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As filed with the Securities and Exchange Commission on March __, 1998
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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(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, 1998; 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 __________
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AMERICAN CAPITAL STRATEGIES, LTD.
3 Bethesda Metro Center
Suite 860
Delaware Bethesda, Maryland 20814 52-1451377
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(State or other jurisdiction of (Address of principal executive offices) (I.R.S. Employer
incorporation or organization) Identification No.)
Registrant's telephone number, including area code: (301) 951-6122
Securities registered pursuant to Section 12(b) of the Act: Not Applicable
Securities registered pursuant to section 12(g) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, $0.01 par value Nasdaq Stock Market
per share
Indicate by check mark whether the registrant (1) has filed all report
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 26, 1998, the aggregate market value of the Registrant's
common stock held by nonaffiliates of the Registrant was approximately
$[180,000,000] based upon a closing price of the Registrant's common stock of
$22.88per share as reported on the NASDQ National Market System 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 26, 1997, there were 11,068,767
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 14, 1998 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.
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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 small and medium sized businesses. On August 29, 1997, the Company
completed an initial public offering ("IPO") of 10,382,437 shares of its 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 small and medium
sized companies. The Company continues to provides financial advisory services
to businesses through ACS Capital Investments Corporation ("CIC"), a
wholly-owned subsidiary. The Company had 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 employee stock ownership plans ("ESOPs"). From its
formation in 1986 through the IPO, the Company arranged 29 financing
transactions aggregating over $400 million.
BUSINESS
The Company is a buyout and specialty finance company that is
principally engaged in providing senior debt, subordinated debt and equity to
companies in need of capital for employee buyouts, management buyouts, growth,
acquisitions, liquidity and restructuring. The Company invests up to $20 million
in each transaction and through its subsidiary, CIC, 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 small
to medium sized businesses with attractive current yields and potential for
equity appreciation.
The Company's loans typically range from $1 million to $20 million,
mature in five to ten years, and require monthly or quarterly interest payments
at 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, 1997 the weighted average effective interest on the Company's debt
investments was 14.5% and dividend rate on the Company's preferred stock
investment was 15% The Company also invests in common stock which may not
provide a current yield but would share in the appreciation of the investment.
At December 31, 1997, common stock investments represented 6.0% of the Company's
portfolio and common stock investments excluding CIC was 7.6% of the Company's
investment in non-publicly traded securities. The Company expects common stock
investments to represent the smallest percentage of its portfolio.
The Company's equity interests in small and medium sized businesses are
purchased with the goal of disposing of such interests and realizing a gain
within three to seven years. The opportunity to realize such gain may occur if
the business recapitalizes its equity, either through a sale to new owners or
makes a public offering of its equity. 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 underwriters.
1
In most cases, the Company also receives the right to require the
business to purchase the warrants or stock held by the Company ("Put Rights")
under various circumstances including, typically, the repayment of the Company's
loans or debt securities. When no public offering is available, 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.
The Company makes available significant managerial assistance to its
portfolio companies. Such assistance typically involves closely monitoring the
operations of the company, participating in its board and management meetings,
being available for consultation with its officers and providing organizational
and financial guidance. Providing assistance to its borrowers serves as a
control for the Company as well as provides an opportunity for the Company to
assist in maximizing the operations of the borrower.
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 believes that its ESOP knowledge and experience
and its ability to fund transactions positions the Company favorably in the
market place.
2
The Company continues providing financial advisory services and
structuring of transactions through its wholly-owned subsidiary CIC. 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 CIC 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, commercial bankers and business and
financial brokers. CIC is continuing the relationships with the referral network
and the Company utilizes the referral network and CIC's client base as its
primary sources of investment opportunities.
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 companies ability to service
and repay debt based on its historical results of operations. The Company does
not expect to lend or invest in start-up or other early stage companies.
Growth. In addition to generating sufficient cash flow to service its
debt, a potential recipient of the Company's financing generally is required to
establish its ability to grow its cash flow. Anticipated growth will be 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 each credit decision. 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 borrower
have or promptly obtain a management team that is experienced and properly
incentivized through a significant ownership interest in the borrower. The
Company requires that a potential recipient of the Company's financing have a
management team who have demonstrated the ability to execute the company's
objectives and implement its business plan.
