-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HUcGuRSIeu53b02MUdPjKtw05RKP1re+SAqeKQfm5hSpMme2Fwp1wIORSSZi2RpC ILUSUGkZz7IikegDO6PIkQ== 0001024739-00-000199.txt : 20000411 0001024739-00-000199.hdr.sgml : 20000411 ACCESSION NUMBER: 0001024739-00-000199 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN CAPITAL STRATEGIES LTD CENTRAL INDEX KEY: 0000817473 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 521451377 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 814-00149 FILM NUMBER: 582633 BUSINESS ADDRESS: STREET 1: 3 BETHESDA METRO CENTER STREET 2: SUITE 860 CITY: BETHESDA STATE: MD ZIP: 20814 BUSINESS PHONE: 3019516122 MAIL ADDRESS: STREET 1: 3 BETHESDA METRO CENTER STREET 2: SUITE 860 CITY: BETHESDA STATE: MD ZIP: 20814 10-K 1 FORM 10-K As filed with the Securities and Exchange Commission on March 29, 2000 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 814-00149 -------------- AMERICAN CAPITAL STRATEGIES, LTD. Delaware 52-1451377 - ------------------------------- ------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) -------------- 2 Bethesda Metro Center 14th Floor Bethesda, Maryland 20814 ---------------------------------------- (Address of principal executive offices) -------------- (301) 951-6122 ---------------------------------------------------- (Registrant's telephone number, including area code) Securities to be registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to section 12(g) of the Act: Name of each exchange Title of each class on which registered --------------------------------------- ------------------- Common Stock, $0.01 par value per share NASDAQ Stock Market Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter earlier period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X|. No | |. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. | | On March 27, 2000, the aggregate market value of the Registrant's common stock held by nonaffiliates of the Registrant was approximately $450,638,000 based upon a closing price of the Registrant's common stock of $24.69 per share as reported on the NASDAQ Stock Market on that date. (For this computation, the registrant has excluded the market value of all shares of its Common Stock reported as beneficially owned by executive officers and directors of the registrant and certain other stockholders; such an exclusion shall not be deemed to constitute an admission that any such person is an "affiliate" of the registrant.) On March 27, 2000, there were 18,253,708 shares of the Registrant's common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE. The Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 3, 2000 is incorporated by reference into certain sections of Part III herein. Certain exhibits previously filed with the Securities and Exchange Commission are incorporated by reference into Part IV of this report. ================================================================================ PART I Item 1. Business of the Company Background American Capital Strategies, Ltd., a Delaware corporation (the "Company"), was incorporated in 1986 to provide financial advisory services to and invest in middle market companies. On August 29, 1997, the Company completed an initial public offering ("IPO") of 10,382,437 shares of its Common Stock and became a non-diversified, closed end investment company that has elected to be treated as a business development company ("BDC") under the Investment Company Act of 1940, as amended (the "1940 Act"). On October 1, 1997, the Company began operations so as to qualify to be taxed as a regulated investment company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the Internal Revenue Code of 1986 as amended (the "Code"). As contemplated by these transactions, the Company materially changed its business plan and format from structuring and arranging financing for buyout transactions on a fee for services basis to primarily being a lender to and investor in middle market companies. On May 26, 1999, the Company filed a shelf registration statement (the "Shelf Registration Statement") with the United States Securities and Exchange Commission ("SEC") with respect to the Company's debt and equity securities. The Shelf Registration Statement allows the Company to sell its registered debt or equity securities on a delayed or continuous basis in an amount up to $250 million. As of August 5, 1999, the Company completed the sale of 5,605,000 shares of its Common Stock (including the over-allotment option granted to the underwriters) through the Shelf Registration Statement (the "Secondary Offering") in the amount of $95 million. The Company is a buyout and specialty finance company that is principally engaged in providing senior debt, subordinated debt and equity to middle market companies in need of capital for management buyouts including ESOP buyouts, growth, acquisitions, liquidity and restructuring. The Company's ability to fund the entire capital structure is an advantage in completing middle market transactions. The Company generally invests up to $25 million in each transaction and through its subsidiary, American Capital Financial Services, Inc. ("ACFS"), will arrange and secure capital for larger transactions. The Company's primary business objectives are to increase its net operating income and net asset value by investing its assets in senior debt, subordinated debt with detachable warrants and equity of middle market companies with attractive current yields and potential for equity appreciation. The Company's loans typically range from $5 million to $25 million, mature in five to ten years, and require monthly or quarterly interest payments at fixed rates or variable rates based on the prime rate, plus a margin. The Company prices its debt and equity investments based on its analysis of each transaction. As of December 31, 1999, the weighted average effective yield on the Company's investments was 13.9%. From its formation in 1986 through the IPO, the Company arranged 29 financing transactions aggregating over $400 million and invested in the equity securities of eight of those transactions. From the IPO through December 31, 1999, the Company invested $347 million in debt and equity securities of middle market companies including over $16 million in funds committed but undrawn under credit facilities. In most cases, the Company receives rights to require the business to purchase the warrants and stock held by the Company ("Put Rights") under various circumstances including, typically, the repayment of the Company's loans or debt securities. The Company may use its Put Rights to dispose of its equity interest in a business, although the Company's ability to exercise Put Rights may be limited or nonexistent if a business is illiquid. In most cases, the Company also receives the right to representation on the businesses' board of directors. At December 31, 1999, the Company had board seats on 25 out of 33 businesses and had board observation rights on 4 of the remaining businesses in which it has made investments. The Company generally acquires equity interests in the companies from which it has purchased debt securities with the goal of enhancing its overall return. As of December 31, 1999, the Company had a weighted average ownership interest of 25% in its portfolio companies. The Company is prepared to be a long-term partner to its portfolio companies thereby positioning the Company to participate in their future financing needs. The opportunity to liquidate its investments and realize a gain may occur if the business recapitalizes its equity, either through a sale to new owners or a public offering of its equity or if the Company exercises its Put Rights. The Company generally does not have the right to require that a business undergo an initial public offering by registering securities under the Securities Act of 1933, but the Company generally does have the right to sell its equity interests in a public offering by the business to the extent permitted by the underwriters. The Company makes available significant managerial assistance to its portfolio companies. Such assistance typically involves closely monitoring the operations of the company, hiring additional senior management, if needed, being available for consultation with its officers, developing the business plan and providing financial guidance and participating on its board of directors. Providing assistance to its borrowers serves as a means of influence for the Company as well as an opportunity for the Company to assist in maximizing the value of the portfolio company. 2 Prior to the IPO, the Company established itself as a leading firm in structuring and obtaining funding for management and employee buyouts of subsidiaries, divisions and product lines being divested by larger corporations through the use of an ESOP. The selling entities have included Sunbeam Corporation, the U.S. Office of Personnel Management, American Premier Underwriters, Inc. (formerly Penn Central Corporation), Campbell Soup Company, Union Carbide Corporation, National Forge Company, Inc., Air Products Company, Ampco-Pittsburgh Corporation and British Petroleum Company. In most of the ESOP transactions structured by the Company, the employees agree to restructure their wages and benefits so that overall cash compensation is reduced while contributions of stock are made to an ESOP. The resulting company is structured so that the fair market value of stock contributed to the ESOP can be deducted from corporate income before paying taxes. Restructuring employee compensation together with the ESOP tax advantages has the effect of improving the cash flow of the ESOP company. The Company is a leading firm in structuring and implementing ESOP employee buyouts. The Company believes that its ESOP knowledge and experience and its ability to fund transactions positions the Company favorably in the market place. The Company provides financial advisory services and structuring of transactions through its wholly-owned subsidiary, ACFS. The typical advisory engagement includes a monthly retainer and a performance fee contingent upon closing of the transaction or event which is the subject of the engagement. Management believes that future growth of ACFS is attainable through adding additional professionals, by gaining additional market share and by realizing the benefits of what is expected to be an increasing client base, which should expand as a result of its relationship with the Company. The Company believes that, through the structuring and advisory business, it has established an extensive referral network comprised of venture capitalists, investment bankers, attorneys, accountants, commercial bankers, unions, business and financial brokers, and existing ESOP companies. The Company has also developed an extensive set of Internet sites that generates financing requests and provides businesses an efficient tool for learning about the Company and its capabilities. The Company has a marketing department headed by a vice president of marketing dedicated to maintaining contact with members of the referral network and receiving opportunities for the Company to consider. During 1999, the vice president of marketing received information concerning in excess of 2,500 transactions for consideration. Many of those transactions did not meet the Company's criteria for initial consideration, but the opportunities that met those criteria were sent to the Company's principals for further review and consideration. The vice president of marketing and ACFS are continuing the relationships with the referral network and the Company utilizes the referral network and ACFS's client base as its primary sources of investment opportunities. The Company's executive offices are located at 2 Bethesda Metro Center, 14th Floor, Bethesda, MD 20814 and its telephone number is (301) 951-6122. In addition to its executive offices, the Company maintains offices in New York, Boston, Pittsburgh, San Francisco, Chicago and Dallas. Internet Strategy The Company believes that the Internet is a significant medium for information and business commerce that provides numerous opportunities for the Company. The Company has been active in developing a series of web sites concerning the Company and its products specifically and finance generally. These sites have provided numerous investment leads to the Company and through December 31, 1999, investments in 2 portfolio companies aggregating $29 million had been sourced through these web sites. The Company has developed a strategy to utilize the Internet to expand its core business, add value to its portfolio companies and enhance the liquidity of its assets and thereby add value to its stockholders. The Company's strategy is as follows: o Financial Portal For Middle Market Companies. In the third quarter of 1999, the Company commenced operation of a financial portal website designed for middle market business to learn about corporate finance, value their business, build financial models, develop financing memoranda, find professionals to assist in the financing process, find sources of capital and research financing terms, criteria and the availability of a variety of financing options, including financing by the Company. In December 1999, the portal site was renamed "Capital.com" and the assets conveyed to a new portfolio company known as Capital.com, Inc. ("Capital.com"). Contemporaneously with these events, a subsidiary of First Union Corporation invested $15 million for a 15% to 20% equity interest in Capital.com. The Company expects this site to generate additional opportunities to provide financing to middle market companies. o Retail Internet Site For Products Manufactured By Portfolio Companies. The Company is in the early stages of developing web sites to market retail products manufactured by certain of its portfolio companies directly to consumers. Additionally, the Company intends to target for investment as possible portfolio companies manufacturing companies that manufacture products that may be sold through a retail Internet site. The strategy will entail a series of marketing joint ventures with these portfolio companies. The Company believes that these sites will provide incremental business to some of its portfolio companies and may thereby enhance the Company's return on its investment with respect to such 3 portfolio companies. This initiative may lead to the creation of a new Internet marketing subsidiary of the Company with the potential for appreciation that would benefit the holders of its Common Stock. o Private Securities Auction Site. The Company has commenced developing a web site to auction certain securities of private companies to institutional investors. This site is in an early stage of development and will require the Company to meet numerous regulatory requirements, including requirements of the Commission, prior to commencing operation of the site. There is no assurance that such requirements can or will be met. The Company believes that it can use its expertise in originating securities to become a market maker in such securities and that the Internet will provide an efficient medium to make such a market and to communicate with and sell securities to qualified investors. Lending and Investment Decision Criteria The Company reviews certain criteria in order to make investment decisions. The criteria listed below provide a general guide for the Company's lending and investment decisions, although not all criteria are required to be favorable in order for the Company to make an investment. Operating History. The Company focuses on target companies that have stable operating histories and are profitable or near profitable at existing operating levels. The Company reviews the target company's ability to service and repay debt based on its historical results of operations. The Company considers factors such as market shares, customer concentration, recession history, competitive environment and ability to sustain margins. The Company does not expect to lend or invest in start-up or other early stage companies. Growth. The Company considers a target company's ability to increase its cash flow. Anticipated growth is a key factor in determining the value ascribed to any warrants and equity interests acquired by the Company. Liquidation Value of Assets. Although the Company does not operate as an asset-based lender, liquidation value of the assets collateralizing the Company's loans is an important factor in many credit decisions. Emphasis is placed both on tangible assets (accounts receivable, inventory, plant, property and equipment) as well as intangible assets such as customer lists, networks, databases and recurring revenue streams. Experienced Management Team. The Company requires that each portfolio company have a management team that is experienced and properly incentivized through a significant ownership interest in the portfolio company. The Company requires that a potential recipient of the Company's financing have a management team who have demonstrated the ability to execute the portfolio company's objectives and implement its business plan. Exit Strategy. Prior to making an investment, the Company analyzes the potential for the target company to experience a liquidity event that will allow the Company to realize value for its equity position. Liquidity events include, among other things, a private sale of the Company's financial interest, a sale of the portfolio company, an initial public offering or a purchase by the portfolio company or one of its stockholders of the Company's equity position. Operations Marketing and Origination Process. The Company and ACFS have 24 professionals responsible for originating loans and investments and providing financial assistance to middle market companies and intend to hire additional professionals during the next twelve months. To discover potential financing opportunities, the Company has a dedicated marketing department headed by a vice president who manages an extensive referral network comprised of venture capitalists, investment bankers, unions, attorneys, accountants, commercial bankers, business and financial brokers and prospective or existing ESOP companies. The Company also uses its Internet sites and those of its portfolio company, Capital.com, Inc., to attract financing opportunities. Approval Process. The Company's financial professionals review informational packages in search of potential financing opportunities and conduct a due diligence investigation of each applicant that passes an initial screening process. This due diligence investigation generally includes one or more on-site visits, a review of the target company's historical and prospective financial information, interviews with management, employees, customers and vendors of the applicant, and background checks and research on the applicant's product, service or particular industry. The Company engages professionals such as environmental consultants, accountants, lawyers, risk managers and management consultants to perform elements of the due diligence review as it deems appropriate. Upon completion of a due diligence investigation, one of the Company's principals prepares an investment committee report summarizing the target company's historical and projected financial statements, industry and management team and analyzing 4 its conformity to the Company's general investment criteria. The principal then presents this profile to the Company's Investment Committee. The Company's Investment Committee and the Company's Board of Directors must approve each financing. Portfolio Management. In addition to the review at the time of original underwriting, the Company attempts to preserve and enhance the earnings quality of its portfolio companies through proactive management of its relationships with its clients. This process includes attendance at portfolio company board meetings, management consultation and review and management of covenant compliance. The Company's investment and finance personnel regularly review portfolio company monthly financial statements to assess cash flow performance and trends, periodically evaluate the operations of the client, seek to identify industry or other economic issues that may adversely affect the client, and prepare quarterly summaries of the aggregate portfolio quality for management review. Loan Grading The Company has implemented a system to evaluate and classify all loans based on their current risk profile. The system requires the Director of Reporting and Compliance to grade a loan on a scale of one to four. Loans graded four involve the least amount of risk of loss, while loans graded one have an unacceptable level of risk and a high probability of loss. The loan grade is then reviewed and approved by the Investment Committee and the Board of Directors. This system is intended to reflect the performance of the portfolio company's business, the collateral coverage of the loans and other factors considered relevant. For more information regarding the Company's loan grading practices, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Portfolio Credit Quality." Competition The Company competes with a large number of private equity funds and venture capital companies, investment banks and other equity and non-equity based investment funds; and other sources of financing, including traditional financial services companies such as commercial banks. Many of the Company's competitors are substantially larger and have considerably greater financial, technical and marketing resources than the Company does. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to the Company. In addition, certain of the Company's competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships and build their market shares. There is no assurance that the competitive pressures the Company faces will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, the Company may not be able to take advantage of attractive investment opportunities from time to time and there can be no assurance that the Company will be able to identify and make investments that satisfy its investment objectives or that the Company will be able to fully invest its available capital. Employees As of December 31, 1999, the Company had 39 employees, 24 of whom are professionals working on financings for middle market companies. The Company believes that the relations with its employees are excellent. The Company's Operations as a BDC and RIC As a BDC, the Company may not acquire any asset other than Qualifying Assets unless, at the time the acquisition is made, Qualifying Assets represent at least 70% of the value of the Company's total assets. The principal categories of Qualifying Assets relevant to the business of the Company are the following: o securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer is an eligible portfolio company. An eligible portfolio company is defined as any issuer that (a) is organized and has its principal place of business in the United States, (b) is not an investment company other than a small business investment company wholly-owned by the BDC, and (c) does not have any class of publicly-traded securities with respect to which a broker may extend credit; o securities received in exchange for or distributed with respect to securities described above, or pursuant to the exercise of options, warrants or rights relating to such securities; and o cash, cash items, Government securities, or high quality debt securities maturing in one year or less from the time of investment. 5 The Company may not change the nature of its business so as to cease to be, or withdraw its election as, a BDC unless authorized by vote of the holders of the majority, as defined in the 1940 Act, of the Company's outstanding voting securities. Since the Company made its BDC election, it has not made any substantial change in its structure or in the nature of its business. Since October 1, 1997, the Company has operated so as to qualify as a RIC under the Code. Generally, in order to qualify as a RIC, the Company must continue to qualify as a BDC and distribute to stockholders in a timely manner, at least 90% of its "investment company taxable income" as defined by the Code. Also, the Company must derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale of stock or other securities or other income derived with respect to its business of investing in such stock or securities as defined by the Code. Additionally, the Company must diversify its holdings so that (a) at least 50% of the value of the Company's assets consists of cash, cash items, government securities, securities of other RICs and other securities if such other securities of any one issuer do not represent more than 5% of the Company's assets and 10% of the outstanding voting securities of the issuer and (b) no more than 25% of the value of the Company's assets (including those owned by ACFS) are invested in the securities of one issuer (other than U.S. government securities and securities of other RICs), or of two or more issuers that are controlled by the Company and are engaged in the same or similar or related trades or businesses. If the Company qualifies as a RIC, it will not be subject to federal income tax on the portion of its taxable income and net capital gains it distributes in a timely fashion to stockholders. In addition, with respect to each calendar year, if the Company distributes or is treated as having distributed (including amounts retained but designated as deemed distributed) in a timely manner 98% of its capital gain net income for each one-year period ending on October 31, and distributes 98% of its net ordinary income for such calendar year (as well as any income not distributed in prior years), it will not be subject to the 4% nondeductible federal excise tax imposed with respect to certain undistributed income of RICs. If the Company fails to satisfy the 90% distribution requirement or otherwise fails to qualify as a RIC in any taxable year, it will be subject to tax in such year on all of its taxable income, regardless of whether the Company makes any distribution to its stockholders. In addition, in that case, all of the Company's distributions to its stockholders will be characterized as ordinary income (to the extent of the Company's current and accumulated earnings and profits). Our wholly-owned subsidiary, ACFS, is an ordinary corporation that is subject to corporate level federal income tax. Temporary Investments Pending investment in other types of Qualifying Assets, the Company has invested its otherwise uninvested cash primarily in cash, cash items, government securities, agency paper or high quality debt securities maturing in one year or less from the time of investment in such high quality debt investments ("Temporary Investments") so that at least seventy percent (70%) of its assets are Qualifying Assets. Typically, the Company invests in U.S. Treasury bills. Additionally, the Company may invest in repurchase obligations of a "primary dealer" in government securities (as designated by the Federal Reserve Bank of New York) or of any other dealer whose credit has been established to the satisfaction of the Board of Directors. There is no percentage restriction on the proportion of the Company's assets that may be invested in such repurchase agreements. A repurchase agreement involves the purchase by an investor, such as the Company, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. Such interest rate is effective for the period of time during which the investor's money is invested in the arrangement and is related to current market interest rates rather than the coupon rate on the purchased security. The Company requires the continual maintenance by its custodian or the correspondent in its account with the Federal Reserve/Treasury Book Entry System of underlying securities in an amount at least equal to the repurchase price. If the seller were to default on its repurchase obligation, the Company might suffer a loss to the extent that the proceeds from the sale of the underlying securities were less than the repurchase price. A seller's bankruptcy could delay or prevent a sale of the underlying securities. Leverage For the purpose of making investments and to take advantage of favorable interest rates, the Company has issued, and intends to continue to issue, senior debt securities and other evidences of indebtedness, up to the maximum amount permitted by the 1940 Act, which currently permits the Company, as a BDC, to issue senior debt securities and preferred stock (collectively, "Senior Securities") in amounts such that the Company's asset coverage, as defined in the 1940 Act, is at least 200% after each issuance of Senior Securities. Such indebtedness may also be incurred for the purpose of effecting share repurchases. As a result, the Company is exposed to the risks of leverage. Although the Company has no current intention to do so, it has retained the right to issue preferred stock. As permitted by the 1940 Act, the Company may, in addition, borrow amounts up to five percent (5%) of its total assets for temporary purposes. 6 Investment Objectives and Policies The Company's investment objectives are to achieve a high level of current income from the collection of interest and advisory fees, as well as long-term growth in its stockholders' equity through the appreciation in value of the Company's equity interests in the portfolio companies in which it invests. The following restrictions, along with these investment objectives, are the Company's only fundamental policies--that is, policies that may not be changed without the approval of the holders of the majority, as defined in the 1940 Act, of the Company's outstanding voting securities. The percentage restrictions set forth below other than the restriction pertaining to the issuance of Senior Securities, as well as those contained elsewhere herein, apply at the time a transaction is effected, and a subsequent change in a percentage resulting from market fluctuations or any cause other than an action by the Company will not require the Company to dispose of portfolio securities or to take other action to satisfy the percentage restriction. The Company will at all times conduct its business so as to retain its status as a BDC. In order to retain that status, the Company may not acquire any assets (other than non-investment assets necessary and appropriate to its operations as a BDC) if after giving effect to such acquisition the value of its "Qualifying Assets" amounts to less than 70% of the value of its total assets. For a summary definition of "Qualifying Assets," see "The Company's Operations as a BDC and RIC." The Company believes that most of the securities it proposes to acquire (provided that the Company controls, or through its officers or other participants in the financing transaction, makes significant managerial assistance available to the issuers of these securities), as well as Temporary Investments, will generally be Qualifying Assets. Securities of public companies, on the other hand, are generally not Qualifying Assets unless they were acquired in a distribution, in exchange for or upon the exercise of a right relating to securities that were Qualifying Assets. The Company may invest up to 100% of its assets in securities acquired directly from issuers in privately-negotiated transactions. With respect to such securities, the Company may, for the purpose of public resale, be deemed an "underwriter" as that term is defined in the 1933 Act. The Company may invest up to 50% of its assets to acquire securities of issuers for the purpose of acquiring control (up to 100% of the voting securities) of such issuers. The Company will not concentrate its investments in any particular industry or group of industries. Therefore, the Company will not acquire any securities (except upon the exercise of a right related to previously acquired securities) if, as a result, 25% or more of the value of its total assets (including assets held by ACFS) consists of securities of companies in the same industry. The Company may issue Senior Securities to the extent permitted by the 1940 Act for the purpose of making investments, to fund share repurchases, or for temporary or emergency purposes. A business development company may issue Senior Securities up to an amount so that the asset coverage, as defined in the 1940 Act, is at least 200% immediately after each issuance of Senior Securities. The Company will not (a) act as an underwriter of securities of other issuers (except to the extent that it may be deemed an "underwriter" of securities purchased by it that must be registered under the 1933 Act before they may be offered or sold to the public); (b) purchase or sell real estate or interests in real estate or real estate investment trusts (except that the Company may purchase and sell real estate or interests in real estate in connection with the orderly liquidation of investments and may own the securities of companies or participate in a partnership or partnerships that are in the business of buying, selling or developing real estate); (c) sell securities short; (d) purchase securities on margin (except to the extent that it may purchase securities with borrowed money); (e) write or buy put or call options (except to the extent of warrants or conversion privileges in connection with its acquisition financing or other investments, and rights to require the issuers of such investments or their affiliates to repurchase them under certain circumstances); (f) engage in the purchase or sale of commodities or commodity contracts, including futures contracts (except where necessary in working out distressed loan or investment situations); or (g) acquire more than 3% of the voting stock of, or invest more than 5% of its total assets in any securities issued by, any other investment company, except as they may be acquired as part of a merger, consolidation or acquisition of assets. With regard to that portion of the Company's investments in securities issued by other investment companies it should be noted that such investments may subject the Company's stockholders to additional expenses. Investment Advisor The Company has no investment advisor and is internally managed by its executive officers under the supervision of the Board of Directors. Item 2. Properties Neither the Company nor any of its subsidiaries owns any real estate or other physical properties materially important to the operation of the Company or any of its subsidiaries. The Company leases an aggregate of approximately 22,174 square feet of office space in four locations for terms ranging up to six years. 7 Item 3. Legal Proceedings Although the Company may, from time to time, be involved in litigation and claims arising out of its operations in the normal course of business, as of December 31, 1999, the Company was not presently a party to any material pending legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of the fiscal year ended December 31, 1999, there were no matters submitted to a vote of the Company's security holders through the solicitation of proxies or otherwise. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Since the IPO, the Company has distributed, and currently intends to continue to distribute in the form of dividends, a minimum of 90% of its net operating income and 98% of its net realized short-term capital gains, if any, on a quarterly basis to its stockholders. Net realized long-term capital gains may be retained to supplement the Company's equity capital and support growth in its portfolio, unless the Board of Directors determines in certain cases to make a distribution. There is no assurance that the Company will achieve investment results or maintain a tax status that will permit any specified level of cash distributions or year-to-year increases in cash distributions. The Company's Common Stock is quoted on the Nasdaq Stock Market under the symbol ACAS. As of March 21, 2000, the Company had 268 stockholders of record and approximately 7,600 beneficial owners. The following table sets forth the range of high and low sales prices of the Company's Common Stock as reported on the Nasdaq Stock Market and the dividends declared by the Company for the period from August 29, 1997, when public trading of the Common Stock commenced pursuant to the IPO, through March 27, 2000. Sale Price ---------- Dividend High Low Declared ---- --- -------- 1997 Third Quarter (beginning August 29, 1997) $ 20.25 $ 18.50 $ 0.00 Fourth Quarter $ 20.75 $ 16.50 $ 0.21 1998 First Quarter $ 22.50 $ 17.25 $ 0.25 Second Quarter $ 24.63 $ 21.25 $ 0.29 Third Quarter $ 24.25 $ 10.13 $ 0.32 Fourth Quarter $ 18.44 $ 9.19 $ 0.48 1999 First Quarter $ 19.00 $ 14.00 $ 0.41 Second Quarter $ 21.25 $ 16.00 $ 0.43 Third Quarter $ 20.00 $ 16.25 $ 0.43 Fourth Quarter $ 23.13 $ 17.88 $ 0.47 2000 First Quarter (through March 27, 2000) $ 26.81 $ 20.88 $ 0.45 8 Item 6. Selected Financial Data AMERICAN CAPITAL STRATEGIES, LTD. Selected Financial Data The selected financial data should be read in conjunction with the Company's financial statements and notes thereto. As discussed in Notes 1 and 2, the Company completed an initial public offering of its common stock on August 29, 1997 and on October 1, 1997 began to operate so as to qualify to be taxed as a RIC. As a result of the changes, the financial results of the Company for periods prior to October 1, 1997 are not comparable to periods commencing October 1, 1997 and are not expected to be representative of the financial results of the Company in the future.
