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EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - Oaktree Specialty Lending Corpd387193dex321.htm
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EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Oaktree Specialty Lending Corpd387193dex311.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Oaktree Specialty Lending Corpd387193dex322.htm
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

 

  þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
       OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

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: 01-33901

Fifth Street Finance Corp.

(Exact name of registrant as specified in its charter)

 

Delaware    26-1219283

(State or jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

10 Bank Street, 12th Floor

White Plains, NY

   10606
(Address of principal executive office)    (Zip Code)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(914) 286-6800

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

Title of Each Class

  

Name of Each Exchange

on Which Registered

Common Stock, par value $0.01 per share    The NASDAQ Global Select Market

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  þ        NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨        NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨
      (Do not check if a smaller reporting company)   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)    YES  ¨        NO  þ

The registrant had 82,511,619 shares of common stock outstanding as of August 8, 2012.

 

 

 


Table of Contents

FIFTH STREET FINANCE CORP.

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2012

TABLE OF CONTENTS

 

  

PART I — FINANCIAL INFORMATION

  

Item 1.

  

Consolidated Financial Statements (unaudited):

  
  

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

     1   
  

Consolidated Statements of Operations for the three and nine months ended June 30, 2012 and June 30, 2011

     2   
  

Consolidated Statements of Changes in Net Assets for the nine months ended June 30, 2012 and  June 30, 2011

     3   
  

Consolidated Statements of Cash Flows for the nine months ended June 30, 2012 and June 30, 2011

     4   
  

Consolidated Schedule of Investments as of June 30, 2012

     5   
  

Consolidated Schedule of Investments as of September 30, 2011

     14   
  

Notes to Consolidated Financial Statements

     21   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     55   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     76   

Item 4.

  

Controls and Procedures

     78   
  

PART II — OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     79   

Item 1A.

  

Risk Factors

     79   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     79   

Item 6.

  

Exhibits

     79   

Signatures

     80   


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

Fifth Street Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except per share data)

(unaudited)

 

     June 30,
2012
    September 30,
2011
 
ASSETS   

Investments at fair value:

    

Control investments (cost June 30, 2012: $15,542; cost September 30, 2011: $13,726)

   $ 14,916      $ 14,500   

Affiliate investments (cost June 30, 2012: $1,080; cost September 30, 2011: $34,182)

     2,444        25,897   

Non-control/Non-affiliate investments (cost June 30, 2012: $1,203,770; cost September 30, 2011: $1,108,174)

     1,180,737        1,079,440   
  

 

 

   

 

 

 

Total investments at fair value (cost June 30, 2012: $1,220,392; cost September 30, 2011: $1,156,082)

     1,198,097        1,119,837   

Cash and cash equivalents

     105,694        67,644   

Interest and fees receivable

     5,922        6,752   

Due from portfolio company

     449        552   

Deferred financing costs

     14,216        14,668   

Collateral posted to bank and other assets

     113        264   
  

 

 

   

 

 

 

Total assets

   $ 1,324,491      $ 1,209,717   
  

 

 

   

 

 

 
LIABILITIES AND NET ASSETS   

Liabilities:

    

Accounts payable, accrued expenses and other liabilities

   $ 1,146      $ 1,175   

Base management fee payable

     6,094        5,710   

Incentive fee payable

     5,477        4,997   

Due to FSC, Inc.

     2,152        1,480   

Interest payable

     3,965        4,669   

Payments received in advance from portfolio companies

     36        35   

Offering costs payable

     9          

Credit facilities payable

     228,541        178,024   

SBA debentures payable

     150,000        150,000   

Convertible senior notes payable

     115,000        135,000   
  

 

 

   

 

 

 

Total liabilities

     512,420        481,090   
  

 

 

   

 

 

 

Net assets:

    

Common stock, $0.01 par value, 150,000 shares authorized, 82,462 and 72,376 shares issued and outstanding at June 30, 2012 and September 30, 2011

     825        724   

Additional paid-in-capital

     930,188        829,620   

Net unrealized depreciation on investments and interest rate swap

     (21,916     (35,976

Net realized loss on investments and interest rate swap

     (90,904     (63,485

Accumulated overdistributed net investment income

     (6,122     (2,256
  

 

 

   

 

 

 

Total net assets (equivalent to $9.85 and $10.07 per common share at June 30, 2012 and September 30, 2011) (Note 12)

     812,071        728,627   
  

 

 

   

 

 

 

Total liabilities and net assets

   $ 1,324,491      $ 1,209,717   
  

 

 

   

 

 

 

See notes to Consolidated Financial Statements.

 

1


Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

     Three  months
ended

June 30,
2012
    Three months
ended
June 30,
2011
    Nine months
ended
June 30,
2012
    Nine months
ended
June 30,
2011
 

Interest income:

        

Control investments

   $ 2      $ 40      $ 434      $ 54   

Affiliate investments

     835        1,126        2,229        3,416   

Non-control/Non-affiliate investments

     27,822        24,271        85,131        61,963   

Interest on cash and cash equivalents

     11        4        29        17   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     28,670        25,441        87,823        65,450   
  

 

 

   

 

 

   

 

 

   

 

 

 

PIK interest income:

        

Control investments

     211        105        249        239   

Affiliate investments

     158        278        467        835   

Non-control/Non-affiliate investments

     3,557        3,179        9,516        9,103   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total PIK interest income

     3,926        3,562        10,232        10,177   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fee income:

        

Control investments

                          127   

Affiliate investments

     377        283        630        550   

Non-control/Non-affiliate investments

     7,954        2,992        23,744        11,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income

     8,331        3,275        24,374        11,677   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividend and other income:

        

Non-control/Non-affiliate investments

     81        164        154        174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total dividend and other income

     81        164        154        174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     41,008        32,442        122,583        87,478   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

        

Base management fee

     6,094        5,381        17,226        13,946   

Incentive fee

     5,477        4,132        16,422        11,785   

Professional fees

     619        456        2,310        1,654   

Board of Directors fees

     30        46        156        132   

Interest expense

     5,611        4,977        16,936        9,640   

Administrator expense

     690        395        2,214        1,140   

General and administrative expenses

     807        529        3,201        2,043   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     19,328        15,916        58,465        40,340   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain on extinguishment of convertible senior notes

     230               1,571          
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     21,910        16,526        65,689        47,138   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized appreciation (depreciation) on interest rate swap

            (919            51   

Unrealized appreciation (depreciation) on investments:

        

Control investments

     (2,493     5,225        (1,404 )     12,538   

Affiliate investments

     322        13,931        9,649        3,760   

Non-control/Non-affiliate investments

     2,350        215        5,815        18,573   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized appreciation on investments

     179        19,371        14,060        34,871   
  

 

 

   

 

 

   

 

 

   

 

 

 

Realized loss on investments:

        

Control investments

                          (7,806

Affiliate investments

            (14,146     (10,620     (14,146 )

Non-control/Non-affiliate investments

                   (16,800 )     (6,157
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized loss on investments

            (14,146     (27,420 )     (28,109 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ 22,089      $ 20,832      $ 52,329      $ 53,951   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income per common share — basic

   $ 0.27      $ 0.25      $ 0.84      $ 0.77   

Earnings per common share — basic

   $ 0.27      $ 0.31      $ 0.67      $ 0.88   

Weighted average common shares outstanding — basic

     82,421        67,081        78,089        61,254   

Net investment income per common share — diluted

   $ 0.26      $ 0.24      $ 0.80      $ 0.76   

Earnings per common share — diluted

   $ 0.26      $ 0.30      $ 0.64      $ 0.87   

Weighted average common shares outstanding — diluted

     90,279        76,020        86,325        64,233   

See notes to Consolidated Financial Statements.

 

2


Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except per share data)

(unaudited)

 

     Nine months ended
June 30,

2012
    Nine months ended
June 30,

2011
 

Operations:

    

Net investment income

   $ 65,689      $ 47,138   

Net unrealized appreciation on investments and interest rate swap

     14,060        34,922   

Net realized loss on investments

     (27,420     (28,109
  

 

 

   

 

 

 

Net increase in net assets from operations

     52,329        53,951   

Stockholder transactions:

    

Distributions to stockholders

     (69,555     (57,644
  

 

 

   

 

 

 

Net decrease in net assets from stockholder transactions

     (69,555 )      (57,644 ) 

Capital share transactions:

    

Issuance of common stock, net

     99,815        206,079   

Issuance of common stock under dividend reinvestment plan

     855        4,091   
  

 

 

   

 

 

 

Net increase in net assets from capital share transactions

     100,670        210,170   
  

 

 

   

 

 

 

Total increase in net assets

     83,444        206,477   
  

 

 

   

 

 

 

Net assets at beginning of period

     728,627        569,172   
  

 

 

   

 

 

 

Net assets at end of period

   $ 812,071      $ 775,649   
  

 

 

   

 

 

 

Net asset value per common share

   $ 9.85      $ 10.72   
  

 

 

   

 

 

 

Common shares outstanding at end of period

     82,462        72,376   

 

 

 

 

 

See notes to Consolidated Financial Statements.

 

3


Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     Nine months
ended
June 30,
2012
    Nine months
ended
June 30,
2011
 

Cash flows from operating activities:

    

Net increase in net assets resulting from operations

   $ 52,329      $ 53,951   

Adjustments to reconcile net increase in net assets resulting from operations to net cash provided (used) by operating activities:

    

Gain on extinguishment of convertible senior notes

     (1,571       

Net unrealized appreciation on investments and interest rate swap

     (14,060     (34,922

Net realized losses on investments and interest rate swap

     27,420        28,109   

PIK interest income

     (10,232     (10,177

Recognition of fee income

     (24,374     (11,677

Accretion of original issue discount on investments

     (1,367     (1,239

Amortization of deferred financing costs

     3,241        1,816   

Change in operating assets and liabilities:

    

Fee income received

     19,336        16,866   

(Increase) decrease in interest and fees receivable

     385        (2,252

(Increase) decrease in due from portfolio company

     103        (329 )

(Increase) decrease in collateral posted to bank and other assets

     151        (218 )

Increase (decrease) in accounts payable, accrued expenses and other liabilities

     (29 )     262   

Increase in base management fee payable

     384        2,505   

Increase in incentive fee payable

     480        1,272   

Increase (decrease) in due to FSC, Inc.

     672        (263

Increase (decrease) in interest payable

     (704     3,185   

Decrease in payments received in advance from portfolio companies

     (1     (545

Purchases of investments and net revolver activity, net of syndications

     (407,854     (566,835 )

Principal payments received on investments (scheduled payments)

     32,795        19,559   

Principal payments received on investments (payoffs)

     283,966        62,447   

PIK interest income received in cash

     5,007        7,030   

Proceeds from the sale of investments

     11,549          
  

 

 

   

 

 

 

Net cash used by operating activities

     (22,374 )     (431,455
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Dividends paid in cash

     (68,699     (53,553

Borrowings under SBA debentures payable

            77,000   

Borrowings under credit facilities

     409,297        406,000   

Repayments of borrowings under credit facilities

     (358,780     (406,000

Proceeds from the issuance of convertible senior notes

            152,000   

Repurchases of convertible senior notes

     (17,939       

Proceeds from the issuance of common stock

     100,700        206,788   

Deferred financing costs paid

     (3,279     (9,230

Offering costs paid

     (876     (709
  

 

 

   

 

 

 

Net cash provided by financing activities

     60,424        372,296   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     38,050        (59,159

Cash and cash equivalents, beginning of period

     67,644        76,765   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 105,694      $ 17,606   
  

 

 

   

 

 

 

Supplemental Information:

    

Cash paid for interest

   $ 14,720      $ 4,639   

Non-cash financing activities:

    

Issuance of shares of common stock under dividend reinvestment plan

   $ 855      $ 4,091   

See notes to Consolidated Financial Statements.

 

4


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost      Fair Value  

Control Investments(3)

           

Lighting By Gregory, LLC(9)(13)(14)

   Housewares & specialties         

First Lien Term Loan A, 9.75% PIK due 2/28/2013

      $ 4,700       $ 3,996       $ 737   

First Lien Bridge Loan, 8% PIK due 3/31/2012(16)

        113         113           

97.38% membership interest

           1,210           
        

 

 

    

 

 

 
           5,319         737   

Coll Materials Group LLC(9)

   Environmental & facilities services         

Second Lien Term Loan, 12% cash due 11/1/2014

        7,096         7,096         7,071   

50% Membership interest in CD Holdco, LLC

           3,127         7,108   
        

 

 

    

 

 

 
           10,223         14,179   
        

 

 

    

 

 

 

Total Control Investments (1.8% of net assets)

         $ 15,542       $ 14,916   
        

 

 

    

 

 

 

Affiliate Investments(4)

           

Caregiver Services, Inc.

   Healthcare services         

1,080,399 shares of Series A Preferred Stock

         $ 1,080       $ 2,444   
        

 

 

    

 

 

 
           1,080         2,444   
        

 

 

    

 

 

 

Total Affiliate Investments (0.3% of net assets)

         $ 1,080       $ 2,444   
        

 

 

    

 

 

 

Non-Control/Non-Affiliate Investments(7)

           

Repechage Investments Limited(13)(14)

   Restaurants         

First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011(16)

      $ 3,632       $ 3,412       $ 898   

7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.

           750           
        

 

 

    

 

 

 
           4,162         898   

Traffic Control & Safety Corporation(9)(14)(16)

   Construction & engineering         

Senior Debtor-in-Possession Loan, LIBOR+12% cash due 10/20/2012

        7,899         7,899         7,899   

Senior Term Loan A, LIBOR+9% cash due 6/29/2012

        5,000         5,000         5,000   

Senior Revolver, LIBOR+9% cash due 6/29/2012

        8,587         8,587         8,587   

Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015(13)

        22,595         21,247         11,518   

Subordinated Term Loan, 15% PIK due 5/28/2015

        6,024         5,531           

24,750 shares of Series B Preferred Stock

           248           

43,494 shares of Series D Preferred Stock

           435           

25,000 shares of Common Stock

           3           
        

 

 

    

 

 

 
           48,950         33,004   

TBA Global, LLC

   Advertising         

53,994 Senior Preferred Shares

           216         326   

191,977 Shares A Shares

           192           
        

 

 

    

 

 

 
           408         326   

Fitness Edge, LLC

   Leisure facilities         

1,000 Common Units(6)

           43         201   
        

 

 

    

 

 

 
           43         201   

Capital Equipment Group, Inc.(9)

   Industrial machinery         

Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013

        10,436         10.350         10,516   

33,463 shares of Common Stock

           345         593   
        

 

 

    

 

 

 
           10,695         11,109   

Rail Acquisition Corp.(14)

   Electronic manufacturing services         

First Lien Term Loan, 12% PIK due 9/1/2013

        20,167         15,637         3,454   

First Lien Revolver, 7.85% cash due 9/1/2013

        4,958         4,958         4,958   
        

 

 

    

 

 

 
           20,595         8,412   

 

5


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost      Fair Value  

Western Emulsions, Inc.

   Construction materials         

Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014

        6,975         6,896         7,114   
        

 

 

    

 

 

 
           6,896         7,114   

Storyteller Theaters Corporation

   Movies & entertainment         

1,692 shares of Common Stock

                   62   

20,000 shares of Preferred Stock

           200         200   
        

 

 

    

 

 

 
           200         262   

HealthDrive Corporation(9)

   Healthcare services         

First Lien Term Loan A, 10% cash due 7/17/2013

        5,001         4,880         5,105   

First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013

        10,361         10,321         10,412   

First Lien Revolver, 12% cash due 7/17/2013

        1,250         1,246         1,266   
        

 

 

    

 

 

 
           16,447         16,783   

idX Corporation

   Distributors         

Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014

        19,185         18,993         19,663   
        

 

 

    

 

 

 
           18,993         19,663   

Cenegenics, LLC

   Healthcare services         

414,419 Common Units(6)

           598         1,308   
        

 

 

    

 

 

 
           598         1,308   

Trans-Trade, Inc.

   Air freight & logistics         

First Lien Term Loan A, 13% cash 2.5% PIK due 9/10/2014

        12,762         12,603         12,786   

First Lien Term Loan B, 12% cash due 9/10/2014

        6,040         5,993         1,437   
        

 

 

    

 

 

 
           18,596         14,223   

Riverlake Equity Partners II, LP

   Multi-sector holdings         

1.89% limited partnership interest(15)

           240         240   
        

 

 

    

 

 

 
           240         240   

Riverside Fund IV, LP

   Multi-sector holdings         

0.33% limited partnership interest(6)(15)

           598         598   
        

 

 

    

 

 

 
           598         598   

Ambath/Rebath Holdings, Inc.(9)

   Home improvement retail         

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014

        4,272         4,264         3,782   

First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014

        23,707         23,691         21,206   
        

 

 

    

 

 

 
           27,955         24,988   

Tegra Medical, LLC(9)

   Healthcare equipment         

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014

        20,217         20,011         20,169   

First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014

        23,042         22,827         22,808   

First Lien Term Loan C, 30% PIK due 12/31/2014

        1,032         1,032         993   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014

        2,500         2,461         2,472   
        

 

 

    

 

 

 
           46,331         46,442   

Psilos Group Partners IV, LP

   Multi-sector holdings         

2.52% limited partnership interest(12)(15)

                     
        

 

 

    

 

 

 
                     

 

6


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Mansell Group, Inc.

