development of a public trading market for, the Notes. If an active public trading market for the Notes does not develop, the market price and liquidity of the Notes may be adversely affected.

Price Stabilizations and Short Positions

In connection with the offering, Keefe, Bruyette & Woods, Inc., on behalf of the underwriters, may purchase and sell Notes in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of Notes than they are required to purchase in the offering. “Covered” short sales are sales made in an amount not greater than the underwriters’ option to purchase additional Notes from us in the offering. The underwriters may close out any covered short position by either exercising their option to purchase additional Notes or purchasing Notes in the open market. In determining the source of Notes to close out the covered short position, the underwriters will consider, among other things, the price of Notes available for purchase in the open market as compared to the price at which they may purchase additional Notes pursuant to the option granted to them. “Naked” short sales are any sales in excess of such option. The underwriters must close out any naked short position by purchasing Notes in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the Notes in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of various bids for or purchases of Notes made by the underwriters in the open market prior to the completion of the offering.

The underwriters may also impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representative has repurchased Notes sold by or for the account of such underwriter in stabilizing or short covering transactions.

Purchases to cover a short position and stabilizing transactions, as well as other purchases by the underwriters for their own accounts, may have the effect of preventing or retarding a decline in the market price of our Notes, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of our Notes. As a result, the price of the Notes may be higher than the price that otherwise might

 

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exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on the NASDAQ Global Select Market, in the over-the-counter market or otherwise.

Additional Underwriter Compensation

The underwriters and their respective affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, investment research, principal investment, hedging, financing and brokerage activities. Certain of the underwriters and their respective affiliates have, from time to time, performed, and may in the future perform, various financial advisory and investment banking services for the issuer, for which they received or will receive customary fees and expenses, including acting as underwriters for our securities offerings. The underwriters and their respective affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or instruments and may at any time hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments. Affiliates of Keefe, Bruyette & Woods, Inc., Deutsche Bank Securities Inc., Raymond James & Associates, Inc., RBC Capital Markets, LLC and Barclays Capital Inc. are lenders under the syndicated ING facility and may receive payments from the Company in connection therewith. In addition, an affiliate of Deutsche Bank Securities Inc. serves as trustee under the indentures governing the Notes, Convertible Notes and 2024 Notes and receive payments from the Company in connection therewith.

Settlement

We expect that delivery of the Notes will be made against payment therefor on or about April 4, 2013, which will be the fifth business day following the date of the pricing of the Notes (such settlement being herein referred to as “T+5”). Under Rule 15c6-1 under the Securities Exchange Act of 1934, as amended, trades in the secondary market generally are required to settle in three business days, unless the parties to any such trade expressly agree otherwise. Accordingly, purchasers who wish to trade the Notes prior to the date of delivery hereunder will be required, by virtue of the fact that the Notes initially will settle in T+5 business days, to specify an alternate settlement arrangement at the time of any such trade to prevent a failed settlement.

Other Jurisdictions

Other than in the United States, no action has been taken by us or the underwriters that would permit a public offering of the Notes offered by this prospectus supplement in any jurisdiction where action for that purpose is required. The Notes offered by this prospectus supplement may not be offered or sold, directly or indirectly, nor may this prospectus supplement or any other offering material or advertisements in connection with the offer and sale of any such Notes be distributed or published in any jurisdiction, except under circumstances that will result in compliance with the applicable rules and regulations of that jurisdiction. Persons into whose possession this prospectus supplement comes are advised to inform themselves about and to observe any restriction relating to the offering and the distribution of this prospectus supplement. This prospectus supplement and the accompanying prospectus do not constitute an offer to sell or a solicitation of an offer to buy the Notes offered by this prospectus supplement and the accompanying prospectus in any jurisdiction in which such an offer or a solicitation is unlawful.

The addresses of the underwriters are: Keefe, Bruyette & Woods, Inc., 787 Seventh Avenue, New York, NY 10019; Deutsche Bank Securities Inc., 60 Wall Street, New York, NY 10005; Raymond James & Associates, Inc., 880 Carillon Parkway, St. Petersburg, Florida 33716; and RBC Capital Markets, LLC, 200 Vesey Street, 8th Floor, New York, NY 10281.