(In thousands except per share data) Three Months || Nine Months Year Ended Year Ended Ended || Ended Year Ended Year Ended December 31, December 31, December 31, || September 30, December 31, December 31, 1999 1998 1997 || 1997 1996 1995 ---------- ---------- ---------- || ---------- --------- ---------- Total operating income $ 33,405 $ 16,979 $ 2,797 || $ 2,901 $ 2,746 $ 2,706 Total operating expenses 7,251 1,709 551 || 2,651 2,862 2,928 ---------- ---------- ---------- || ---------- ---------- ---------- || Operating income (loss) before equity in || (loss) earnings of unconsolidated || operating subsidiary 26,154 15,270 2,246 || 250 (116) (222) Equity in (loss) earnings of unconsolidated || operating subsidiary (1,493) (482) 24 || -- -- -- ---------- ---------- ---------- || ---------- ---------- ---------- || Net operating income (loss) 24,661 14,788 2,270 || 250 (116) (222) Realized gain on investments 2,711 -- -- || -- -- 66 Increase in unrealized appreciation on || investments 69,829 2,127 167 || 5,321 484 371 ---------- ---------- ---------- || ---------- ---------- ---------- || Income before income taxes 97,201 16,915 2,437 || 5,571 368 215 Provision for income taxes -- -- -- || 2,128 159 57 ---------- ---------- ---------- || ---------- ---------- ---------- || Net increase in shareholders' equity || resulting from operations 97,201 16,915 2,437 || 3,443 209 158 ========== ========== ========== || ========== ========== ========== || Per share data: || Net operating income: || Basic $ 1.79 $ 1.34 $ 0.21 || Diluted $ 1.73 $ 1.29 $ 0.20 || Net increase in shareholders' equity || resulting from operations: || Basic $ 7.07 $ 1.53 $ 0.22 || Diluted $ 6.80 $ 1.48 $ 0.21 || Cash dividends $ 1.74 $ 1.34 $ 0.21 || || Balance Sheet Data: || Total assets $ 395,372 $ 270,019 $ 150,705 || $ 154,322 $ 5,432 $ 4,382 Total shareholders' equity 311,745 152,723 150,652 || 150,539 3,372 2,946 || Other Data: || Number of portfolio companies at period end 33 15 3 || Principal amount of loan originations $ 139,433 $ 116,864 $ 16,817 || Principal amount of loan repayments $ 30,731 $ 1,719 $ 93 || Return on equity (1) (2) 41.9% 11.2% 6.5% || Weighted average yield on investments 13.9% 13.0% 12.2% ||
(1) Amounts are annualized for the three months ended December 31, 1997. (2) Return represents net increase in shareholders' equity resulting from operations. 9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (In thousands except per share data) Management's Discussion and Analysis of Financial Condition and Results of Operations All statements contained herein that are not historical facts including, but not limited to, statements regarding anticipated activity are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: changes in the economic conditions in which the Company operates negatively impacting the financial resources of the Company; certain of the Company's competitors with substantially greater financial resources than the Company reducing the number of suitable investment opportunities offered to the Company or reducing the yield necessary to consummate the investment; volatility in the value of equity investments including Internet properties, such as Capital.com; increased costs related to compliance with laws, including environmental laws; general business and economic conditions and other risk factors described in the Company's reports filed from time to time with the Securities and Exchange Commission. The Company cautions readers not to place undue reliance on any such forward looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's financial statements and the notes thereto. As discussed in Notes 1 and 2, the Company completed an initial public offering ("IPO") of its common stock on August 29, 1997, and on October 1, 1997, began to operate so as to qualify to be taxed as a regulated investment company ("RIC"). After the IPO, the Company changed its primary business plan and format from structuring and arranging financing for buyout transactions on a fee for services basis to being a lender to and investor in middle market companies. As a result of the changes, the Company's predominant source of operating income has changed from financial performance and advisory fees to interest and dividends earned from investing the Company's assets in debt and equity of businesses. Additionally, pursuant to RIC accounting requirements, effective October 1, 1997, the Company's accounting for its operating subsidiary, American Capital Financial Services, Inc. ("ACFS"), changed from a consolidated basis to the equity method. The financial results of the Company for the periods through September 30, 1997 are not comparable to periods commencing October 1, 1997 and are not expected to be representative of the financial results of the Company in the future. Accordingly, those periods are discussed separately. Portfolio Composition The Company's primary business is investing in and lending to businesses through investments in senior debt, subordinated debt with detachable common stock warrants, preferred stock, and common stock. The total portfolio value of investments in publicly and non-publicly traded securities, excluding government securities, was $377,554 and $165,035 at December 31, 1999 and 1998, respectively. During the years ended December 31, 1999 and 1998, the Company made investments totaling $175,823 and $150,249, including $13,500 and $7,384 in funds committed but undrawn under credit facilities, respectively. The weighted average effective interest rate on the investment portfolio was 13.9% and 13.0% at December 31, 1999 and 1998, respectively. Summaries of the composition of the Company's portfolio of publicly and non-publicly traded securities, excluding government securities, at December 31, 1999 and 1998 at cost and fair value are shown in the following table: COST December 31, 1999 December 31, 1998 - ---- ----------------- ----------------- Senior debt 11.9% 15.2% Subordinated debt 69.4% 66.4% Convertible preferred stock 2.2% 3.3% Common stock warrants 13.6% 12.6% Common stock 2.9% 2.5% FAIR VALUE December 31, 1999 December 31, 1998 - ---------- ----------------- ----------------- Senior debt 9.7% 15.0% Subordinated debt 56.0% 65.5% Convertible preferred stock 2.0% 3.3% Common stock warrants 11.6% 13.4% Common stock 20.7% 2.8% 10 On a fair value basis, the Company's portfolio composition was weighted more heavily toward common stock at December 31, 1999 than at December 31, 1998 due to the value of the Capital.com investment of $72,500. At December 31, 1999, Capital.com accounted for 19% of the total portfolio value of investments in publicly and non-publicly traded securities (see discussion of Capital.com under Results of Operations). The following table shows the portfolio composition by industry grouping at cost and at fair value: COST December 31, 1999 December 31, 1998 - ---- ----------------- ----------------- Manufacturing 56.6% 65.9% Wholesale & Retail 11.5% 7.4% Construction 7.7% 10.1% Healthcare 6.5% -- Media 5.5% 9.2% Telecommunications 4.3% -- Service 3.5% 2.0% Information Technology 2.5% -- Transportation 1.4% 5.4% Internet 0.5% -- FAIR VALUE December 31, 1999 December 31, 1998 - ---------- ----------------- ----------------- Manufacturing 46.2% 66.1% Internet 19.2% -- Wholesale & Retail 9.3% 7.4% Construction 6.2% 10.0% Healthcare 5.2% -- Media 4.5% 9.1% Telecommunications 3.5% -- Service 2.8% 2.0% Information Technology 2.0% -- Transportation 1.1% 5.4% Management expects that the largest percentage of its investments will continue to be in manufacturing companies, however, the Company intends to continue to diversify its portfolio and will explore new investment opportunities in a variety of industries. Results of Operations The Company's financial performance, as reflected in its Statements of Operations, is composed of three primary elements. The first element is "Net operating income (loss)," which for periods prior to October 1, 1997 ("pre-RIC") is the difference between the Company's revenue earned from arranging financing for middle market companies and other financial advisory work and its total operating expenses including ESOP contributions, depreciation and interest expense. For periods prior to October 1, 1997, ESOP contributions represented a significant component of total operating expenses. Net operating income (loss) for periods commencing October 1, 1997 ("post-RIC") is primarily the interest and dividends earned from investing in debt and equity securities and the equity in earnings of its unconsolidated operating subsidiary less the operating expenses of the Company. The second element is "Change in unrealized appreciation of investments," which is the net change in the estimated fair value of the Company's portfolio assets at the end of the period compared with their estimated fair values at the beginning of the period or their stated costs, as appropriate. The third element is "Realized gain on investments," which reflects the difference between the proceeds from a sale or maturity of a portfolio investment and the cost at which the investment was carried on the Company's balance sheet. 11 As discussed above, as a RIC, the Company is required to account for investments in operating subsidiaries under the equity method, regardless of ownership interest. Accordingly, the Company's investment in ACFS, which prior to RIC status was consolidated, is presented on the equity method effective October 1, 1997. The operating results for the years ended December 31, 1999 and 1998 are as follows:
Year Ended Year Ended December 31, 1999 December 31, 1998 ----------------- ----------------- Operating income $ 33,405 $ 16,979 Operating expenses 7,251 1,709 Equity in loss of unconsolidated operating subsidiary (1,493) (482) ------------- ------------- Net operating income 24,661 14,788 Net realized gain on investments 2,711 -- Increase in unrealized appreciation of investments 69,829 2,127 ------------ ------------- Net increase in shareholders' equity resulting from operations $ 97,201 $ 16,915 ============ =============
Total operating income for the year ended December 31, 1999, increased $16,426, or 97%, over the year ended December 31, 1998. The increase is a result of the company closing 24 investments in private companies totaling $162 million and selling investments in 2 portfolio companies during 1999. Total operating income for 1999 consisted of $2,044 in loan fees, $528 in prepayment fees, $29,893 in interest and dividends on non-publicly traded securities, and $940 in interest on government agency securities, bank deposits, repurchase agreements, and shareholder loans. Total operating income for 1998 consisted of $2,549 in loan processing fees and $11,020 in interest and dividends on non-publicly traded securities and $3,410 in interest on government agency securities, bank deposits and repurchase agreements. Operating expenses for 1999 increased $5,542, or 324%, over 1998. The increase is primarily due to an increase in interest expense from $57 in 1998 to $4,716 in 1999. Interest expense increased due to an increase in the Company's weighted average borrowings from $1,031 in 1998 to $48,608 in 1999. In addition, the weighted average interest rate on outstanding borrowings, including amortization of deferred finance costs, increased from 5.9% in 1998 to 9.7% in 1999. Operating expenses for 1999 consisted of $1,045 in salaries and benefits, $1,490 in general and administrative expenses, and $4,716 in interest expense. Operating expenses also increased due to increases in salaries and benefits from $843 in 1998 to $1,045 in 1999 due to an increase in employees from 30 at December 31, 1998 to 39 at December 31, 1999. Equity in loss of unconsolidated operating subsidiary, which represents ACFS's results, increased from a loss of $482 in 1998 to a loss of $1,493 in 1999. For the year ended December 31, 1999, ACFS's results included $6,030 of operating income, $9,114 of operating expenses, $925 of realized gains, $246 of unrealized depreciation of investments, and $912 of other income. The realized gain was a result of the sale of ACFS's common stock investment in Four-S Baking Company ("Four-S") and the unrealized depreciation was due to the reversal of previously recorded unrealized appreciation of ACFS's Four S investment, netted against unrealized gains on other investments. For the year ended December 31, 1998, ACFS's results included $5,227 of operating income, $6,451 of operating expenses, $481 of unrealized appreciation of investments, and $261 in other income. The decrease in ACFS's earnings for 1999 was primarily attributable to the increase in salaries and benefits caused by an increase in employees from 30 to 39. During 1999, the Company recorded a realized gain of $2,395 from the prepayment of $8,000 of subordinated debt by Specialty Transportation Services, Inc. ("STS") and the sale of the Company's common stock and warrant investments in STS, and a realized gain of $316 on the sale of its investment in Four-S. Total proceeds from the repayment of the STS subordinated debt and the sale of the Company's equity interest in STS totaled $11,000 ; the realized gain on the subordinated debt was a result of the realization of unamortized loan discounts and the gains on the warrants and equity were equal to the excess cash received over the cost basis of the securities. In addition, STS paid ACFS a $1,000 fee to terminate an investment banking contract between STS and ACFS. Total proceeds from the sale of the Four-S securities, which included senior debt, subordinated debt, preferred stock, common stock warrants, and common stock, were $7,200. The realized gain for the Four-S transactions was comprised of the realization of unamortized loan discounts. The Company did not record any realized gains on investments in 1998. During 1999, the Company paid federal income taxes of $309 on retained realized gains recorded on the Four-S and STS transactions during the tax year ended September 30, 1999; $1,844 of gains on the STS sale were realized subsequent to September 30, 1999. The payment was treated as a deemed distribution because it was paid on behalf of the Company's shareholders. As a result, the Company did not record income tax expense. The Company may elect to retain future realized gains and pay taxes on behalf of the shareholders. 12 The increase in unrealized appreciation of investments is based on portfolio asset valuations determined by the Company's Board of Directors. The increase in unrealized appreciation of investments was $69,829 in 1999, compared to $2,717 in 1998. The increase was primarily due to the increase in the valuation of Capital.com of $71,008 (see further discussion of Capital.com below). Excluding Capital.com, the Company experienced unrealized depreciation of investments of $1,179, which consisted of valuation increases of $6,254 at seven portfolio companies, valuation decreases of $6,719 at eight portfolio companies, valuation decreases of $163 related to interest rate basis swaps used to manage interest rate risk, and $551 of unrealized depreciation resulting from the reversal of previously recorded unrealized appreciation of the Company's investments in Four-S and STS. The increase in unrealized appreciation of investments for the year ended December 31, 1998 was $2,127, which consisted of valuation increases of $2,324 at nine portfolio companies and valuation decreases of $197 at three portfolio companies. Capital.com, an Internet finance portal, was launched in July 1999 under the name of AmericanCapitalOnline.com. In December 1999, the assets of AmericanCapitalOnline.com were contributed to Capital.com, Inc., a newly formed entity, and the site was renamed Capital.com. The total cost of the assets contributed to Capital.com by the Company was $1,492. During December, 1999, a subsidiary of First Union Corporation ("First Union") invested $15,000 in Capital.com in exchange for a 15% common equity stake and warrants to acquire up to an additional 5% of the common equity at a nominal price. The warrants are exercisable based on a subsequent valuation of Capital.com in connection with a subsequent investment or offer to invest within a year of First Union's stock purchase. If the subsequent valuation results in a value of Capital.com of $100,000 or more, the warrants will be extinguished. If the subsequent valuation results in a value of Capital.com of $75,000 or less, all the warrants will be exercisable. If the subsequent valuation results in a value between $75,000 and $100,000, a pro-rata portion of the warrants will be exercisable. In considering the appropriate valuation of this investment at December 31, 1999, in addition to the value implied by First Union's investment for a 15% equity interest, management and the Board of Directors considered several factors including: o The valuation of comparable public company entities; o The very early development stage of Capital.com; o An estimated value for the warrants issued to First Union and the uncertainty of a subsequent valuation of Capital.com affecting the number of shares for which such warrants could be exercised. Based on all these factors and others that were considered, the Board of Directors valued the investment in Capital.com at $72,500 at December 31, 1999. This investment represents 18% of total assets and 23% of total shareholders' equity at December 31, 1999 and the change in unrealized appreciation represents 73% of the net increase in shareholders' equity resulting from operations for 1999. Realization of this valuation in subsequent periods is subject to a high degree of uncertainty including the ability of Capital.com to attract and retain financial and service providers, develop and maintain a significant customer base that will support the on going investment and capital needs of the business, attract additional investors in the business, and develop and execute an exit strategy for investors. The outcome of these matters is highly uncertain. Inability to achieve these or other factors could negatively impact future valuations of Capital.com and such differences could be material. The post-RIC operating results for the three months ended December 31, 1997 are summarized as follows:
Three Months Ended December 31, 1997 ----------------- Operating income $ 2,797 Operating expenses 551 Equity in earnings of unconsolidated operating subsidiary 24 --------------- Net operating income 2,270 Increase in unrealized appreciation of investments 167 --------------- Net increase in shareholders' equity resulting from operations $ 2,437 ===============
Total operating income consisted of approximately $700 in loan processing fees and $200 in interest on non-publicly traded securities and $1,897 in interest on government agency securities and overnight repurchase agreements. The loan fees were earned as a result of closing three investments in private companies totaling $21 million during the period. 13 Operating expenses for the period consisted of $243 in salaries and benefits and $308 in general and administrative expenses. Equity in earnings of unconsolidated operating subsidiary represents ACFS's results including the portfolio companies. For the three months ended December 31, 1997, ACFS's results included $414 of operating income, $987 of operating expenses, $605 of unrealized appreciation of investments and $8 in tax provisions. The increase in unrealized appreciation of investments as discussed in Note 2 to the financial statements is determined by the Company's Board of Directors. The change in unrealized appreciation of investments for the three month period is $167 which consists of an increase of $52 in the valuation of the government agency securities and an increase of $115 in the valuation of the investments in private companies. The pre-RIC operating results for the nine months ended September 30, 1997 are as follows:
Nine Months Ended September 30, 1997 ---- Operating income $ 2,901 Operating expenses 2,651 ----------- Net operating income 250 Increase in unrealized appreciation of investments 5,321 Provision for income taxes 2,128 ----------- Net increase in shareholders' equity resulting from operations $ 3,443 ===========
Total operating income was $2,901 for the nine months ended September 30, 1997, consisting of financial advisory fees of $1,122 , financial performance fees of $798, other operating income of $428, and interest income earned on investment securities and overnight repurchase agreements of $553. Total operating expenses for the nine months ended September 30, 1997, were $2,651. Operating expenses consisted of salaries and benefits of $1,221, general and administrative expenses of $1,547, and interest expense of $60. In addition, during the nine months ended September 30, 1997, the Company changed its evaluation of collectibility of a receivable from Martino's Bakery, Inc., due to Martino's improved financial condition, restructuring of repayment terms, and subsequent payment history. Therefore, the Company recorded a reversal in its provision for doubtful accounts totaling $177. During the nine months ended September 30, 1996, the Company had accrued $164 as a provision for doubtful accounts related to two companies, one of which was Martino's Bakery, Inc. For the nine months ended September 30, 1997, the Company recorded net increases in unrealized appreciation of investments in its portfolio companies of $5,321. Included in unrealized appreciation of investments during the first nine months of 1997 was $4,400 associated with an investment in Biddeford Textile Coorporation, formerly the blanket operation of the electric blanket manufacturing division of Sunbeam Products, Inc. Also included in unrealized appreciation of investments during the first nine months of 1997 was appreciation of $731 associated with the Company's investment in Mobile Tool International, Inc., appreciation of $356 associated with Four-S, and depreciation of $138 associated with Martino's Bakery, Inc. The following table sets forth the components of the increase in unrealized appreciation of investments for the nine months ended September 30, 1997: Nine Months Ended September 30, 1997 ---- Government Securities $ (27) Erie Forge and Steel, Inc -- Four S Baking Company, Inc 355 Indiana Steel & Wire Corporation -- Martino's Bakery, Inc. (138) Mobile Tool International, Inc. 731 Biddeford Textile Corporation 4,400 --------- Increase in unrealized appreciation of investments $ 5,321 ========= 14 The Company recorded a provision for income taxes for the nine months ended September 30, 1997, of $2,128. Unrealized appreciation (depreciation) of investments does not affect the actual tax paid by the Company. However, under GAAP, the Company provides for income taxes based on its GAAP pretax income, which includes unrealized appreciation (depreciation) of investments. Actual income taxes paid may differ substantially from the provision for income taxes. The Company accounted for this difference by recognition of a deferred tax liability in the Pre-RIC balance sheet of ACFS. Financial Condition, Liquidity, and Capital Resources At December 31, 1999, the Company had $2,037 in cash and cash equivalents. In addition, the Company had outstanding debt secured by assets of the Company of $78,545 under a $225,000 debt funding facility. During 1999, the Company funded its investments with proceeds from a debt funding facility, short term borrowings, and a follow-on equity offering from which it received net proceeds of approximately $90,000. On March 31, 1999, the Company closed a maximum $100,000 debt funding facility; this facility was increased to a $125,000 on June 17, 1999, and to $225,000 on December 10, 1999. In connection with the closing, the Company established ACS Funding Trust I (the "Trust"), an affiliated business trust and contributed or sold to the Trust approximately $157,000 in loans. The Company subsequently contributed an additional $100,000 in loans to the Trust. Subject to certain conditions precedent, the Company will remain servicer of the loans. Simultaneously with the initial contribution, the Trust entered into a loan agreement with First Union Capital Markets Corp., as deal agent, and certain other parties providing for loans in an amount up to 50% of the eligible loan