   Advertising        

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015

        9,846         9,727        9,819   

First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015

        9,247         9,135        9,153   

First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)

           (23 )       
        

 

 

   

 

 

 
           18,839        18,972   

NDSSI Holdings, LLC(9)

   Electronic equipment & instruments        

First Lien Term Loan A, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012

        21,864         21,687        21,590   

First Lien Term Loan B, LIBOR+9.75% (3% floor) cash 3.75% PIK due 12/31/2012

        8,153         8,153        8,187   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012

        3,500         3,474        3,478   

2,000 Series D Preferred Units

           2,564        2,564   
        

 

 

   

 

 

 
           35,878        35,819   

Eagle Hospital Physicians, Inc.(9)

   Healthcare services        

First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015

        24,617         24,239        24,570   

First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015

        1,100         1,069        1,046   
        

 

 

   

 

 

 
           25,308        25,616   

Enhanced Recovery Company, LLC

   Diversified support services        

First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015

        11,345         11,183        11,362   

First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015

        11,070         10,933        11,059   

First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015(11)

           (50 )       
        

 

 

   

 

 

 
           22,066        22,421   

Specialty Bakers LLC

   Food distributors        

First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015

        4,476         4,264        4,463   

First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015

        11,000         10,820        10,888   

First Lien Revolver, LIBOR+8.5% cash due 9/15/2015

        2,500         2,435        2,493   
        

 

 

   

 

 

 
           17,519        17,844   

Welocalize, Inc.

   Internet software & services        

First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015

        20,685         20,393        20,865   

First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015

        23,971         23,639        24,189   

First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015(11)

           (172       

3,393,060 Common Units in RPWL Holdings, LLC

           3,393        3,985   
        

 

 

   

 

 

 
           47,253        49,039   

Miche Bag, LLC

   Apparel, accessories & luxury goods        

First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013

        9,300         9,101        9,336   

First Lien Term Loan B, LIBOR+10% (3% floor) cash 3% PIK due 12/7/2015

        17,827         15,825        17,648   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015

        1,500         1,413        1,511   

10,371 Preferred Equity units in Miche Holdings, LLC

           1,037        1,169   

146,289 Series D Common Equity units in Miche Holdings, LLC

           1,463        427   
        

 

 

   

 

 

 
           28,839        30,091   

Bunker Hill Capital II (QP), LP

   Multi-sector holdings        

0.50% limited partnership interest(15)

           66        66   
        

 

 

   

 

 

 
           66        66   

Advanced Pain Management

   Healthcare services        

First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015

        7,271         7,169        7,323   

First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015(11)

           (4       
        

 

 

   

 

 

 
           7,165        7,323   

 

7


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Drugtest, Inc. (formerly DISA, Inc.)

   Human resources & employment services        

First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015

        11,540         11,368        11,701   

First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015

        8,492         8,378        8,711   

First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015(11)

           (55       
        

 

 

   

 

 

 
           19,691        20,412   

Saddleback Fence and Vinyl Products, Inc.

   Building products        

First Lien Term Loan, 8% cash due 11/30/2013

        648         648        648   

First Lien Revolver, 8% cash due 11/30/2013

        100         100        100   
        

 

 

   

 

 

 
           748        748   

Best Vinyl Fence & Deck, LLC

   Building products        

First Lien Term Loan B, 8% PIK due 6/30/2012(16)

        4,275         4,275        1,365   
        

 

 

   

 

 

 
           4,275        1,365   

Physicians Pharmacy Alliance, Inc.

   Healthcare services        

First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016

        16,105         15,840        15,923   

First Lien Revolver, LIBOR+6% cash due 1/4/2016(11)

           (31       
        

 

 

   

 

 

 
           15,809        15,923   

Cardon Healthcare Network, LLC(9)

   Diversified support services        

First Lien Term Loan A, LIBOR+10% (1.75% floor) cash due 1/24/2017

        10,530         10,358        10,714   

First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 1/24/2017

        22,001         21,788        22,099   

First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/24/2017(11)

           (40       

65,903 Class A Units(6)

           250        385   
        

 

 

   

 

 

 
           32,356        33,198   

U.S. Retirement Partners, Inc.

   Diversified financial services        

First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016

        32,600         32,196        32,822   
        

 

 

   

 

 

 
           32,196        32,822   

Phoenix Brands Merger Sub LLC(9)

   Household products        

Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016

        7,125         6,980        7,146   

Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017

        20,989         20,595        20,332   

First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016

        2,571         2,451        2,661   
        

 

 

   

 

 

 
           30,026        30,139   

U.S. Collections, Inc.

   Diversified support services        

First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016

        10,084         9,962        10,045   
        

 

 

   

 

 

 
           9,962        10,045   

CCCG, LLC(9)

   Oil & gas equipment services        

First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015

        34,747         34,056        34,887   
        

 

 

   

 

 

 
           34,056        34,887   

Maverick Healthcare Group, LLC

   Healthcare equipment        

First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016

        24,625         24,163        24,424   
        

 

 

   

 

 

 
           24,163        24,424   

Refac Optical Group

   Specialty stores        

First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016

        12,673         12,402        12,721   

First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016

        20,281         19,866        20,429   

First Lien Revolver, LIBOR+7.5% cash due 3/23/2016(11)

           (106       

1,000 Shares of Common Stock in Refac Holdings, Inc.

           1          

1,000 Shares of Preferred Stock in Refac Holdings, Inc.

           999        998   
        

 

 

   

 

 

 
           33,162        34,148   

 

8


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Pacific Architects & Engineers, Inc.

   Diversified support services        

First Lien Term Loan A, LIBOR+5% (1.5% floor) cash due 4/4/2017

        3,994         3,939        4,002   

First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017

        4,700         4,639        4,725   
        

 

 

   

 

 

 
           8,578        8,727   

Securus Technologies, Inc.(9)

   Integrated telecommunication services        

Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018

        22,500         22,103        22,382   
        

 

 

   

 

 

 
           22,103        22,382   

Gundle/SLT Environmental, Inc.

   Environmental & facilities services        

First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016

        8,925         8,843        8,976   
        

 

 

   

 

 

 
           8,843        8,976   

Titan Fitness, LLC

   Leisure facilities        

First Lien Term Loan A, LIBOR+8.75 (1.25% floor) cash due 6/30/2016

        15,625         15,484        15,649   

First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016

        11,677         11,574        11,795   

First Lien Term Loan C, 18% PIK due 6/30/2016

        3,111         3,088        3,139   

First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016(11)

           (31       
        

 

 

   

 

 

 
           30,115        30,583   

Baird Capital Partners V, LP

   Multi-sector holdings        

0.4% limited partnership interest(15)

           386        386   
        

 

 

   

 

 

 
           386        386   

Charter Brokerage, LLC(9)

   Oil & gas equipment services        

Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016

        16,413         16,272        16,329   

Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017

        10,195         10,115        10,086   

Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016

        882         824        987   
        

 

 

   

 

 

 
           27,211        27,402   

Stackpole Powertrain International ULC(15)

   Auto parts & equipment        

Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018

        18,335         18,179        19,047   

1,000 Common Units

           1,000        1,514   
        

 

 

   

 

 

 
           19,179        20,561   

Discovery Practice Management, Inc.

   Healthcare services        

Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016

        6,570         6,506        6,538   

Senior Term Loan B, 12% cash 3% PIK due 8/8/2016

        6,392         6,335        6,476   

Senior Revolver, LIBOR+7% cash due 8/8/2016

        400         371        449   
        

 

 

   

 

 

 
           13,212        13,463   

CTM Group, Inc.

   Leisure products        

Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017

        10,691         10,594        10,732   

Mezzanine Term Loan B, 18.4% PIK due 2/10/2017

        3,636         3,607        3,766   
        

 

 

   

 

 

 
           14,201        14,498   

Bojangles

   Restaurants        

First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017

        5,603         5,504        5,703   
        

 

 

   

 

 

 
           5,504        5,703   

Milestone Partners IV, LP

   Multi-sector holdings        

3.07% limited partnership interest(15)

           657        657   
        

 

 

   

 

 

 
           657        657   

Insight Pharmaceuticals, LLC

   Pharmaceuticals        

First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016

        9,925         9,861        10,072   

Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017

        17,500         17,355        17,480   
        

 

 

   

 

 

 
           27,216        27,552   

 

9


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

National Spine and Pain Centers, LLC

   Healthcare services        

Mezzanine Term Loan, 11% cash 1.6% PIK due 9/27/2017

        26,939         26,703        27,172   

300,700.98 Class A Units(6)

           301        248   
        

 

 

   

 

 

 
           27,004        27,420   

RCPDirect, LP.

   Multi-sector holdings        

0.91% limited partnership interest(15)

           348        348   
        

 

 

   

 

 

 
           348        348   

The MedTech Group, Inc.

   Healthcare equipment        

Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 9/7/2016

        12,870         12,772        12,818   
        

 

 

   

 

 

 
           12,772        12,818   

Digi-Star Acquisition Holdings, Inc.

   Industrial machinery        

Mezzanine Term Loan, 12% cash 1.5% PIK due 11/18/2017

        10,094         9,983        10,226   

225 Class A Preferred Units

           225        225   

2,500 Class A Common Units

           25        80   
        

 

 

   

 

 

 
           10,233        10,531   

CPASS Acquisition Company

   Internet software & services        

Senior Term Loan, LIBOR+9% (1.5% floor) cash 1% PIK due 11/21/2016

        4,906         4,811        4,978   

Senior Revolver, LIBOR+9% (1.5% floor) cash due 11/21/2016(11)

           (17       
        

 

 

   

 

 

 
           4,794        4,978   

Genoa Healthcare Holdings, LLC

   Pharmaceuticals        

Mezzanine Term Loan, 12% cash 2% PIK due 6/1/2017

        12,648         12,536        12,755   

500,000 Preferred units

           475        500   

500,000 Class A Common Units

           25        84   
        

 

 

   

 

 

 
           13,036        13,339   

SolutionSet, Inc.

   Advertising        

Senior Term Loan, LIBOR+6% (1% floor) cash due 12/21/2016

        9,739         9,652        9,736   
        

 

 

   

 

 

 
           9,652        9,736   

Slate Pharmaceuticals Acquisition Corp.

   Healthcare services        

Subordinated Term Loan, 12% cash 1.5% PIK due 12/29/2017

        20,154         19,973        20,534   
        

 

 

   

 

 

 
           19,973        20,534   

ACON Equity Partners III, LP

   Multi-sector holdings        

0.31% limited partnership interest(15)

           14        14   
        

 

 

   

 

 

 
           14        14   

Blue Coat Systems, Inc.

   Internet software & services        

First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 2/15/2018

        15,000         14,858        15,140   

Second Lien Term Loan, LIBOR+10% (1.5% floor) cash due 8/15/2018

        7,000         6,934        6,975   
        

 

 

   

 

 

 
           21,792        22,115   

CRGT, Inc.

   IT consulting & other services        

Mezzanine Term Loan, 12.5% cash 3% PIK due 3/9/2018

        25,741         25,500        25,967   
        

 

 

   

 

 

 
           25,500        25,967   

Riverside Fund V, LP

   Multi-sector holdings        

0.4% limited partnership interest(12)(15)

                    
        

 

 

   

 

 

 
                    

World 50, Inc.

   Research & consulting services        

Senior Term Loan A, LIBOR+6.25% (1.5% floor) cash due 3/30/2017

        8,819         8,686        8,820   

Senior Term Loan B, 12.5% cash due 3/30/2017

        5,500         5,420        5,505   

Senior Revolver, LIBOR+6.25% (1.5% floor) cash due 3/30/2017(11)

           (58 )       
        

 

 

   

 

 

 
           14,048        14,325   

 

10


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Huddle House, Inc.

   Restaurants        

Subordinated Term Loan, 11% cash 1.6% PIK due 3/30/2018

        13,907         13,776        13,843   
        

 

 

   

 

 

 
           13,776        13,843   

Nixon, Inc.

   Apparel, accessories & luxury goods        

First Lien Term Loan, 8.75% cash 2.75% PIK due 4/16/2018

        10,057         9,961        10,057   
        

 

 

   

 

 

 
           9,961        10,057   

JTC Education, Inc.(10)

   Education services        

Subordinated Term Loan, 13% cash due 11/1/2017

        11,500         11,388        11,535   

17,391 Shares of Series A-1 Preferred Stock

           313        307   

17,391 Shares of Common Stock

           187          
        

 

 

   

 

 

 
           11,888        11,842   

BMC Acquisition, Inc.

   Diversified financial services        

Senior Term Loan, LIBOR+5.5% (1% floor) cash due 5/1/2017

        5,750         5,708        5,750   

Senior Revolver, LIBOR+5% (1% floor) cash due 5/1/2017

        350         341        350   

500 Series A Preferred Shares

           500        500   

50,000 Common Shares

           1        1   
        

 

 

   

 

 

 
           6,550        6,601   

Ansira Partners, Inc.

   Advertising        

First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/4/2017

        12,500         12,410        12,500   

First Lien Revolver, LIBOR+5.5% (1.5% floor) cash due 5/4/2017(11)

           (9       

250 Preferred Units & 250 Class A Common Units of Ansira Holdings, LLC

           250        250   
        

 

 

   

 

 

 
           12,651        12,750   

MX USA, Inc.

   Healthcare services        

Second Lien Term Loan, LIBOR+10.5% (1.25% floor) cash due 10/31/2017

        20,000         19,806        20,000   
        

 

 

   

 

 

 
           19,806        20,000   

PLATO, Inc.

   Education services        

First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 5/17/2018

        15,000         15,000        15,000   

Second Lien Term Loan, LIBOR+9.75% (1.5% floor) cash due 5/17/2019

        10,000         10,000        10,000   
        

 

 

   

 

 

 
           25,000        25,000   

I Drive Safely, LLC

   Education services        

First Lien Term Loan, LIBOR+8.5% (1.5% floor) cash due 5/25/2017

        27,000         26,996        27,000   

First Lien Revolver, LIBOR+6.5% (1.5% floor) cash due 5/25/2017(11)

           (1       

75,000 Class A Common Units of IDS Investments, LLC

           750        750   
        

 

 

   

 

 

 
           27,745        27,750   

ConvergeOne Holdings Corp.

   Integrated telecommunication services        

First Lien Term Loan, LIBOR+7% (1.5% floor) cash due 6/8/2017

        10,000         10,000        10,000   
        

 

 

   

 

 

 
           10,000        10,000   

Yeti Acquisition, LLC

   Leisure products        

First Lien Term Loan A, LIBOR+8% (1.25% floor) cash due 6/15/2017

        28,000         27,962        28,000   

First Lien Term Loan B, LIBOR+11.25% (1.25% floor) cash 1% PIK due 6/15/2017

        12,005         11,989        12,005   

First Lien Revolver, LIBOR+8% (1.25% floor) cash due 6/15/2017(11)

           (14       

1,500 Common Stock Units of Yeti Holdings, Inc.

           1,500        1,500   
        

 

 

   

 

 

 
           41,437        41,505   

Specialized Education Services, Inc.

   Education services        

Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 6/28/2017

        10,000         10,000        10,000   

Subordinated Term Loan, 11% cash 1.5% PIK due 6/28/2018

        17,501         17,501        17,501   
        

 

 

   

 

 

 
           27,501        27,501   

Total Non-Control/Non-Affiliate Investments (145.4% of net assets)

         $ 1,203,770      $ 1,180,737   
        

 

 

   

 

 

 

Total Portfolio Investments (147.5% of net assets)

         $ 1,220,392      $ 1,198,097   
        

 

 

   

 

 

 

 

11


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

 

(1) Debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.

 

(2) See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.

 

(3) Control Investments are defined by the Investment Company Act of 1940 (“1940 Act”) as investments in companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation.

 

(4) Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.

 

(5) Equity ownership may be held in shares or units of companies related to the portfolio companies.

 

(6) Income producing through payment of dividends or distributions.

 

(7) Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.

 

(8) Principal includes accumulated PIK interest and is net of repayments.

 

(9) Interest rates have been adjusted on certain term loans and revolvers. These rate adjustments are temporary in nature due to financial or payment covenant violations in the original credit agreements, or permanent in nature per loan amendment or waiver documents. The table below summarizes these rate adjustments by portfolio company:

 

Portfolio Company

 

Effective date

 

Cash interest

 

PIK interest

 

Reason

Securus Technologies Holdings, Inc.   June 6, 2012   + 0.75% on Term Loan     Per loan amendment
Charter Brokerage, LLC   May 9, 2012   - 0.5% on Senior Term Loan & Revolver     Tier pricing per loan agreement
Coll Materials Group LLC   April 1, 2012   - 12.0% on Second Lien Term Loan   + 12.0% on Second Lien Term Loan   Per loan amendment
HealthDrive Corporation   April 1, 2012   + 2.0% on Term Loan A     Tier pricing per loan agreement
AmBath/Rebath Holdings, Inc.   April 1, 2012  

- 2.0% on Term Loan A

- 4.5% on Term Loan B

 

+ 2.0% on Term Loan A

+ 4.5% on Term Loan B

  Per loan amendment
Cardon Healthcare Network, LLC   April 1, 2012  

- 2.5% on Term Loan A

- 1.25% on Term Loan B

    Tier pricing per loan agreement
Traffic Control & Safety Corporation   January 1, 2012   + 3.0% on Senior Term Loan & Senior Revolver  

+ 2.0% on Subordinated Term Loan

+ 2.0% on Second Lien Term Loan

 

Default interest

per loan agreement

Tegra Medical, LLC   January 1, 2012     + 0.5% on Term Loan B   Per loan amendment
NDSSI Holdings, Inc.   December 31, 2011     – 1.0% on Term Loan A   Per loan amendment
Phoenix Brands Merger Sub LLC   December 22, 2011  

+ 0.75% on Subordinated Term Loan;

+ 0.50% on Senior Term Loan & Revolver

    Per loan amendment
CCCG, LLC   November 15, 2011   + 0.5% on Term Loan     Per waiver agreement
Eagle Hospital Physicians, Inc.   July 1, 2011   – 0.25% on Term Loan & Revolver     Per loan amendment
Lighting By Gregory, LLC   March 11, 2011   + 6.0% on Bridge Loan   – 8.0% on Bridge Loan   Per loan amendment
Capital Equipment Group, Inc.   July 1, 2010   – 2.0% on Term Loan   – 0.75% on Term Loan   Per waiver agreement

 

12


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

June 30, 2012

(dollar amounts in thousands)

(unaudited)

 

(10) In May 2012, the Company received a cash payment from JTC Education, Inc. in full satisfaction of all obligations under the senior loan agreement. As part of this refinancing, the Company closed on an $11.5 million subordinated debt investment in JTC Education, Inc.