3
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, an initial public offering, a private sale of the Company's
financial interest, a sale of the company, or a purchase by the company or one
of its stockholders of the Company's equity position.
OPERATIONS
Marketing and Origination Process. The Company and CIC have thirteen
professionals responsible for originating loans and investments and providing
financial assistance to small and medium sized businesses and intends to hire an
additional five professionals by year end. To originate financing opportunities,
these professionals use an extensive referral network comprised of venture
capitalists, investment bankers, unions, attorneys, accountants, commercial
bankers, unions, business brokers and prospective or existing ESOP companies.
The Company also has an extensive set of internet sites that it uses 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 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. Upon completion of the due diligence
investigation, the financial professional creates a profile summarizing the
target company's historical financial statements, industry and management team
and analyzing its conformity to the Company's general investment criteria. The
financial professional then presents this profile to the Company's Credit
Committee, which is comprised of David Gladstone, Malon Wilkus and Adam
Blumenthal, the Chairman, President and Executive Vice President, respectively,
of the Company. The Company's Credit Committee and the Company's Board of
Directors must approve each financing.
Support Services. A commercial bank provides certain loan accounting and
administrative services for the Company's investments and also acts as the
custodian of the Company's portfolio assets pursuant to and in accordance with
the 1940 Act.
COMPETITION
The Company's primary competitors include financial institutions and
venture capital firms and other nontraditional lenders. Many of these entities
have greater financial and managerial resources than the Company. Nevertheless,
the Company believes that it competes effectively with these entities through,
among other means, its responsiveness to the needs of its customers and its
flexibility in structuring transactions.
4
EMPLOYEES
As of March 20, 1998, the Company had twenty-two employees, thirteen of
whom are professionals working on financings for small and medium sized
businesses. The Company believes that its relations with its employees are
excellent. The Company intends to continue maintaining a relatively low overhead
by outsourcing many functions not directly related to marketing or underwriting
its investments and the executive management of the Company.
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:
(i) 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;
(ii) 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
(iii) cash, cash items, Government securities, or high quality debt
securities maturing in one year or less from the time of
investment.
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 a majority,
as defined in the 1940 Act, of the Company's shares. Since the Company made its
BDC election, it has not made any substantial change in its structure or in the
nature of its business.
The Company operates so as to qualify as a RIC under the Internal
Revenue Code of 1986 as amended. Generally in order to qualify as a RIC, the
Company must distribute to shareholders in a timely manner, at least 90% of its
"investment company taxable income" and 98% of its capital gain net income as
defined by the code. The Company must derive at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, gain 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 (i) at least 50%
of the value of the Company's assets consists of cash, cash items, government
securities 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 (ii) no more than 25% of the value of the
Company's assets are invested in the securities of one issuer (other than U.S.
government securities), 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.
5
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 or
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 other than Temporary Investments
and to take advantage of favorable interest rates, the Company intends to issue
in the future senior debt securities, 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 would become 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 or emergency
purposes.
6
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
10,000 square feet of office space in four locations for terms ranging up to
seven years.
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, 1997, the Company was not presently a party to any material legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December 31, 1997,
there were no matters submitted to a vote of the Company's security holders
through the solicitation of proxies or otherwise.
7
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 90% of its net operating income and 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 Common Stock is quoted on the Nasdaq Stock Market under the symbol
ACAS. As of March 25, 1998, the Company had 49 stockholders of record and
approximately 1300 beneficial owners. The following table sets forth the range
of high and low bid 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, through
March 25, 1998.
BID PRICE
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DIVIDEND
HIGH LOW DECLARED
---- --- --------
1997
Third Quarter (beginning August 29, 1997) . . $20.25 $18.50 $.00
Fourth Quarter. . . . . . . . . . . . . . . . 20.75 16.50 .21
1998
First Quarter (through March 25, 1998). . . . 22.25 17.25 .25
8
ITEM 6. SELECTED FINANCIAL DATA
[Furnish the information required by Item 301 of Regulation S-K.]
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
[Furnish the information required in Item 303 of Regulation S-K.]
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET
RISK
[Furnish the information required by Item 305 of Regulation S-K.]