balance subject to certain concentration limits. The transfer of assets to the Trust and the related borrowings by the Trust have been treated as a financing arrangement by the Company under Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The term of the facility is two years and interest on borrowings had been charged at LIBOR (6.47% at December 31, 1999) plus 2.50%; the interest rate was decreased to LIBOR plus 1.50% on December 10, 1999. The full amount of principal is due at the end of the term and interest is payable monthly. The Company has used borrowings under this facility to repay debt and to make investments in the debt and equity securities of middle market companies; the Company intends to continue to use this facility in this fashion. As of December 31, 1999, the Company has $78,545 of borrowings outstanding under this facility. Portfolio Credit Quality The Company has implemented a system under which it grades all loans on a scale of 1 to 4. This system is intended to reflect the performance of the borrower's business, the collateral coverage of the loans and other factors considered relevant. Under this system, management believes that loans with a grade of 4 involve the least amount of risk in the Company's portfolio. The borrower is performing above expectations and the trends and risk factors are generally favorable. Management believes that loans graded 3 involve an acceptable level of risk that is similar to the risk at the time of origination. The borrower is performing as expected and the risk factors are neutral to favorable. All new loans are initially graded 3. Loans graded 2 involve a borrower performing slightly below expectations and the loan risk has increased since origination. The borrower may be out of compliance with debt covenants, however, loan payments are not more than 120 days past due. For loans graded 2, the Company's management will increase procedures to monitor the borrower and the fair value generally will be lowered. A loan grade of 1 indicates that the borrower is performing materially below expectations and the loan risk has substantially increased since origination. Some or all of the debt covenants are out of compliance and payments are delinquent. Loans graded 1 are not anticipated to be repaid in full and the Company will reduce the fair value of the loan to the amount it anticipates will be recovered. To monitor and manage the investment portfolio risk, management tracks the weighted average investment grade. The weighted average investment grade was 3.2 at both December 31, 1999 and 1998. In addition, all of the Company's outstanding loans are performing and paying as agreed as of December 31, 1999. At December 31, 1999 and 1998, the Company's investment portfolio was graded as follows: December 31, 1999 December 31, 1998 ----------------- ----------------- Percentage of Percentage of Investments at Total Investments at Total Grade Fair Value Portfolio Fair Value Portfolio ----- ---------- --------- ---------- --------- 4 $ 65,638 21.5% $ 26,036 15.8% 3 223,898 73.4% 138,999 84.2% 2 15,577 5.1% -- 0.0% 1 -- -- -- -- ------------ --------- ------------ ---------- 305,113 100.0% 165,035 100.0% 15 The amounts at December 31, 1999 do not include the Company's investments in Capital.com, Wrenchead.com, and ACS Equities, LP for which the Company has only invested in the equity securities of these companies. Impact of the Year 2000 The "Year 2000 Issue" is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruption of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company created a Year 2000 Compliance Committee to address the Year 2000 compliance of the Company's information technology and non-information technology systems, the systems of third parties, and the systems of the portfolio companies. The Company also engaged outside technology consultants to assist with its Year 2000 project. All of the software used by the Company in its information technology systems is provided by outside vendors. The Company replaced its accounting software package during 1999 and purchased upgrades of various other software products. Subsequent to December 31, 1999, the Company's internal information-technology systems did not experience any significant Year 2000 related difficulties. In addition to the internal technology systems, the Company has not experienced any Year 2000 related problems with its non-information technology systems, such as telecommunications systems, or with third parties that do not share information systems with the Company, such as banks, landlords, telecommunication providers and other vendors. During 1999, the Company evaluated the Year 2000 readiness of its portfolio companies. Beginning in the summer of 1998, the Company had required that each portfolio company expressly warrant in its loan agreement that it is or will be Year 2000 compliant prior to December 31, 1999. The Company had also submitted questionnaires to all of its portfolio companies to determine their exposure to the Year 2000 problem and the adequacy of their plans to address the issues. Based on the correspondence received from the portfolio companies, management concluded that the portfolio companies were adequately addressing the Year 2000 problem. Subsequent to December 31, 1999, the Company is not aware of any Year 2000 related problems at any of its portfolio companies. The total cost of the Company's Year 2000 project was approximately $100. The Company does not expect to incur any further cost related to the Year 2000 issue. This amount includes the cost of additional software, reviewing the portfolio companies' readiness, and outside systems professionals working on the Company's Year 2000 compliance. Impact of Inflation Management believes that inflation can influence the value of the Company's investments through the impact it may have on the capital markets, the valuations of business enterprises and the relationship of the valuations to underlying earnings. Interest Rate Risk Because the Company funds a portion of its investments with borrowings under its debt funding facility, the Company's net operating income is affected by the spread between the rate at which it invests and the rate at which it borrows. At December 31, 1999, approximately 75% of the Company's interest bearing assets provided fixed rate returns and approximately 25% of the company's interest bearing assets provided floating rate returns. All of the Company's outstanding debt at December 31, 1999 has a variable rate of interest based on LIBOR. A change in the floating interest rate would have the following annual impact on the investment portfolio at December 31, 1999: Increase (decrease) in ------------------------------------------------------ Change in floating Net operating Interest Rate Interest income Interest expense Income ------------- --------------- ---------------- ----------- + 2% $ 1,442 $ 1,571 $ (129) + 1% 721 785 (64) - 1% (721) (785) 64 - 2% (1,442) (1,571) 129 16 In order to maintain the low sensitivity to changes in interest rates evidenced above, the Company also enters into interest rate basis swap agreements. At December 31, 1999, the Company had entered into in 4 interest rate basis swap agreements with a total notional amount of $61,325. The Company intends to use derivative instruments for non-trading and non-speculative purposes only. Item 7a Qualitative and Quantitative Disclosures About Market Risk Not applicable. 17 Item 8. Financial Statements and Supplementary Data Report of Independent Auditors Board of Directors American Capital Strategies, Ltd. We have audited the accompanying balance sheets of American Capital Strategies, Ltd., including the schedules of investments, as of December 31, 1999 and 1998, the related statements of operations, shareholders' equity and cash flows for the years ended December 31, 1999 and 1998, the three months ended December 31, 1997, and the nine months ended September 30, 1997, and the financial highlights for the years ended December 31, 1999 and 1998, and the three months ended December 31, 1997. These financial statements and the financial highlights are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Capital Strategies, Ltd. at December 31, 1999 and 1998, and the results of its operations and its cash flows for the years ended December 31, 1999 and 1998, the three months ended December 31, 1997, and the nine months ended September 30, 1997, and the financial highlights for the years ended December 31, 1999 and 1998, and the three months ended December 31, 1997, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP McLean, Virginia February 2, 2000 18 AMERICAN CAPITAL STRATEGIES, LTD. BALANCE SHEETS (In thousands except per share data)
December 31, December 31, 1999 1998 ------------- --------- Assets Cash and cash equivalents $ 2,037 $ 6,149 Investments at fair value (cost of $305,264 and $252,718, respectively) 377,554 254,983 Investment in unconsolidated operating subsidiary 4,893 6,386 Due from unconsolidated operating subsidiary 2,331 778 Interest receivable 2,417 1,561 Other 6,140 162 --------------- --------------- Total assets $ 395,372 $ 270,019 =============== =============== Liabilities and Shareholders' Equity Notes payable $ -- $ 85,948 Revolving credit facility 78,545 30,000 Accrued dividends payable 547 1,222 Other 4,535 126 -------------- -------------- Total liabilities 83,627 117,296 Shareholders' equity: Undesignated preferred stock, $0.01 par value, 5,000 shares authorized, 0 issued and outstanding -- -- Common stock, $.01 par value, 70,000 shares authorized, and 18,252 and 11,081 issued and outstanding, respectively 183 111 Capital in excess of par value 255,922 145,245 Notes receivable from sale of common stock (23,052) (300) Undistributed (distributions in excess of) net realized earnings 1,080 (116) Unrealized appreciation of investments 77,612 7,783 --------------- --------------- Total shareholders' equity 311,745 152,723 --------------- --------------- Total liabilities and shareholders' equity $ 395,372 $ 270,019 =============== ===============
See accompanying notes. 19 AMERICAN CAPITAL STRATEGIES, LTD. SCHEDULE OF INVESTMENTS December 31, 1999 (In thousands except per share data)
Industry Cost Fair Value -------- ---- ---------- Senior Debt--9.53% - ------------------ BIW Connector Systems, LLC Manufacturing $ 3,404 $ 3,404 JAG Industries, Inc. (2) Manufacturing 1,200 1,200 Chance Coach, Inc. (2) Bus Manufacturer 1,071 1,071 Cycle Gear, Inc. Motor Cycle Accessories 750 750 EuroCaribe Packing Company, Inc. (2) Meat Processing 6,276 6,276 Patriot Medical Technologies, Inc. (2) Repair Services 3,250 3,250 Tube City Olympic of Ohio, Inc. Mill Services 9,700 9,700 MBT International Inc. (2) Musical Instrument Distributor 4,200 4,200 Caswell-Massey Holdings Corp. Toiletries 2,000 2,000 Warner Power, LLC Power Systems and Electric Ballasts 4,610 4,610 --------- -------- Subtotal 36,461 36,461 Subordinated Debt--55.35% - ------------------------- BIW Connector Systems, LLC Manufacturing 6,829 6,829 Westwind Group Holdings, Inc. Restaurant 2,984 2,984 JAG Industries, Inc. (2) Manufacturing 2,385 2,385 Chance Coach, Inc. (2) Bus Manufacturer 7,520 7,520 The L.A. Studios, Inc. Audio Production 2,466 2,466 Decorative Surfaces International, Inc. (2) Decorative Paper & Vinyl Mfg. 5,606 5,606 New Piper Aircraft, Inc. Aircraft Manufacturing 18,023 18,023 Electrolux, LLC Vacuum Cleaners 7,849 7,849 Cycle Gear, Inc. Motor Cycle Accessories 2,262 2,262 Confluence Holdings Corp. Canoes & Kayaks 8,812 8,812 EuroCaribe Packing Company, Inc. (2) Meat Processing 8,971 8,971 Starcom Holdings, Inc. Electrical Contractor 18,929 18,929 Centennial Broadcasting, Inc. Radio Stations 16,975 16,975 Lion Brewery, Inc. (2) Malt Beverages 5,975 5,975 Auxi-Health, Inc. Home Health Care 10,136 10,136 Patriot Medical Technologies, Inc. (2) Repair Services 2,487 2,487 Tube City, Inc. Mill Services 6,017 6,017 Erie County Plastics Corporation Molded Plastic Manufacturing 8,858 8,858 Aeriform Corporation Packaged Industrial Gas 7,774 7,774 MBT International, Inc. (2) Musical Instrument Distributor 6,439 6,439 Dixie Trucking Company, Inc. (2) Overnight Shorthaul Delivery 4,064 4,064 Caswell-Massey Holdings Corp. Toiletries 1,670 1,670 Transcore Holdings, Inc. Transportation Info. Mgmt. Services 5,656 5,656 The Inca Group (2) Manufacturing 11,177 11,177 Crosman Corporation Small Arms 3,702 3,702 Parts Plus Group Auto Parts Distributor 4,119 4,119 IGI, Inc. Veterinary vaccines 5,037 5,037 Clear Communications Group Communications Networks 10,348 10,348 Warner Power, LLC Power Systems and Electric Ballasts 3,871 3,871 A.H. Harris & Sons, Inc. Construction Material Distribution 4,733 4,733 --------- -------- Subtotal 211,674 211,674 Convertible Preferred Stock--2.00% - ---------------------------------- Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Bus Manufacturer 2,000 2,793 Decorative Surfaces International, Inc. (2) prime rate plus 4% dividend convertible into 2.9% of Co. Decorative Paper & Vinyl 728 728 Mfg. Patriot Medical Technologies, Inc. (2) 8% dividend convertible into Repair Services 1,020 1,020 16.9% of Co. MBT International, Inc. (1)(2) convertible into 53.1% of Co. Musical Instrument Distribution 2,250 2,250 Transcore Holdings, Inc. (2) 8% dividend convertible into 0.7% of Co. Transportation Service 306 306 Parts Plus Group (1) convertible into 1.9% of Co. Auto Parts Distributor 556 556 --------- -------- Subtotal 6,860 7,653
See accompanying notes. 20 AMERICAN CAPITAL STRATEGIES, LTD. SCHEDULE OF INVESTMENTS -- CONTINUED December 31, 1999 (In thousands except per share data)
Industry Cost Fair Value -------- ---- ---------- Common Stock and Membership Interest Warrants(1)--11.48% - -------------------------------------------------------- BIW Connector Systems, LLC 8% of LLC Manufacturing $ 652 $ 451 Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 244 JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 -- Chance Coach, Inc. (2) 43.2% of Co. Bus Manufacturer 4,041 5,950 The L.A. Studios, Inc. 17% of Co. Audio Production 902 902 Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 4,394 New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,884 Cycle Gear, Inc. 27.6% of Co. Motor Cycle Accessories 374 374 Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,217 EuroCaribe Packing Company, Inc. (2) 37.1% of Co. Meat Processing 1,110 1,046 Starcom Holdings, Inc. 17.5% of Co. Electrical Contractor 3,914 3,914 Lion Brewery, Inc. (2) 54% of Co. Malt Beverages 675 1,863 Auxi Health, Inc. 20% of Co. Home Health Care 2,599 1,856 Patriot Medical Technologies, Inc. (2) 14.9% of Co. Repair Services 612 612 Tube City, Inc. 14.75% of Co. Mill Services 2,523 2,523 Erie County Plastics Corporation 8% of Co. Molded Plastic Manufacturing 1,170 1,170 MBT International, Inc. (2) 30.6% of Co. Musical Instrument Distributor 1,214 1,214 Dixie Trucking Company, Inc. (2) 32% of Co. Overnight Shorthaul Delivery 141 141 Caswell-Massey Holdings Corp. 24% of Co. Toiletries 552 552 Transcore Holdings, Inc. 6.6% of Co. Transportation Info. Mgmt. Services 1,694 1,694 The Inca Group (2) 66.5% of Co. Manufacturing 3,060 3,060 Crosman Corporation 3.5% of Co. Small Arms 330 330 Parts Plus Group 2.4% of Co. Auto Parts Distributor 333 333 IGI, Inc. 16.7% of Co. Veterinary Vaccines 2,003 2,587 Clear Communications Group 11.5% of Co. Communications Networks 2,698 2,698 Warner Power, LLC (2) 53.1% of LLC Power Systems and Electric 1,629 1,629 A.H. Harris & Sons, Inc. 3.5% of Co. Construction Material 267 267 --------- -------- Subtotal 41,469 43,905 Common Stock and Membership Interests(1)--20.40% - ------------------------------------------------ Chance Coach, Inc. (2) 20.5% of Co. Bus Manufacturer 1,896 2,793 Electrolux, LLC 2.5% of Co. Vacuum Cleaners 246 1,144 Confluence Holdings Corp. 0.7% of Co. Canoes & Kayaks 45 17 Starcom Holdings, Inc. 2.8% of Co. Electrical Contractor 616 616 The Inca Group (2) 18.5% of Co. Manufacturing 850 850 Capital.com, Inc. (2) 85% of Co. Internet-based Financial Portal 1,492 72,500 Wrenchead.com, Inc. 1% of Co. Internet-based Auto Parts Distributor -- 104 ACS Equities, LP (2) 90% of LP Investment partnership 3,655 -- --------- -------- Subtotal 8,800 78,024 --------- -------- 305,264 377,717 Interest Rate Basis Swap Agreements--(0.04)% - -------------------------------------------- No. of Notional Expiration Receive Contracts Amount Date Rate Pay Rate - --------- ------ ---- ---- -------- 4 $ 61,325 4/10/04 Floating Floating -- (163) --------- -------- Total Investments 305,264 377,554 ========= ======== Investment in Unconsolidated Operating Subsidiary---1.28% - --------------------------------------------------------- American Capital Financial Services(1)(2)100% of Co. Investment Banking 403 4,893 --------- -------- Totals $ 305,667 $382,447 ========= ========
(1) Non-income producing (2) Affiliate See accompanying notes. 21 AMERICAN CAPITAL STRATEGIES, LTD. SCHEDULE OF INVESTMENTS December 31, 1998 (In thousands except per share data)
Industry Cost Fair Value -------- ---- ---------- Senior Debt--9.47% - ------------------ Four S Baking Company (2) Baking $ 1,266 $ 1,266 BIW Connector Systems, LLC Manufacturing 3,404 3,404 Chance Coach, Inc. (2) Bus Manufacturer 1,286 1,286 JAG Industries, Inc. (2) Manufacturing 1,200 1,200 Confluence Holdings Corp. Canoes & Kayaks 9,675 9,675 Cycle Gear, Inc. Motor Cycle Accessories 750 750 EuroCaribe Packing Company, Inc. (2) Meat Processing 7,181 7,181 ------------- ------------- Subtotal 24,762 24,762 Subordinated Debt--41.37% - ------------------------- Four S Baking Company (2) Baking 1,588 1,588 BIW Connector Systems, LLC. Manufacturing 6,710 6,710 Westwind Group Holdings, Inc. Restaurant 2,932 2,932 JAG Industries, Inc. (2) Manufacturing 2,335 2,335 Specialty Transportation Services, Inc. (2) Waste Hauler 7,368 7,368 Chance Coach, Inc. (2) Bus Manufacturer 7,060 7,060 The L.A. Studios, Inc. Audio Production 2,393 2,393 Decorative Surfaces International, Inc. (2) Decorative Paper & Vinyl Mfg. 10,490 10,490 New Piper Aircraft, Inc. Aircraft Manufacturing 17,858 17,858 Electrolux, LLC Vacuum Cleaners 7,264 7,264 Cycle Gear, Inc. Motor Cycle Accessories 633 633 Confluence Holdings Corp. Canoes & Kayaks 4,701 4,701 EuroCaribe Packing Company, Inc. (2) Meat Processing 8,905 8,905 Starcom Holdings, Inc. Electrical Contractor 12,839 12,839 Centennial Broadcasting, Inc. Radio Stations 15,040 15,040 ------------- ------------- Subtotal 108,116 108,116 Convertible Preferred Stock--2.10% - ---------------------------------- Four S Baking Company (2) 15% dividend convertible into Baking 2,756 2,756 10.89 of Co. Bus Manufacturer 2,000 2,079 Chance Coach, Inc. (2) 12% dividend convertible into 20% of Co. Decorative Paper & Vinyl Mfg. 646 646 Decorative Surfaces International, Inc. (2) prime rate ------------- ------------- plus 4% divided convertible into 2.9% of Co. Subtotal 5,402 5,481 Common Stock and Membership Interests Warrants(1)--8.43% - -------------------------------------------------------- Four S Baking Company (2) 3.26% of Co. Baking 462 600 BIW Connector Systems, LLC 8% of LLC Manufacturing 652 540 Westwind Group Holdings, Inc. 5% of Co. Restaurant 350 421 JAG Industries, Inc. (2) 75% of Co. Manufacturing 505 465 Specialty Transportation Services, Inc. (2) Up to 39.1% Waste Hauler 694 784 Chance Coach, Inc. (2) 43.7% of Co. Bus Manufacturer 4,041 4,543 The L.A. Studios, Inc. 17% of Co. Audio Production 902 857 Decorative Surfaces International, Inc. (2) 42.3% of Co. Decorative Paper & Vinyl Mfg. 4,571 5,596 New Piper Aircraft, Inc. 4% of Co. Aircraft Manufacturing 2,231 2,231 Cycle Gear, Inc. 16.5% of Co. Motor Cycle Accessories 374 374 Confluence Holdings Corp. 18% of Co. Canoes & Kayaks 1,319 1,319 EuroCaribe Packing Company, Inc. (2) 37% of Co. Meat Processing 1,110 1,110 Starcom Holdings, Inc. 17.5% of Co. Electrical Contractor 3,171 3,171 ------------- ------------- Subtotal 20,382 22,011 Common Stock and Membership Interests(1)--1.78% - ------------------------------------------------ Four-S Baking Company (2) 5.5% of Co. Baking 966 1,004 Specialty Transportation Services, Inc. (2) 9.1% of Co. Waste Hauler 500 784 Chance Coach, Inc. (2) 18.3% of Co. Bus Manufacturer 1,896 2,131 Electrolux, LLC 2.5% of Co. Vacuum Cleaners 246 246 Starcom Holdings, Inc. 2.8% Electrical Contractor 500 500 ------------- ------------- Subtotal 4,108 4,665 Subtotal--non-publicly traded securities--63.15% 162,770 165,035 Government Securities--34.41% - ----------------------------- FHLB Discount Note due 1/4/99 89,948 89,948 ------------- ------------- Total Investments 252,718 254,983 Investment in Unconsolidated Operating Subsidiary--2.44% - -------------------------------------------------------- American Capital Financial Services(1)(2)--100% of Co. Investment Banking 403 6,386 ------------- ------------- Totals $ 253,121 $ 261,369 ============= =============
(1) Non-income producing (2) Affiliate See accompanying notes. 22 AMERICAN CAPITAL STRATEGIES, LTD. STATEMENTS OF OPERATIONS (In thousands except per share data)
Year Year Three Months || Nine Months Ended Ended Ended || Ended December 31, December 31, December 31, || September 30, 1999 1998 1997 || 1997 ------------- ------------- ------------- || ------------- Operating income: || || Interest and dividend income $ 30,833 $ 14,430 $ 2,123 || $ 553 Loan fees 2,572 2,549 654 || -- Financial advisory and performance fees -- -- -- || 1,920 Other -- 20 || 428 ------------- ------------- ------------- || ------------- || Total operating income 33,405 16,979 2,797 || 2,901 || Operating expenses: || || Salaries and benefits 1,045 843 243 || 1,221 General and administrative 1,490 809 308 || 1,514 Interest 4,716 57 -- || 60 Other -- -- -- || (144) ------------- ------------- ------------- || ------------- || Total operating expenses 7,251 1,709 551 || 2,651 ------------- ------------- ------------- || ------------- || Operating income before equity in (loss) earnings || of unconsolidated operating subsidiary 26,154 15,270 2,246 || 250 Equity in (loss) earnings of unconsolidated || operating subsidiary (1,493) (482) 24 || -- ------------- ------------- ------------- || ------------- || Net operating income 24,661 || 250 Net realized gain on investments 2,711 -- -- || -- Increase in unrealized appreciation of investments 69,829 2,127 167 || 5,321 ------------- ------------- ------------- || ------------- || Income before income taxes 97,201 16,915 2,437 || 5,571 Provision for income taxes -- -- -- || 2,128 ------------- ------------- ------------- || ------------- || Net increase in shareholders' equity resulting from || operations $ 97,201 $ 16,915 $ 2,437 || $ 3,443 ============= ============= ============= || ============= || Net operating income per share: || Basic $ 1.79 $ 1.34 $ 0.21 || Diluted $ 1.73 $ 1.29 $ 0.20 || || Earnings per common share: || Basic $ 7.07 $ 1.53 $ 0.22 || Diluted $ 6.80 $ 1.48 $ 0.21 || || Weighted average shares of Basic 13,744 11,068 11,069 || Common stock outstanding Diluted 14,294 11,424 11,405 ||
See accompanying notes. 23 AMERICAN CAPITAL STRATEGIES, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands except per share data)