 

(11) Cost amounts represent unearned income related to undrawn commitments.

 

(12) Represents an unfunded commitment to fund limited partnership interest.

 

(13) Investment was on cash non-accrual status as of June 30, 2012.

 

(14) Investment was on PIK non-accrual status as of June 30, 2012.

 

(15) Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.

 

(16) Investment is under negotiation and, as such, the maturity date of the loan has been temporarily suspended.

 

13


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost      Fair Value  

Control Investments(3)

           

Lighting By Gregory, LLC(9)(13)(14)

   Housewares & specialties         

First Lien Term Loan A, 9.75% PIK due 2/28/2013

      $ 4,366       $ 3,996       $ 2,526   

First Lien Bridge Loan, 8% PIK due 3/31/2012

        112         113           

97.38% membership interest

           1,210           
        

 

 

    

 

 

 
           5,319         2,526   

Nicos Polymers & Grinding, Inc.

   Environmental & facilities services         

First Lien Term Loan, 8% cash due 12/4/2017

        5,347         5,280         5,189   

First Lien Revolver, 8% cash due 12/4/2017

        1,500         1,500         1,551   

50% Membership interest in CD Holdco, LLC

           1,627         5,234   
        

 

 

    

 

 

 
           8,407         11,974   
        

 

 

    

 

 

 

Total Control Investments (2.0% of net assets)

         $ 13,726       $ 14,500   
        

 

 

    

 

 

 

Affiliate Investments(4)

           

O’Currance, Inc.(13)(14)

   Data Processing & outsourced services         

First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012

      $ 11,414       $ 11,254       $ 3,173   

First Lien Term Loan B, 12.875% cash 4% PIK 3/21/2012

        1,164         1,140         324   

1.75% Preferred Membership interest in O’Currance Holding Co., LLC

           130           

3.3% Membership Interest in O’Currance Holding Co., LLC

           250           
        

 

 

    

 

 

 
           12,774         3,497   

Caregiver Services, Inc.

   Healthcare services         

Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013

        5,712         5,527         5,843   

Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013

        15,161         14,801         15,067   

1,080,399 shares of Series A Preferred Stock

           1,080         1,490   
        

 

 

    

 

 

 
           21,408         22,400   
        

 

 

    

 

 

 

Total Affiliate Investments (3.6% of net assets)

         $ 34,182       $ 25,897   
        

 

 

    

 

 

 

Non-Control/Non-Affiliate Investments(7)

           

Repechage Investments Limited(13)(14)

   Restaurants         

First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011

      $ 3,558       $ 3,412       $ 1,829   

7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.

           750           
        

 

 

    

 

 

 
           4,162         1,829   

Traffic Control & Safety Corporation(9)

   Construction & engineering         

Senior Term Loan, LIBOR+9% cash due 6/29/2012

        5,000         4,870         4,957   

Senior Revolver, LIBOR+9% cash due 6/29/2012

        11,986         11,754         11,966   

Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015

        20,795         20,602         17,545   

Subordinated Loan, 15% PIK due 5/28/2015

        5,325         5,325         1,346   

24,750 shares of Series B Preferred Stock

           247           

43,494 shares of Series D Preferred Stock

           435           

25,000 shares of Common Stock

           3           
        

 

 

    

 

 

 
           43,236         35,814   

TBA Global, LLC

   Advertising         

53,994 Senior Preferred Shares

           216         388   

191,977 Shares A Shares

           192         74   
        

 

 

    

 

 

 
           408         462   

Fitness Edge, LLC

   Leisure facilities         

First Lien Term Loan A, LIBOR+5.25% (4.75% floor) cash due 7/31/2012

        750         749         757   

First Lien Term Loan B, 12.5% cash 2.5% PIK due 7/31/2012

        5,776         5,750         5,814   

1,000 Common Units(6)

           43         181   
        

 

 

    

 

 

 
           6,542         6,752   

 

14


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Boot Barn

   Apparel, accessories & luxury goods and footwear        

255.78 shares of Series A&B Preferred Stock

           247        71   

1,354 shares of Common Stock

           9        9   
        

 

 

   

 

 

 
           256        80   

Premier Trailer Leasing, Inc.(9)(13)(14)

   Trucking        

Second Lien Term Loan, 13.25% cash 3.25% PIK due 10/23/2012

        19,070         17,064          

285 shares of Common Stock

           1          
        

 

 

   

 

 

 
           17,065          

Capital Equipment Group, Inc.(9)

   Industrial machinery        

Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013

        10,278         10,112        10,226   

33,463 shares of Common Stock

           345        634   
        

 

 

   

 

 

 
           10,457        10,860   

Rail Acquisition Corp.

   Electronic manufacturing services        

First Lien Term Loan, 12% PIK due 9/1/2013

        18,415         15,636        4,106   

First Lien Revolver, 7.85% cash due 9/1/2013

        4,554         4,554        4,554   
        

 

 

   

 

 

 
           20,190        8,660   

Western Emulsions, Inc.

   Construction materials        

Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014

        6,844         6,736        6,840   
        

 

 

   

 

 

 
           6,736        6,840   

Storyteller Theaters Corporation

   Movies & entertainment        

1,692 shares of Common Stock

                  62   

20,000 shares of Preferred Stock

           200        200   
        

 

 

   

 

 

 
           200        262   

HealthDrive Corporation

   Healthcare services        

First Lien Term Loan A, 10% cash due 7/17/2013

        6,263         6,049        6,352   

First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013

        10,282         10,212        10,217   

First Lien Revolver, 12% cash due 7/17/2013(11)

           (7 )       
        

 

 

   

 

 

 
           16,254        16,569   

idX Corporation

   Distributors        

Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014

        18,895         18,631        18,938   
        

 

 

   

 

 

 
           18,631        18,938   

Cenegenics, LLC

   Healthcare services        

414,419 Common Units(6)

           598        1,060   
        

 

 

   

 

 

 
           598        1,060   

IZI Medical Products, Inc.

   Healthcare technology        

First Lien Term Loan A, 12% cash due 3/31/2014

        3,236         3,215        3,244   

First Lien Term Loan B, 13% cash 3% PIK due 3/31/2014

        17,258         16,861        17,061   

First Lien Revolver, 10% cash due 3/31/2014(11)

           (25 )       

453,755 Preferred units of IZI Holdings, LLC

           454        642   
        

 

 

   

 

 

 
           20,505        20,947   

Trans-Trade, Inc.

   Air freight & logistics        

First Lien Term Loan, 13% cash 2.5% PIK due 9/10/2014

        12,523         12,287        11,763   

First Lien Revolver, 12% cash due 9/10/2014

        5,800         5,697        5,479   
        

 

 

   

 

 

 
           17,984        17,242   

Riverlake Equity Partners II, LP

   Multi-sector holdings        

1.89% limited partnership interest(16)

           122        122   
        

 

 

   

 

 

 
           122        122   

Riverside Fund IV, LP

   Multi-sector holdings        

0.33% limited partnership interest(16)

           445        445   
        

 

 

   

 

 

 
           445        445   

 

15


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

ADAPCO, Inc.

   Fertilizers & agricultural chemicals        

First Lien Term Loan A, 10% cash due 12/17/2014

        8,000         7,871        8,010   

First Lien Term Loan B, 12% cash 2% PIK due 12/17/2014

        15,521         15,306        15,371   

First Lien Term Revolver, 10% cash due 12/17/2014

        5,750         5,623        5,809   
        

 

 

   

 

 

 
           28,800        29,190   

Ambath/Rebath Holdings, Inc.

   Home improvement retail        

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014

        3,500         3,500        3,497   

First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014

        22,999         22,999        22,600   

First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014(10)

        1,500         1,500        1,479   
        

 

 

   

 

 

 
           27,999        27,576   

JTC Education, Inc.

   Education services        

First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014

        30,134         29,467        29,780   

First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014(11)

           (305 )       

17,391 Shares of Series A-1 Preferred Stock

           313        313   

17,391 Shares of Common Stock

           187        83   
        

 

 

   

 

 

 
           29,662        30,176   

Tegra Medical, LLC

   Healthcare equipment        

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014

        22,540         22,244        22,744   

First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014

        22,551         22,270        22,226   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014

        2,500         2,449        2,501   
        

 

 

   

 

 

 
           46,963        47,471   

Psilos Group Partners IV, LP

   Multi-sector holdings        

2.52% limited partnership interest(12)(16)

                    
        

 

 

   

 

 

 
                    

Mansell Group, Inc.

   Advertising        

First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015

        10,675         10,512        10,654   

First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015

        9,142         9,001        9,067   

First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)

           (29 )       
        

 

 

   

 

 

 
           19,484        19,721   

NDSSI Holdings, LLC

   Electronic equipment & instruments        

First Lien Term Loan, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012

        29,788         29,370        29,278   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012

        3,500         3,435        3,538   

2,000 Series D Preferred Units

           2,047        2,047   
        

 

 

   

 

 

 
           34,852        34,863   

Eagle Hospital Physicians, Inc.(9)

   Healthcare services        

First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015

        25,400         24,907        25,246   

First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015(11)

           (42 )       
        

 

 

   

 

 

 
           24,865        25,246   

Enhanced Recovery Company, LLC

   Diversified support services        

First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015

        13,961         13,713        13,945   

First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015

        11,070         10,882        11,015   

First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015(11)

           (69 )       
        

 

 

   

 

 

 
           24,526        24,960   

Epic Acquisition, Inc.

   Healthcare services        

First Lien Term Loan A, LIBOR+8% (3% floor) cash due 8/13/2015

        8,329         8,189        8,343   

First Lien Term Loan B, 12.25% cash 3% PIK due 8/13/2015

        17,246         16,962        17,281   

First Lien Revolver, LIBOR+6.5% (3% floor) cash due 8/13/2015(11)

           (50 )       
        

 

 

   

 

 

 
           25,101        25,624   

 

16


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Specialty Bakers LLC

   Food distributors        

First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015

        8,325         8,148        8,220   

First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015

        11,000         10,770        10,756   

First Lien Revolver, LIBOR+8.5% cash due 9/15/2015

        2,000         1,916        2,029   
        

 

 

   

 

 

 
           20,834        21,005   

CRGT, Inc.

   IT consulting & other services        

First Lien Term Loan A, LIBOR+7.5% cash due 10/1/2015

        27,913         27,495        27,659   

First Lien Term Loan B, 12.5% cash 10/1/2015

        22,000         21,648        21,869   

First Lien Revolver, LIBOR+7.5% cash due 10/1/2015(11)

           (200 )       
        

 

 

   

 

 

 
           48,943        49,528   

Welocalize, Inc.

   Internet software & services        

First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015

        15,990         15,720        15,668   

First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015

        21,231         20,888        20,983   

First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015

        5,250         5,152        5,162   

2,086,163 Common Units in RPWL Holdings, LLC

           2,086        1,973   
        

 

 

   

 

 

 
           43,846        43,786   

Miche Bag, LLC

   Apparel, accessories & luxury goods        

First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013

        13,708         13,353        13,735   

First Lien Term Loan B, LIBOR+10% (3% floor) cash 3% PIK due 12/7/2015

        17,425         14,983        17,115   

First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015(11)

           (105 )       

10,371 Preferred Equity units in Miche Holdings, LLC(6)

           1,037        1,169   

146,289 Series D Common Equity units in Miche Holdings, LLC(6)

           1,463        1,496   
        

 

 

   

 

 

 
           30,731        33,515   

Bunker Hill Capital II (QP), LP

   Multi-sector holdings        

0.50% limited partnership interest(16)

           40        40   
        

 

 

   

 

 

 
           40        40   

Dominion Diagnostics, LLC(9)

   Healthcare services        

First Lien Term Loan A, LIBOR+7% (2.5% floor) cash due 12/17/2015

        29,550         29,030        29,442   

First Lien Term Loan B, LIBOR+10.5% (2.5% floor) cash 1% PIK due 12/17/2015

        20,008         19,675        19,546   

First Lien Revolver, LIBOR+6.5% (2.5% floor) cash due 12/17/2015(11)

           (83 )       
        

 

 

   

 

 

 
           48,622        48,988   

Advanced Pain Management

   Healthcare services        

First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015

        8,046         7,923        8,007   

First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015

        133         129        135   
        

 

 

   

 

 

 
           8,052        8,142   

DISA, Inc.

   Human resources & employment services        

First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015

        12,460         12,256        12,542   

First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015

        8,395         8,264        8,410   

First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015(11)

           (63 )       
        

 

 

   

 

 

 
           20,457        20,952   

Saddleback Fence and Vinyl Products, Inc.

   Building products        

First Lien Term Loan, 8% cash due 11/30/2013

        773         773        773   

First Lien Revolver, 8% cash due 11/30/2013

                    
        

 

 

   

 

 

 
           773        773   

 

17


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Best Vinyl Fence & Deck, LLC

   Building products        

First Lien Term Loan A, 8% cash due 11/30/2013

        2,061         1,947        2,061   

First Lien Term Loan B, 8% PIK due 7/31/2011(15)

        3,969         3,969        2,000   

First Lien Revolver, 8% cash due 11/30/2013

                    
        

 

 

   

 

 

 
           5,916        4,061   

Physicians Pharmacy Alliance, Inc.

   Healthcare services        

First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016

        16,766         16,461        16,702   

First Lien Revolver, LIBOR+6% cash due 1/4/2016(11)

           (35 )       
        

 

 

   

 

 

 
           16,426        16,702   

Cardon Healthcare Network, LLC

   Diversified support services        

First Lien Term Loan, LIBOR+10% (1.75% floor) cash due 1/6/2016(9)

        11,250         11,051        11,210   

First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/6/2016(11)

           (35 )       
        

 

 

   

 

 

 
           11,016        11,210   

U.S. Retirement Partners, Inc.

   Diversified financial services        

First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016

        13,600         13,311        13,329   
        

 

 

   

 

 

 
           13,311        13,329   

IOS Acquisitions, Inc.

   Oil & gas equipment & services        

First Lien Term Loan A, LIBOR+8% (2% floor) cash due 1/14/2016

        8,700         8,576        8,656   

First Lien Term Loan B, LIBOR+10% (2% floor) cash 2% PIK due 1/14/2016

        10,618         10,466        10,480   

First Lien Revolver, LIBOR+8% (2% floor) cash due 1/14/2016

        750         714        777   
        

 

 

   

 

 

 
           19,756        19,913   

Actient Pharmaceuticals, LLC

   Healthcare services        

First Lien Term Loan, LIBOR+6.25% (2% floor) cash due 7/29/2015

        9,180         9,018        9,169   
        

 

 

   

 

 

 
           9,018        9,169   

Phoenix Brands Merger Sub LLC

   Household products        

Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016

        8,036         7,875        7,674   

Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017

        20,390         20,035        19,071   

First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016

        3,429         3,303        3,198   
        

 

 

   

 

 

 
           31,213        29,943   

U.S. Collections, Inc.

   Diversified support services        

First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016

        10,847         10,649        10,828   
        

 

 

   

 

 

 
           10,649        10,828   

CCCG, LLC

   Oil & gas equipment & services        

First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015

        34,738         34,115        34,152   
        

 

 

   

 

 

 
           34,115        34,152   

Maverick Healthcare Group, LLC

   Healthcare equipment        

First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016

        24,813         24,292        24,440   
        

 

 

   

 

 

 
           24,292        24,440   

Refac Optical Group

   Specialty stores        

First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016

        14,220         13,920        14,273   

First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016

        20,162         19,731        20,078   

First Lien Revolver, LIBOR+7.5% cash due 3/23/2016(11)

           (113 )       

1,000 Shares of Common Stock in Refac Holdings, Inc.

           1          

1,000 Shares of Preferred Stock in Refac Holdings, Inc.

           999        847   
        

 

 

   

 

 

 
           34,538        35,198   

 

18


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal(8)      Cost     Fair Value  

Pacific Architects & Engineers, Inc.

   Diversified support services        

First Lien Term Loan A, LIBOR+5% (1.5% floor) cash due 4/4/2017

        4,416         4,352        4,332   

First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017

        5,000         4,929        4,903   
        

 

 

   

 

 

 
           9,281        9,235   

Ernest Health, Inc.