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
[Furnish the financial statements meeting the requirements of Regulation
S-X, except ss. 210.3-05 and Article 11 thereof, and the supplementary financial
information required by Item 302 of Regulation S-K. Financial statements of the
registrant and its subsidiaries consolidated (as required by Rule 14a-3(b))
shall be filed under this Item. Other financial statements and schedules
required under Regulation S-X may be filed as "Financial Statement Schedules"
pursuant to Item 13, Exhibits, Financial Statement Schedules, and Reports on
Form 8-K, of this Form.]
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
[Furnish the information required by Item 302 of Regulation S-K.]
9
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 14, 1998 (the "1998 Proxy Statement")
under the heading "Directors and Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this Item is incorporated herein by reference
to the information provided in the 1998 Proxy Statement under the heading
"Compensation of Directors and Executive Officers."
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 1998 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 1998 Proxy Statement under the heading
"Certain Transactions."
10
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
[(a) List the following: (1) all financial statements; (2) financial
statement schedules required by Item 8 and paragraph (d) below; and (3) those
exhibits required by Item 601 of Regulation S-K and paragraph (c) below.
Identify in the list each management contract or compensatory plan or
arrangement required to be filed as an exhibit to this Form pursuant to Item
149c) of this report
(b) State whether any reports on Form 8-K have been filed during the
last quarter of the period covered by this report.
(c) File as exhibits those exhibits required by Item 601 of Regulation
S-K.
(d) Registrants shall file, as financial statement schedules to this
Form, the financial statements required by Regulation S-X which are excluded
from the annual report to shareholders by Rule 14a-3(b), including: (1) separate
financial statements of subsidiaries not consolidated and fifty percent or less
owned persons; (2) separate financial statements of affiliates whose securities
are pledged as collateral; and (3) schedules.]
11
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
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: March 31, 1998
12
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/ David J. Gladstone Chairman and Director March __, 1998
- ----------------------
David J. Gladstone
/s/ Malon Wilkus President and Director March __, 1998
- ----------------
Malon Wilkus
/s/ Adam Blumenthal Executive Vice President March __, 1998
- ------------------- and Director
Adam Blumenthal
/s/ John Erickson Vice President and Chief March __, 1998
- ----------------- Financial Officer
John Erickson
/s/ Stephen L. Hester Vice President and General March __, 1998
- --------------------- Counsel
Stephen L. Hester
/s/ Roland Cline Vice President March __, 1998
- ----------------
Roland Cline
/s/ Robert L. Allbritton Director March __, 1998
- ------------------------
Robert L. Allbritton
/s/ Landon Butler Director March __, 1998
- -----------------
Landon Butler
/s/ Neil M. Hahl Director March __, 1998
- ----------------
Neil M. Hahl
/s/ Phillip R. Harper Director March __, 1998
- ---------------------
Phillip R. Harper
/s/ Stan Lundine Director March __, 1998
- ----------------
Stan Lundine
/s/ Stephen P. Walko Director March __, 1998
- --------------------
Stephen P. Walko
13
EXHIBIT INDEX
Exhibit Description
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3.1 American Capital Strategies, Ltd. Second Amended and Restated Certificate of
Incorporation. Incorporated herein by reference to Exhibit 2.a of the Pre-Effective
Amendment Number 1 to the Registration Statement on Form N-2 (File No.
333-29943) filed on August 12, 1997.
3.2 American Capital Strategies, Ltd. 1997 Stock Option Plan. Incorporated herein by
reference to Exhibit i.2 of the Pre-Effective Amendment Number 1 to the
Registration Statement on Form N-2 (File No. 333-29943) filed on August 12, 1997.
4 Instruments defining rights of security holders, including indentures.
9 Voting Trust Agreement.
10 Material Contracts.
11 Statement regarding computation of per share earnings.
12 Statement regarding computation of ratios.
13 Annual Report.
18 Letter regarding change in accounting principles.
21 Subsidiaries of the registrant.
22 Published report regarding matters submitted to vote of security holders.
23 Consents of experts and counsel [Where the opinion of
the expert or counsel has been incorporated by
reference into a previously filed Securities Act
registration statement].
24 Power of Attorney.
27 Financial Data Schedule.
14