Notes Unearned Capital in Receivable Preferred ESOP Common Stock Excess of Retained From Sale of Stock Shares Shares Amount Par Value Earnings Common Stock ----- ------ ------ ------ --------- -------- ------------ Balance at December 31, 1996 $ 1,419 $ (117) 481 $ 5 $ 11 $ 2,054 -- Net increase in shareholders' equity resulting from -- -- -- -- -- 3,443 -- operations Contribution of common stock to ESOP -- -- 1 -- 8 (8) -- Conversion of preferred stock to common stock (1,419) -- 205 2 1,417 -- -- Issuance of common stock -- -- 10,382 104 143,504 -- -- ESOP shares earned -- 117 -- -- -- -- -- ------------ --------- ----------- --------- --------- --------- ----------- Balance at September 30, 1997 $ -- $ -- 11,069 $ 111 $ 144,940 $ 5,489 $ -- ============ ========= =========== ========= ========= ========= =========== =========================================================================================================================== Effect of reorganization as a RIC -- -- -- -- -- (5,489) -- Net increase in shareholders' equity resulting from operations -- -- -- -- -- -- -- Distributions -- -- -- -- -- -- -- ------------ --------- ----------- --------- --------- --------- ----------- Balance at December 31, 1997 $ -- $ -- 11,069 $ 111 $ 144,940 $ -- $ -- ============ ========= =========== ========= ========= ========= =========== Issuance of common stock under the 1997 Stock Option Plan -- -- 28 -- 396 -- -- Issue of common stock under the Dividend Reinvestment Plan -- -- 7 -- 128 -- -- Repurchase of outstanding shares -- -- (23) -- (219) -- -- Issuance of note receivable from sale of common stock -- -- -- -- -- -- (300) Net increase in shareholders' equity resulting from operations -- -- -- -- -- -- -- Distributions -- -- -- -- -- -- -- ------------ --------- ----------- --------- --------- --------- ----------- Balance at December 31, 1998 $ -- $ -- 11,081 $ 111 $ 145,245 $ -- $ (300) ============ ========= =========== ========= ========= ========= =========== Issuance of common stock -- -- 5,605 57 89,151 -- -- Issuance of common stock under stock option plans -- -- 1,520 15 22,832 -- (22,752) Issue of common stock under the Dividend Reinvestment Plan -- -- 36 -- 693 -- -- Re-purchase of common stock warrants -- -- -- -- (2,165) -- -- Issuance of restricted shares -- -- 10 -- 166 -- -- Net increase in shareholders' equity resulting from operations -- -- -- -- -- -- -- Distributions -- -- -- -- -- -- -- ------------ --------- ----------- --------- --------- --------- ----------- Balance at December 31, 1999 $ -- $ -- 18,252 $ 183 $ 255,922 $ -- $ (23,052) ============ ========= =========== ========= ========= ========= =========== Undistributed Unrealized Total Net Realized Appreciation Shareholders' Earnings of Investments Equity -------- -------------- ------------- Balance at December 31, 1996 -- -- $ 3,372 Net increase in shareholders' equity resulting from -- -- 3,443 operations Contribution of common stock to ESOP -- -- -- Conversion of preferred stock to common stock -- -- -- Issuance of common stock -- -- 143,608 ESOP shares earned -- 117 ---------- ------------ ----------- Balance at September 30, 1997 $ -- $ -- $ 150,540 ========== ============ =========== =============================================================================== Effect of reorganization as a RIC -- 5,489 -- Net increase in shareholders' equity resulting from operations 2,269 167 2,436 Distributions (2,324) -- (2,324) ---------- ------------ ----------- Balance at December 31, 1997 $ (55) $ 5,656 $ 150,652 ========== ============ =========== Issuance of common stock under the 1997 Stock Option Plan -- -- 396 Issue of common stock under the Dividend Reinvestment Plan -- -- 128 Repurchase of outstanding shares -- -- (219) Issuance of note receivable from sale of common stock -- -- (300) Net increase in shareholders' equity resulting from operations 14,788 2,127 16,915) Distributions (14,849) -- (14,849) ---------- ------------ ----------- Balance at December 31, 1998 $ (116) $ 7,783 $ 152,723 ========== ============ =========== Issuance of common stock -- -- 89,208 Issuance of common stock under stock option plans -- -- 95 Issue of common stock under the Dividend Reinvestment Plan -- -- 693 Re-purchase of common stock warrants -- -- (2,165) Issuance of restricted shares -- -- 166 Net increase in shareholders' equity resulting from operations 27,372 69,829 97,201 Distributions (26,176) -- (26,176) ---------- ------------ ----------- Balance at December 31, 1999 $ 1,080 $ 77,612 $ 311,745 ========== ============ ===========
See accompanying notes. 24 AMERICAN CAPITAL STRATEGIES, LTD. STATEMENTS OF CASH FLOWS (In thousands except per share data)
Three Months || Nine Months Year Ended Year Ended Ended || Ended December 31, December 31, December 31, || September 30, 1999 1998 1997 || 1997 ------------ ------------ ------------ || ------------- Operating activities || Net increase in shareholders' equity resulting from || operations $ 97,201 $ 16,915 $ 2,437 || $ 3,443 Adjustments to reconcile net increase in || shareholders' equity resulting from operations || to net cash provided by operating activities: || Depreciation and amortization -- -- -- || 33 Unrealized appreciation of investments (69,829) (2,127) (167) || (5,321) Realized gain on investments (2,711) -- -- || -- Net amortization of securities -- (1,336) (1,234) || (337) Amortization of loan discounts (2,049) (913) -- || -- Amortization of deferred finance costs 854 -- -- || 3 Provision for deferred income taxes -- -- -- || 2,102 Contribution of stock to ESOP -- -- -- || 117 Increase in interest receivable (856) (917) (207) || (122) Provision for doubtful accounts -- -- -- || (177) Increase in accrued payment-in-kind dividends || and interest (3,038) (478) -- || -- (Increase) decrease in due from unconsolidated || subsidiary (1,553) 83 (526) || -- Decrease in accounts receivable -- -- -- || 486 Decrease in income taxes receivable -- -- -- || 24 (Increase) decrease in other assets (3,065) (71) 62 || (113) Increase (decrease) in other liabilities 4,409 73 (328) || 128 Loss (earnings) of unconsolidated operating || subsidiary 1,493 482 (24) || -- ----------- ----------- ---------- || ---------- || Net cash provided by operating activities 20,856 11,711 13 || 266 Investing activities || Proceeds from sale or maturity of investments 27,823 231,580 35,000 || 60 Principal repayments 30,731 1,719 93 || -- Purchases of investments (171,595) (142,865) (20,622) || (483) Purchases of securities (12,900) (207,146) (16,593) || (129,896) Increase in other assets (1,273) -- -- || -- Purchases of property and equipment, net of disposals -- -- -- || (29) ----------- ----------- ---------- || ---------- || Net cash used in investing activities (127,214) (116,712) (2,122) || (130,348) Financing activities || (Repayments of) proceeds from short term notes || payable, net (5,000) 85,948 -- || (430) Drawings on revolving credit facilities, net 48,545 30,000 -- || -- Increase in deferred financing costs (2,427) (37) -- || -- Decrease in due to related parties, net -- -- -- || (78) Repurchase of common stock -- (219) -- || -- Issuance of common stock 89,451 224 -- || 143,608 Re-purchase of common stock warrants (2,165) -- -- || -- Distributions paid (26,158) (13,628) (2,325) || -- ----------- ----------- ---------- || ---------- || Net cash provided by (used in) financing activities 102,246 102,288 (2,325) || 143,100 ----------- ----------- ---------- || ---------- || Net (decrease) increase in cash and cash equivalents (4,112) (2,713) (4,434) || 13,018 Cash and cash equivalents at beginning of period 6,149 8,862 13,296 || 323 ----------- ----------- ---------- || ---------- || Cash and cash equivalents at end of period $ 2,037 $ 6,149 $ 8,862 || $ 13,341 =========== =========== ========== || ========== || Non-cash financing activities: || - ------------------------------ || Issuance of common stock in conjunction with || dividend reinvestment $ 693 $ 128 $ -- || $ -- Notes receivable issued in exchange for || common stock $ 22,752 $ 300 $ -- || $ -- Net repayment of notes payable $ 80,948 $ -- $ -- || $ --
See accompanying notes. 25 AMERICAN CAPITAL STRATEGIES, LTD. FINANCIAL HIGHLIGHTS (In thousands except per share data)
Year Ended Year Ended December Three Months Ended December 31, 1999 31, 1998 December 31, 1997 ----------------- ------------------- ------------------ Per Share Data (1) Net asset value at beginning of the period $ 13.80 $ 13.61 $ 13.60 Net operating income 1.79 1.34 0.21 Realized gain on investments 0.20 -- -- Increase in unrealized appreciation on investments 5.08 0.19 0.01 ---------------- ----------------- ------------------- Net increase in shareholders' equity resulting from operations $ 7.07 $ 1.53 $ 0.22 Issuace of common stock 0.71 -- -- Dilutive effect of stock option loans (2.76) -- -- Distribution of net investment income (1.74) (1.34) (0.21) ---------------- ---------------- -------------------- Net asset value at end of period $ 17.08 $ 13.80 $ 13.61 Per share market value at end of period $ 22.75 $ 17.25 $ 18.125 Total return (2) 41.97% 2.57% 22.23% Shares outstanding at end of period 18,252 11,081 11,069 Ratio/Supplemental Data Net assets at end of period $ 311,745 $ 152,723 $ 150,652 Ratio of operating expenses to average net assets(3) 3.81% 1.13% 1.46% Ratio of net operating income to average net assets(3) 12.94% 9.74% 6.03%
- ------------------ (1) Basic per share data. (2) Amounts were not annualized for the results of the three month period ended December 31, 1997. (3) Amounts were annualized for the results of the three month period ended December 31, 1997. See accompanying notes. 26 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) Note 1. Organization American Capital Strategies, Ltd., a Delaware corporation (the "Company"), was incorporated in 1986 to provide financial advisory services to and invest in middle market companies. On August 29, 1997, the Company completed an initial public offering ("IPO") of 10,382 shares of common stock ("Common Stock"), and became a non-diversified closed end investment company that has elected to be treated as a business development company ("BDC") under the Investment Company Act of 1940, as amended ("1940 Act"). On October 1, 1997, the Company began operations so as to qualify to be taxed as a regulated investment company ("RIC") as defined in Subtitle A, Chapter 1, under Subchapter M of the Internal Revenue Code of 1986 as amended (the "Code"). As contemplated by these transactions, the Company materially changed its business plan and format from structuring and arranging financing for buyout transactions on a fee for services basis to primarily being a lender to and investor in middle market companies. In addition to being a lender to and investor in middle market companies, in 1999 the Company launched Capital.com, an Internet financial portal (see Note 4). As a result of the changes, the Company is operating as a holding company whose predominant source of operating income has changed from financial performance and advisory fees to interest and dividends earned from investing the Company's assets in debt and equity of businesses. The Company's investment objectives are to achieve current income from the collection of interest and dividends, as well as long-term growth in its shareholders' equity through appreciation in value of the Company's equity interests. The Company continues to provide financial advisory services to businesses through American Capital Financial Services ("ACFS"), formerly ACS Capital Investments Corporation ("CIC"), a wholly-owned subsidiary. The Company is headquartered in Bethesda, Maryland, and has offices in New York, Boston, Pittsburgh, San Francisco, Chicago, and Dallas. The Company's reportable segments are its investing operations as a business development company and the financial advisory operations of its wholly-owned subsidiary, ACFS (see Note 5). The Company has no foreign operations. Note 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying financial statements have been prepared in accordance with generally accepted accounting principles and for periods commencing with the Company's election to be treated as a RIC, in accordance with Article 6 of Regulation S-X of the Code of Federal Regulations. For the nine months ended September 30, 1997, the financial statements are prepared on a consolidated basis with the accounts of ACFS, the Company's wholly owned subsidiary. All intercompany transactions and balances were eliminated. Effective October 1, 1997, pursuant to RIC accounting requirements, ACFS was deconsolidated, and, as a result, for the years ended December 31, 1999 and 1998 and the three months ended December 31, 1997 the Company accounted for its investment in ACFS under the equity method. In connection with this change, the Company contributed the following assets and liabilities to ACFS: Investment in Erie Forge and Steel $2,736 Other assets 791 Other liabilities 69 Deferred tax liability 3,333 As a result of these changes, the Company's statement of operations for the nine months ended September 30, 1997 ("pre-RIC") is not comparable with the statements of operations for periods commencing after October 1, 1997 ("post-RIC"). Valuation of Investments Investments are carried at fair value, as determined by the Board of Directors. Securities which are publicly traded are valued at the closing bid price on the valuation date. Debt and equity securities which are not publicly traded are valued at fair value as determined in good faith by the Board of Directors. In making such determination, the Board of Directors will value non-convertible debt securities at cost plus amortized original issue discount, if any, unless adverse factors lead to a determination of a lesser valuation. In valuing convertible debt, equity or other securities, the Board of Directors determines the fair value based on the collateral, the issuer's ability to make payments, the earnings of the issuer, sales to third parties of similar securities, the comparison to publicly traded securities and other pertinent factors. Due to the uncertainty inherent in the 27 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material (see Note 4). Cash and Cash Equivalents Cash and cash equivalents consist of demand deposits and highly liquid investments with original maturities of three months or less. Cash and cash equivalents are carried at cost which approximates fair value. Interest and Dividend Income Recognition Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. Original issue discount is amortized into interest income using the effective interest method. Dividend income is recognized on the ex-dividend date. Financial Advisory and Performance Fee Recognition Financial advisory fees represent amounts received for providing advice and analysis to middle market companies and are recognized as earned based on hours incurred. Financial performance fees represent amounts received for structuring, financing, and executing transactions and are generally payable only if the transaction closes and are recognized as earned when the transaction is completed. Financial advisory and performance fees are for services provided by ACFS. Loan Fee and Loan Processing Fee Recognition The Company records loan fees as income on the closing date of the related loan. Loan processing fees are recorded by the Company's wholly owned subsidiary, ACFS, as income on the closing date of the related loan. Prepayment penalties are booked as revenue as they are received. Realized Gain or Loss and Unrealized Appreciation or Depreciation of Investments Realized gain or loss is recorded at the disposition of an investment and is the difference between the net proceeds from the sale and the cost basis of the investment using the specific identification method. Unrealized appreciation or depreciation reflects the difference between the Board of Directors' valuation of the investments and the cost basis of the investments. Distributions to Shareholders Distributions to shareholders are recorded on the ex-dividend date. Federal Income Taxes The Company operates so as to qualify to be taxed as a RIC under the Internal Revenue Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders from its income to determine "taxable income." The Company has distributed and currently intends to distribute sufficient dividends to eliminate taxable income. Therefore, the statement of operations contains no provision for income taxes for the years ended December 31, 1999 and 1998 and the three months ended December 31, 1997. During the pre-RIC periods, the Company operated under Subchapter C of the Internal Revenue Code and calculated its tax provision pursuant to Statement of Financial Accounting Standards No. 109. Deferred income taxes were determined based on the differences between financial reporting and tax basis of assets and liabilities. Use of Estimates in Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Actual results could differ from those estimates (see Note 4). 28 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) Property and Equipment Property and equipment are carried at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets ranging from five to seven years. Management Fees The Company is self-managed and therefore does not incur management fees payable to third parties. Reclassifications Certain previously reported amounts have been reclassified to conform with the current financial statement presentation. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments. The statement requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This statement was to be effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133," which extended the effective date of SFAS 133 to fiscal years beginning after June 15, 2000. Adoption of SFAS 133 is not expected to have a material impact on the Company's financial statements or disclosures. Note 3. Investments Investments consists primarily of securities issued by publicly and privately-held companies which have been valued at $377,554 as of December 31, 1999. These securities consist of senior debt, subordinated debt with equity warrants, convertible preferred stock and common stock. The debt securities have effective interest rates ranging from 9.75% to 28.26% and are payable in installments with final maturities from 5 to 10 years and are generally collateralized by assets of the borrower. The Company's investments in equity warrants and common stock do not produce current income. The net unrealized appreciation in investments for Federal income tax purposes is the same as for book purposes and none of the Company's investments are on non-accrual status. Note 4. Capital.com Capital.com, an Internet finance portal, was launched in July 1999 under the name of AmericanCapitalOnline.com. In December 1999, the assets of AmericanCapitalOnline.com were contributed to Capital.com, Inc., a newly formed entity, and the site was renamed Capital.com. The total cost of the assets contributed to Capital.com by the Company was $1,492. During December, 1999, a subsidiary of First Union Corporation ("First Union") invested $15,000 in Capital.com in exchange for a 15% common equity stake and warrants to acquire up to an additional 5% of the common equity at a nominal price. The warrants are exercisable based on a subsequent valuation of Capital.com in connection with a subsequent investment or offer to invest within a year of First Union's stock purchase. If the subsequent valuation results in a value of Capital.com of $100,000 or more, the warrants will be extinguished. If the subsequent valuation results in a value of Capital.com of $75,000 or less, all the warrants will be exercisable. If the subsequent valuation results in a value between $75,000 and $100,000, a pro-rata portion of the warrants will be exercisable. In considering the appropriate valuation of this investment at December 31, 1999, in addition to the value implied by First Union's investment for a 15% equity interest, management and the Board of Directors considered several factors including: o The valuation of comparable public company entities; o The very early development stage of Capital.com; o An estimated value for the warrants issued to First Union and the uncertainty of a subsequent valuation of Capital.com affecting the number of shares for which such warrants could be exercised. Based on all these factors and others that were considered, the Board of Directors valued the investment in Capital.com at $72,500 at December 31, 1999. This investment represents 18% of total assets and 23% of total shareholders' equity at December 31, 1999 and the change in unrealized appreciation represents 73% of the net increase in shareholders' equity resulting from operations for 1999. Realization of this valuation in subsequent periods is subject to a high degree of uncertainty including the ability of 29 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) Capital.com to attract and retain financial and service providers, develop and maintain a significant customer base that will support the on going investment and capital needs of the business, attract additional investors in the business, and develop and execute an exit strategy for investors. The outcome of these matters is highly uncertain. Inability to achieve these or other factors could negatively impact future valuations of Capital.com and such differences could be material. Note 5. Investment in Unconsolidated Operating Subsidiary As discussed in Note 2, ACFS is an operating subsidiary of the Company and is accounted for under the equity method effective October 1, 1997. Condensed financial information for ACFS is as follows:
December 31, 1999 December 31, 1998 ----------------- ----------------- Assets Investments in ACS Equities, LP and portfolio companies, at fair value (See Note 15) $ 10,365 $ 10,837 Other assets, net 3,572 1,359 ------------- ----------- Total assets $ 13,937 $ 12,196 ============= =========== Liabilities and Shareholder's Equity Deferred income taxes $ 2,007 $ 2,921 Due to parent 2,331 778 Other liabilities 4,706 2,111 Shareholder's equity 4,893 6,386 ------------- ----------- Total liabilities and shareholder's equity $ 13,937 $ 12,196 ============= ===========
Year Ended Year Ended Three Months Ended December 31, 1999 December 31, 1998 December 31, 1997 ----------------- ----------------- ----------------- Operating income $ 6,030 $ 5,227 $ 532 Operating expense 9,114 6,451 1,084 ------------- ------------- ----------- Net operating loss (3,084) (1,224) (552) Realized gain on investments 925 -- -- (Decrease) increase in unrealized appreciation of investments (246) 481 605 Other 912 261 (29) ------------- ------------- ----------- Net (loss) income $ (1,493) $ (482) $ 24 ============== ============= ===========
Note 6. Stock Option Plan The Company applies APB No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related interpretations in accounting for its stock-based compensation plan. In accordance with SFAS 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company elected to continue to apply the provisions of APB 25 and provide pro forma disclosure of the Company's net operating income and net increase in shareholders' equity resulting from operations calculated as if compensation costs were computed in accordance with SFAS 123. The Company is providing this information for the post-RIC period as discussed in Notes 1 and 2 and from the time the 1997 Stock Option Plan (the 1997 Plan) was established by the Company. The 1997 Plan provided for the granting of options to purchase up to 1,328 shares of common stock at a price of not less than the fair market value of the common stock on the date of grant to employees of the Company. On May 14, 1998, the Company authorized 500 additional shares to be granted under the 1997 Plan. As of December 31, 1999, there are 16 shares available to be granted under the 1997 Plan. 30 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) On November 6, 1997, the Board of Directors authorized the establishment of a stock option plan for the non-employee directors (the "Director Plan"). The Director Plan was approved by shareholders at the annual meeting held on May 14, 1998. The Company received approval of the plan from the Securities and Exchange Commission (SEC) on May 14, 1999. The Company has issued 15 options to each of the six non-employee directors for a total grant of 90 options. At December 31, 1999, there are 60 shares available for grant under the Director Plan. Options granted under the 1997 Plan may be either incentive stock options within the meaning of Section 422 of the Code or nonstatutory stock options; options granted under the Director Plan are nonstatuatory stock options. Only employees of the Company and its subsidiaries are eligible to receive incentive stock options under the 1997 Plan. Options under both the 1997 Plan and the Director Plan generally vest over a three year period. Incentive stock options must have a per share exercise price of no less than the fair market value on the date of the grant. Nonstatutory stock options granted under the 1997 Plan and the Director Plan must have a per share exercise price of no less than the fair market value on the date of the grant. Options granted under both plans may be exercised for a period of no more than ten years from the date of grant.