   Healthcare services        

Second Lien Term Loan, LIBOR+8.5% (1.75% floor) cash due 5/13/2017

        25,000         24,656        25,049   
        

 

 

   

 

 

 
           24,656        25,049   

Securus Technologies, Inc.

   Integrated telecommunication services        

Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018

        26,500         25,995        26,374   
        

 

 

   

 

 

 
           25,995        26,374   

Gundle/SLT Environmental, Inc.

   Environmental & facilities services        

First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016

        7,980         7,904        7,977   
        

 

 

   

 

 

 
           7,904        7,977   

Titan Fitness, LLC

   Leisure facilities        

First Lien Term Loan A, LIBOR+8.75 (1.25% floor) cash due 6/30/2016

        17,063         16,878        16,938   

First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016

        11,545         11,422        11,343   

First Lien Term Loan C, 18% PIK due 6/30/2016

        2,721         2,693        2,593   

First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016

        543         506        821   
        

 

 

   

 

 

 
           31,499        31,695   

Baird Capital Partners V, LP

   Multi-sector holdings        

0.4% limited partnership interest(16)

           299        299   
        

 

 

   

 

 

 
           299        299   

Charter Brokerage, LLC

   Oil & gas equipment services        

Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016

        17,411         17,242        17,411   

Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017

        10,043         9,948        10,043   

Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016

        1,176         1,107        1,177   
        

 

 

   

 

 

 
           28,297        28,631   

Stackpole Powertrain International ULC(16)

   Auto parts & equipment        

Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018

        18,059         17,883        18,059   

1,000 Common Units

           1,000        1,000   
        

 

 

   

 

 

 
           18,883        19,059   

Discovery Practice Management, Inc.

   Healthcare services        

Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016

        7,027         6,942        7,027   

Senior Term Loan B, 12% cash 3% PIK due 8/8/2016

        6,248         6,174        6,248   

Senior Revolver, LIBOR+7% cash due 8/8/2016(11)

           (37 )       
        

 

 

   

 

 

 
           13,079        13,275   

CTM Group, Inc.

   Leisure products        

Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017

        10,530         10,417        10,530   

Mezzanine Term Loan B, 18.4% PIK due 2/10/2017

        3,181         3,147        3,181   
        

 

 

   

 

 

 
           13,564        13,711   

Bojangles

   Restaurants        

First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017

        10,000         9,803        10,000   
        

 

 

   

 

 

 
           9,803        10,000   

Milestone Partners IV, LP

   Multi-sector holdings        

3.07% limited partnership interest(12)(16)

                    
        

 

 

   

 

 

 
                    

 

19


Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

Portfolio Company/Type of Investment(1)(2)(5)

  

Industry

   Principal
(8)
     Cost      Fair Value  

Insight Pharmaceuticals, LLC

   Pharmaceuticals         

First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016

        10,000         9,926         10,000   

Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017

        17,500         17,331         17,500   
        

 

 

    

 

 

 
           27,257         27,500   

National Spine and Pain Centers, LLC

   Healthcare services         

Mezzanine Term Loan, 11% cash 1.6% PIK due 9/27/2017

        19,002         18,816         19,002   

250,000 Class A Units

           250         250   
        

 

 

    

 

 

 
           19,066         19,252   
        

 

 

    

 

 

 

Total Non-Control/Non-Affiliate Investments (148.1% of net assets)

         $ 1,108,174       $ 1,079,440   
        

 

 

    

 

 

 

Total Portfolio Investments (153.7% of net assets)

         $ 1,156,082       $ 1,119,837   
        

 

 

    

 

 

 

 

(1) Debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.

 

(2) See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.

 

(3) Control Investments are defined by the 1940 Act as investments in companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation.

 

(4) Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.

 

(5) Equity ownership may be held in shares or units of companies related to the portfolio companies.

 

(6) Income producing through payment of dividends or distributions.

 

(7) Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.

 

(8) Principal includes accumulated PIK interest and is net of repayments.

 

(9) Interest rates have been adjusted on certain term loans and revolvers. These rate adjustments are temporary in nature due to financial or payment covenant violations in the original credit agreements, or permanent in nature per loan amendment or waiver documents. The table below summarizes these rate adjustments by portfolio company:

 

Portfolio Company

 

Effective date

 

Cash interest

 

PIK interest

 

Reason

Cardon Healthcare Network, LLC

  July 1, 2011   – 2.5% on Term Loan     Tier pricing per credit agreement

Eagle Hospital Physicians, Inc.

  July 1, 2011   – 0.25% on Term Loan & Revolver     Per loan agreement

Dominion Diagnostics, LLC

  April 1, 2011   – 0.5% on Term Loan A   – 1.0% on Term Loan B   Tier pricing per credit agreement

Lighting by Gregory, LLC

  March 11, 2011   – 2.0% on Bridge Loan     Per loan amendment

Capital Equipment Group, Inc.

  July 1, 2010   – 2.0% on Term Loan   – 0.75% on Term Loan   Per waiver agreement

Traffic Control & Safety Corporation

  June 1, 2010   – 4.0% on Second Lien Term Loan   + 1.0% on Second Lien Term Loan   Per restructuring agreement

Premier Trailer Leasing, Inc.

  August 4, 2009   + 4.0% on Term Loan     Default interest per credit agreement

 

(10) Revolving credit line had been suspended and was deemed unlikely to be renewed in the future.

 

(11) Cost amounts represent unearned income related to undrawn commitments.

 

(12) Represents an unfunded commitment to fund limited partnership interest.

 

(13) Investment was on cash non-accrual status as of September 30, 2011.

 

(14) Investment was on PIK non-accrual status as of September 30, 2011.

 

(15) Best Vinyl Fence & Deck, LLC Term Loan B was under negotiation and, as such, the maturity date of the loan had been temporarily suspended.

 

(16) Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.

 

20


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Note 1. Organization

Fifth Street Mezzanine Partners III, L.P. (the “Partnership”), a Delaware limited partnership, was organized on February 15, 2007 to primarily invest in debt securities of small and middle market companies. FSMPIII GP, LLC was the Partnership’s general partner (the “General Partner”). The Partnership’s investments were managed by Fifth Street Management LLC (the “Investment Adviser”). The General Partner and Investment Adviser were under common ownership.

Effective January 2, 2008, the Partnership merged with and into Fifth Street Finance Corp. (the “Company”), an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940 (the “1940 Act”). Fifth Street Finance Corp. is managed by the Investment Adviser. Prior to January 2, 2008, references to the Company are to the Partnership.

The Company also has certain wholly-owned subsidiaries, including subsidiaries that are not consolidated with the Company for income tax purposes, which hold certain portfolio investments of the Company. The subsidiaries are consolidated with the Company for accounting purposes, and the portfolio investments held by the subsidiaries are included in the Company’s Consolidated Financial Statements. All significant intercompany balances and transactions have been eliminated.

On November 28, 2011, the Company transferred the listing of its common stock from the New York Stock Exchange to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.” The following table reflects common stock offerings that have occurred from inception through June 30, 2012:

 

Date

  

Transaction

   Shares      Offering price     Gross proceeds  

June 17, 2008

   Initial public offering      10,000,000       $ 14.12      $ 141.2 million   

July 21, 2009

   Follow-on public offering (including underwriters’ exercise of over-allotment option)      9,487,500         9.25        87.8 million   

September 25, 2009

   Follow-on public offering (including underwriters’ exercise of over-allotment option)      5,520,000         10.50        58.0 million   

January 27, 2010

   Follow-on public offering      7,000,000         11.20        78.4 million   

February 25, 2010

   Underwriters’ partial exercise of over-allotment option      300,500         11.20        3.4 million   

June 21, 2010

   Follow-on public offering (including underwriters’ exercise of over-allotment option)      9,200,000         11.50        105.8 million   

December 2010

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

February 4, 2011

   Follow-on public offering (including underwriters’ exercise of over-allotment option)      11,500,000         12.65        145.5 million   

June 24, 2011

   Follow-on public offering (including underwriters’ partial exercise of over-allotment option)      5,558,469         11.72        65.1 million   

January 26, 2012

   Follow-on public offering      10,000,000         10.07        100.7 million   

 

(1) Average offering price

On February 3, 2010, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. (“FSMP IV”), received a license, effective February 1, 2010, from the United States Small Business Administration, or SBA, to operate as a small business investment company, or SBIC, under Section 301(c) of the Small Business Investment Act of 1958. On May 15, 2012, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. (“FSMP V”), received a license, effective May 10, 2012, from the SBA to operate as an SBIC. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

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

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

SBA regulations currently limit the amount of SBA-guaranteed debentures that an SBIC may issue to $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million in SBA-guaranteed debentures when they have at least $112.5 million in combined regulatory capital. As of June 30, 2012, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $126.2 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:

 

Rate Fix Date

   Debenture
Amount
     Fixed
Interest
Rate
    SBA
Annual
Charge
 

September 2010

   $ 73,000         3.215 %     0.285 %

March 2011

     65,300         4.084 %     0.285 %

September 2011

     11,700         2.877 %     0.285 %

As of June 30, 2012, FSMP V had $37.5 million in regulatory capital but did not yet have any SBA-guaranteed debentures outstanding. For the three and nine months ended June 30, 2012 the Company recorded interest expense of $1.6 million and $4.7 million, respectively, related to the SBA-guaranteed debentures.

The SBA restricts the ability of SBICs to repurchase their capital stock. SBA regulations also include restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in accordance with SBA regulations. In addition, the Company’s SBIC subsidiaries may also be limited in their ability to make distributions to the Company if they do not have sufficient capital, in accordance with SBA regulations.

The Company’s SBIC subsidiaries are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that the SBIC subsidiaries will receive SBA-guaranteed debenture funding and is dependent upon the SBIC subsidiaries’ continuing to be in compliance with SBA regulations and policies.

The SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiaries upon an event of default.

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

 

Note 2. Significant Accounting Policies

Basis of Presentation and Liquidity:

The Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and Regulation S-X. In the opinion of management, all adjustments of a normal recurring nature considered necessary for the fair presentation of the Consolidated Financial Statements have been made. The financial results of the Company’s portfolio investments are not consolidated in the Company’s Consolidated Financial Statements.

Although the Company expects to fund the growth of its investment portfolio through the net proceeds from equity offerings, the Company’s dividend reinvestment plan, and issuances of senior securities or future borrowings, to the extent permitted by the 1940 Act, the Company cannot assure that its plans to raise capital will be successful. In addition, the Company intends to distribute to its stockholders between 90% and 100% of its taxable income each year in order to satisfy the requirements applicable to Regulated Investment Companies (“RICs”) under Subchapter M of the Internal Revenue Code (“Code”). Consequently, the Company may not have the funds or the ability to fund new investments, to make additional investments in its portfolio companies, to fund its unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of its portfolio investments may make it difficult for the Company to sell these investments when desired and, if the Company is required to sell these investments, it may realize significantly less than their recorded value.

 

22


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Use of Estimates:

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the financial statements and accompanying notes. These estimates are based on the information that is currently available to the Company and on various other assumptions that the Company believes to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions and conditions. The most significant estimates inherent in the preparation of the Company’s Consolidated Financial Statements are the valuation of investments and revenue recognition.

The Consolidated Financial Statements include portfolio investments at fair value of $1.20 billion and $1.12 billion at June 30, 2012 and September 30, 2011, respectively. The portfolio investments represent 147.5% and 153.7% of net assets at June 30, 2012 and September 30, 2011, respectively, and their fair values have been determined by the Company’s Board of Directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation; “Affiliate Investments” are defined as investments in companies in which the Company owns between 5% and 25% of the voting securities; and “Non-Control/Non-Affiliate Investments” are defined as investments that are neither Control Investments nor Affiliate Investments.

Fair Value Measurements:

The Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 820 Fair Value Measurements and Disclosures (“ASC 820”) defines fair value as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available or reliable, valuation techniques are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the investments or market and the investments’ complexity.

Assets recorded at fair value in the Company’s Consolidated Financial Statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value.

Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:

 

   

Level 1 — Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

   

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.

 

   

Level 3 — Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Under ASC 820, the Company performs detailed valuations of its debt and equity investments on an individual basis, using market, income and bond yield approaches as appropriate. In general, the Company utilizes the bond yield method in determining the fair value of its investments, as long as it is appropriate. If, in the Company’s judgment, the bond yield approach is not appropriate, it may use the market approach or income approach in determining the fair value of the Company’s investment in the portfolio company. If there is deterioration in the credit quality of the portfolio company or an investment is in workout status, the Company may use alternative methodologies, including an asset liquidation or expected recovery model.

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Under the bond yield approach, the Company uses bond yield models to determine the present value of the future cash flow streams of its debt investments. The Company reviews various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assesses the information in the valuation process.

Under the market approach, the Company estimates the enterprise value of the portfolio companies in which it invests. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which the Company derives a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, the Company analyzes various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (earnings before interest, taxes, depreciation and amortization), cash flows, net income, revenues or, in limited cases, book value. The Company generally requires portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.

Under the income approach, the Company generally prepares and analyzes discounted cash flow models based on projections of the future free cash flows of the business.

The Company’s Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of the Company’s investments:

 

   

The quarterly valuation process begins with each portfolio company or investment being initially valued by the Company’s finance department;

 

   

Preliminary valuations are then reviewed and discussed with principals of the Investment Adviser;

 

   

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

 

   

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

 

   

The finance department prepares a valuation report for the Valuation Committee of the Board of Directors;

 

   

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

 

   

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

 

   

The Valuation Committee of the Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in the Company’s portfolio; and

 

   

The Board of Directors discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith.

The fair value of all of the Company’s investments at June 30, 2012 and September 30, 2011 was determined by the Board of Directors. The Board of Directors is solely responsible for the valuation of the portfolio investments at fair value as determined in good faith pursuant to the Company’s valuation policy and a consistently applied valuation process.

The Board of Directors has authorized the engagement of independent valuation firms to provide valuation assistance. Upon completion of their processes each quarter, the independent valuation firms provide the Company with written reports regarding the preliminary valuations of selected portfolio securities as of the close of such quarter. The Company will continue to engage independent valuation firms to provide assistance regarding the determination of the fair value of selected portfolio securities each quarter; however, the Board of Directors is ultimately and solely responsible for determining the fair value of the Company’s investments in good faith. The Company intends to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued on an annual basis.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Investment Income:

Interest income, adjusted for accretion of original issue discount or “OID,” is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. In connection with its investment, the Company sometimes receives nominal cost equity that is valued as part of the negotiation process with the particular portfolio company. When the Company receives nominal cost equity, the Company allocates its cost basis in its investment between its debt securities and its nominal cost equity at the time of origination. Any resulting discount from recording the loan is accreted into interest income over the life of the loan.

Distributions of earnings from portfolio companies are recorded as dividend income when the distribution is received.

The Company has investments in debt securities which contain payment-in-kind or “PIK” interest provisions. PIK interest is computed at the contractual rate specified in each investment agreement and added to the principal balance of the investment and recorded as income.

Fee income consists of the monthly servicing fees, advisory fees and prepayment fees that the Company receives in connection with its debt investments and the accreted portion of the debt origination fees. The Company capitalizes a portion of the upfront loan origination fees received in connection with investments. The unearned fee income from such fees is accreted into fee income, based on the straight line method or effective interest method as applicable, over the life of the investment.

The Company has also structured exit fees across certain of its portfolio investments to be received upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt security. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.

Gain on Extinguishment of Convertible Senior Notes:

The Company may repurchase its Convertible Senior Notes in accordance with the 1940 Act and the rules promulgated thereunder and may surrender these Notes to the Trustee for cancellation. If the repurchase occurs at a purchase price below par value, a gain on the extinguishment of these Notes is recorded. The amount of the gain recorded is the difference between the reacquisition price and the net carrying amount of the Notes, net of the proportionate amount of unamortized debt issuance costs.

Cash and Cash Equivalents:

Cash and cash equivalents consist of demand deposits and highly liquid investments with maturities of three months or less, when acquired. The Company places its cash and cash equivalents with financial institutions and, at times, cash held in bank accounts may exceed the Federal Deposit Insurance Corporation insured limit. Included in cash and cash equivalents is $16.9 million that is held at Wells Fargo Bank, National Association (“Wells Fargo”) in connection with the Company’s credit facility. The Company is restricted in terms of access to this cash until such time as the Company submits its required monthly reporting schedules and Wells Fargo verifies the Company’s compliance per the terms of the credit agreement.

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Deferred Financing Costs:

Deferred financing costs consist of fees and expenses paid in connection with the closing or amending of credit facilities and the Convertible Senior Notes, and are capitalized at the time of payment. Deferred financing costs are amortized using the straight line method over the terms of the respective credit facilities. This amortization expense is included in interest expense in the Company’s Consolidated Statement of Operations.

Collateral Posted to Bank:

Collateral posted to bank consisted of cash posted as collateral with respect to the Company’s interest rate swap, which was terminated in August 2011. The Company was restricted in terms of access to this collateral until such swap was terminated or the swap agreement expired. Cash collateral posted was held in an account at Wells Fargo.

Interest Rate Swap:

The Company does not utilize hedge accounting and marks its interest rate swaps to fair value on a quarterly basis through its Consolidated Statement of Operations. As of June 30, 2012, the Company was not party to any interest rate swap agreements.

Offering Costs:

Offering costs consist of fees and expenses incurred in connection with the public offer and sale of the Company’s common stock, including legal, accounting and printing fees. $0.9 million of offering costs were charged to capital during the nine months ended June 30, 2012.