 

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LEGAL MATTERS

The validity of the Notes offered by this prospectus supplement and certain other legal matters will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington D.C. Certain legal matters related to the offering will be passed upon for the underwriters by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The financial statements as of September 30, 2012 and 2011 and for each of the three years in the period ended September 30, 2012, included herein, have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in its report appearing herein.

AVAILABLE INFORMATION

We have filed with the SEC a registration statement on Form N-2, together with all amendments and related exhibits, under the Securities Act, with respect to the Notes offered by this prospectus supplement. The registration statement contains additional information about us and the Notes being offered by this prospectus supplement.

We file with or furnish to the SEC annual, quarterly and current reports, proxy statements and other information meeting the informational requirements of the Securities Exchange Act of 1934. You may inspect and copy these reports, proxy statements and other information, as well as the registration statement and related exhibits and schedules, at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information filed electronically by us with the SEC, which are available on the SEC’s website at www.sec.gov. Copies of these reports, proxy and information statements and other information may be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.

 

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INDEX TO FINANCIAL STATEMENTS

 

     Page  

UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

  

Consolidated Statements of Assets and Liabilities as of December 31, 2012 and September  30, 2012

     S-68   

Consolidated Statements of Operations for the three months ended December  31, 2012 and December 31, 2011

     S-69   

Consolidated Statements of Changes in Net Assets for the three months ended December  31, 2012 and December 31, 2011

     S-70   

Consolidated Statements of Cash Flows for the three months ended December  31, 2012 and December 31, 2011

     S-71   

Consolidated Schedule of Investments as of December 31, 2012

     S-72   

Consolidated Schedule of Investments as of September 30, 2012

     S-83   

Notes to Consolidated Financial Statements

     S-93   
  

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

  

Report of Independent Registered Public Accounting Firm

     S-129   

Consolidated Statements of Assets and Liabilities as of September 30, 2012 and 2011

     S-130   

Consolidated Statements of Operations for the Years Ended September 30, 2012, 2011 and 2010

     S-131   

Consolidated Statements of Changes in Net Assets for the Years Ended September  30, 2012, 2011 and 2010

     S-132   

Consolidated Statements of Cash Flows for the Years Ended September 30, 2012, 2011 and 2010

     S-133   

Consolidated Schedules of Investments as of September 30, 2012 and 2011

     S-134   

Notes to Consolidated Financial Statements

     S-150   

 

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Fifth Street Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except per share amounts)

(unaudited)

 

    December 31,
2012
    September 30,
2012
 
ASSETS   

Investments at fair value:

   

Control investments (cost December 31, 2012: $58,238; cost September 30, 2012: $58,557)

  $ 51,698      $ 53,240   

Affiliate investments (cost December 31, 2012: $29,964; cost September 30, 2012: $29,496)

    31,499        31,187   

Non-control/Non-affiliate investments (cost December 31, 2012: $1,481,966; cost September 30, 2012: $1,180,436)

    1,497,251        1,203,681   
 

 

 

   

 

 

 

Total investments at fair value (cost December 31, 2012: $1,570,168; cost September 30, 2012: $1,268,489)

    1,580,448        1,288,108   

Cash and cash equivalents

    37,438        74,393   

Interest and fees receivable

    8,583        7,652   

Due from portfolio company

    1,684        3,292   

Receivables from unsettled transactions

    250        1,750   

Deferred financing costs

    18,136        13,751   

Other assets

    145        56   
 

 

 

   

 

 

 

Total assets

  $ 1,646,684      $ 1,389,002   
 

 

 

   

 

 

 
LIABILITIES AND NET ASSETS   

Liabilities:

   

Accounts payable, accrued expenses and other liabilities

  $ 1,377      $ 978   

Base management fee payable

    1,548        6,573   

Incentive fee payable

    1,230        5,579   

Due to FSC, Inc.