Year Ended Year Ended Three months ended December 31, 1999 December 31, 1998 December 31, 1997 ----------------- ----------------- ----------------- Net operating income As reported $ 24,661 $ 14,788 $ 2,270 Pro forma $ 22,643 $ 13,609 $ 2,030 Net increase in shareholders' equity resulting from operations As reported $ 97,201 $ 16,915 $ 2,437 Pro forma $ 95,183 $ 15,737 $ 2,197
The effects of applying SFAS 123 for providing pro forma disclosures are not likely to be representative of the effects on reported net operating income and net increase in shareholders' equity resulting from operations for future years. For options granted during the year ended December 31, 1999, the Company estimated a fair value per option on the date of grant of $6.12 using a Black-Scholes option pricing model and the following assumptions: dividend yield 7.7%, risk free interest rate 6.4%, expected volatility factor .32, and expected lives of the options of 7 years. For options granted during the year ended December 31, 1998, the Company estimated a fair value per option on the date of grant of $4.72 using a Black-Scholes option pricing model and the following assumptions: dividend yield 7.9%, risk free interest rate 5.1%, expected volatility factor .51, and expected lives of the options of 7 years. For options granted during the three months ended December 31, 1997, the Company estimated a fair value per option on the date of grant of $2.44 using a Black-Scholes option pricing model and the following assumptions; dividend yield 6.5%, risk free interest rate 6.5%, expected volatility factor .25, and expected lives of the options of 7 years. A summary of the status of the Company's stock option plans as of and for the years ended December 31, 1999 and 1998 is as follows:
Year Ended December 31, Year Ended December 31, 1999 1998 ---------------------------- -------------------------------- Weighted-Average Weighted-Average Exercise Exercise Shares Price Shares Price ------ ----- ------ ----- Options outstanding, beginning of year 1,633 $ 14.96 1,297 $ 15.00 Granted 303 $ 19.01 692 $ 18.42 Exercised (1,520) $ 15.00 (28) $ 15.00 Canceled (62) $ 17.76 (328) $ 22.38 ----------- -------- ---------- ---------- Options outstanding, end of year 354 $ 17.60 1,633 $ 14.96 ========== ========= ========== ========== Options exercisable at year end 354 1,633
31 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) The following table summarizes information about stock options outstanding at December 31, 1999:
Options Outstanding Options Exercisable ------------------- ------------------- Weighted-Average Weighted Weighted Number Outstanding Remaining Average Number Exercisable Average Range of Exercise Prices at December 31, 1999 Contractual Life Exercise Price at December 31, 1999 Exercise Price - ------------------------ -------------------- ---------------- -------------- -------------------- -------------- $15.00 to $17.00 116 8.5 Years $ 15.00 116 $ 15.00 $17.01 to $18.00 5 9.7 Years $ 17.31 5 $ 17.31 $18.00 to $18.74 85 8.4 Years $ 18.63 85 $ 18.63 $18.74 to $19.05 100 9.4 Years $ 18.75 100 $ 18.75 $19.06 to $19.75 48 9.4 Years $ 19.71 48 $ 19.71 ----------- --------- --------- --------- ----------- $15.00 to $19.75 354 8.9 Years $ 17.60 354 $ 17.60 =========== ========= ========= ========= ===========
During 1999, the Company issued 1,520 shares of common stock to employees of the Company, pursuant to option exercises, in exchange for notes receivable totaling $22,752. In 1998, the Company issued 20 shares of common stock to an officer of the Company in exchange for a note receivable in the amount of $300. These transactions were executed pursuant to the 1997 Stock Option Plan, which allows the Company to lend to its employees funds to pay for the exercise of stock options. All loans made under this arrangement are fully secured by the value of the common stock purchased. Certain of the loans are also secured by pledges of life insurance policies. Interest is charged and paid on such loans at the Applicable Federal Rate as defined in the Internal Revenue Code. See Note 15 for further discussion of the note receivable issued for common stock. Note 7. Borrowings On March 31, 1999, the Company closed a maximum $100,000 debt funding facility; this facility was increased to a $125,000 on June 17, 1999 and to $225,000 on December 10, 1999. In connection with the closing, the Company established ACS Funding Trust I (the "Trust"), an affiliated business trust and contributed or sold to the Trust approximately $157,000 in loans. The Company subsequently contributed an additional $100,000 in loans to the Trust. Subject to certain conditions precedent, the Company will remain servicer of the loans. Simultaneously with the initial contribution, the Trust entered into a loan agreement with First Union Capital Markets Corp., as deal agent, and certain other parties providing for loans in an amount up to 50% of the eligible loan balance subject to certain concentration limits. The term of the facility is two years and interest on borrowings had been charged at LIBOR (6.47% at December 31, 1999) plus 2.50%; the interest rate was decreased to LIBOR plus 1.50% on December 10, 1999. The full amount of principal is due at the end of the term and interest is payable monthly. The transfer of assets to the Trust and the related borrowings by the Trust have been treated as a financing arrangement by the Company under Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." As of December 31, 1999, the Company has $78,545 of borrowings outstanding under this facility. During December, 1998, the Company borrowed $5 million from a corporation. Interest was accrued and paid monthly at 7.75% and the principal of the note was repaid in March 1999. During December, 1998, the Company borrowed $80,948 secured by government agency securities with a fair value of $89,948. The interest rate on the Note was 4.25% and the note was fully repaid in January 1999. During November, 1998, the Company entered into a credit agreement with two banks under which the Company had the ability to borrow up to $30 million. Interest on borrowings was accrued and paid monthly at the prime rate (7.75% at December 31, 1998). At December 31, 1998, the outstanding balance was $30 million, and the balance was repaid in March in 1999. The credit facility was secured by the certain investments of the Company. During the years ended December 31, 1999 and 1998, and the nine months ended September 30, 1997 the cash paid for interest was approximately $4,385, $56, and $88, respectively. The weighted average interest rates,m including amortization of deferred finance costs, for the years ended December 31, 1999 and 1998 were 9.7% and 5.9%. 32 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) Due to the short term of the borrowings, the fair value of the borrowings approximates cost. Note 8. Income Taxes The Company operates so as to qualify to be taxed as a RIC under the Internal Revenue Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders from its income to determine taxable income. The Company has distributed and currently intends to distribute sufficient dividends to eliminate taxable income. Therefore, the statement of operations contains no provision for income taxes for the years ended December 31, 1999 and 1998, and the three months ended December 31, 1997. During the pre-RIC periods, the Company operated under Subchapter C of the Internal Revenue Code and calculated its tax provision pursuant to Statement of Financial Accounting Standards No. 109. The aggregate gross unrealized appreciation over the cost for Federal income tax purposes was $77,833, $2,310, and $7,414 as of December 31, 1999, 1998, and 1997, respectively. The net unrealized appreciation over cost was $72,305, 2,265 and 7,414, respectively, for the same periods. The aggregate cost of securities for Federal income tax purposes was $305,264, $252,718, and $132,870 as of December 31, 1999, 1998 and 1997, respectively. The Company obtained a ruling in April 1998 from the IRS which the Company had requested to clarify the tax consequences of the conversion from taxation under subchapter C to subchapter M in order for the Company to avoid incurring a tax liability associated with the unrealized appreciation of assets whose fair market value exceeded their basis immediately prior to conversion. Under the terms of the ruling the Company elected to be subject to rules similar to the rules of Section 1374 of the Internal Revenue Code with respect to any unrealized gain inherent in its assets, upon its conversion to RIC status (built-in gain). Generally, this treatment allows deferring recognition of the built-in gain. If the Company were to divest itself of any assets in which it had built-in gains prior to the end of a ten year recognition period, the Company would then be subject to tax on its built-in gain. During 1999, the Company paid federal income taxes of $309 on retained realized gains recorded during the tax year ended September 30, 1999. The payment was treated as a deemed distribution because taxes were paid on behalf of the Company's shareholders. As a result, the Company did not record income tax expense. Note 9. Commitments and Contingencies The Company has non-cancelable operating leases for office space and office equipment. The leases expire over the next seven years and contain provisions for certain annual rental escalations. Rent expense for operating leases for the years ended December 31, 1999 and 1998, the three months ended December 31, 1997, and the nine months ended September 30, 1997 was approximately $113, $60, $73, and $97, respectively. Future minimum lease payments under non-cancelable operating leases at December 31, 1999 were as follows: 2000 $ 798 2001 801 2002 773 2003 673 2004 and thereafter 3,322 ------------ Total 6,367 ============ In addition, at December 31, 1999, the Company had commitments under loan agreements to fund up to $16,683 to five portfolio companies. These commitments are composed of four working capital credit facilities and one acquisition credit facility. The commitments are subject to the borrowers meeting certain criteria. The terms of the borrowings subject to commitment are comparable to the terms of other debt securities in the Company's portfolio. Note 10. Employee Stock Ownership Plan The Company maintains an ESOP, which includes all employees and is fully funded on a pro rata basis by the Company and its wholly owned subsidiary, ACFS. Contributions are made at the Company's discretion up to the lesser of $30 or 25% of annual compensation expense for each employee. Employees are not fully vested until completing five years of service. For the years ended 33 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) December 31, 1999 and 1998, the Company and ACFS contributed $88 and $97 to the ESOP, respectively, or 3% of total eligible employee compensation. The Company sponsors an employee stock ownership trust to act as the depository of employer contributions to the ESOP as well as to administer and manage the actual trust assets which are deposited into the ESOP. Note 11. Capital Stock In July, 1997, all unearned ESOP shares became earned and were allocated to the ESOP accounts of the Company's employees. Pursuant to the Company's Class A preferred stock declaration, the Class A preferred stock held by the ESOP was converted into common stock on a one share to one share basis. The Company also contributed an additional 529 shares of common stock to the ESOP. In August 1997, the Company increased its authorized shares of unallocated preferred stock to 5,000 and increased its authorized shares of common stock to 20,000. During May, 1999, the authorized shares of common stock were increased to 70,000. On August 27, 1997, the Company declared a stock split effective August 29, 1997, effected in the form of a stock dividend pursuant to which each outstanding share of common stock was effectively converted into 29.859 shares. Outstanding shares and per share amounts for all periods presented have been restated to reflect this stock split. On August 29, 1997, the Company completed its IPO and sold 10,382 shares of its common stock at a price of $15.00 per share. Pursuant to the terms of the Company's agreement with the underwriter of the offering, the Company issued 443 common stock warrants ("Warrants") to the underwriter. The Warrants have a term of five years from the date of issuance and may be exercised at a price of $15.00 per share. During December, 1999, the Company repurchased 394 of these Warrants at a price of $5.50 per warrant. In 1998, in accordance with regulations governing RIC's, the Company notified shareholders of its intention to periodically repurchase its outstanding common stock. Following release of this notification, the Company repurchased 23 shares of it common stock at a weighted average price of $10.12 per share during 1998. In August 1999 the Company sold 5,605 shares of common stock in a follow-on equity offering. The net proceeds of the offering of approximately $90 million were used to repay outstanding borrowings under the debt funding facility and to fund investments. The Company declared dividends of $25,867, and $14,849, or $1.74 and $1.34 per share for the years ended December 31, 1999 and 1998; at December 31, 1999, $547 remained accrued and undistributed to shareholders. For the three months ended December 31, 1997, the Company distributed $2,324, or $0.21 per share, to its shareholders. For Federal income tax purposes, the distributions were 100% from ordinary income. Note 12. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 1999 and 1998, and the three months ended December 31, 1997. For all other periods, earnings per share is not presented since it is not considered meaningful due to the IPO and reorganization of the Company as a RIC.
Year Ended Year Ended Three Months Ended December 31, 1999 December 31, 1998 December 31, 1997 ----------------- ----------------- ----------------- Numerator for basic and diluted earnings per share $ 97,201 $ 16,915 $ 2,437 Denominator for basic weighted average shares 13,744 11,068 11,069 Employee stock options 167 269 251 Contingently issuable shares 303 -- -- Warrants 80 87 85 ------------ ------------ ------------ Dilutive potential shares 550 356 336 ------------ ------------ ------------ Denominator for diluted weighted average shares 14,294 11,424 11,405 ------------ ------------ ------------ Basic earnings per share $ 7.07 $ 1.53 $ 0.22 Diluted earnings per share $ 6.80 $ 1.48 $ 0.21
34 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) Note 13. Realized Gain on Investments During March, 1999, the Company sold its investment in Four-S Baking Company ("Four-S"). The Company's investment included senior debt, subordinated debt, preferred stock, common stock and common stock warrants. The Company received $7.2 million in total proceeds from the sale and recognized a net realized gain of $316. The realized gain was comprised of a $331 realization of unamortized loan discounts on the subordinated debt and a net loss of $15 on the common stock and warrants. In addition, the Company earned prepayment fees of $87 from the early repayment of the senior and subordinated debt. In conjunction with the sale, the Company also recorded $177 of unrealized depreciation to reverse previously recorded unrealized appreciation. During June, 1999, the Company received a prepayment of subordinated debt from Specialty Transportation Services, Inc. ("STS") in the amount of $7,500. In conjunction with the repayment, the Company received prepayment fees of $225 and recognized a realized gain of $551 from the realization of unamortized original issue discount. In October, 1999, the Company received a prepayment of the remaining balance of its subordinated debt investment in STS of $515, including prepayment penalties. In addition, STS repurchased from the Company the common stock and common stock purchase warrants owned by the Company for total consideration of $3,000. The Company recorded $1,844 of realized gains and reversed $1,806 of previously unrealized gains on the sale of the subordinated debt, common stock and common stock purchase warrants. In addition, STS paid a $1,000 fee to ACFS to cancel an investment banking contract between ACFS and STS. Note 14. Interest Rate Risk Management The Company enters into interest rate swap agreements with financial institutions as part of its strategy to manage interest rate risks and to fulfill its obligation under the terms of its debt funding facility. The Company uses interest rate swap agreements for hedging and risk management only and not for speculative purposes. During the year ended December 31, 1999, the Company entered into four interest rate basis swap agreements with an aggregate notional amount of $61,325. Pursuant to these swap agreements, the Company pays a variable rate equal to the prime lending rate (8.75% at December 31, 1999) and receives a weighted average rate of the 30-day LIBOR (6.47% at December 31, 1999) plus 2.70%. The swaps have a remaining weighted average maturity of approximately four and one half years. At December 31, 1999, the fair value of the interest rate basis swap agreements represented a liability of $163. Note 15. Related Party Transactions The Company has provided loans to employees for the exercise of options under the 1997 Stock Option Plan. The loans require the current payment of interest at the Applicable Federal Rate of interest in effect at the date of issue, have varying terms not exceeding nine years and have been recorded as a reduction of shareholders' equity. The loans are evidenced by full recourse notes that are due upon maturity or 60 days following termination of employment, and the shares of common stock purchased with the proceeds of the loan are posted as collateral. During the year ended December 31, 1999, the Company issued $24,025 in loans to 18 employees for the exercise of options and related taxes. The Company recognized interest income from these loans of $623 during the year ended December 31, 1999. In connection with the issuance of these notes, the Company entered into agreements to purchase split dollar life insurance for three executive officers. The aggregate cost of the split dollar life insurance of $2,811 is being amortized over a ten year period as long as each executive officer continues employment. During the period the loans are outstanding, the Company will have a collateral interest in the cash value and death benefit of these policies as additional security for the loans. Additionally, as long as the policy premium is not fully amortized, the Company will have a collateral interest in such items generally equal to the unamortized cost of the policies. In the event of an individual's termination of employment with the Company prior to the end of such ten year period, or, his election not to be bound by non compete agreements, such individual must reimburse the company the unamortized cost of his policy. For the year ended December 31, 1999, the Company recorded $67 of amortization expense. 35 AMERICAN CAPITAL STRATEGIES, LTD. NOTES TO FINANCIAL STATEMENTS (In thousands except per share data) During 1999, the Company formed ACS Equities, LP, along with ACFS. Upon formation, ACFS contributed all of its equity investments held as of September 30, 1999 at fair value; the Company contributed $50,000 of capital. The investments contributed by ACFS consisted of the following common stock investments: Fair Value at Fair Value at September 30, 1999 December 31, 1999 ------------------ ----------------- Biddeford Textile Corporation $ 5,687 $ 2,173 Erie Forge & Steel, Inc. 2,694 2,553 Mobile Tool International, Inc. 1,984 1,984 ------------ ------------ $ 10,365 $ 6,710 ============ ============ Under the terms of the partnership agreement, the Company has guaranteed the fair value of the assets contributed by ACFS. The Company will share in 90% of the income and losses of the partnership; however, if the losses of the partnership reduce the capital below the original basis, the Company will be responsible for 100% of all losses below the original basis. ACFS will receive 10% of investment income and losses to the extent that its original capital account basis is not impaired. In the event that investment losses cause the capital of the partnership to decrease below the original basis, ACFS will not be responsible for any losses. For the year ended December 31, 1999, the Company recorded unrealized depreciation of 3,655 on its investment in ACS Equities, LP; a corresponding liability to ACS Equities, LP of $3,655 is included in other liabilities. Note 16. Selected Quarterly Data (Unaudited)
Year Ended December 31, 1999 -------------------------------------------------- QTR 1 QTR 2 QTR 3 QTR 4 ----- ----- ----- ----- Total operating income $ 6,520 $ 7,155 $ 9,143 $ 10,587 Net operating income 4,727 5,084 6,664 8,186 Net increase in shareholders' equity resulting from operations 7,024 6,161 10,234 73,782 Basic earnings per common share 0.63 0.55 0.69 4.14 Diluted earnings per common share 0.62 0.53 0.66 4.02
36 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information in response to this Item is incorporated herein by reference to the information provided in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held May 3, 2000 (the "2000 Proxy Statement") under the headings "ELECTIONS OF DIRECTORS" and "SECTION (16) (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE". ITEM 11. EXECUTIVE COMPENSATION Information in response to this Item is incorporated herein by reference to the information provided in the 2000 Proxy Statement under the heading "COMPENSATION OF EXECUTIVE OFFICERS" and "DIRECTOR COMPENSATION". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information in response to this Item is incorporated herein by reference to the information provided in the 2000 Proxy Statement under the heading "Security Ownership of Management and Certain Beneficial Owners." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information in response to this Item is incorporated herein by reference to the information provided in the 2000 Proxy Statement under the heading "Certain Transactions." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) The following financial statements are filed herewith: AMERICAN CAPITAL STRATEGIES, LTD. Report of Independent Auditors Balance Sheets as of December 31, 1999 and 1998 Schedules of Investments as of December 31, 1999 and 1998 Statements of Operations for the Years Ended December 31, 1999 and 1998, the Three Months Ended December 31, 1997, and the Nine Months September 30, 1997. Statements of Shareholders' Equity for the Years Ended December 31, 1999 and 1998, the Three Months Ended December 31, 1997, and the Nine Months September 30, 1997. Statement of Cash Flows for the Years Ended December 31, 1999 and 1998, the Three Months Ended December 31, 1997, and the Nine Months Ended September 30, 1997. Financial Highlights for the Years Ended December 31, 1999 and 1998, and the Three Months Ended December 31, 1997 37 Notes to Financial Statements (2) No financial statement schedules of the Company are filed herewith because (i) such schedules are not required or (ii) the information required has been presented in the aforementioned financial statement (3) The following exhibits are filed herewith or incorporated herein by reference Exhibit Description - ------- ----------- *3.1 American Capital Strategies, Ltd. Second Amended and Restated of Certificate of Incorporation, incorporated herein by reference Exhibit a of the Pre-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333-29943) filed August 12, 1997, as amended by a certain Amendment No. 1 filed herewith. *3.2 American Capital Strategies, Ltd. Second Amended and Restated Bylaws, incorporated herein by reference to Exhibit b of the Pre-Effective Amendment Number 1 to the Registration Statement Form N-2 (File No. 333-29943) filed on August 12, 1997. *4.1. Instruments defining the rights of holders of securities: See Article IV of the Company's Second Amended and Restated Certificate of Incorporation, incorporated herein by reference to Exhibit 2.a of the Amendment No. 1 to the Form N-2 filed by the Company, filed on August 12, 1997 (Commission File No. 333-29943). *4.2 Instruments defining the rights of holders of securities: See Section I of the Company's Second Amended and Restated Bylaws, incorporated herein by reference to Exhibit 2.b of the Amendment No. 1 to the Form N-2 filed by the Company, filed on August 12, 1997 (Commission File No. 333-29943). *+10.1 Second Amended and Restated Employment Agreement between the Company and David Gladstone, dated as of August 6, 1999, incorporated herein by reference to Exhibit 10.1 on Form 10-Q for the quarter ended September 30, 1999, filed on November 15, 1999. *+10.2 Amended and Restated Employment Agreement between the Company and Adam Blumenthal, dated June 7, 1999, incorporated herein by reference Exhibit 10.6 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.3 Amended and Restated Employment Agreement between the Company and Roland Cline, dated June 7, 1999, incorporated herein by reference Exhibit 10.7 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.4 Stock Option Exercise Agreement between the Company and Adam Blumenthal, dated June 7, 1999, incorporated herein by reference Exhibit 10.8 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.5 Stock Option Exercise Agreement between the Company and Roland Cline, dated June 7, 1999, incorporated herein by reference Exhibit 10.9 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.6 Stock Option Exercise Agreement between the Company and Malon Wilkus, dated June 7, 1999, incorporated herein by reference Exhibit 10.10 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.7 Stock Option Exercise Agreement between the Company and John Erickson, dated June 7, 1999, incorporated herein by reference Exhibit 10.11 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.8 Stock Option Exercise Agreement between the Company and David J. Gladstone, dated September 6, 1999, incorporated herein by reference to Exhibit 10.2 of Form 10-Q for the quarter ending September 30, 1999, filed November 15, 1999. 38 *+10.9 Letter Agreement Regarding the Exercise of Options between the Company and David Gladstone, dated as of July 8, 1999, incorporated herein by reference Exhibit 10.13 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.10 Purchase Note by Adam Blumenthal in favor of the Company, dated as of June 7, 1999, incorporated herein by reference Exhibit 10.14 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.11 Purchase Note by Roland Cline in favor of the Company, dated as of June 7, 1999, incorporated herein by reference Exhibit 10.15 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.12 Purchase Note by Malon Wilkus in favor of the Company, dated as of June 7, 1999, incorporated herein by reference Exhibit 10.16 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.13 Purchase Note by John Erickson in favor of the Company, dated as of June 7, 1999, incorporated herein by reference Exhibit 10.17 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. *+10.14 Purchase Note by David J. Gladstone in favor of the Company, dated as of September 6, 1999, incorporated herein by reference to Exhibit 10.3 of Form 10-Q for the quarter ending September 30, 1999, filed November 15, 1999. +10.15 Split Dollar Agreement between the Company and Adam Blumenthal dated as of September 7, 1999, filed herewith. +10.16 Split Dollar Agreement between the Company and Roland Cline dated as of September 7, 1999, filed herewith. *+10.17 Split Dollar Agreement dated as of September 7, 1999, among the Company David J. Gladstone and the David J. Gladstone Irrevocable Insurance Trust, Lorna Gladstone, Trustee, incorporated herein by reference to Exhibit 10.4 of Form 10-Q for the quarter ended September 30, 1999, filed November 15, 1999. *10.18 Purchase and Sale Agreement between ACS Funding Trust I and American Capital Strategies, Ltd., dated as of March 31, 1999, incorporated herein by reference to Exhibit 10.1 of Form 10-Q for the quarter ended March 31, 1999, filed May 17, 1999. *10.19 Loan Funding and Servicing Agreement among ACS Funding Trust I, American Capital Strategies, Ltd., Variable Funding Capital Corporation, First Union Capital Markets Corp., First Union National Bank, Norwest Bank Minnesota, N.A. and certain investors named therein, together with all exhibits thereto, dated as of March 31, 1999, incorporated herein by reference to Exhibit 10.2 of Form 10-Q for the quarter ended March 31, 1999, filed May 17, 1999, as amended by a certain Amendment No. 1 dated as of June 30, 1999, an Amendment No. 2 dated as of September 24, 1999 and an Amendment No. 3 dated as of December 14, 1999, each of which is filed herewith. 10.20 Amended, Restated and Substituted Investor Note in the amount of $225,000,000 made by ACS Funding Trust I in favor of certain Investors specified therein, dated as of March 31, 1999, filed herewith. 10.21 Amended, Restated and Substituted VFCC Note in the principal amount of $225,000,000 made by ACS Funding Trust I in favor of First Union Securities, Inc., dated as of March 31, 1999, filed herewith. 10.22 Amended, Restated and Substituted FUNB Note in the aggregate principal amount of $10,000,000 made by ACS Funding Trust I in favor of First Union National Bank, dated as of March 31, 1999, filed herewith. *10.23 Pledge and Security Agreement among American Capital Strategies, Ltd., ACS Funding Trust I and Norwest Bank Minnesota, N.A., dated as of March 31, 1999, incorporated herein by reference to Exhibit 10.6 on Form 10-Q for the quarter ended Mach 31, 1999, filed May 17, 1999. *10.24 Escrow Agreement between American Capital Strategies, Ltd. and Norwest Bank Minnesota, N.A., dated as of March 31, 1999, incorporated herein by reference to Exhibit 10.7 of Form 10-Q for the quarter ended Mach 31, 1999, filed May 17, 1999. 39 *10.25 Lock-Box Agreement between ACS Funding Trust I and LaSalle National Bank, dated as of March 31, 1999, incorporated herein by reference to Exhibit 10.8 of Form 10-Q for the quarter ended Mach 31, 1999, filed May 17, 1999. *10.26 Certificate of Trust of ACS Funding Trust I, dated as of March 26, 1999, incorporated herein by reference to Exhibit 10.9 of Form 10-Q for the quarter ended Mach 31, 1999, filed May 17, 1999. *10.27 Trust Agreement among American Capital Strategies, Ltd., as grantor and owner, Malon Wilkus, as beneficiary trustee, and Evelyne Steward and William Holloran, as independent trustees, dated as of March 26, 1999, incorporated herein by reference to Exhibit 10.10 of Form 10-Q for the quarter ended Mach 31, 1999, filed May 17, 1999. *21 Subsidiaries of the Company and jurisdiction of incorporation, incorporated herein by reference to Item 27 of the Post-Effective Amendment Number 1 to the Registration Statement on Form N-2 (File No. 333- 79377), filed August 5, 1999. 23 Consent of Ernst & Young LLP, filed herewith. 27 Financial Data Schedule, filed herewith. - ----------------- * Fully or partly previously filed + Management contract or compensatory plan (b) Reports on Form 8-K NONE (c) Exhibits. See the exhibits filed herewith (d) Additional financial statement schedules NONE 40 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMERICAN CAPITAL STRATEGIES, LTD. By: /s/ John R. Erickson ----------------------- John R. Erickson Vice President and Chief Financial Officer Date: March 28, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /s/ Malon Wilkus - ------------------------ Chairman and Chief Executive Officer March 28, 2000 Malon Wilkus /s/ David Gladstone - ------------------------ Vice Chairman and Director March 28, 2000 David Gladstone /s/ Adam Blumenthal - ------------------------ President, Chief Operating Officer, and March 28, 2000 Adam Blumenthal Director /s/ John R. Erickson - ------------------------ Vice President and Chief Financial Officer March 28, 2000 John R. Erickson (Principal Financial and Accounting Officer) /s/ Robert L. Allbritton - ------------------------ Director March 28, 2000 Robert L. Allbritton /s/ Alvin N. Puryear - ------------------------ Director March 28, 2000 Alvin N. Puryear /s/ Neil M. Hahl - ------------------------ Director March 28, 2000 Neil M. Hahl /s/ Philip R. Harper - ------------------------ Director March 28, 2000 Philip R. Harper /s/ Stan Lundine - ------------------------ Director March 28, 2000 Stan Lundine - ------------------------ Director Steven P. Walko