Income Taxes:

As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company intends to distribute between 90% and 100% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2012). The Company anticipates timely distribution of its taxable income within the tax rules; however, the Company incurred a de minimis federal excise tax for calendar years 2008, 2009 and 2010. The Company did not incur a federal excise tax for calendar year 2011 and does not expect to incur a federal excise tax for calendar year 2012. The Company may incur a federal excise tax in future years.

The purpose of the Company’s taxable subsidiaries is to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for federal tax purposes in order to comply with the “source income” requirements contained in the RIC tax requirements. The taxable subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense as a result of their ownership of certain portfolio investments. This income tax expense, if any, would be reflected in the Company’s Consolidated Statements of Operations. The Company uses the asset and liability method to account for its taxable subsidiaries’ income taxes. Using this method, the Company recognizes deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and tax bases of assets and liabilities. In addition, the Company recognizes deferred tax benefits associated with net operating loss carry forwards that it may use to offset future tax obligations. The Company measures deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

ASC 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the Company’s Consolidated Financial Statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax benefit or expense in the current year. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. The Company recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years 2008, 2009, 2010 or 2011. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months.

Recent Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 amends ASC 820 and requires entities to change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements related to the application of the highest and best use and valuation premise concepts for financial and nonfinancial instruments, measuring the fair value of an instrument classified in shareholders’ equity, and disclosures about fair value measurements. ASU 2011-04 changes the measurement of the fair value of financial instruments that are managed within a portfolio and the application of premiums and discounts in a fair value measurement related to size as a characteristic of the reporting entity’s holding rather than a characteristic of the asset or liability. ASU 2011-04 requires additional disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy including the valuation processes used by the reporting entity, the sensitivity of the fair value to changes in unobservable inputs, and the interrelationships between those unobservable inputs, if any. All the amendments to ASC 820 made by ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011. The adoption of this disclosure-only guidance is included in Note 3 — Portfolio Investments and did not have an impact on the Company’s consolidated financial results.

 

Note 3. Portfolio Investments

At June 30, 2012, 147.5% of net assets or $1.20 billion was invested in 76 long-term portfolio investments and 13.0% of net assets or $105.7 million was invested in cash and cash equivalents. In comparison, at September 30, 2011, 153.7% of net assets or $1.12 billion was invested in 65 long-term portfolio investments and 9.3% of net assets or $67.6 million was invested in cash and cash equivalents. As of June 30, 2012, 80.5% of the Company’s portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of the portfolio companies. Moreover, the Company held equity investments in certain of its portfolio companies consisting of common stock, preferred stock, limited partnership interests or limited liability company interests. These instruments generally do not produce a current return but are held for potential investment appreciation and capital gain.

During the three and nine months ended June 30, 2012, the Company recorded no net realized losses and net realized losses of $27.4 million, respectively. During the three and nine months ended June 30, 2011, the Company recorded net realized losses of $14.1 million and $28.1 million, respectively. During the three and nine months ended June 30, 2012, the Company recorded net unrealized appreciation of $0.2 million and $14.1 million, respectively. During the three and nine months ended June 30, 2011, the Company recorded net unrealized appreciation of $18.5 million and $34.9 million, respectively.

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The composition of the Company’s investments as of June 30, 2012 and September 30, 2011 at cost and fair value was as follows:

 

     June 30, 2012      September 30, 2011  
     Cost      Fair Value      Cost      Fair Value  

Investments in debt securities

   $ 1,194,379       $ 1,168,060       $ 1,137,754       $ 1,099,708   

Investments in equity securities

     26,013         30,037         18,328         20,129   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,220,392       $ 1,198,097       $ 1,156,082       $ 1,119,837   
  

 

 

    

 

 

    

 

 

    

 

 

 

The composition of the Company’s debt investments as of June 30, 2012 and September 30, 2011 at fixed rates and floating rates was as follows:

 

     June 30, 2012     September 30, 2011  
     Fair Value      % of
Debt Portfolio
    Fair Value      % of
Debt Portfolio
 

Fixed rate debt securities

   $ 372,729         31.91   $ 359,873         32.72

Floating rate debt securities

     795,331         68.09     739,835         67.28
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,168,060         100.00   $ 1,099,708         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table presents the financial instruments carried at fair value as of June 30, 2012, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820.

 

     Level 1      Level 2      Level 3      Total  

Investments in debt securities (first lien)

   $       $       $ 831,847       $ 831,847   

Investments in debt securities (second lien)

                     132,718         132,718   

Investments in debt securities (subordinated)

                     203,495         203,495   

Investments in equity securities (preferred)

                     9,233         9,233   

Investments in equity securities (common)

                     20,804         20,804   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments at fair value

   $       $       $ 1,198,097       $ 1,198,097   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the financial instruments carried at fair value as of September 30, 2011, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820.

 

     Level 1      Level 2      Level 3      Total  

Investments in debt securities (first lien)

   $       $       $ 875,092       $ 875,092   

Investments in debt securities (second lien)

                     143,383         143,383   

Investments in debt securities (subordinated)

                     81,233         81,233   

Investments in equity securities (preferred)

                     7,167         7,167   

Investments in equity securities (common)

                     12,962         12,962   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments at fair value

   $       $       $ 1,119,837       $ 1,119,837   
  

 

 

    

 

 

    

 

 

    

 

 

 

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the fact that the unobservable factors are the most significant to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated by external sources). Accordingly, the appreciation (depreciation) in the tables below includes changes in fair value due in part to observable factors that are part of the valuation methodology.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The following table provides a roll-forward in the changes in fair value from March 31, 2012 to June 30, 2012 for all investments for which the Company determines fair value using unobservable (Level 3) factors.

 

     First Lien
Debt
    Second
Lien Debt
    Subordinated
Debt
    Preferred
Equity
     Common
Equity
    Total  

Fair value as of March 31, 2012

   $ 736,192      $ 122,261      $ 171,208      $ 7,801       $ 18,761      $ 1,056,223   

New investments & net revolver activity

     141,260        30,000        29,000        500         2,747        203,507   

Redemptions/repayments

     (47,885 )     (18,507                           (66,392 )

Net accrual of PIK interest income

     1,254        (1,552     1,091        184                977   

Accretion of original issue discount

     248        205                              453   

Net change in unearned income

     1,587        44        (25                    1,606   

Net unrealized appreciation (depreciation)

     (1,871     (215     2,221        748         (704     179   

Unrealized adjustments due to deal exits

     1,062        482                              1,544   

Transfer into (out of) Level 3

                                           
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Fair value as of June 30, 2012

   $ 831,847      $ 132,718      $ 203,495      $ 9,233       $ 20,804      $ 1,198,097   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at June 30, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended June 30, 2012

   $ (809   $ 267      $ 2,221      $ 748       $ (704   $ 1,723   

The following table provides a roll-forward in the changes in fair value from March 31, 2011 to June 30, 2011 for all investments for which the Company determines fair value using unobservable (Level 3) factors.

 

     First Lien
Debt
    Second
Lien Debt
    Subordinated
Debt
    Preferred
Equity
     Common
Equity
    Total  

Fair value as of March 31, 2011

   $ 821,885      $ 82,586      $ 24,347      $ 4,559       $ 6,372      $ 939,749   

New investments & net revolver activity

     56,108        56,500                       1,569        114,177   

Redemptions/repayments

     (9,299     (458                           (9,757

Net accrual of PIK interest income

     2,212        612        419                       3,243   

Accretion of original issue discount

     348        82                              430   

Net change in unearned income

     1,129        (875     17                       271   

Net unrealized appreciation (depreciation)

     10,533        1,077        (107     337         7,531        19,371   

Unrealized adjustments due to deal exits

     (13,233                           (772     (14,005

Transfer into (out of) Level 3

                                           
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Fair value as of June 30, 2011

   $ 869,683      $ 139,524      $ 24,676      $ 4,896       $ 14,700      $ 1,053,479   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at June 30, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended June 30, 2011

   $ (2,700   $ 1,077      $ (107 )   $ 337       $ 6,759      $ 5,366   

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The following table provides a roll-forward in the changes in fair value from September 30, 2011 to June 30, 2012 for all investments for which the Company determines fair value using unobservable (Level 3) factors.

 

     First Lien
Debt
    Second
Lien Debt
    Subordinated
Debt
    Preferred
Equity
    Common
Equity
    Total  

Fair value as of September 30, 2011

   $ 875,092      $ 143,383      $ 81,233      $ 7,167      $ 12,962      $ 1,119,837   

New investments & net revolver activity

     244,079        37,000        118,516        1,200        7,059        407,854   

Redemptions/repayments

     (289,426 )     (41,994            (713 )     (9 )     (332,142

Net accrual of PIK interest income

     2,798        (904     2,814        517               5,225   

Accretion of original issue discount

     1,043        324                             1,367   

Net change in unearned income

     5,012        1,130        (919 )                   5,223   

Net unrealized appreciation (depreciation)

     (22     10,008        1,851        1,180        1,043        14,060   

Unrealized adjustments due to deal exits

     (6,729 )     (16,229 )            (118 )     (251 )     (23,327 )

Transfer into (out of) Level 3

                                          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of June 30, 2012

   $ 831,847      $ 132,718      $ 203,495      $ 9,233      $ 20,804      $ 1,198,097   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at June 30, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the nine months ended June 30, 2012

   $ (6,751 )   $ (6,221 )   $ 1,851      $ 1,062      $ 792      $ (9,267 )

The following table provides a roll-forward in the changes in fair value from September 30, 2010 to June 30, 2011 for all investments for which the Company determines fair value using unobservable (Level 3) factors.

 

     First Lien
Debt
    Second
Lien Debt
    Subordinated
Debt
    Preferred
Equity
    Common
Equity
    Total  

Fair value as of September 30, 2010

   $ 416,324      $ 136,786      $ 5,470      $ 2,892      $ 2,349      $ 563,821   

New investments & net revolver activity

     482,057        56,500        20,000        2,036        6,297        566,890   

Redemptions/repayments

     (33,378 )     (52,180 )     —          —          —          (85,558 )

Net accrual of PIK interest income

     5,903        (3,601     845        —          —          3,147   

Accretion of original issue discount

     842        397        —          —          —          1,239   

Net change in unearned income

     (5,992     43        (373     —          —          (6,322

Net unrealized appreciation (depreciation)

     27,687        1,359        (1,266     222        6,869        34,871   

Unrealized adjustments due to deal exits

     (23,760 )     220        —          (254 )     (815 )     (24,609 )

Transfer into (out of) Level 3

     —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value as of June 30, 2011

   $ 869,683      $ 139,524      $ 24,676      $ 4,896      $ 14,700      $ 1,053,479   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at June 30, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the nine months ended June 30, 2011

   $ 3,927      $ 1,579      $ (1,266   $ (32 )   $ 6,054      $ 10,262   

The Company generally utilizes a bond yield model to estimate the fair value of its debt investments where there is not a readily available market value (Level 3) which model is based on the present value of expected cash flows from the debt investments. The significant observable inputs into the model are market interest rates for debt with similar characteristics, which are adjusted for the portfolio company’s credit risk. The credit risk component of the valuation considers several factors including financial performance, business outlook, debt priority and collateral position. These factors are incorporated into the calculation of the capital structure premium, tranche specific risk premium, size premium and industry premium, which are significant unobservable inputs into the model.

 

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Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Significant Unobservable Inputs for Level 3 Investments

The following table provides quantitative information related to the significant unobservable inputs for Level 3 investments, which are carried at fair value as of June 30, 2012:

 

Asset

   Fair Value    

Valuation Technique

 

Unobservable Input

   Range      Weighted
Average
 
First lien debt    $ 796,763      Bond yield approach   Capital structure premium      (a )      0.0%        -         1.0%         0.4%   
       Tranche specific risk premium/(discount)      (a )      (2.8%     -         25.0%         2.5%   
       Size premium      (a )      1.0%        -         2.0%         1.2%   
       Industry premium/(discount)      (a )      (1.7%     -         3.7%         0.3%   
                   
     35,084      Enterprise value approach   Weighted average cost of capital        19.0%        -         31.0%         23.4%   
       Company specific risk premium      (a )      6.0%        -         15.0%         7.0%   
       Revenue growth rate        (10.8%     -         10.4%         8.5%   
       EBITDA multiple      (b )      3.7x        -         9.1x         8.6x   
                   

Second lien &

subordinated Debt

     324,695      Bond yield approach   Capital structure premium      (a )      2.0%        -         2.0%         2.0%   
       Tranche specific risk premium      (a )      1.3%        -         7.8%         3.3%   
       Size premium      (a )      0.5%        -         2.0%         0.7%   
       Industry premium/(discount)      (a )      (1.5%     -         1.2%         (0.3%
                   
     11,518      Enterprise value approach   Weighted average cost of capital        23.0%        -         23.0%         23.0%   
       Company specific risk premium      (a )      6.0%        -         6.0%         6.0%   
       Revenue growth rate        10.4%        -         10.4%         10.4%   
       EBITDA multiple      (b )      9.1x        -         9.1x         9.1x   
                   

Preferred &

common equity

     30,037      Enterprise value approach   Weighted average cost of capital        9.0%        -         35.0%         17.1%   
       Company specific risk premium      (a )      2.0%        -         21.0%         8.3%   
       Revenue growth rate        1.9%        -         133.6%         38.4%   
       EBITDA multiple      (b )      4.6x        -         15.4x         7.6x   
                   
  

 

 

                  

Total

   $ 1,198,097                    
  

 

 

                  

 

(a) Used when market participant would take into account this premium or discount when pricing the investment.

 

(b) Used when market participant would use such multiples when pricing the investment.

 

31


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Under the bond yield approach, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt securities are capital structure premium, tranche specific risk premium/(discount), size premium and industry premium/(discount). Significant increases or decreases in any of those inputs in isolation may result in a significantly lower or higher fair value measurement, respectively.

Under the enterprise value approach, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt or equity securities are the weighted average cost of capital, company specific risk premium, revenue growth rate and EBITDA multiple. Significant increases or decreases in a portfolio company’s weighted average cost of capital or company specific risk premium in isolation may result in a significantly lower or higher fair value measurement, respectively. Significant increases or decreases in the revenue growth rate or EBITDA multiple in isolation may result in a significantly higher or lower fair value measurement, respectively.

Financial Instruments Disclosed, But Not Carried, At Fair Value

The following table presents the carrying value and fair value of the Company’s financial liabilities disclosed, but not carried, at fair value as of June 30, 2012 and the level of each financial liability within the fair value hierarchy:

 

     Carrying
Value
     Fair Value      Level 1      Level 2      Level 3  

Credit facilities payable

   $ 228,541       $ 228,541       $       $       $ 228,541   

SBA debentures payable

     150,000         126,185                         126,185   

Convertible senior notes payable

     115,000         109,394                         109,394   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 493,541       $ 464,120       $       $       $ 464,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The carrying values of credit facilities payable approximates their fair values and are included in Level 3 of the hierarchy.

The Company utilizes the bond yield approach to estimate the fair value of its SBA debentures payable, which are included in Level 3 of the hierarchy. Under the bond yield approach, the Company uses bond yield models to determine the present value of the future cash flows streams for the debentures. The Company reviews various sources of data involving investments with similar characteristics and assesses the information in the valuation process.

The Company uses recent market transactions to estimate the fair value of the convertible senior notes payable, which are included in Level 3 of the hierarchy.

 

32


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The Company’s off-balance sheet arrangements consisted of $96.0 million and $108.8 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of June 30, 2012 and September 30, 2011, respectively. Such commitments are subject to the portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on the Company’s Consolidated Statements of Assets and Liabilities.

A summary of the composition of the unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of June 30, 2012 and September 30, 2011 is shown in the table below:

 

      June 30, 2012      September 30, 2011  

Welocalize, Inc.

   $ 10,000       $ 750   

Yeti Acquisition, LLC

     7,500           

Charter Brokerage, LLC

     6,471         6,176   

Refac Optical Group

     5,500         5,500   

Rail Acquisition Corp.

     5,042         5,446   

I Drive Safely, LLC

     5,000           

Traffic Control & Safety Corporation

     4,876         3,014   

Enhanced Recovery Company, LLC

     4,000         4,000   

Drugtest, Inc.

     4,000         4,000   

World 50, Inc.

     4,000           

Phoenix Brands Merger Sub LLC

     3,857         3,000   

Miche Bag, LLC

     3,500         5,000   

Titan Fitness, LLC

     3,500         2,957   

Cardon Healthcare Network, LLC

     3,000         2,000   

Tegra Medical, LLC

     3,000         1,500   

Discovery Practice Management, Inc.

     2,600         3,000   

Mansell Group, Inc.

     2,000         2,000   

Physicians Pharmacy Alliance, Inc.

     2,000         2,000   

Riverside Fund V, LP (limited partnership interest)

     2,000           

Specialty Bakers, LLC

     1,500         2,000   

Eagle Hospital Physicians, Inc.

     1,400         2,500   

Milestone Partners IV, LP (limited partnership interest)

     1,343         2,000   

Ansira Partners, Inc.

     1,190           

Psilos Group Partners IV, LP (limited partnership interest)

     1,000         1,000   

CPASS Acquisition Company

     1,000           

ACON Equity Partners III, LP (limited partnership interest)

     986           

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

     934         960   

BMC Acquisition, Inc.