    763        1,630   

Interest payable

    5,096        4,219   

Payments received in advance from portfolio companies

    41        40   

Offering costs payable

           162   

Credit facilities payable

    218,000        201,251   

SBA debentures payable

    181,750        150,000   

Convertible senior notes payable

    115,000        115,000   

Senior unsecured notes payable

    75,000          
 

 

 

   

 

 

 

Total liabilities

    599,805        485,432   

Net assets:

   

Common stock, $0.01 par value, 150,000 shares authorized, 105,943 and 91,048 shares issued and outstanding at December 31, 2012 and September 30, 2012

    1,059        910   

Additional paid-in-capital

    1,171,963        1,019,053   

Net unrealized appreciation on investments

    10,658        19,998   

Net realized loss on investments and interest rate swap

    (127,436     (128,062

Accumulated overdistributed net investment income

    (9,365     (8,329
 

 

 

   

 

 

 

Total net assets (equivalent to $9.88 and $9.92 per common share at December 31, 2012 and September 30, 2012) (Note 12)

    1,046,879        903,570   
 

 

 

   

 

 

 

Total liabilities and net assets

  $ 1,646,684      $ 1,389,002   
 

 

 

   

 

 

 

See notes to Consolidated Financial Statements.

 

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Fifth Street Finance Corp.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

 

     Three  months
ended
December 31,

2012
    Three  months
ended
December 31,

2011
 

Interest income:

    

Control investments

   $ 882      $ 221   

Affiliate investments

     584        704   

Non-control/Non-affiliate investments

     33,454        29,126   

Interest on cash and cash equivalents

     3        4   
  

 

 

   

 

 

 

Total interest income

     34,923        30,055   
  

 

 

   

 

 

 

PIK interest income:

    

Control investments

     108        38   

Affiliate investments

     456        155   

Non-control/Non-affiliate investments

     3,156        3,222   
  

 

 

   

 

 

 

Total PIK interest income

     3,720        3,415   
  

 

 

   

 

 

 

Fee income:

    

Control investments

     99          

Affiliate investments

     12        108   

Non-control/Non-affiliate investments

     12,683        5,885   
  

 

 

   

 

 

 

Total fee income

     12,794        5,993   
  

 

 

   

 

 

 

Dividend and other income:

    

Non-control/Non-affiliate investments

     346        34   
  

 

 

   

 

 

 

Total dividend and other income

     346        34   
  

 

 

   

 

 

 

Total investment income

     51,783        39,497   
  

 

 

   

 

 

 

Expenses:

    

Base management fee

     8,046        5,741   

Incentive fee

     6,639        5,247   

Professional fees

     1,188        1,091   

Board of Directors fees

     129        56   

Interest expense

     7,156        5,724   

Administrator expense

     930        816   

General and administrative expenses

     1,139        1,138   
  

 

 

   

 

 

 

Total expenses

     25,227        19,813   
  

 

 

   

 

 

 

Gain on extinguishment of convertible senior notes

            1,305   
  

 

 

   

 

 

 

Net investment income

     26,556        20,989   
  

 

 

   

 

 

 

Unrealized appreciation (depreciation) on investments:

    

Control investments

     (1,222     1,114   

Affiliate investments

     (156     (1,283

Non-control/Non-affiliate investments

     (7,961     6,002   
  

 

 

   

 

 

 

Net unrealized appreciation (depreciation) on investments

     (9,339     5,833   
  

 

 

   

 

 

 

Realized gain (loss) on investments:

    

Control investments

              

Affiliate investments

            76   

Non-control/Non-affiliate investments

     626        (16,714 )
  

 

 

   

 

 

 

Net realized gain (loss) on investments

     626        (16,638 )
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ 17,843      $ 10,184   
  

 

 

   

 

 

 

Net investment income per common share — basic

   $ 0.28      $ 0.29   

Earnings per common share — basic

   $ 0.19      $ 0.14   

Weighted average common shares outstanding — basic

     94,889        72,376   

Net investment income per common share — diluted

   $ 0.27      $ 0.27   

Earnings per common share — diluted

   $ 0.19      $ 0.13   

Weighted average common shares outstanding — diluted

     102,679        80,913   

See notes to Consolidated Financial Statements.

 

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Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except per share amounts)

(unaudited)

 

     Three months
ended
December 31,
2012
    Three months
ended
December 31,
2011
 

Operations:

    

Net investment income

   $ 26,556      $ 20,989   

Net unrealized appreciation (depreciation) on investments

     (9,339     5,833   

Net realized gain (loss) on investments

     626        (16,638 )
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

     17,843        10,184   
  

 

 

   

 

 

 

Stockholder transactions:

    

Distributions to stockholders

     (27,593     (23,146
  

 

 

   

 

 

 

Net decrease in net assets from stockholder transactions

     (27,593     (23,146
  

 

 

   

 

 

 

Capital share transactions:

    

Issuance of common stock, net