41 EX-3.1 2 CERTIFICATE OF INCORPORATION Exhibit 3.1 CERTIFICATE OF AMENDMENT OF SECOND AMENDED AND RESTATED CERTIFICATE OF INCORPORATION AMERICAN CAPITAL STRATEGIES, LTD., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), DOES HEREBY CERTIFY AS FOLLOWS: FIRST: The Board of Directors of the Corporation duly adopted resolutions in accordance with Section 242 of the General Corporation Law of the State of Delaware proposing, declaring advisable and recommending this amendment (the "Certificate of Amendment") to the Second Amended and Restated Certificate of Incorporation (the "Certificate of Incorporation") of the Corporation. Accordingly, Section 4.1 of Article IV of the Certificate of Incorporation is deleted in its entirety and replaced as follows: "Section 4.1. Total Number of Shares of Capital Stock. The total number of shares of capital stock of all classes that the Corporation shall have authority to issue is 75,000,000 shares. The authorized stock is divided into 5,000,000 shares of preferred stock, with the par value of $0.01 each (the "Preferred Stock"), and 70,000,000 shares of voting common stock, with the par value of $0.01 each (the "Common Stock")." SECOND: That the annual meeting of the stockholders of the Corporation was duly called and held upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the necessary number of shares was voted in favor of said amendment. THIRD: The aforesaid amendment was duly adopted in accordance with the applicable provisions of Section 242 of the General Corporation Law of the State of Delaware. FOURTH: This Certificate of Amendment to the Certificate of Incorporation is to become effective upon filing. A:\Exh. 3.1.doc IN WITNESS WHEREOF, the undersigned, AMERICAN CAPITAL STRATEGIES, LTD., has caused this Certificate of Amendment to be executed on its behalf by its President and attested to by its Secretary as of this 17th day of May, 1999. AMERICAN CAPITAL STRATEGIES, LTD. By: ------------------------------ Name: Malon Wilkus Title: President Attest: ----------------------- Adam Blumenthal Secretary - 2 - EX-10.15 3 SPLIT DOLLAR AGREEMENT Exhibit 10.15 SPLIT DOLLAR AGREEMENT This SPLIT DOLLAR AGREEMENT (this "Agreement") is entered into as of September 7, 1999, by and between ADAM BLUMENTHAL (the "Owner") and AMERICAN CAPITAL STRATEGIES, LTD., a Delaware corporation (the "Employer"). R E C I T A L S WHEREAS, the Owner and the Employer have entered into a Stock Option Exercise Agreement of event date herewith (the "Exercise Agreement") pursuant to which they have agreed to enter into and consummate this Agreement; and WHEREAS, Owner will be the owner and possessor of the Policy (as defined herein) and will assign an interest in the Policy's death benefit and cash value to the Employer as collateral to secure repayment of Employer's premium payments with respect to the Policy pursuant to the Exercise Agreement; and WHEREAS, it is the intent of the Employer and Owner to define the extent of the Employer's security interest in the Policy; NOW, THEREFORE, the parties hereto, in consideration of the foregoing and intending to be legally bound hereby, agree as follows: 1. Interests in the Policy. The Policy that is the subject of this Split Dollar Agreement is Security Life of Denver Insurance Company (the "Insurer") Policy Number 610014591 on the life of the Owner (the "Policy"). The Employer's interest in the cash value and death benefits of the Policy (the "Employer's Interest") as of any date, shall be equal to the Unamortized Premium Payment (as defined herein) as of such date with interest accumulated at a rate of 4.5% per annum. The Owner's interest in the cash value and death benefits of A:\Exh. 10.15.doc the Policy (the "Owner's Interest") shall be equal to the remaining cash value and death benefits of the Policy, if any, in excess of the Employer's Interest, reduced by any distributions made to the Owner prior to such date. 2. Premium Payments. The Employer will, on or as of the date hereof and on each of the first four anniversaries of the date hereof, make cash premium payments on the Policy in the amount of $100,800 (each payment being an "Annual Premium Payment" and collectively, the "Aggregate Premium Payments"). The Owner shall have imputed income each year in an amount equal to (a) the annual cost of current death benefit protection on the life of the Owner, measured by the lower of (i) the PS 58 rate, as set forth in Revenue Ruling 55-747 (or the corresponding applicable provision of any future Revenue Ruling), or (ii) the Insurer's current published premium rate for annually renewable term insurance for standard risks plus, without duplication, (b) one-tenth of the Aggregate Premium Payments. The "Unamortized Premium Payment" as of any date shall be the aggregate Annual Premium Payments made through such date reduced by 2.5% of the Aggregate Premium Payments on each October 1, January 1, March 1 and July 1 during the term of this Agreement. 3. Death Benefit Amounts. a. In the event of Owner's death prior to the termination of this Agreement, the death benefit payable to the Employer (or the Employer's designated beneficiaries) under this Agreement shall be equal to the Employer's Interest in the Policy at the time of Owner's death. b. In the event of the Owner's death prior to the termination of this Agreement, the death benefit payable to the Owner (or the Owner's - 2 - designated beneficiaries) shall be the excess of the total death proceeds under the Policy less the amount payable to the Employer (or the Employer's designated beneficiaries). Following the termination of this Agreement and upon the satisfaction of the Employer's Interest in the Policy, the Owner's death benefit will be equal to the total death benefit provided by the Policy. c. Owner understands that sufficiency of cash value in the Policy to provide expected amounts of death benefit under this Agreement may vary as a result of Policy performance and duration of premium payments and this is in no event guaranteed by the Employer or the Insurer. 4. Ownership and Rights in the Policy. a. The Policy will be owned exclusively by the Owner. While this Agreement is in effect, the Employer has a security interest in the Policy under this Agreement limited exclusively to the Employer's Interest in the Policy; provided, however, this paragraph 4 shall not in any way limit or affect the obligations or rights of the parties under that Exercise Agreement. b. The Owner shall have the right to make any investment choices permitted by the Policy and that appear on Exhibit A hereto with respect to the cash value of the Policy. Any other investment choices will require the consent of the Employer. c. The Owner's rights shall also include the right to select and change beneficiaries to receive Owner's death benefits. The Owner will not be permitted to borrow against, or partially or totally surrender the Policy as long as the Collateral Assignment remains in force, except as provided in the - 3 - Exercise Agreement. Any other rights in the Policy other than those specifically mentioned in this Agreement must be exercised with the written consent of both the Owner and the Employer. d. Notwithstanding anything to the contrary in this Agreement, Owner shall have the right to assign ownership of the Policy to an insurance trust created by the Owner, provided that any such assignment shall be made expressly subject to the rights and interests of the Employer to the Policy created under this Agreement and under the Exercise Agreement and the trustee thereof shall have executed such instrument as the Employer may reasonably request confirming such rights and interests of the Employer. 5. Assignment of Policy to Secure Employer's Payments. To secure Employer's Interest in the Policy under this Agreement, Owner will collaterally assign the Policy to the Employer by signing the separate Collateral Assignment. The Collateral Assignment cannot be altered without the Employer's, Owner's and Insurer's consent. 6. Termination of Split Dollar Agreement. This Agreement will terminate upon the earliest to occur of the following: a. Death of the Owner and the payment to Employer of all amounts due it hereunder; b. Written agreement of both the Owner and the Employer to terminate this Agreement; c. Termination of Owner's employment; provided however, that if the Employer and Owner are parties to a Supplemental Employment Agreement substantially in the form of Exhibit 4.11 to the Second Amended and Restated Employment Agreement dated as of June 7, 1999, between Employer and Owner, Owner - 4 - shall be deemed to be employed by Employer only if Employee has elected to be bound by Section 5.2(a) thereof; or d. A release of the Collateral Assignment pursuant to Section 7 herein. Upon termination of this Agreement, the Employer shall receive the Employer's Interest in the Policy as soon as is practical, but in no event shall receipt be later than sixty (60) days from the earliest of the dates listed above. In the event of termination of this Agreement for reason other than the death of the Owner, the payment of the Employer's Interest in the Policy and under this Agreement shall be satisfied either directly from the cash value of the Policy or by direct payment by the Owner, at the discretion of the Owner. In this event, the recovery of the Employer's Interest shall be limited to the cash value of the Policy at that time. In the event of termination of this Agreement by reason of the death of the Owner, the Employer's Interest in the Policy and under this Agreement shall be satisfied through direct payment from the Insurer from the Policy proceeds. 7. Release of Collateral Assignment. Upon receipt of the Employer's Interest in the Policy, as provided above, either whether from the Policy, or from the Owner, the Employer will release the Collateral Assignment. Upon satisfaction of the Employer's Interest in the Policy, the Owner shall have unrestricted ownership to the Policy, subject to the terms of the Exercise Agreement. 8. Miscellaneous. a. Not an Employment Agreement. This Agreement does not in any way constitute an employment agreement, and the Employer reserves the right to terminate Owner's employment to the same extent as though this Agreement did not - 5 - exist. This Agreement may be amended at any time by written agreement signed on behalf of the Employer and by the Owner. b. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Employer and its successors and assigns, and to the Owner and the Owner's heirs, executor or personal representative and beneficiaries. c. Notices. Any notice, consent or demand required or permitted under this Agreement shall be made in writing and shall be signed by the party making the notice, consent, or demand. Such notice shall be sent by United States certified mail, postage pre-paid and shall be sent to the other party's last known address as shown on the records of the Employer. The date of such mailing shall be deemed to be the date of such notice, consent or demand. d. Governing Law. This Agreement shall be governed by and be construed in accordance with the laws of the State of Maryland, without reference to the conflicts of laws provisions thereof. 9. Claims Procedures. a. Claimants. Any person or entity claiming a benefit, requesting an interpretation or ruling under the Plan (hereinafter referred to as "Claimant") shall present the request in writing to the Employer, which shall respond in writing as soon as practicable. If the claim or request is denied, the written notice of denial shall state the reason for denial, with specific reference to the provisions on which the denials is based, a description of any additional material or information required and an explanation of why it is necessary, and an explanation of the program's claims review procedure. - 6 - b. Review of Claim. Any Claimant whose claim or request is denied or who has not received a response within sixty (60) days may request a review by notice given in writing to the Employer. Such request must be made within sixty (60) days after receipt by the Claimant of the written notice of denial, or in the event Claimant has not received a response sixty (60) days after receipt by the Employer of Claimant's claim or request. The claim or request shall be reviewed by the Employer which may, but shall not be required to, grant the Claimant a hearing. On review, the Claimant may have representation, examine pertinent documents, and submit issues and comments in writing. c. Final Decision. The decision or review shall normally be made within sixty (60) days after the Employer's receipt of Claimant's claim or request. If an extension of time is required for a hearing or other special circumstances, the Claimant shall be notified and the time limit shall be one hundred twenty (120) days. The decision shall be in writing and shall state the reason and the relevant provisions. All decisions on review shall be final and bind all parties concerned. - 7 - IN WITNESS WHEREOF, the Employer and the Owner have executed and delivered this Split Dollar Agreement, which is effective as of the effective date of the Policy described herein. AMERICAN CAPITAL STRATEGIES. LTD. By: ------------------------------- Name: ------------------------ Title: ------------------------ OWNER ----------------------------------- - ----------------------------- Witness - 8 - EX-10.16 4 SPLIT DOLLAR AGREEMENT Exhibit 10.16 SPLIT DOLLAR AGREEMENT This SPLIT DOLLAR AGREEMENT (this "Agreement") is entered into as of September 7, 1999, by and between ROLAND CLINE (the "Owner") and AMERICAN CAPITAL STRATEGIES, LTD., a Delaware corporation (the "Employer"). R E C I T A L S WHEREAS, the Owner and the Employer have entered into a Stock Option Exercise Agreement of event date herewith (the "Exercise Agreement") pursuant to which they have agreed to enter into and consummate this Agreement; and WHEREAS, Owner will be the owner and possessor of the Policy (as defined herein) and will assign an interest in the Policy's death benefit and cash value to the Employer as collateral to secure repayment of Employer's premium payments with respect to the Policy pursuant to the Exercise Agreement; and WHEREAS, it is the intent of the Employer and Owner to define the extent of the Employer's security interest in the Policy; NOW, THEREFORE, the parties hereto, in consideration of the foregoing and intending to be legally bound hereby, agree as follows: 1. Interests in the Policy. The Policy that is the subject of this Split Dollar Agreement is Security Life of Denver Insurance Company (the "Insurer") Policy Number 610014589 on the life of the Owner (the "Policy"). The Employer's interest in the cash value and death benefits of the Policy (the "Employer's Interest") as of any date, shall be equal to the Unamortized Premium Payment (as defined herein) as of such date with interest accumulated at a rate of 4.5% per annum. The Owner's interest in the cash value and death benefits of the Policy (the "Owner's Interest") shall be equal to the remaining cash value A:\Exh. 10.16.doc and death benefits of the Policy, if any, in excess of the Employer's Interest, reduced by any distributions made to the Owner prior to such date. 2. Premium Payments. The Employer will, on or as of the date hereof and on each of the first four anniversaries of the date hereof, make cash payments on the Policy in the amount of $96,315 (each payment being an "Annual Premium Payment" and collectively, the "Aggregate Premium Payments"). The Owner shall have imputed income each year in an amount equal to (a) the annual cost of current death benefit protection on the life of the Owner, measured by the lower of (i) the PS 58 rate, as set forth in Revenue Ruling 55-747 (or the corresponding applicable provision of any future Revenue Ruling), or (ii) the Insurer's current published premium rate for annually renewable term insurance for standard risks plus, without duplication, (b) one-tenth of the Aggregate Premium Payments. The "Unamortized Premium Payment" as of any date shall be the aggregate Annual Premium Payments made through such date reduced by 2.5% of the Aggregate Premium Payments on each October 1, January 1, March 1 and July 1 during the term of this Agreement. 3. Death Benefit Amounts. a. In the event of Owner's death prior to the termination of this Agreement, the death benefit payable to the Employer (or the Employer's designated beneficiaries) under this Agreement shall be equal to the Employer's Interest in the Policy at the time of Owner's death. b. In the event of the Owner's death prior to the termination of this Agreement, the death benefit payable to the Owner (or the Owner's designated beneficiaries) shall be the excess of the total death proceeds under - 2 - the Policy less the amount payable to the Employer (or the Employer's designated beneficiaries). Following the termination of this Agreement and upon the satisfaction of the Employer's Interest in the Policy, the Owner's death benefit will be equal to the total death benefit provided by the Policy. c. Owner understands that sufficiency of cash value in the Policy to provide expected amounts of death benefit under this Agreement may vary as a result of Policy performance and duration of premium payments and this is in no event guaranteed by the Employer or the Insurer. 4. Ownership and Rights in the Policy. a. The Policy will be owned exclusively by the Owner. While this Agreement is in effect, the Employer has a security interest in the Policy under this Agreement limited exclusively to the Employer's Interest in the Policy; provided, however, this paragraph 4 shall not in any way limit or affect the obligations or rights of the parties under that Exercise Agreement. b. The Owner shall have the right to make any investment choices permitted by the Policy and that appear on Exhibit A hereto with respect to the cash value of the Policy. Any other investment choices will require the consent of the Employer. c. The Owner's rights shall also include the right to select and change beneficiaries to receive Owner's death benefits. The Owner will not be permitted to borrow against, or partially or totally surrender the Policy as long as the Collateral Assignment remains in force, except as provided in the Exercise Agreement. Any other rights in the Policy other than those specifically - 3 - mentioned in this Agreement must be exercised with the written consent of both the Owner and the Employer. d. Notwithstanding anything to the contrary in this Agreement, Owner shall have the right to assign ownership of the Policy to an insurance trust created by the Owner, provided that any such assignment shall be made expressly subject to the rights and interests of the Employer to the Policy created under this Agreement and under the Exercise Agreement and the trustee thereof shall have executed such instrument as the Employer may reasonably request confirming such rights and interests of the Employer. 5. Assignment of Policy to Secure Employer's Payments. To secure Employer's Interest in the Policy under this Agreement, Owner will collaterally assign the Policy to the Employer by signing the separate Collateral Assignment. The Collateral Assignment cannot be altered without the Employer's, Owner's and Insurer's consent. 6. Termination of Split Dollar Agreement. This Agreement will terminate upon the earliest to occur of the following: a. Death of the Owner and the payment to Employer of all amounts due it hereunder; b. Written agreement of both the Owner and the Employer to terminate this Agreement; c. Termination of Owner's employment; provided however, that if the Employer and Owner are parties to a Supplemental Employment Agreement substantially in the form of Exhibit 4.11 to the Second Amended and Restated Employment Agreement dated as of June 7, 1999, between Employer and Owner, Owner - 4 - shall be deemed to be employed by Employer only if Employee has elected to be bound by Section 5.2(a) thereof; or d. A release of the Collateral Assignment pursuant to Section 7 herein. Upon termination of this Agreement, the Employer shall receive the Employer's Interest in the Policy as soon as is practical, but in no event shall receipt be later than sixty (60) days from the earliest of the dates listed above. In the event of termination of this Agreement for reason other than the death of the Owner, the payment of the Employer's Interest in the Policy and under this Agreement shall be satisfied either directly from the cash value of the Policy or by direct payment by the Owner, at the discretion of the Owner. In this event, the recovery of the Employer's Interest shall be limited to the cash value of the Policy at that time. In the event of termination of this Agreement by reason of the death of the Owner, the Employer's Interest in the Policy and under this Agreement shall be satisfied through direct payment from the Insurer from the Policy proceeds. 7. Release of Collateral Assignment. Upon receipt of the Employer's Interest in the Policy, as provided above, either whether from the Policy, or from the Owner, the Employer will release the Collateral Assignment. Upon satisfaction of the Employer's Interest in the Policy, the Owner shall have unrestricted ownership to the Policy, subject to the terms of the Exercise Agreement. 8. Miscellaneous. a. Not an Employment Agreement. This Agreement does not in any way constitute an employment agreement, and the Employer reserves the right to terminate Owner's employment to the same extent as though this Agreement did not - 5 - exist. This Agreement may be amended at any time by written agreement signed on behalf of the Employer and by the Owner. b. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Employer and its successors and assigns, and to the Owner and the Owner's heirs, executor or personal representative and beneficiaries. c. Notices. Any notice, consent or demand required or permitted under this Agreement shall be made in writing and shall be signed by the party making the notice, consent, or demand. Such notice shall be sent by United States certified mail, postage pre-paid and shall be sent to the other party's last known address as shown on the records of the Employer. The date of such mailing shall be deemed to be the date of such notice, consent or demand. d. Governing Law. This Agreement shall be governed by and be construed in accordance with the laws of the State of Maryland, without reference to the conflicts of laws provisions thereof. 