     900           

Riverlake Equity Partners II, LP (limited partnership interest)

     760         878   

HealthDrive Corporation

     750         2,000   

RCP Direct, LP (limited partnership interest)

     652           

Baird Capital Partners V, LP (limited partnership interest)

     615         701   

Riverside Fund IV, LP (limited partnership interest)

     402         555   

Advanced Pain Management

     400         267   

Saddleback Fence and Vinyl Products, Inc.

     300         400   

JTC Education, Inc.

             14,000   

CRGT, Inc.

             12,500   

Dominion Diagnostics, LLC

             5,000   

ADAPCO, Inc.

             4,250   

Epic Acquisition, Inc.

             3,000   

IZI Medical Products, Inc.

             2,500   

Flatout, Inc.

             1,500   

IOS Acquisitions, Inc.

             1,250   

Best Vinyl Fence & Deck, LLC

             1,000   

Trans-Trade, Inc.

             200   
  

 

 

    

 

 

 

Total

   $ 95,978       $ 108,804   
  

 

 

    

 

 

 

 

33


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Summaries of the composition of the Company’s investment portfolio at cost and fair value as a percentage of total investments are shown in the following tables:

 

      June 30, 2012     September 30, 2011  

Cost:

          

First lien debt

   $ 847,616         69.45   $ 890,729         77.05

Second lien debt

     140,781         11.54     161,455         13.97

Subordinated debt

     205,982         16.88     85,570         7.40

Purchased equity

     18,231         1.49     11,263         0.97

Equity grants

     5,474         0.45     6,158         0.53

Limited partnership interests

     2,308         0.19     907         0.08
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,220,392         100.00   $ 1,156,082         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 
      June 30, 2012     September 30, 2011  

Fair value:

          

First lien debt

   $ 831,847         69.43   $ 875,092         78.14

Second lien debt

     132,718         11.08     143,383         12.80

Subordinated debt

     203,495         16.98     81,233         7.25

Purchased equity

     21,691         1.81     12,548         1.12

Equity grants

     6,037         0.50     6,675         0.60

Limited partnership interests

     2,309         0.20     906         0.09
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,198,097         100.00   $ 1,119,837         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company invests in portfolio companies located in North America. The following tables show the portfolio composition by geographic region at cost and fair value as a percentage of total investments. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business.

 

      June 30, 2012     September 30, 2011  

Cost:

          

Northeast U.S.

   $ 404,520         33.15   $ 389,185         33.66

Southwest U.S.

     268,943         22.04     273,513         23.66

West U.S.

     215,338         17.64     142,745         12.35

Southeast U.S.

     195,092         15.99     244,988         21.19

Midwest U.S.

     117,320         9.61     86,768         7.51

Canada

     19,179         1.57     18,883         1.63
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,220,392         100.00   $ 1,156,082         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 
      June 30, 2012     September 30, 2011  

Fair value:

          

Northeast U.S.

   $ 406,736       $ 33.95   $ 389,898         34.82

Southwest U.S.

     253,087         21.12 %     246,358         22.00

West U.S.

     199,362         16.64 %     127,522         11.39

Southeast U.S.

     199,354         16.64 %     248,588         22.20

Midwest U.S.

     118,997         9.93     88,412         7.90

Canada

     20,561         1.72     19,059         1.69
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,198,097         100.00   $ 1,119,837         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

 

34


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The composition of the Company’s portfolio by industry at cost and fair value as of June 30, 2012 and September 30, 2011 were as follows:

 

      June 30, 2012     September 30, 2011  

Cost:

          

Healthcare services

   $ 146,402         12.00   $ 227,145         19.65

Education services

     92,136         7.55     29,662         2.57

Healthcare equipment

     83,266         6.82     71,254         6.16

Internet software & services

     73,838         6.05     43,846         3.79

Diversified support services

     72,962         5.98     55,472         4.80

Oil & gas equipment services

     61,267         5.02     82,168         7.11

Leisure products

     55,637         4.56     13,564         1.17

Construction and engineering

     48,950         4.01     43,236         3.74

Advertising

     41,550         3.40     19,892         1.72

Pharmaceuticals

     40,252         3.30     27,257         2.36

Apparel, accessories & luxury goods

     38,800         3.18     30,986         2.68

Diversified financial services

     38,745         3.17     13,311         1.15

Electronic equipment & instruments

     35,879         2.94     34,852         3.01

Specialty stores

     33,162         2.72     34,538         2.99

Integrated telecommunication services

     32,103         2.63     25,995         2.25

Leisure facilities

     30,158         2.47     38,041         3.29

Household products

     30,026         2.46     31,213         2.70

Home improvement retail

     27,955         2.29     27,999         2.42

IT consulting & other services

     25,500         2.09     48,943         4.23

Restaurants

     23,442         1.92     13,966         1.21

Industrial machinery

     20,928         1.71     10,457         0.90

Electronic manufacturing services

     20,595         1.69     20,190         1.75

Human resources & employment services

     19,691         1.61     20,457         1.77

Auto parts & equipment

     19,179         1.57     18,883         1.63

Environmental & facilities services

     19,067         1.56     16,311         1.41

Distributors

     18,993         1.56     18,631         1.61

Air freight & logistics

     18,596         1.52     17,984         1.56

Food distributors

     17,520         1.44     20,834         1.80

Research & consulting services

     14,048         1.15             0.00

Construction materials

     6,896         0.57     6,736         0.58

Housewares & specialties

     5,319         0.44     5,319         0.46

Building products

     5,023         0.41     6,689         0.58

Multi-sector holdings

     2,307         0.19     907         0.09

Movies & entertainment

     200         0.02     199         0.02

Fertilizers & agricultural chemicals

             0.00     28,800         2.49

Healthcare technology

             0.00     20,505         1.77

Trucking

             0.00     17,065         1.48

Data processing & outsourced services

             0.00     12,775         1.10
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,220,392         100.00   $ 1,156,082         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

 

35


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

      June 30, 2012     September 30, 2011  

Fair Value:

          

Healthcare services

   $ 150,814         12.59   $ 231,478         20.67

Education services

     92,094         7.69     30,176         2.69

Healthcare equipment

     83,685         6.98     71,911         6.42

Internet software & services

     76,131         6.35     43,786         3.91

Diversified support services

     74,391         6.21     56,232         5.02

Oil & gas equipment services

     62,289         5.20     82,696         7.38

Leisure products

     56,002         4.67     13,711         1.22

Advertising

     41,784         3.49     20,183         1.80

Pharmaceuticals

     40,891         3.41     27,500         2.46

Apparel, accessories & luxury goods

     40,150         3.35     33,595         3.00

Diversified financial services

     39,422         3.29     13,329         1.19

Electronic equipment & instruments

     35,820         2.99     34,863         3.11

Specialty stores

     34,148         2.85     35,198         3.14

Construction and engineering

     33,004         2.75     35,814         3.20

Integrated telecommunication services

     32,382         2.70     26,374         2.36

Leisure facilities

     30,784         2.57     38,447         3.43

Household products

     30,139         2.52     29,943         2.67

IT consulting & other services

     25,967         2.17     49,528         4.42

Home improvement retail

     24,988         2.09     27,576         2.46

Environmental & facilities services

     23,155         1.93     19,952         1.78

Industrial machinery

     21,641         1.81     10,860         0.97

Auto parts & equipment

     20,561         1.72     19,059         1.70

Restaurants

     20,445         1.71     11,829         1.06

Human resources & employment services

     20,412         1.70     20,952         1.87

Distributors

     19,663         1.64     18,938         1.69

Food distributors

     17,844         1.49     21,006         1.88

Research & consulting services

     14,324         1.20             0.00

Air freight & logistics

     14,223         1.19     17,243         1.54

Electronic manufacturing services

     8,412         0.70     8,660         0.77

Construction materials

     7,114         0.59     6,840         0.61

Multi-sector holdings

     2,308         0.19     907         0.11

Building products

     2,111         0.18     4,833         0.43

Housewares & specialties

     737         0.06     2,526         0.23

Movies & entertainment

     262         0.02     262         0.02

Fertilizers & agricultural chemicals

             0.00     29,186         2.61

Healthcare technology

             0.00     20,947         1.87

Data processing & outsourced services

             0.00     3,497         0.31
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,198,097         100.00   $ 1,119,837         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company’s investments are generally in small and mid-sized companies in a variety of industries. At June 30, 2012 and September 30, 2011, the Company had no single investment that represented greater than 10% of the total investment portfolio at fair value. Income, consisting of interest, dividends, fees, other investment income and realization of gains or losses, can fluctuate upon repayment or sale of an investment and in any given year can be highly concentrated among several investments. For the three and nine months ended June 30, 2012 and June 30, 2011, no individual investment produced income that exceeded 10% of investment income.

 

36


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Note 4. Fee Income

The Company receives a variety of fees in the ordinary course of business. Certain fees, such as origination fees, are capitalized and amortized in accordance with ASC 310-20 Nonrefundable Fees and Other Costs. In accordance with ASC 820, the net unearned fee income balance is netted against the cost of the respective investments. Other fees, such as servicing fees, are classified as fee income and recognized as they are earned on a monthly basis.

Accumulated unearned fee income activity for the nine months ended June 30, 2012 and June 30, 2011 was as follows:

 

      Nine months ended
June 30, 2012
    Nine months ended
June 30, 2011
 

Beginning unearned fee income balance

   $ 18,333      $ 11,901   

Net fees received

     18,937        13,311   

Unearned fee income recognized

     (24,160     (6,989
  

 

 

   

 

 

 

Ending unearned fee income balance

   $ 13,110      $ 18,223   
  

 

 

   

 

 

 

As of June 30, 2012, the Company had structured $6.8 million in aggregate exit fees across nine portfolio investments upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt investment. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.

 

Note 5. Share Data

Effective January 2, 2008, the Partnership merged with and into the Company. At the time of the merger, all outstanding partnership interests in the Partnership were exchanged for 12,480,972 shares of common stock of the Company. An additional 26 fractional shares were payable to the stockholders in cash.

On June 17, 2008, the Company completed an initial public offering of 10,000,000 shares of its common stock at the offering price of $14.12 per share. The net proceeds totaled $129.5 million after deducting investment banking commissions of $9.9 million and offering costs of $1.8 million.

On July 21, 2009, the Company completed a follow-on public offering of 9,487,500 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $9.25 per share. The net proceeds totaled $82.7 million after deducting investment banking commissions of $4.4 million and offering costs of $0.7 million.

On September 25, 2009, the Company completed a follow-on public offering of 5,520,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $10.50 per share. The net proceeds totaled $54.9 million after deducting investment banking commissions of $2.8 million and offering costs of $0.3 million.

On January 27, 2010, the Company completed a follow-on public offering of 7,000,000 shares of its common stock at the offering price of $11.20 per share, with 300,500 additional shares being sold as part of the underwriters’ partial exercise of their over-allotment option on February 25, 2010. The net proceeds totaled $77.5 million after deducting investment banking commissions of $3.7 million and offering costs of $0.5 million.

On April 20, 2010, at the Company’s 2010 Annual Meeting, the Company’s stockholders approved, among other things, amendments to the Company’s restated certificate of incorporation to increase the number of authorized shares of common stock from 49,800,000 shares to 150,000,000 shares and to remove the Company’s authority to issue shares of Series A Preferred Stock.

 

37


Table of Contents

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

On June 21, 2010, the Company completed a follow-on public offering of 9,200,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $11.50 per share. The net proceeds totaled $100.5 million after deducting investment banking commissions of $4.8 million and offering costs of $0.5 million.

On December 7, 2010, the Company entered into an at-the-market equity offering sales agreement relating to shares of its common stock. Throughout the month of December 2010, the Company sold 429,110 shares of its common stock at an average offering price of $11.87 per share. The net proceeds totaled $5.0 million after deducting fees and commissions of $0.1 million. The Company terminated the at-the-market equity offering sales agreement effective January 20, 2011 and did not sell any shares of the Company’s common stock pursuant thereto subsequent to December 31, 2010.

On February 4, 2011, the Company completed a follow-on public offering of 11,500,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $12.65 per share. The net proceeds totaled $138.6 million after deducting investment banking commissions of $6.5 million and offering costs of $0.3 million.

On June 24, 2011, the Company completed a follow-on public offering of 5,558,469 shares of its common stock, which included the underwriters’ partial exercise of their over-allotment option, at the offering price of $11.72 per share. The net proceeds totaled $62.7 million after deducting investment banking commissions of $2.3 million and offering costs of $0.2 million.

On January 26, 2012, the Company completed a follow-on public offering of 10,000,000 shares of its common stock at the offering price of $10.07 per share. The net proceeds totaled $99.9 million after deducting offering costs of $0.8 million.

The following table sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10 Earnings per Share, for the three and nine months ended June 30, 2012 and June 30, 2011:

 

     Three months
ended
June 30,
2012
     Three months
ended
June 30,
2011
     Nine months
ended
June 30,
2012
     Nine months
ended
June 30,
2011
 

(Amounts in thousands, except per share amounts)

           

Earnings per common share — basic:

           

Net increase in net assets resulting from operations

   $ 22,089       $ 20,832       $ 52,329       $ 53,951   

Weighted average common shares outstanding — basic

     82,421         67,081         78,089         61,254   

Earnings per common share — basic

   $ 0.27       $ 0.31       $ 0.67       $ 0.88   

Earnings per common share — diluted:

           

Net increase in net assets resulting from operations, before adjustments

   $ 22,089       $ 20,832       $ 52,329       $ 53,951   

Adjustments for interest on convertible senior notes, base management fees, incentive fees and gain on extinguishment of convertible senior notes

     1,205         1,636         3,113         1,636   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net increase in net assets resulting from operations, as adjusted

     23,294         22,468         55,442         55,587   

Weighted average common shares outstanding — basic

     82,421         67,081         78,089         61,254   

Adjustments for dilutive effect of convertible notes

     7,858         8,939         8,236         2,979   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding — diluted

     90,279         76,020         86,325         64,233   

Earnings per common share — diluted

   $ 0.26       $ 0.30       $ 0.64       $ 0.87   

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The following table reflects the dividend distributions per share that the Board of Directors of the Company has declared and the Company has paid, including shares issued under the dividend reinvestment plan (“DRIP”), on its common stock from inception to June 30, 2012:

 

Date Declared

   Record
Date
     Payment
Date
     Amount
per Share
     Cash
Distribution
     DRIP Shares
Issued
    DRIP Shares
Value
 

5/1/2008

     5/19/2008         6/3/2008       $ 0.30       $ 1.9 million         133,317      $ 1.9 million   

8/6/2008

     9/10/2008         9/26/2008         0.31         5.1 million         196,786 (1)      1.9 million   

12/9/2008

     12/19/2008         12/29/2008         0.32         6.4 million         105,326        0.8 million   

12/9/2008

     12/30/2008         1/29/2009         0.33         6.6 million         139,995        0.8 million   

12/18/2008

     12/30/2008         1/29/2009         0.05         1.0 million         21,211        0.1 million   

4/14/2009

     5/26/2009         6/25/2009         0.25         5.6 million         11,776        0.1 million   

8/3/2009

     9/8/2009         9/25/2009         0.25         7.5 million         56,890        0.6 million   

11/12/2009

     12/10/2009         12/29/2009         0.27         9.7 million         44,420        0.5 million   

1/12/2010

     3/3/2010         3/30/2010         0.30         12.9 million         58,689        0.7 million   

5/3/2010

     5/20/2010         6/30/2010         0.32         14.0 million         42,269        0.5 million   

8/2/2010

     9/1/2010         9/29/2010         0.10         5.2 million         25,425        0.3 million   

8/2/2010

     10/6/2010         10/27/2010         0.10         5.2 million         24,850        0.3 million   

8/2/2010

     11/3/2010         11/24/2010         0.11         5.7 million         26,569        0.3 million   

8/2/2010

     12/1/2010         12/29/2010         0.11         5.7 million         28,238        0.3 million   

11/30/2010

     1/4/2011         1/31/2011         0.1066         5.4 million         36,038        0.5 million   

11/30/2010

     2/1/2011         2/28/2011         0.1066         5.5 million         29,072        0.4 million   

11/30/2010

     3/1/2011         3/31/2011         0.1066         6.5 million         43,766        0.6 million   

1/30/2011

     4/1/2011         4/29/2011         0.1066         6.5 million         45,193        0.6 million   

1/30/2011

     5/2/2011         5/31/2011         0.1066         6.5 million         48,870        0.6 million   

1/30/2011

     6/1/2011         6/30/2011         0.1066         6.5 million         55,367        0.6 million   

5/2/2011

     7/1/2011         7/29/2011         0.1066         7.1 million         58,829 (1)     0.6 million   

5/2/2011

     8/1/2011         8/31/2011         0.1066         7.1 million         64,431 (1)      0.6 million   

5/2/2011

     9/1/2011         9/30/2011         0.1066         7.2 million         52,487 (1)     0.5 million   

8/1/2011

     10/14/2011         10/31/2011         0.1066         7.3 million         40,388 (1)     0.4 million   

8/1/2011

     11/15/2011         11/30/2011         0.1066         7.3 million         43,034 (1)     0.4 million   

8/1/2011

     12/13/2011         12/23/2011         0.1066         7.3 million         43,531 (1)     0.4 million   

11/10/2011

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

11/10/2011

     2/15/2012         2/29/2012         0.0958         7.4 million         45,071        0.4 million   

11/10/2011

     3/15/2012         3/30/2012         0.0958         7.5 million         41,807 (1)     0.4 million   

2/7/2012

     4/13/2012         4/30/2012         0.0958         7.4 million         48,328 (1)     0.5 million   

2/7/2012

     5/15/2012         5/31/2012         0.0958         7.4 million         47,877 (1)     0.5 million   

2/7/2012

     6/15/2012         6/29/2012         0.0958         7.5 million         41,499        0.4 million   

 

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

In October 2008, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $8 million of the Company’s outstanding common stock. Stock repurchases under this program were made through the open market at times and in such amounts as Company management deemed appropriate. The stock repurchase program expired in December 2009. In October 2008, the Company repurchased 78,000 shares of common stock on the open market as part of this share repurchase program.

In October 2010, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $20 million of the Company’s outstanding common stock. Stock repurchases under this program were to be made through the open market at times and in such amounts as the Company’s management deemed appropriate. The stock repurchase program expired December 31, 2011, with the Company not repurchasing any shares of its common stock pursuant to this repurchase program.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

In May 2012, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $30 million of the Company’s outstanding common stock. Stock repurchases under this program would be made through the open market at times and in such amounts as the Company’s management deems appropriate, provided they are below the most recently published net asset value per share. Unless extended by the Company’s Board of Directors, the stock repurchase program will expire on May 7, 2013 and may be limited or terminated at any time without prior notice. As of June 30, 2012, the Company had not repurchased any shares of its common stock pursuant to this repurchase program.

 

Note 6. Lines of Credit

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

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

On November 5, 2010, the Company amended the Wells Fargo facility to, among other things, provide for the issuance from time to time of letters of credit for the benefit of the Company’s portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million. On February 28, 2011, the Company amended the Wells Fargo facility to, among other things, (i) reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, (ii) extend the period during which the Company may make new borrowings under the facility to February 25, 2013 and (iii) extend the maturity date of the facility to February 25, 2014. The facility may be extended for up to two additional years upon the mutual consent of Wells Fargo and each of the lender parties thereto. On November 30, 2011, the Company amended the Wells Fargo facility to, among other things, reduce the interest rate to LIBOR plus 2.75% per annum, with no LIBOR floor. On April 23, 2012, the Company amended the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, the Company received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which the Company may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

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

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

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The Wells Fargo facility is secured by all of the assets of Funding, and all of the Company’s equity interest in Funding. The Company uses the Wells Fargo facility to fund a portion of its loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. The Company cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of June 30, 2012, the Company had $26.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $26.0 million. The Company’s borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.120% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, the Company recorded interest expense of $0.7 million and $2.0 million, respectively, related to the Wells Fargo facility.

On May 27, 2010, the Company entered into a three-year secured syndicated revolving credit facility (“ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allowed for the Company to borrow money at a rate of either (i) LIBOR plus 3.5% per annum or (ii) 2.5% per annum plus an alternate base rate based on the greatest of the Prime Rate, Federal Funds Rate plus 0.5% per annum or LIBOR plus 1% per annum, and had a maturity date of May 27, 2013. The ING facility also allows the Company to request letters of credit from ING Capital LLC, as the issuing bank. The initial commitment under the ING facility was $90 million, and the ING facility included an accordion feature that allowed for potential future expansion of the facility up to a total of $150 million. The ING facility is secured by substantially all of the Company’s assets, as well as the assets of the Company’s wholly-owned subsidiary, FSFC Holdings, Inc., and its indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC, subject to certain exclusions for, among other things, equity interests in the Company’s SBIC subsidiaries, and equity interests in Funding and Funding II (which is defined and discussed below) as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and the Company. Fifth Street Fund of Funds LLC and FSFC Holdings, Inc. were formed to hold certain of the Company’s portfolio companies for tax purposes and have no other operations. None of the Company’s SBIC subsidiaries, Funding or Funding II is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that the Company may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

On February 22, 2011, the Company amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion up to a total of $300 million and the maturity date was extended to February 22, 2014. On July 8, 2011, the Company amended the ING facility to, among other things, expand the borrowing capacity to $230 million and increase the accordion feature to allow for potential future expansion up to a total of $350 million. In addition, the ING facility’s interest rate was reduced to LIBOR plus 3.0% per annum, with no LIBOR floor, when the facility is drawn more than 35%. Otherwise, the interest rate will be LIBOR plus 3.25% per annum, with no LIBOR floor.

On February 29, 2012, the Company amended the ING facility to, among other things, (i) extend the period during which the Company may make and repay borrowings under the ING facility to February 27, 2015, (ii) extend the maturity date to February 29, 2016 and (iii) increase the accordion feature to allow for potential future expansion up to a total of $450 million.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

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

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

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. The Company cannot be assured that it will be able to borrow funds under the ING facility at any particular time or at all.

As of June 30, 2012, the Company had $151.5 million of borrowings outstanding under the ING facility that had a fair value of $151.5 million. The Company’s borrowings under the ING facility bore interest at a weighted average interest rate of 3.390% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, the Company recorded interest expense of $1.3 million and $4.1 million, respectively, related to the ING facility.

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

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

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

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. There is no assurance that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of June 30, 2012, the Company had $51.0 million of borrowings outstanding under the Sumitomo facility that had a fair value of $51.0 million. The Company’s borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.885% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, the Company recorded interest expense of $0.3 million and $0.7 million, respectively, related to the Sumitomo facility.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

As of June 30, 2012, except for assets that were funded through the Company’s SBIC subsidiaries, substantially all of the Company’s assets were pledged as collateral under the Wells Fargo facility, the ING facility or the Sumitomo facility. With respect to the assets funded through the Company’s SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over the Company’s stockholders.

Interest expense for the three and nine months ended June 30, 2012 was $5.6 million and $16.9 million, respectively. Interest expense for the three and nine months ended June 30, 2011 was $5.0 million and $9.6 million, respectively.

 

Note 7. Interest and Dividend Income

Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. In accordance with the Company’s policy, accrued interest is evaluated periodically for collectability. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.

The Company holds debt in its portfolio that contains PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. The Company generally ceases accruing PIK interest if there is insufficient value to support the accrual or if the Company does not expect the portfolio company to be able to pay all principal and interest due. The Company’s decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; the Company’s assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by the Company in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, the Company determines whether to cease accruing PIK interest on a loan or debt security. The Company’s determination to cease accruing PIK interest on a loan or debt security is generally made substantially before the Company’s full write-down of such loan or debt security.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Accumulated PIK interest activity for the nine months ended June 30, 2012 and June 30, 2011 was as follows:

 

     Nine months ended
June 30,

2012
    Nine months ended
June 30,

2011
 

PIK balance at beginning of period

   $ 22,672      $ 19,301   

Gross PIK interest accrued

     13,310        10,718   

PIK income reserves(1)

     (3,078     (541

PIK interest received in cash

     (5,007     (7,030

Loan exits and other PIK adjustments

            (317 )
  

 

 

   

 

 

 

PIK balance at end of period

   $ 27,897      $ 22,131   
  

 

 

   

 

 

 

 

(1) PIK income is generally reserved for when a loan is placed on PIK non-accrual status.

As of June 30, 2012, the Company had stopped accruing cash and/or PIK interest and OID on four investments, including three that had not paid all of their scheduled cash interest payments for the period ended June 30, 2012. As of June 30, 2011, the Company had stopped accruing cash interest, PIK interest and OID on two investments that had not paid all of their scheduled cash interest payments for the period ended June 30, 2011.

Cash non-accrual status is inclusive of PIK and other noncash income, where applicable. The percentages of the Company’s portfolio investments at cost and fair value by accrual status as of June 30, 2012, September 30, 2011 and June 30, 2011 were as follows:

 

     June 30, 2012     September 30, 2011     June 30, 2011  
     Cost      % of
Portfolio
    Fair
Value
     % of
Portfolio
    Cost      % of
Portfolio
    Fair
Value
     % of
Portfolio
    Cost      % of
Portfolio
    Fair
Value
     % of
Portfolio
 

Accrual

   $ 1,168,495         95.75   $ 1,181,490         98.61   $ 1,116,762         96.60   $ 1,111,986         99.30   $ 1,025,169         97.86   $ 1,046,526         99.34

PIK non-accrual

     15,637         1.28     3,454         0.29             0.00             0.00             0.00             0.00

Cash non-accrual

     36,260         2.97     13,153         1.10     39,320         3.40     7,851         0.70     22,383         2.14     6,953         0.66
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,220,392         100.00   $ 1,198,097         100.00   $ 1,156,082         100.00   $ 1,119,837         100.00   $ 1,047,552         100.00   $ 1,053,479         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The non-accrual status of the Company’s portfolio investments as of June 30, 2012, September 30, 2011 and June 30, 2011 was as follows:

 

     June 30, 2012      September 30, 2011      June 30, 2011  

Lighting by Gregory, LLC

     Cash non-accrual         Cash non-accrual         Cash non-accrual   

O’Currance, Inc.(1)

             Cash non-accrual           

Premier Trailer Leasing, Inc.(1)

             Cash non-accrual         Cash non-accrual   

Repechage Investments Limited

     Cash non-accrual         Cash non-accrual           

Rail Acquisition Corp.

     PIK non-accrual                   

Traffic Control & Safety Corp. — Second Lien and Subordinated Debt

     Cash non-accrual                   

 

(1) The Company no longer holds this investment. See Note 9 for a discussion of the Company’s recent realization events.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Income non-accrual amounts related to the above investments for the three and nine months ended June 30, 2012 and June 30, 2011 were as follows:

 

    Three months ended
June 30, 2012
    Three months ended
June 30, 2011
    Nine months ended
June 30, 2012
    Nine months ended
June 30, 2011
 

Cash interest income

  $ 524      $ 917      $ 2,681      $ 4,484   

PIK interest income

    1,033        155        3,078        541   

OID income

                  95        60   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,557      $ 1,072      $ 5,854      $ 5,085   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

Note 8. Taxable/Distributable Income and Dividend Distributions

Taxable income differs from net increase (decrease) in net assets resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in taxable income until they are realized; (2) origination fees received in connection with investments in portfolio companies, which are amortized into fee income over the life of the investment for book purposes, are treated as taxable income upon receipt; (3) organizational and deferred offering costs; (4) recognition of interest income on certain loans; and (5) income or loss recognition on exited investments.

At September 30, 2011, the Company had net loss carryforwards of $11.8 million to offset net capital gains, to the extent provided by federal tax law. Of the capital loss carryforwards, $1.5 million will expire on September 30, 2017 and $10.3 million will expire on September 30, 2019. During the year ended September 30, 2011, the Company realized capital losses from the sale of investments after October 31, 2010 and prior to year end (“post-October capital losses”) of $29.9 million, which for tax purposes are treated as arising on the first day of the following year.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Listed below is a reconciliation of “net increase in net assets resulting from operations” to taxable income for the three and nine months ended June 30, 2012:

 

     Three months ended
June 30, 2012
    Nine months ended
June 30, 2012
 

Net increase in net assets resulting from operations

   $ 22,089      $ 52,329   

Net unrealized appreciation

     (179     (14,060 )

Book/tax difference due to deferred loan origination fees, net

     (1,728     (9,540

Book/tax difference due to organizational and deferred offering costs

     (22 )     (65 )

Book/tax difference due to interest income on certain loans

     1,359        3,591   

Book/tax difference due to capital losses not recognized

     —          27,420   

Other book-tax differences

     (81 )     (154
  

 

 

   

 

 

 

Taxable/Distributable Income(1)

   $ 21,438      $ 59,521   
  

 

 

   

 

 

 

 

(1) The Company’s taxable income for 2012 is an estimate and will not be finally determined until the Company files its tax return for the fiscal year ended September 30, 2012. Therefore, the final taxable income may be different than the estimate.

On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the “Act”) was enacted, which changed various technical rules governing the tax treatment of RICs. The changes are generally effective for taxable years beginning after the date of enactment. Under the Act, the Company will be permitted to carryforward net capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment net loss carryforwards may be more likely to expire unused.

Distributions to stockholders are recorded on the record date. The Company is required to distribute annually to its stockholders at least 90% of its net taxable income and net realized short-term capital gains in excess of net realized long-term capital losses for each taxable year in order to be eligible for the tax benefits allowed to a RIC under Subchapter M of the Code. The Company anticipates paying out as a dividend all or substantially all of those amounts. The amount to be paid out as a dividend is determined by the Board of Directors and is based on management’s estimate of the Company’s annual taxable income. For tax purposes, distributions may include returns of capital. The Company maintains an “opt out” dividend reinvestment plan for its stockholders.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The Company’s Board of Directors has declared the following distributions from inception to June 30, 2012:

 

Dividend Type

   Date Declared      Record Date      Payment Date      Amount Per Share  

Quarterly

     5/1/2008         5/19/2008         6/3/2008       $ 0.30   

Quarterly

     8/6/2008         9/10/2008         9/26/2008       $ 0.31   

Quarterly

     12/9/2008         12/19/2008         12/29/2008       $ 0.32   

Quarterly

     12/9/2008         12/30/2008         1/29/2009       $ 0.33   

Special

     12/18/2008         12/30/2008         1/29/2009       $ 0.05   

Quarterly

     4/14/2009         5/26/2009         6/25/2009       $ 0.25   

Quarterly

     8/3/2009         9/8/2009         9/25/2009       $ 0.25   

Quarterly

     11/12/2009         12/10/2009         12/29/0209       $ 0.27   

Quarterly

     1/12/2010         3/3/2010         3/30/2010       $ 0.30   

Quarterly

     5/3/2010         5/20/2010         6/30/2010       $ 0.32   

Quarterly

     8/2/2010         9/1/2010         9/29/2010       $ 0.10   

Monthly

     8/2/2010         10/6/2010         10/27/2010       $ 0.10   

Monthly

     8/2/2010         11/3/2010         11/24/2010       $ 0.11   

Monthly

     8/2/2010         12/1/2010         12/29/2010       $ 0.11   

Monthly

     11/30/2010         1/4/2011         1/31/2011       $ 0.1066   

Monthly

     11/30/2010         2/1/2011         2/28/2011       $ 0.1066   

Monthly

     11/30/2010         3/1/2011         3/31/2011       $ 0.1066   

Monthly

     1/30/2011         4/1/2011         4/29/2011       $ 0.1066   

Monthly

     1/30/2011         5/2/2011         5/31/2011       $ 0.1066   

Monthly

     1/30/2011         6/1/2011         6/30/2011       $ 0.1066   

Monthly

     5/2/2011         7/1/2011         7/29/2011       $ 0.1066   

Monthly

     5/2/2011         8/1/2011         8/31/2011       $ 0.1066   

Monthly

     5/2/2011         9/1/2011         9/30/2011       $ 0.1066   

Monthly

     8/1/2011         10/14/2011         10/31/2011       $ 0.1066   

Monthly

     8/1/2011         11/15/2011         11/30/2011       $ 0.1066   

Monthly

     8/1/2011         12/13/2011         12/23/2011       $ 0.1066   

Monthly

     11/10/2011         1/13/2012         1/31/2012       $ 0.0958   

Monthly

     11/10/2011         2/15/2012         2/29/2012       $ 0.0958   

Monthly

     11/10/2011         3/15/2012         3/30/2012       $ 0.0958   

Monthly

     2/7/2012         4/13/2012         4/30/2012       $ 0.0958   

Monthly

     2/7/2012         5/15/2012         5/31/2012       $ 0.0958   

Monthly

     2/7/2012         6/15/2012         6/29/2012       $ 0.0958   

Monthly

     5/7/2012         7/13/2012         7/31/2012       $ 0.0958   

Monthly

     5/7/2012         8/15/2012         8/31/2012       $ 0.0958   

Monthly

     5/7/2012         9/14/2012         9/28/2012       $ 0.0958   

For income tax purposes, the Company estimates that its distributions for the calendar year 2012 will be composed primarily of ordinary income, and will be reflected as such on the Form 1099-DIV for the calendar year 2012.

As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis. Because the Company did not satisfy these distribution requirements for calendar years 2008, 2009 and 2010, the Company incurred a de minimis federal excise tax for those calendar years. The Company did not incur a federal excise tax for calendar year 2011 and does not expect to incur a federal excise tax for calendar year 2012.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Note 9. Realized Gains or Losses and Net Unrealized Appreciation or Depreciation on Investments and Interest Rate Swap

Realized gains or losses are measured by the difference between the net proceeds from the sale or redemption and the cost basis of the investment or interest rate swap without regard to unrealized appreciation or depreciation previously recognized, and includes investments written-off during the period, net of recoveries. Realized losses may also be recorded in connection with the Company’s determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

Net unrealized appreciation or depreciation reflects the net change in the valuation of the portfolio pursuant to the Company’s valuation guidelines and the reclassification of any prior period unrealized appreciation or depreciation.