9. Claims Procedures. a. Claimants. Any person or entity claiming a benefit, requesting an interpretation or ruling under the Plan (hereinafter referred to as "Claimant") shall present the request in writing to the Employer, which shall respond in writing as soon as practicable. If the claim or request is denied, the written notice of denial shall state the reason for denial, with specific reference to the provisions on which the denials is based, a description of any additional material or information required and an explanation of why it is necessary, and an explanation of the program's claims review procedure. - 6 - b. Review of Claim. Any Claimant whose claim or request is denied or who has not received a response within sixty (60) days may request a review by notice given in writing to the Employer. Such request must be made within sixty (60) days after receipt by the Claimant of the written notice of denial, or in the event Claimant has not received a response sixty (60) days after receipt by the Employer of Claimant's claim or request. The claim or request shall be reviewed by the Employer which may, but shall not be required to, grant the Claimant a hearing. On review, the Claimant may have representation, examine pertinent documents, and submit issues and comments in writing. c. Final Decision. The decision or review shall normally be made within sixty (60) days after the Employer's receipt of Claimant's claim or request. If an extension of time is required for a hearing or other special circumstances, the Claimant shall be notified and the time limit shall be one hundred twenty (120) days. The decision shall be in writing and shall state the reason and the relevant provisions. All decisions on review shall be final and bind all parties concerned. - 7 - IN WITNESS WHEREOF, the Employer and the Owner have executed and delivered this Split Dollar Agreement, which is effective as of the effective date of the Policy described herein. AMERICAN CAPITAL STRATEGIES. LTD. By: ------------------------------- Name: ------------------------ Title: ------------------------ OWNER ----------------------------------- - ----------------------------- Witness - 8 - EX-10.19 5 LOAN FUNDING AND SERVICING AGREEMENT Exhibit 10.19 -------------- EXECUTION COPY -------------- AMENDMENT NO. 3 TO LOAN FUNDING AND SERVICING AGREEMENT THIS AMENDMENT NO. 3 TO LOAN FUNDING AND SERVICING AGREEMENT, dated as of December 14, 1999 (this "Amendment"), is entered into by and among ACS FUNDING TRUST I ("Borrower"), as Borrower, AMERICAN CAPITAL STRATEGIES, LTD. ("Servicer"), as Servicer, certain INVESTORS, VARIABLE FUNDING CAPITAL CORPORATION ("VFCC"), as a Lender, FIRST UNION SECURITIES, INC. (successor-in-interest to First Union Capital Markets Corp.), as Deal Agent, FIRST UNION NATIONAL BANK ("First Union"), as a Lender and as Liquidity Agent and NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION, as Collateral Custodian and the Backup Servicer. Capitalized terms used and not otherwise defined herein are used as defined in the Agreement (as defined below). WHEREAS, the parties hereto entered into that certain Loan Funding and Servicing Agreement, dated as of March 31, 1999 as amended by that Amendment No. 1, dated as of June 30, 1999, and that Amendment No. 2, dated as of September 24, 1999 (as amended, the "Agreement"); WHEREAS, the parties hereto desire to amend the Agreement in certain respects as provided herein; NOW THEREFORE, in consideration of the premises and the other mutual covenants contained herein, the parties hereto agree as follows: SECTION 1. Amendments. (a) The definition of "Facility Amount" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "Facility Amount: At any time, $225,000,000.00; provided, however, on or after the Termination Date, the Facility Amount shall be zero." (b) The second sentence of Section 2.5(a) of the Agreement is hereby amended and restated in its entirety as follows: "The Notes shall be dated the Closing Date and shall be in a maximum principal amount equal to (i) $225,000,000 in the case of VFCC Note, (ii) $225,000,000 in the case of the Investor Note, and (iii) $10,000,000 in the case of the FUNB Note; provided, however, that anything to the contrary CHAR1\507942_ 1 notwithstanding, the indebtedness of the Borrower evidenced by the Notes shall not in the aggregate exceed the Facility Amount." (c) The Commitment of First Union National Bank as an Investor set forth on the signature pages of the Agreement is hereby amended and restated to be "$225,000,000." (d) The Commitment of First Union National Bank as a Lender set forth on the signature pages of the Agreement is hereby amended and restated to be "$10,000,000." SECTION 2. Increase in Facility Amount and Amount of Notes. Effective on the date of this Amendment, the Facility Amount shall be increased to $225,000,000; provided, that First Union shall first have received executed versions of the Notes referenced in clauses (i), (ii) and (iii) of the succeeding sentence. In connection with such increase, the Borrower agrees to execute and deliver to First Union, on behalf of the holders of the Notes, (i) an amended, restated and substituted VFCC Note in the maximum principal amount of $225,000,000, (ii) an amended, restated and substituted Investor Note in the maximum principal amount of $225,000,000, and (iii) an amended, restated and substituted FUNB Note in the maximum principal amount of $10,000,000 (collectively the "New Notes"). Such New Notes shall replace and supersede any note or notes previously executed by the Borrower pursuant to the Agreement (collectively, the "Replaced Notes"). Such New Notes evidence the same indebtedness, and are secured by the same Collateral as the Replaced Notes. SECTION 3. Agreement in Full Force and Effect as Amended. Except as specifically amended hereby, the Agreement shall remain in full force and effect. All references to the Agreement shall be deemed to mean the Agreement as modified hereby. This Amendment shall not constitute a novation of the Agreement, but shall constitute an amendment thereof. The parties hereto agree to be bound by the terms and conditions of the Agreement, as amended by this Agreement, as though such terms and conditions were set forth herein. SECTION 4. Representations. Each of the Borrower and Servicer represent and warrant as of the date of this Amendment as follows: (i) it is duly incorporated or organized, validly existing and in good standing under the laws of its jurisdiction of incorporation or organization; (ii) the execution, delivery and performance by it of this Amendment are within its powers, have been duly authorized, and do not contravene (A) its charter, by-laws, or other organizational documents, or (B) any Applicable Law; (iii) no consent, license, permit, approval or authorization of, or registration, filing or declaration with any governmental authority, is required in connection with the execution, delivery, performance, validity or enforceability of this Amendment by or against it; (iv) this Amendment has been duly executed and delivered by it; 2 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) (v) this Amendment constitutes its legal, valid and binding obligation enforceable against it in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally or by general principles of equity; (vi) it is not in default under the Agreement; and (vii) there is no Termination Event, Unmatured Termination Event, or Servicer Termination Event; SECTION 5. Expenses. In connection with the execution of this Amendment, the Borrower agrees to pay all reasonable and actual costs and expenses (including without limitation the reasonable fees and expenses of legal counsel) of Canadian Imperial Bank of Commerce ("CIBC") and VFCC, respectively, incurred in connection with the review and negotiation of this Amendment. SECTION 6. Conditions Precedent. The effectiveness of this Amendment is subject to the following conditions precedent: (i) execution and delivery to First Union of the New Notes; (ii) delivery to the Deal Agent and CIBC of a copy of this Amendment duly executed by each of the parties hereto; (iii) delivery to the Deal Agent and CIBC (in a form acceptable to the Deal Agent) of a due authorization, execution and enforceability opinion with respect to this Amendment; and (iv) such other documents, agreements, certification, or legal opinions as the Deal Agent, may reasonably require. SECTION 7. Miscellaneous. (a) This Amendment may be executed in any number of counterparts, and by the different parties hereto on the same or separate counterparts, each of which shall be deemed to be an original instrument but all of which together shall constitute one and the same agreement. (b) The descriptive headings of the various sections of this Amendment are inserted for convenience of reference only and shall not be deemed to affect the meaning or construction of any of the provisions hereof. (c) This Amendment may not be amended or otherwise modified except as provided in the Agreement. (d) First Union certifies by execution hereof that it is an Investor with Commitments in excess of 66-2/3% of the Facility Amount, and therefore is a Required Investor pursuant to the Agreement. (e) The failure or unenforceability of any provision hereof shall not affect the other provisions of this Amendment. 3 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) (f) Whenever the context and construction so require, all words used in the singular number herein shall be deemed to have been used in the plural, and vice versa, and the masculine gender shall include the feminine and neuter and the neuter shall include the masculine and feminine. (g) This Amendment represents the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous or subsequent oral agreements between the parties. There are no unwritten oral agreements between the parties. (h) THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICT OF LAWS PROVISIONS. [Remainder of Page Intentionally Left Blank] 4 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) IN WITNESS WHEREOF, the parties have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written. THE BORROWER: ACS FUNDING TRUST I By: ------------------------------ Name: ------------------------------ Title: ------------------------------ ACS Funding Trust I c/o American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301) 951-6122 THE SERVICER: AMERICAN CAPITAL STRATEGIES, LTD. By: ------------------------------ Name: ------------------------------ Title: ------------------------------ American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301 951-6122 [SIGNATURES CONTINUED ON FOLLOWING PAGE] S-1 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) THE INVESTORS: FIRST UNION NATIONAL BANK By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- Commitment: $225,000,000.00 First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Confirmation No: (704) 374-4001 LENDER: VARIABLE FUNDING CAPITAL CORPORATION By First Union Securities, Inc. (successor-in-interest to First Union Capital Markets Corp.), as attorney-in-fact By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- Variable Funding Capital Corporation c/o First Union Securities, Inc. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Confirmation No.: (704) 383-9343 With a copy to: Lord Securities Corp. 2 Wall Street, 19th Floor Attention: Vice President Facsimile No.: (212) 346-9012 Confirmation No.: (212) 346-9008 [SIGNATURES CONTINUED ON FOLLOWING PAGE] S-2 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) THE BACKUP SERVICER: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue Minneapolis, MN 55479-0070 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 THE COLLATERAL CUSTODIAN: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue Minneapolis, MN 55479-0070 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 [SIGNATURES CONTINUED ON THE FOLLOWING PAGE] S-3 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) THE DEAL AGENT: FIRST UNION SECURITIES, INC. (successor-in-interest to First Union Capital Markets Corp.) By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- First Union Capital Markets Corp. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Telephone No.: (704) 383-9343 LENDER AND LIQUIDITY AGENT FIRST UNION NATIONAL BANK By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Telephone No.: (704) 374-4001 Lender Commitment: $10,000,000 [SIGNATURES CONTINUED ON FOLLOWING PAGE] S-4 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) CONSENTED TO: CANADIAN IMPERIAL BANK OF COMMERCE By: ----------------------------------------- Name: ----------------------------------------- Title: ----------------------------------------- Canadian Imperial Bank of Commerce 425 Lexington Avenue, 7th Floor New York, New York 10017 Attention: Asset Securitization Group - Credit Administration Reference: American Capital Strategies Facsimile No.: (212) 856-3643 Confirmation No.: (212) 856-3753 S-5 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) -------------- EXECUTION COPY -------------- AMENDMENT NO. 2 TO LOAN FUNDING AND SERVICING AGREEMENT THIS AMENDMENT NO. 2 TO LOAN FUNDING AND SERVICING AGREEMENT, dated as of September 24, 1999 (this "Amendment"), is entered into by and among ACS FUNDING TRUST I ("Borrower"), as Borrower, AMERICAN CAPITAL STRATEGIES, LTD. ("Servicer"), as Servicer, certain Investors, VARIABLE FUNDING CAPITAL CORPORATION ("VFCC"), as a Lender, FIRST UNION CAPITAL MARKETS CORP., as Deal Agent, FIRST UNION NATIONAL BANK ("First Union"), as a Lender and as Liquidity Agent and NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION, as Collateral Custodian and the Backup Servicer. Capitalized terms used and not otherwise defined herein are used as defined in the Agreement (as defined below). WHEREAS, the parties hereto entered into that certain Loan Funding and Servicing Agreement, dated as of March 31, 1999 (the "Agreement"); WHEREAS, the parties amended the Agreement pursuant to Amendment No. 1 to Loan Funding and Servicing Agreement, dated as of June 30, 1999 (the Agreement as amended shall be referred to herein as the "Agreement"); and WHEREAS, the parties hereto desire to amend the Agreement in certain respects as provided herein. NOW THEREFORE, in consideration of the premises and the other mutual covenants contained herein, the parties hereto agree as follows: SECTION 8. Amendments. (a) The definition of "Commitment Termination Date" in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "Commitment Termination Date: March 31, 2001 or such later date to which the Commitment Termination Date may be extended (if extended) in the sole discretion of VFCC and each Investor in accordance with the terms of Section 2.2(b); provided, however in the event that the Borrower fails to deliver or fails to cause the Servicer to deliver (i) a draft of its Credit and Collection Policy and revised loan grading system in a form satisfactory to the Deal Agent (in its sole discretion) on or before September 30, 1999, or (ii) a final version of its Credit and Collection Policy and revised loan grading system in a form satisfactory to the Deal Agent (in its sole discretion) on or before October 30, 1999, the Commitment Termination Date shall be March 29, 2000." 1 CHAR1\507942_ 1 Amendment No. 3 to Loan Funding and Servicing Agreement (American Capital Strategies) (b) Section 6.25(a)(xi) of the Agreement is hereby amended by deleting the "or" at the end thereof; (c) Section 6.25(a)(xii) of the Agreement is hereby amended and restated in its entirety as follows: "(xii) on or before September 30, 1999, a draft of its Credit and Collection Policy and revised loan grading system are not delivered to the Deal Agent by the Borrower and the Servicer in a form acceptable to the Deal Agent; or" (d) Section 6.25(a)(xiii) of the Agreement is hereby amended by adding the following: "(xiii) on or before October 29, 1999, a final version of its Credit and Collection Policy and revised loan grading system are not delivered to the Deal Agent and Borrower and Servicer in a form acceptable to the Deal Agent." SECTION 9. Agreement in Full Force and Effect as Amended. Except as specifically amended hereby, the Agreement shall remain in full force and effect. All references to the Agreement shall be deemed to mean the Agreement as modified hereby. This Amendment shall not constitute a novation of the Agreement, but shall constitute an amendment thereof. The parties hereto agree to be bound by the terms and conditions of the Agreement, as amended by this Agreement, as though such terms and conditions were set forth herein. SECTION 10. Representations. The Borrower and Servicer represent and warrant that, as of the effective date of this Amendment (i) they are not in default under the Agreement and (ii) there are no Termination Events, Unmatured Termination Events or Servicer Termination Events under the Agreement. SECTION 11. Miscellaneous. (a) This Amendment may be executed in any number of counterparts, and by the different parties hereto on the same or separate counterparts, each of which shall be deemed to be an original instrument but all of which together shall constitute one and the same agreement. (b) The descriptive headings of the various sections of this Amendment are inserted for convenience of reference only and shall not be deemed to affect the meaning or construction of any of the provisions hereof. (c) This Amendment may not be amended or otherwise modified except as provided in the Agreement. CHAR1\KPK\BANK\485213_ 3 2 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) (d) First Union certifies by execution hereof that it is an Investor with Commitments in excess of 66-2/3% of the Facility Amount, and therefore is a Required Investor pursuant to the Agreement. (e) The failure or unenforceability of any provision hereof shall not affect the other provisions of this Amendment. (f) Whenever the context and construction so require, all words used in the singular number herein shall be deemed to have been used in the plural, and vice versa, and the masculine gender shall include the feminine and neuter and the neuter shall include the masculine and feminine. (g) This Amendment represents the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous or subsequent oral agreements between the parties. There are no unwritten oral agreements between the parties. CHAR1\KPK\BANK\485213_ 3 3 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) (h) THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICT OF LAWS PROVISIONS. [Remainder of Page Intentionally Left Blank] CHAR1\KPK\BANK\485213_ 3 4 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) IN WITNESS WHEREOF, the parties have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written. THE BORROWER: ACS FUNDING TRUST I By --------------------------------- Title: ACS Funding Trust I c/o American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301) 951-6122 THE SERVICER: AMERICAN CAPITAL STRATEGIES, LTD. By --------------------------------- Title: American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301 951-6122 [SIGNATURES CONTINUED ON FOLLOWING PAGE] CHAR1\KPK\BANK\485213_ 3 S-1 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) THE INVESTORS: FIRST UNION NATIONAL BANK By --------------------------------- Title: Commitment: $125,000,000.00 First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Confirmation No: (704) 374-4001 LENDER: VARIABLE FUNDING CAPITAL CORPORATION By First Union Capital Markets Corp., as attorney-in-fact By --------------------------------- Title: Variable Funding Capital Corporation c/o First Union Capital Markets Corp. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Confirmation No.: (704) 383-9343 With a copy to: Lord Securities Corp. 2 Wall Street, 19th Floor Attention: Vice President Facsimile No.: (212) 346-9012 Confirmation No.: (212) 346-9008 [SIGNATURES CONTINUED ON FOLLOWING PAGE] CHAR1\KPK\BANK\485213_ 3 S-2 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) THE BACKUP SERVICER: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By --------------------------------- Title: Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue MAC N9311-161 Minneapolis, MN 55479 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 THE COLLATERAL CUSTODIAN: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By --------------------------------- Title: Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue MAC N9311-161 Minneapolis, MN 55479 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 [SIGNATURES CONTINUED ON THE FOLLOWING PAGE] CHAR1\KPK\BANK\485213_ 3 S-3 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) THE DEAL AGENT: FIRST UNION CAPITAL MARKETS CORP. By --------------------------------- Title: First Union Capital Markets Corp. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Telephone No.: (704) 383-9343 LENDER AND LIQUIDITY AGENT FIRST UNION NATIONAL BANK By --------------------------------- Title: First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Telephone No.: (704) 374-4001 Lender Commitment: $30,000,000 until the Swingline Reduction Date, and then $10,000,000 thereafter. CHAR1\KPK\BANK\485213_ 3 S-4 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) Consented and Agreed to this 24thday of September, 1999: CANADIAN IMPERIAL BANK OF COMMERCE By --------------------------------- Title: Canadian Imperial Bank of Commerce 425 Lexington Avenue, 7th Floor New York, New York 10017 Attention: Asset Securitization Group-Credit Administration-American Capital Strategies Facsimile No.: (212) 856-3643 Confirmation No.: (212) 856-3753 CHAR1\KPK\BANK\485213_ 3 S-5 Amendment No. 2 to Loan Funding and Servicing Agreement (American Capital Strategies) -------------- EXECUTION COPY -------------- AMENDMENT NO. 1 TO LOAN FUNDING AND SERVICING AGREEMENT THIS AMENDMENT NO. 1 TO LOAN FUNDING AND SERVICING AGREEMENT, dated as of June 30, 1999 (this "Amendment"), is entered into by and among ACS FUNDING TRUST I ("Borrower"), as Borrower, AMERICAN CAPITAL STRATEGIES, LTD. ("Servicer"), as Servicer, certain Investors, VARIABLE FUNDING CAPITAL CORPORATION ("VFCC"), as a Lender, FIRST UNION CAPITAL MARKETS CORP., as Deal Agent, FIRST UNION NATIONAL BANK ("First Union"), as a Lender and as Liquidity Agent and NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION, as Collateral Custodian and the Backup Servicer. Capitalized terms used and not otherwise defined herein are used as defined in the Agreement (as defined below). WHEREAS, the parties hereto entered into that certain Loan Funding and Servicing Agreement, dated as of March 31, 1999 (the "Agreement"); WHEREAS, the parties hereto desire to amend the Agreement in certain respects as provided herein; NOW THEREFORE, in consideration of the premises and the other mutual covenants contained herein, the parties hereto agree as follows: SECTION 12. Amendments. (a) The definition of "Concentration Limits" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "Concentration Limits: On any date of determination, each of the following (calculated on the basis of Aggregate Outstanding Loan Balance): (a) the sum of the Outstanding Loan Balances of Eligible Loans the Obligors of which are residents of any one state shall not exceed 35%; (b) the sum of the Outstanding Loan Balances of Eligible Loans the Obligors of which are in the same Industry shall not exceed 10%; (c) the Outstanding Loan Balance of any Eligible Loan shall not exceed the Large Loan Limit; (d) the sum of the Outstanding Loan Balances of Eligible Loans the Obligors of which are Grade 2 Obligors shall not exceed 10%; CHAR1\KPK\BANK\477154_ 10 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) (e) the sum of the Outstanding Loan Balances of Eligible Loans that have interest due and payable monthly shall not be less than 50%; (f) the sum of the Outstanding Loan Balances of Eligible Loans that are secured by a security interest in all assets of the related Obligor shall not be less than 75%; (g) the sum of the Outstanding Loan Balance of Eligible Loans that are PIK Loans shall not exceed 30%; and (h) with respect to each PIK Loan included as a part of the Collateral, at least a portion of the monthly or quarterly interest that is due under the PIK Loan must be payable by Obligor thereof in cash or such Obligor shall have another Loan included as part of the Collateral that pays current monthly or quarterly interest in cash." (b) The definition of "Facility Amount" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "Facility Amount: At any time, $125,000,000.00; provided, however, on or after the Termination Date, the Facility Amount shall be zero." (c) Section (ii) of the definition of "Grade 1 Obligor" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "(ii) an Obligor designated by the Servicer, prior to delivery of the Credit and Collection Policy, as a `Grade 1 Obligor' with the prior written consent of the Deal Agent." (d) Section (ii) of the definition of "Grade 2 Obligor" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "(ii) an Obligor designated by the Servicer, prior to delivery of the Credit and Collection Policy, as a `Grade 2 Obligor' with the prior written consent of the Deal Agent." (e) Section (ii) of the definition of "Grade 3 Obligor" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "(ii) an Obligor designated by the Servicer, prior to delivery of the Credit and Collection Policy, as a `Grade 3 Obligor' with the prior written consent of the Deal Agent." CHAR1\KPK\BANK\477154_ 10 2 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) (f) Section (ii) of the definition of "Grade 4 Obligor" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "(ii) an Obligor designated by the Servicer, prior to delivery of the Credit and Collection Policy, as a `Grade 4 Obligor' with the prior written consent of the Deal Agent." (g) The definition of "Large Loan Limit" contained in Section 1.1 of the Agreement is hereby amended and restated to read in its entirety as follows: "Large Loan Limit: (i) $10,000,000.00, provided the Aggregate Outstanding Loan Balance is less than $200,000,000.00, (ii) $13,000,000.00, provided by the Aggregate Outstanding Loan Balance is at least $200,000,000.00 but less than $300,000,000.00, and (iii) $15,000,000.00, provided the Aggregate Outstanding Loan Balance is at least $300,000,000.00. (h) The first line of Section 2.2(d) of the Agreement is hereby amended and restated to read in its entirety as follows: "No later than 12:00 p.m. (New York City time) on the proposed Funding Date, the". (i) The second sentence of Section 2.5(a) of the Agreement is hereby amended and restated in its entirety as follows: "The Notes shall be dated the Closing Date and shall be in a maximum principal amount equal to (i) $125,000,000 in the case of VFCC Note, (ii) $125,000,000 in the case of the Investor Note, and (iii) (a) $30,000,000 from the date of this Amendment through and including July 30, 1999 (the "Swingline Reduction Date") and (b) $10,000,000 after July 30, 1999, in the case of the FUNB Note; provided, however, that anything to the contrary notwithstanding, the indebtedness of the Borrower evidenced by the Notes shall not in the aggregate exceed the Facility Amount; provided, further, on the Swingline Reduction Date, the Borrower shall reduce the amount of FUNB Advances outstanding to an amount not to exceed the maximum principal amount of the FUNB Note and shall execute and deliver to First Union a second amended, restated and substituted FUNB Note in the maximum principal amount of $10,000,000." (j) Section 3.2 of the Agreement is hereby amended as follows: (i) Section 3.2(a)(ii) is hereby amended and restated to read in its entirety as follows: CHAR1\KPK\BANK\477154_ 10 3 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) "(ii) No event has occurred, or would result from such Advance or from the application of proceeds therefrom, that constitutes a Termination Event or an Unmatured Termination Event;"; (ii) Section 3.2(g) is amended by deleting the word "and" at the end thereof; (iii) Section 3.2(h) is amended by deleting the period at the end thereof and substituting in its place the following: "; and"; and (iv) The following new Section 3.2(i) is hereby added to the end of Section 3.2: "(i) After giving effect to the Advance or reinvestment of Available Collections, the weighted average life of the Aggregate Outstanding Loan Balance will not exceed eight (8) years." (k) The second sentence of Section 4.1(v) of the Agreement is hereby amended and restated to read in its entirety as follows: "The Deal Agent, as agent for the Secured Parties, has a first priority perfected security interest in the Collateral." (l) The first sentence of Section 6.9(g) is hereby amended and restated to read in its entirety as follows: "The Servicer will (a) comply in all material respects with the Credit and Collection Policy in regard to each Loan and (b) furnish to the Deal Agent and any Lender, prior to its effective date, prompt notice of any change in the Credit and Collection Policy." (m) Section 7.1(n) of the Agreement is hereby amended and restated to read in its entirety as follows: "(n) the Borrower or the Servicer agrees or consents to, or otherwise permits to occur, any amendment, modification, change, supplement or recession of or to the Credit and Collection Policy in whole or in part that could have a material adverse effect upon the Loans or interest of any Lender, without the prior written consent of the Deal Agent and the other Lenders; or". (n) Section 9.6 of the Agreement is hereby amended by deleting therefrom all references to "VFCC." CHAR1\KPK\BANK\477154_ 10 4 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) (o) The following new Section 9.9 is added to the end of Section 9: "The Deal Agent shall provide to Canadian Imperial Bank of Commerce a copy of the Monthly Report and the credit report and transaction summary referenced to in Section 2.2(c) within two (2) Business Days following the Deal Agent's receipt of same." (p) The Commitment of First Union National Bank as an Investor set forth on the signature pages of the Agreement is hereby amended and restated to be "$125,000,000." (q) The Commitment of First Union National Bank as a Lender set forth on the signature pages of the Agreement is hereby amended and restated to be "$30,000,000 until the Swingline Reduction Date, and $10,000,000 thereafter." SECTION 13. Increase in Facility Amount and Amount of Notes. Effective on the date of this Amendment, the Facility Amount shall be increased to $125,000,000; provided, that First Union shall first have received executed versions of the Notes referenced in clauses (i), (ii) and (iii)(a) of the succeeding sentence. In connection with such increase, the Borrower agrees to execute and deliver to First Union, on behalf of the holders of the Notes, (i) an amended, restated and substituted VFCC Note in the maximum principal amount of $125,000,000, (ii) an amended, restated and substituted FUNB Note in the maximum principal amount of $125,000,000, and (iii) (a) an amended, restated and substituted FUNB Note in the maximum principal amount of $30,000,000, and (b) on the Swingline Reduction Date, a second amended and restated FUNB Note in the maximum principal amount of $10,000,000 (collectively the "New Notes"). Such New Notes shall replace and supersede any note or notes previously executed by the Borrower pursuant to the Agreement (collectively, the "Replaced Notes"). Such New Notes evidence the same indebtedness, and are secured by the same Collateral as the Replaced Notes. SECTION 14. Agreement in Full Force and Effect as Amended. Except as specifically amended hereby, the Agreement shall remain in full force and effect. All references to the Agreement shall be deemed to mean the Agreement as modified hereby. This Amendment shall not constitute a novation of the Agreement, but shall constitute an amendment thereof. The parties hereto agree to be bound by the terms and conditions of the Agreement, as amended by this Agreement, as though such terms and conditions were set forth herein. SECTION 15. Representations. The Borrower and Servicer represent and warrant that, as of the effective date of this Amendment (i) they are not in default under the Agreement and (ii) there are no Termination Events, Unmatured Termination Events or Servicer Termination Events under the Agreement. SECTION 16. Expenses. In connection with the execution of this Amendment, the Borrower agrees to pay all reasonable and actual costs and expenses (including without CHAR1\KPK\BANK\477154_ 10 5 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) limitation the reasonable fees and expenses of legal counsel) of CIBC and First Union, respectively, incurred in connection with the negotiation and preparation of the Participation Agreement, dated as of even date with this Amendment, between CIBC and First Union. SECTION 17. Miscellaneous. (a) This Amendment may be executed in any number of counterparts, and by the different parties hereto on the same or separate counterparts, each of which shall be deemed to be an original instrument but all of which together shall constitute one and the same agreement. (b) The descriptive headings of the various sections of this Amendment are inserted for convenience of reference only and shall not be deemed to affect the meaning or construction of any of the provisions hereof. (c) This Amendment may not be amended or otherwise modified except as provided in the Agreement. (d) First Union certifies by execution hereof that it is an Investor with Commitments in excess of 66-2/3% of the Facility Amount, and therefore is a Required Investor pursuant to the Agreement. (e) The failure or unenforceability of any provision hereof shall not affect the other provisions of this Amendment. (f) Whenever the context and construction so require, all words used in the singular number herein shall be deemed to have been used in the plural, and vice versa, and the masculine gender shall include the feminine and neuter and the neuter shall include the masculine and feminine. (g) This Amendment represents the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous or subsequent oral agreements between the parties. There are no unwritten oral agreements between the parties. CHAR1\KPK\BANK\477154_ 10 6 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) (h) THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICT OF LAWS PROVISIONS. [Remainder of Page Intentionally Left Blank] CHAR1\KPK\BANK\477154_ 10 7 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) IN WITNESS WHEREOF, the parties have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written. THE BORROWER: ACS FUNDING TRUST I By --------------------------------- Title: ACS Funding Trust I c/o American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301) 951-6122 THE SERVICER: AMERICAN CAPITAL STRATEGIES, LTD. By --------------------------------- Title: American Capital Strategies, Ltd. 3 Bethesda Metro Center, Suite 860 Bethesda, Maryland 20814 Attention: President Facsimile No.: (301) 654-6714 Confirmation No.: (301 951-6122 [SIGNATURES CONTINUED ON FOLLOWING PAGE] CHAR1\KPK\BANK\477154_ 10 S-1 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) THE INVESTORS: FIRST UNION NATIONAL BANK By --------------------------------- Title: Commitment: $125,000,000.00 First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Confirmation No: (704) 374-4001 LENDER: VARIABLE FUNDING CAPITAL CORPORATION By First Union Capital Markets Corp., as attorney-in-fact By --------------------------------- Title: Variable Funding Capital Corporation c/o First Union Capital Markets Corp. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Confirmation No.: (704) 383-9343 With a copy to: Lord Securities Corp. 2 Wall Street, 19th Floor Attention: Vice President Facsimile No.: (212) 346-9012 Confirmation No.: (212) 346-9008 [SIGNATURES CONTINUED ON FOLLOWING PAGE] CHAR1\KPK\BANK\477154_ 10 S-2 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) THE BACKUP SERVICER: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By --------------------------------- Title: Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue Minneapolis, MN 55479-0070 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 THE COLLATERAL CUSTODIAN: NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION By --------------------------------- Title: Norwest Bank Minnesota, National Association Sixth Street and Marquette Avenue Minneapolis, MN 55479-0070 Attention: Corporate Trust Services Asset-Backed Administration Facsimile No.: (612) 667-3464 Confirmation No.: (612) 667-8058 [SIGNATURES CONTINUED ON THE FOLLOWING PAGE] CHAR1\KPK\BANK\477154_ 10 S-3 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) THE DEAL AGENT: FIRST UNION CAPITAL MARKETS CORP. By --------------------------------- Title: First Union Capital Markets Corp. One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Conduit Administration Facsimile No.: (704) 383-6036 Telephone No.: (704) 383-9343 LENDER AND LIQUIDITY AGENT FIRST UNION NATIONAL BANK By --------------------------------- Title: First Union National Bank One First Union Center, TW-9 Charlotte, North Carolina 28288 Attention: Capital Markets Credit Administration Facsimile No.: (704) 374-3254 Telephone No.: (704) 374-4001 Lender Commitment: $30,000,000 until the Swingline Reduction Date, and then $10,000,000 thereafter. CHAR1\KPK\BANK\477154_ 10 S-4 Amendment No. 1 to Loan Funding and Servicing Agreement (American Capital Strategies) EX-10.20 6 INVESTOR NOTE Exhibit 10.20 AMENDED, RESTATED AND SUBSTITUTED INVESTOR NOTE $225,000,000 March 31, 1999 FOR VALUE RECEIVED, ACS FUNDING TRUST I, a Delaware business trust (the "Borrower"), promises to pay to the INVESTORS named below (the "Lender"), or registered assigns, the principal sum of TWO HUNDRED AND TWENTY-FIVE MILLION DOLLARS ($225,000,000) or, if less, the unpaid principal amount of the aggregate loans ("Advances") made by the Lender to the Borrower pursuant to the Loan Funding and Servicing Agreement (as defined below), as set forth on the attached Schedule, on the dates specified in Section 2.6 of the Loan Funding and Servicing Agreement, and to pay interest on the unpaid principal amount of each Advance on each day that such unpaid principal amount is outstanding at the Interest Rate related to such Advance as provided in the Loan Funding and Servicing Agreement on each Payment Date and each other dates specified in the Loan Funding and Servicing Agreement. This Amended, Restated and Substituted Investor Note (the "Note") is issued pursuant to the Loan Funding and Servicing Agreement, dated as of March 31, 1999 (as amended, modified, supplemented or restated from time to time, the "Loan Funding and Servicing Agreement"), by and among the Borrower, American Capital Strategies, Ltd., as servicer, Variable Funding Capital Corporation, as a lender, the Investors named therein (the "Investors"), Norwest Bank Minnesota, National Association, as backup servicer and as collateral custodian, First Union Securities, Inc. (successor-in-interest to First Union Capital Markets Corp.), as deal agent, and First Union National Bank, as a lender and as liquidity agent. Capitalized terms used but not defined in this Note are used with the meanings ascribed to them in the Loan Funding and Servicing Agreement. Notwithstanding any other provisions contained in this Note, if at any time the rate of interest payable by the Borrower under this Note, when combined with any and all other charges provided for in this Note, in the Loan Funding and Servicing Agreement or in any other document (to the extent such other charges would constitute interest for the purpose of any applicable law limiting interest that may be charged on this Note), exceeds the highest rate of interest permissible under applicable law (the "Maximum Lawful Rate"), then so long as the Maximum Lawful Rate would be exceeded the rate of interest under this Note shall be equal to the Maximum Lawful Rate. If at any time thereafter the rate of interest payable under this Note is less than the Maximum Lawful Rate, the Borrower shall continue to pay interest under this Note at the Maximum Lawful Rate until such time as the total interest paid by the Borrower is equal to the total interest that would have been paid had applicable law not limited the interest rate payable under this Note. In no event shall the total interest received by the Lender under CHAR1\508039_ 1 this Note exceed the amount which the Lender could lawfully have received had the interest due under this Note been calculated since the date of this Note at the Maximum Lawful Rate. Payments of the principal of, and interest on, Advances represented by this Note shall be made by the Borrower to the holder hereof by wire transfer of immediately available funds in the manner and at the address specified for such purpose as provided in Article 2 of the Loan Funding and Servicing Agreement, or in such manner or at such other address as the holder of this Note shall have specified in writing to the Borrower for such purpose, without the presentation or surrender of this Note or the making of any notation on this Note. If any payment under this Note falls due on a day that is not a Business Day, then such due date shall be extended to the next succeeding Business Day and interest shall be payable on any principal so extended at the applicable Interest Rate. If all or a portion of (i) the principal amount hereof or (ii) any interest payable thereon or (iii) any other amounts payable hereunder shall not be paid when due (whether at maturity, by acceleration or otherwise), such overdue amount shall bear interest at a rate per annum that is equal to the Base Rate plus 1.0%, in each case from the date of such non-payment to (but excluding) the date such amount is paid in full. Portions or all of the principal amount of the Note shall become due and payable at the time or times set forth in the Loan Funding and Servicing Agreement. Any portion or all of the principal amount of this Note may be prepaid, together with interest thereon (and as set forth in the Loan Funding and Servicing Agreement, certain costs and expenses of the Lender) at the time and in the manner set forth in, but subject to the provisions of, the Loan Funding and Servicing Agreement. Except as provided in the Loan Funding and Servicing Agreement, the Borrower expressly waives presentment, demand, diligence, protest and all notices of any kind whatsoever with respect to this Note. All amounts evidenced by this Note, the Lender or Lenders making such Advance and all payments and prepayments of the principal hereof and the respective dates and maturity dates thereof shall be endorsed by Deal Agent, as agent for the Lender, on the schedule attached hereto and made a part hereof or on a continuation thereof which shall be attached hereto and made a part hereof, or otherwise recorded by the Deal Agent or Lender in its internal records; provided, however, that the failure of Deal Agent to make such a notation shall not in any way limit or otherwise affect the obligations of the Borrower under this Note as provided in the Loan Funding and Servicing Agreement. The holder hereof may sell, assign, transfer, negotiate, grant participations in or otherwise dispose of all or any portion of any Advances made by such Lender and represented by this Note and the indebtedness evidenced by this Note. This Note is secured by the security interests granted pursuant to Section 2.9 of the Loan Funding and Servicing Agreement. The holder of this Note is entitled to the benefits of the Loan CHAR1\508039_ 1 2 Funding and Servicing Agreement and may enforce the agreements of the Borrower contained in the Loan Funding and Servicing Agreement and exercise the remedies provided for by, or otherwise available in respect of, the Loan Funding and Servicing Agreement, all in accordance with, and subject to the restrictions contained in, the terms of the Loan Funding and Servicing Agreement. If a Termination Event shall occur and be continuing, the unpaid balance of the principal of all Advances, together with accrued interest thereon, shall be declared, and become due and payable in the manner and with the effect provided in the Loan Funding and Servicing Agreement. This Note is the "Investors Note" referred to in the Loan Funding and Servicing Agreement. This Note shall be construed in accordance with and governed by the laws of the State of New York. This Note is intended to be an amendment to, and replacement of, the Investor Note, dated March 31, 1999, in the maximum principal amount of $125,000,000 (the "Replaced Note"). This Note evidences the same indebtedness and is secured by the same Collateral securing the Replaced Note and is not intended to constitute a novation in any manner. [Remainder of Page Intentionally Left Blank] CHAR1\508039_ 1 3 IN WITNESS WHEREOF, the undersigned has executed this Note as on the date first written above. ACS FUNDING TRUST I By: -------------------------------- Name: ------------------------------ Title: ----------------------------- CHAR1\508039_ 1 4 Schedule to Note
Name Date of Principal Principal Outstanding of Advance or Amount of Amount of Principal Lender Repayment Advance Repayment Amount ------ --------- ------- --------- ------
EX-10.21 7 FUNB NOTE Exhibit 10.21 AMENDED, RESTATED AND SUBSTITUTED FUNB NOTE $10,000,000 March 31, 1999 FOR VALUE RECEIVED, ACS FUNDING TRUST I, a Delaware business trust (the "Borrower"), promises to pay to FIRST UNION NATIONAL BANK (the "Lender"), or registered assigns, the principal sum of TEN MILLION DOLLARS ($10,000,000) or, if less, the unpaid principal amount of the aggregate loans ("Advances") made by the Lender (as defined below) to the Borrower pursuant to the Loan Funding and Servicing Agreement (as defined below), as set forth on the attached Schedule, on the dates specified in Section 2.6 of the Loan Funding and Servicing Agreement, and to pay interest on the unpaid principal amount of each Advance on each day that such unpaid principal amount is outstanding at the Interest Rate related to such Advance as provided in the Loan Funding and Servicing Agreement on each Payment Date and each other dates specified in the Loan Funding and Servicing Agreement. This Amended, Restated and Substituted FUNB Note is issued pursuant to the Loan Funding and Servicing Agreement, dated as of March 31, 1999 (as amended, modified, supplemented, or restated from time to time, the "Loan Funding and Servicing Agreement"), by and among the Borrower, American Capital Strategies, Ltd., as servicer, Variable Funding Capital Corporation, as a lender, the Investors named therein, Norwest Bank Minnesota, National Association, as backup servicer and as collateral custodian, First Union Securities, Inc. (successor-in-interest to First Union Capital Markets Corp.), as deal agent, and First Union National Bank, as liquidity agent. Capitalized terms used but not defined in this Note are used with the meanings ascribed to them in the Loan Funding and Servicing Agreement. Notwithstanding any other provisions contained in this Note, if at any time the rate of interest payable by the Borrower under this Note, when combined with any and all other charges provided for in this Note, in the Loan Funding and Servicing Agreement or in any other document (to the extent such other charges would constitute interest for the purpose of any applicable law limiting interest that may be charged on this Note), exceeds the highest rate of interest permissible under applicable law (the "Maximum Lawful Rate"), then so long as the Maximum Lawful Rate would be exceeded the rate of interest under this Note shall be equal to the Maximum Lawful Rate. If at any time thereafter the rate of interest payable under this Note is less than the Maximum Lawful Rate, the Borrower shall continue to pay interest under this Note at the Maximum Lawful Rate until such time as the total interest paid by the Borrower is equal to the total interest that would have been paid had applicable law not limited the interest rate payable under this Note. In no event shall the total interest received by the Lender under this Note exceed the amount which the Lender could lawfully have received had the interest due under this Note been calculated since the date of this Note at the Maximum Lawful Rate. CHAR1\508036_ 1 Payments of the principal of, and interest on, Advances represented by this Note shall be made by the Borrower to the holder hereof by wire transfer of immediately available funds in the manner and at the address specified for such purpose as provided in Article 2 of the Loan Funding and Servicing Agreement, or in such manner or at such other address as the holder of this Note shall have specified in writing to the Borrower for such purpose, without the presentation or surrender of this Note or the making of any notation on this Note. If any payment under this Note falls due on a day that is not a Business Day, then such due date shall be extended to the next succeeding Business Day and interest shall be payable on any principal so extended at the applicable Interest Rate. If all or a portion of (i) the principal amount hereof or (ii) any interest payable thereon or (iii) any other amounts payable hereunder shall not be paid when due (whether at maturity, by acceleration or otherwise), such overdue amount shall bear interest at a rate per annum that is equal to the Base Rate plus 1.0%, in each case from the date of such non-payment to (but excluding) the date such amount is paid in full. Portions or all of the principal amount of the Note shall become due and payable at the time or times set forth in the Loan Funding and Servicing Agreement. Any portion or all of the principal amount of this Note may be prepaid, together with interest thereon (and as set forth in the Loan Funding and Servicing Agreement, certain costs and expenses of the Lender) at the time and in the manner set forth in, but subject to the provisions of, the Loan Funding and Servicing Agreement. Except as provided in the Loan Funding and Servicing Agreement, the Borrower expressly waives presentment, demand, diligence, protest and all notices of any kind whatsoever with respect to this Note. All amounts evidenced by this Note, the Lender or Lenders making such Advance and all payments and prepayments of the principal hereof and the respective dates and maturity dates thereof shall be endorsed by Deal Agent, as agent for the Lender, on the schedule attached hereto and made a part hereof or on a continuation thereof which shall be attached hereto and made a part hereof, or otherwise recorded by such Deal Agent or Lender in its internal records; provided, however, that the failure of the Deal Agent to make such a notation shall not in any way limit or otherwise affect the obligations of the Borrower under this Note as provided in the Loan Funding and Servicing Agreement. The holder hereof may sell, assign, transfer, negotiate, grant participations in or otherwise dispose of all or any portion of any Advances made by such Lender and represented by this Note and the indebtedness evidenced by this Note. This Note is secured by the security interests granted pursuant to Section 2.9 of the Loan Funding and Servicing Agreement. The holder of this Note is entitled to the benefits of the Loan Funding and Servicing Agreement and may enforce the agreements of the Borrower contained in the Loan Funding and Servicing Agreement and exercise the remedies provided for by, or 2 CHAR1\508036_ 1 otherwise available in respect of, the Loan Funding and Servicing Agreement, all in accordance with, and subject to the restrictions contained in, the terms of the Loan Funding and Servicing Agreement. If a Termination Event shall occur and be continuing, the unpaid balance of the principal of all Advances, together with accrued interest thereon, shall be declared, and become due and payable in the manner and with the effect provided in the Loan Funding and Servicing Agreement. This Note is the "FUNB Note" referred to in the Loan Funding and Servicing Agreement. This Note shall be construed in accordance with and governed by the laws of the State of New York. This Note is intended to be and is an amendment to, and replacement of, the FUNB Note, dated March 31, 1999, in the maximum principal amount of $30,000,000 (the "Replaced Note"). This Note evidences the same indebtedness and is secured by the same Collateral securing the Replaced Note and is not intended to constitute a novation in any manner. [Remainder of Page Intentionally Left Blank] 3 CHAR1\508036_ 1 IN WITNESS WHEREOF, the undersigned has executed this Note as on the date first written above. ACS FUNDING TRUST I By:______________________________ Name:____________________________ Title:___________________________ 4 CHAR1\508036_ 1 Schedule to Note Name Date of Principal Principal Outstanding of Advance or Amount of Amount of Principal Lender Repayment Advance Repayment Amount ------ --------- ------- --------- ------ 5 CHAR1\508036_ 1 EX-10.22 8 VFCC NOTE Exhibit 10.22 AMENDED, RESTATED AND SUBSTITUTED VFCC NOTE $225,000,000 March 31, 1999 FOR VALUE RECEIVED, ACS FUNDING TRUST I, a Delaware business trust (the "Borrower"), promises to pay to FIRST UNION SECURITIES, INC. (successor-in-interest to First Union Capital Markets Corp.), as the agent (the "Deal Agent") for Variable Funding Capital Corporation (the "Lender"), or registered assigns, the principal sum of TWO HUNDRED AND TWENTY-FIVE MILLION DOLLARS ($225,000,000) or, if less, the unpaid principal amount of the aggregate loans ("Advances") made by the Lender to the Borrower pursuant to the Loan Funding and Servicing Agreement (as defined below), as set forth on the attached Schedule, on the dates specified in Section 2.6 of the Loan Funding and Servicing Agreement, and to pay interest on the unpaid principal amount of each Advance on each day that such unpaid principal amount is outstanding at the Interest Rate related to such Advance as provided in the Loan Funding and Servicing Agreement on each Payment Date and each other dates specified in the Loan Funding and Servicing Agreement. This Amended, Restated and Substituted VFCC Note (the "Note") is issued pursuant to the Loan Funding and Servicing Agreement, dated as of March 31, 1999 (as amended, modified, supplemented or restated from time to time, the "Loan Funding and Servicing Agreement"), by and among the Borrower, American Capital Strategies, Ltd., as servicer, Variable Funding Capital Corporation, as a lender, the Investors named therein, Norwest Bank Minnesota, National Association, as backup servicer and as collateral custodian, First Union Securities, Inc. (successor-in-interest to First Union Capital Markets Corp.), as deal agent, and First Union National Bank, as a lender and as liquidity agent. Capitalized terms used but not defined in this Note are used with the meanings ascribed to them in the Loan Funding and Servicing Agreement. Notwithstanding any other provisions contained in this Note, if at any time the rate of interest payable by the Borrower under this Note, when combined with any and all other charges provided for in this Note, in the Loan Funding and Servicing Agreement or in any other document (to the extent such other charges would constitute interest for the purpose of any applicable law limiting interest that may be charged on this Note), exceeds the highest rate of interest permissible under applicable law (the "Maximum Lawful Rate"), then so long as the Maximum Lawful Rate would be exceeded the rate of interest under this Note shall be equal to the Maximum Lawful Rate. If at any time thereafter the rate of interest payable under this Note is less than the Maximum Lawful Rate, the Borrower shall continue to pay interest under this Note at the Maximum Lawful Rate until such time as the total interest paid by the Borrower is equal to the total interest that would have been paid had applicable law not limited the interest rate payable under this Note. In no event shall the total interest received by the Lender under this Note exceed the amount which the Lender could lawfully have received had the interest due under this Note been calculated since the date of this Note at the Maximum Lawful Rate. CHAR1\508049_ 1 Amended, Restated and Substituted VFCC Note Payments of the principal of, and interest on, Advances represented by this Note shall be made by the Borrower to the holder hereof by wire transfer of immediately available funds in the manner and at the address specified for such purpose as provided in Article 2 of the Loan Funding and Servicing Agreement, or in such manner or at such other address as the holder of this Note shall have specified in writing to the Borrower for such purpose, without the presentation or surrender of this Note or the making of any notation on this Note. If any payment under this Note falls due on a day that is not a Business Day, then such due date shall be extended to the next succeeding Business Day and interest shall be payable on any principal so extended at the applicable Interest Rate. If all or a portion of (i) the principal amount hereof or (ii) any interest payable thereon or (iii) any other amounts payable hereunder shall not be paid when due (whether at maturity, by acceleration or otherwise), such overdue amount shall bear interest at a rate per annum that is equal to the Base Rate plus 1.0%, in each case from the date of such non-payment to (but excluding) the date such amount is paid in full. Portions or all of the principal amount of the Note shall become due and payable at the time or times set forth in the Loan Funding and Servicing Agreement. Any portion or all of the principal amount of this Note may be prepaid, together with interest thereon (and as set forth in the Loan Funding and Servicing Agreement, certain costs and expenses of the Lender) at the time and in the manner set forth in, but subject to the provisions of, the Loan Funding and Servicing Agreement. Except as provided in the Loan Funding and Servicing Agreement, the Borrower expressly waives presentment, demand, diligence, protest and all notices of any kind whatsoever with respect to this Note. All amounts evidenced by this Note, the Lender or Lenders making such Advance and all payments and prepayments of the principal hereof and the respective dates and maturity dates thereof shall be endorsed by the Deal Agent on the schedule attached hereto and made a part hereof or on a continuation thereof which shall be attached hereto and made a part hereof, or otherwise recorded by such Deal Agent in its internal records; provided, however, that the failure of the Deal Agent to make such a notation shall not in any way limit or otherwise affect the obligations of the Borrower under this Note as provided in the Loan Funding and Servicing Agreement. The holder hereof may sell, assign, transfer, negotiate, grant participations in or otherwise dispose of all or any portion of any Advances made by such Lender and represented by this Note and the indebtedness evidenced by this Note. This Note is secured by the security interests granted pursuant to Section 2.9 of the Loan Funding and Servicing Agreement. The holder of this Note, as agent for the Lender, is entitled to the benefits of the Loan Funding and Servicing Agreement and may enforce the agreements of the Borrower contained in the Loan Funding and Servicing Agreement and exercise the remedies provided for by, or otherwise available in respect of, the Loan Funding and Servicing Agreement, all in accordance with, and subject to the restrictions contained in, the terms of the Loan Funding and Servicing CHAR1\508049_ 1 Amended, Restated and Substituted VFCC Note Agreement. If a Termination Event shall occur and be continuing, the unpaid balance of the principal of all Advances, together with accrued interest thereon, shall be declared, and become due and payable in the manner and with the effect provided in the Loan Funding and Servicing Agreement. This Note is the "VFCC Note" referred to in the Loan Funding and Servicing Agreement. This Note shall be construed in accordance with and governed by the laws of the State of New York. This Note is intended to be and is an amendment to, and replacement of, the VFCC Note, dated March 31, 1999 in the maximum principal amount of $125,000,000 (the "Replaced Note"). This Note evidences the same indebtedness and is secured by the same Collateral securing the Replaced Note and is not intended to constitute a novation in any manner. [Remainder of Page Intentionally Left Blank] CHAR1\508049_ 1 Amended, Restated and Substituted VFCC Note IN WITNESS WHEREOF, the undersigned has executed this Note as on the date first written above. ACS FUNDING TRUST I By:____________________________ Name:__________________________ Title:_________________________ CHAR1\508049_ 1 Amended, Restated and Substituted VFCC Note Schedule to Note Name Date of Principal Principal Outstanding of Advance or Amount of Amount of Principal Lender Repayment Advance Repayment Amount ------ --------- ------- --------- ------ CHAR1\508049_ 1 Amended, Restated and Substituted VFCC Note EX-23 9 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the following Registration Statements (Form S-8, No. 333-68993 and Form S-3, No. 333-68991) of American Capital Strategies, Ltd. and in the related Prospectuses, of our report dated February 2, 2000, with respect to the financial statements of American Capital Strategies, Ltd. included in this Annual Report (Form 10-K) for the year ended December 31, 1999. /s/ Ernst & Young LLP McLean, Virginia March 27, 2000 EX-27 10 FINANCIAL DATA SCHEDULE -- FDS
6 817473 American Capital Strategies, Ltd. 1000 U.S. Dollars 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 1.000 305,264 377,554 4,748 6,140 6,930 395,372 0 78,545 5,082 83,627 0 256,105 18,252 11,081 (23,052) 0 (1,631) 2,711 0 77,612 311,745 449 30,384 2,572 7,251 26,154 2,711 69,829 0 25,867 0 309 7,135 0 36 97,201 0 0 (116) 0 0 4,716 7,251 190,530 5.08 1.74 1.76 0.00 17.08 0.038 97,247 6.80
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