During the nine months ended June 30, 2012, the Company recorded investment realization events, including the following:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

   

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

 

   

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

 

   

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

 

   

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

During the nine months ended June 30, 2011, the Company recorded investment realization events, including the following:

 

   

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

 

   

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

 

   

In November 2010, the Company restructured its investment in Vanguard Vinyl, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $1.7 million in accordance with ASC 470-50;

 

   

In December 2010, the Company restructured its investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $3.9 million in accordance with ASC 470-50;

 

   

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

 

   

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

 

   

In December 2010, the Company restructured its investment in Lighting by Gregory, LLC. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $7.8 million in accordance with ASC 470-50;

 

   

In March 2011, the Company received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $0.3 million in accordance with ASC 470-50; and

 

   

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

During the nine months ended June 30, 2012, the Company recorded net unrealized appreciation of $14.1 million. This consisted of $1.9 million of net unrealized appreciation on equity investments and $27.7 million of net reclassifications to realized losses, offset by $15.5 million of net unrealized depreciation on debt investments. During the nine months ended June 30, 2011, the Company recorded net unrealized appreciation of $34.9 million. This consisted of $24.9 million of net reclassifications to realized losses, $4.0 million of net unrealized appreciation on debt investments and $6.0 million of net unrealized appreciation on equity investments.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Note 10. Concentration of Credit Risks

The Company places its cash in financial institutions and at times such balances may be in excess of the FDIC insured limit. The Company limits its exposure to credit loss by depositing its cash with high credit quality financial institutions and monitoring their financial stability.

 

Note 11. Related Party Transactions

The Company has entered into an investment advisory agreement with the Investment Adviser. Under the investment advisory agreement, the Company pays the Investment Adviser a fee for its services consisting of two components — a base management fee and an incentive fee.

Base management Fee

The base management fee is calculated at an annual rate of 2% of the Company’s gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents. The base management fee is payable quarterly in arrears, and is calculated based on the value of the Company’s gross assets at the end of each fiscal quarter, and appropriately adjusted on a pro rata basis for any equity capital raises or repurchases during such quarter. The base management fee for any partial month or quarter is appropriately prorated.

For the three and nine months ended June 30, 2012, base management fees were $6.1 million and $17.2 million, respectively. For the three and nine months ended June 30, 2011, base management fees were $5.4 million and $13.9 million, respectively. At June 30, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $6.1 million reflecting the unpaid portion of the base management fee payable to the Investment Adviser.

Incentive Fee

The incentive fee portion of the investment advisory agreement has two parts. The first part is calculated and payable quarterly in arrears based on the Company’s “Pre-Incentive Fee Net Investment Income” for the immediately preceding fiscal quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including (i) any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies or (ii) other income that must be distributed to its stockholders, including, for example, any gain recorded in connection with the extinguishment of its debt) accrued during the fiscal quarter, minus the Company’s operating expenses for the quarter (including the base management fee, expenses payable under the Company’s administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding indebtedness or preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding fiscal quarter, will be compared to a “hurdle rate” of 2% per quarter (8% annualized), subject to a “catch-up” provision measured as of the end of each fiscal quarter. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of its gross assets used to calculate the 2% base management fee. The operation of the incentive fee with respect to the Company’s Pre-Incentive Fee Net Investment Income for each quarter is as follows:

 

   

No incentive fee is payable to the Investment Adviser in any fiscal quarter in which the Company’s Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);

 

   

100% of the Company’s Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than or equal to 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser. The Company refers to this portion of its Pre-Incentive Fee Net Investment Income (which exceeds the hurdle rate but is less than or equal to 2.5%) as the “catch-up.” The “catch-up” provision is intended to provide the Investment Adviser with an incentive fee of 20% on all of the Company’s Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when the Company’s Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

   

20% of the amount of the Company’s Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser once the hurdle is reached and the catch-up is achieved (20% of all Pre-Incentive Fee Net Investment Income thereafter is allocated to the Investment Adviser).

The second part of the incentive fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date), commencing on September 30, 2008, and equals 20% of the Company’s realized capital gains, if any, on a cumulative basis from inception through the end of each fiscal year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees.

GAAP requires the Company to accrue for the theoretical capital gains incentive fee that would be payable after giving effect to the net realized and unrealized capital appreciation and depreciation. It should be noted that a fee so calculated and accrued would not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of capital gains incentive fees in subsequent periods. Amounts ultimately paid under the investment advisory agreement will be consistent with the formula reflected in the investment advisory agreement.

The Company does not currently accrue for capital gains incentive fees due to the accumulated realized and unrealized losses in the portfolio.

For the three and nine months ended June 30, 2012, incentive fees were $5.5 million and $16.4 million, respectively. For the three and nine months ended June 30, 2011, incentive fees were $4.1 million and $11.8 million, respectively. At June 30, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.5 million reflecting the unpaid portion of the incentive fee payable to the Investment Adviser.

Indemnification

The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of their respective duties or by reason of the reckless disregard of their respective duties and obligations, the Company’s Investment Adviser and its officers, managers, agents, employees, controlling persons, members (or their owners) and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Investment Adviser’s services under the investment advisory agreement or otherwise as the Company’s Investment Adviser.

Administration Agreement

The Company has also entered into an administration agreement with FSC, Inc. under which FSC, Inc. provides administrative services for the Company, including office facilities and equipment, and clerical, bookkeeping and recordkeeping services at such facilities. Under the administration agreement, FSC, Inc. also performs or oversees the performance of the Company’s required administrative services, which includes being responsible for the financial records which the Company is required to maintain and preparing reports to the Company’s stockholders and reports filed with the SEC. In addition, FSC, Inc. assists the Company in determining and publishing the Company’s net asset value, overseeing the preparation and filing of the Company’s tax returns and the printing and dissemination of reports to the Company’s stockholders, and generally overseeing the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. For providing these services, facilities and personnel, the Company reimburses FSC, Inc. the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement, including rent and the Company’s allocable portion of the costs of compensation and related expenses of the Company’s chief financial officer and chief compliance officer and their staffs. Such reimbursement is at cost with no profit to, or markup by, FSC, Inc.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for the Company by its chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. FSC, Inc. may also provide, on the Company’s behalf, managerial assistance to the Company’s portfolio companies. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.

For the three and nine months ended June 30, 2012, the Company incurred administration expenses of $1.0 million, including $0.3 million of general and administrative expenses, and $3.2 million, including $1.0 million of general and administrative expenses, that are due to FSC, Inc., respectively. At June 30, 2012, $2.2 million (inclusive of these administration expenses) was included in Due to FSC, Inc. in the Consolidated Statement of Assets and Liabilities.

 

Note 12. Financial Highlights

 

Per share data:

   Three months
ended
June 30,
2012
    Three months
ended
June 30,
2011
    Nine months
ended
June 30,
2012
    Nine months
ended
June 30,
2011
 

Net asset value at beginning of period

   $ 9.87      $ 10.68      $ 10.07      $ 10.43   

Net investment income

     0.27        0.25        0.84        0.77   

Net unrealized appreciation on investments and interest rate swap

     0.00        0.28        0.18        0.57   

Net realized loss on investments and interest rate swap

     0.00        (0.21 )     (0.35 )     (0.46 )

Dividends paid

     (0.29 )     (0.32 )     (0.89 )     (0.94 )

Issuance of common stock

     0.00        0.04        0.00        0.35   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net asset value at end of period

   $ 9.85      $ 10.72      $ 9.85      $ 10.72   

Per share market value at beginning of period

   $ 9.76      $ 13.35      $ 9.32      $ 11.14   

Per share market value at end of period

   $ 9.98      $ 11.60      $ 9.98      $ 11.60   

Total return(1)

     5.29 %     (10.85 )%     17.28 %     12.32 %

Common shares outstanding at beginning of period

     82,421        66,668        72,376        54,550   

Common shares outstanding at end of period

     82,462        72,376        82,462        72,376   

Net assets at beginning of period

   $ 813,322      $ 711,748      $ 728,627      $ 569,172   

Net assets at end of period

   $ 812,071      $ 775,649      $ 812,071      $ 775,649   

Average net assets(2)

   $ 816,609      $ 718,704      $ 777,094      $ 650,881   

Ratio of net investment income to average net assets(3)

     10.76 %     9.22 %     11.26 %     9.68 %

Ratio of total expenses to average net assets(3)

     9.49 %     8.88 %     10.02 %     8.29 %

Ratio of portfolio turnover to average investments at fair value

     5.22 %     0.00 %     25.13 %     1.75 %

Weighted average outstanding debt(4)

   $ 371,346      $ 294,542      $ 409,254      $ 206,797   

Average debt per share

   $ 4.51      $ 4.39      $ 5.24      $ 3.38   

 

(1) Total return equals the increase or decrease of ending market value over beginning market value, plus distributions, divided by the beginning market value, assuming dividend reinvestment prices obtained under the Company’s DRIP. Total return is not annualized during interim periods.

 

(2) Calculated based upon the weighted average net assets for the period.

 

(3) Interim periods are annualized.

 

(4) Calculated based upon the weighted average of loans payable for the period.

 

Note 13. Interest Rate Swap

In August 2010, the Company entered into a three-year interest rate swap agreement to mitigate its exposure to adverse fluctuations in interest rates for a total notional amount of $100.0 million. Under the interest rate swap agreement, the Company paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

Swaps contain varying degrees of off-balance sheet risk which could result from changes in the market values of underlying assets, indices or interest rates and similar items. As a result, the amounts recognized in the Consolidated Statement of Assets and Liabilities at any given date may not reflect the total amount of potential losses that the Company could ultimately incur.

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

 

Note 14. Convertible Senior Notes

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

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

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when the Company’s shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, the Company will deliver shares of its common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of the Company’s common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115 million convertible debt outstanding at June 30, 2012 is 7,790,273. If the Company delivers shares of common stock upon a conversion at the time that net asset value per share exceeds the conversion price in effect at such time, the Company’s stockholders may incur dilution. In addition, the Company’s stockholders will experience dilution in their ownership percentage of common stock upon the issuance of common stock in connection with the conversion of the Company’s convertible senior notes and any dividends paid on common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

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

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

Interest expense for the three and nine months ended June 30, 2012 was $1.7 million and $5.4 million, respectively, related to the Convertible Notes.

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

 

The Company may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by the Company may, at the Company’s option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by the Company. Any Convertible Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the Indenture. During the nine months ended June 30, 2012, the Company repurchased $20.0 million principal of the Convertible Notes in the open market for an aggregate purchase price of $17.9 million and surrendered them to the Trustee for cancellation. The Company recorded a gain on the extinguishment of these Convertible Notes in the amount of the difference between the reacquisition price and the net carrying amount, net of the proportionate amount of unamortized debt issuance costs. The net gain recorded was $1.6 million.

As of June 30, 2012, there were $115.0 million Convertible Notes outstanding, which had a fair value of $109.4 million.

 

Note 15. Subsequent Events

The Company’s management evaluated subsequent events through the date of issuance of these Consolidated Financial Statements. There have been no subsequent events that occurred during such period that would require disclosure in, or would be required to be recognized in, the Consolidated Financial Statements as of and for the nine months ended June 30, 2012.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in connection with our Consolidated Financial Statements and the notes thereto included elsewhere in this quarterly report on Form 10-Q.

Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q may include statements as to:

 

   

our future operating results and dividend projections;

 

   

our business prospects and the prospects of our portfolio companies;

 

   

the impact of the investments that we expect to make;

 

   

the ability of our portfolio companies to achieve their objectives;

 

   

our expected financings and investments;

 

   

the adequacy of our cash resources and working capital; and

 

   

the timing of cash flows, if any, from the operations of our portfolio companies.

In addition, words such as “anticipate,” “believe,” “expect,” “project” and “intend” indicate forward-looking statements, although not all forward-looking statements include these words. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Risk Factors” in our annual report on Form 10-K for the year ended September 30, 2011, in our quarterly report on Form 10-Q for the quarter ended March 31, 2012 and elsewhere in this quarterly report on Form 10-Q for the quarter ended June 30, 2012. Other factors that could cause actual results to differ materially include:

 

   

changes in the economy and the financial markets;

 

   

risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters;

 

   

future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to business development companies, small business investment companies, or SBICs, and regulated investment companies, or RICs; and

 

   

other considerations that may be disclosed from time to time in our publicly disseminated documents and filings.

We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of the filing of this quarterly report with the Securities and Exchange Commission, or the SEC, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

Except as otherwise specified, references to the “Company,” “we,” “us,” and “our,” refer to Fifth Street Finance Corp.

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

Overview

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

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

 

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

Critical Accounting Policies

Basis of Presentation

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

Investment Valuation

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

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

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

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

The Valuation Committee of our Board of Directors makes a recommendation to the Board of Directors; and

 

   

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

 

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The fair value of all of our investments at June 30, 2012 and September 30, 2011 was determined by our Board of Directors. Our Board of Directors is solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and our consistently applied valuation process.

Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. Upon completion of their processes each quarter, the independent valuation firms provide us with written reports regarding the preliminary valuations of selected portfolio securities as of the close of such quarter. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for determining the fair value of our investments in good faith. We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued on an annual basis.

The portions of our portfolio valued, as a percentage of the portfolio at fair value, by independent valuation firms by period were as follows:

 

For the quarter ended December 31, 2007

     91.9

For the quarter ended March 31, 2008

     92.1

For the quarter ended June 30, 2008

     91.7

For the quarter ended September 30, 2008

     92.8

For the quarter ended December 31, 2008

     100.0

For the quarter ended March 31, 2009

     88.7 %(1) 

For the quarter ended June 30, 2009

     92.1

For the quarter ended September 30, 2009

     28.1

For the quarter ended December 31, 2009

     17.2 %(2) 

For the quarter ended March 31, 2010

     26.9

For the quarter ended June 30, 2010

     53.1

For the quarter ended September 30, 2010

     61.8

For the quarter ended December 31, 2010

     73.9

For the quarter ended March 31, 2011

     82.0

For the quarter ended June 30, 2011

     82.9

For the quarter ended September 30, 2011

     91.2

For the quarter ended December 31, 2011

     89.1

For the quarter ended March 31, 2012

     87.3

For the quarter ended June 30, 2012

     84.3

 

(1) 96.0% excluding our investment in IZI Medical Products, Inc., which closed on March 31, 2009, and therefore was not part of the independent valuation process

 

(2) 24.8% excluding four investments that closed in December 2009 and therefore were not part of the independent valuation process

As of June 30, 2012 and September 30, 2011, approximately 90.5% and 92.6%, respectively, of our total assets represented investments in portfolio companies valued at fair value.

Revenue Recognition

Interest and Dividend Income

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

Fee Income

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

 

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We have also structured exit fees across certain of our portfolio investments to be received upon the future exit of those investments. Exit fees are payable upon the exit of a debt security. These fees are to be paid to us upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan. As of June 30, 2012, we had structured $6.8 million in aggregate exit fees across nine portfolio investments upon the future exit of those investments.

Payment-in-Kind (PIK) Interest

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

For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments” in our annual report on Form 10-K for the year ended September 30, 2011. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest. The accrual of PIK interest on our debt investments increases the recorded cost basis of these investments in our consolidated financial statements and, as a result, increases the cost basis of these investments for purposes of computing the capital gains incentive fee payable by us to our investment adviser.

To maintain our status as a RIC, PIK income must be paid out to our stockholders in the form of dividends even though we have not yet collected the cash and may never collect the cash relating to the PIK interest. Accumulated PIK interest was $27.9 million and represented 2.3% of the fair value of our portfolio of investments as of June 30, 2012 and $22.7 million or 2.0% as of September 30, 2011. The net increase in loan balances as a result of contracted PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

Portfolio Composition

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

 

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

 

     June 30, 2012     September 30, 2011  

Cost:

    

First lien debt

     69.45     77.05

Second lien debt

     11.54     13.97

Subordinated debt

     16.88     7.40

Purchased equity

     1.49     0.97

Equity grants

     0.45     0.53

Limited partnership interests

     0.19     0.08
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 
     June 30, 2012     September 30, 2011  

Fair value:

    

First lien debt

     69.43     78.14

Second lien debt

     11.08     12.80

Subordinated debt

     16.98     7.25

Purchased equity

     1.81     1.12

Equity grants

     0.50     0.60

Limited partnership interests

     0.20     0.09
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

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

 

     June 30,
2012
    September 30,
2011
 

Cost:

    

Healthcare services

     12.00     19.65

Education services

     7.55     2.57

Healthcare equipment

     6.82     6.16

Internet software & services

     6.05     3.79

Diversified support services

     5.98     4.80

Oil & gas equipment services

     5.02     7.11

Leisure products

     4.56     1.17

Construction and engineering

     4.01     3.74

Advertising

     3.40     1.72

Pharmaceuticals

     3.30     2.36

Apparel, accessories & luxury goods

     3.18     2.68

Diversified financial services

     3.17     1.15

Electronic equipment & instruments

     2.94     3.01

Specialty stores

     2.72     2.99

Integrated telecommunication services

     2.63     2.25

Leisure facilities

     2.47     3.29

Household products

     2.46     2.70

Home improvement retail

     2.29     2.42

IT consulting & other services

     2.09     4.23

Restaurants

     1.92     1.21

Industrial machinery

     1.71     0.90

Electronic manufacturing services

     1.69     1.75

Human resources & employment services

     1.61     1.77

Auto parts & equipment

     1.57     1.63

Environmental & facilities services

     1.56     1.41

 

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Distributors

     1.56     1.61

Air freight & logistics

     1.52     1.56

Food distributors

     1.44     1.80

Research & consulting services

     1.15     0.00

Construction materials

     0.57     0.58

Housewares & specialties

     0.44     0.46

Building products

     0.41     0.58

Multi-sector holdings

     0.19     0.09

Movies & entertainment

     0.02     0.02

Fertilizers & agricultural chemicals

     0.00     2.49

Healthcare technology

     0.00     1.77

Trucking

     0.00     1.48

Data processing & outsourced services

     0.00     1.10
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

 

     June 30,
2012
    September 30,
2011
 

Fair Value:

    

Healthcare services

     12.59     20.67

Education services

     7.69     2.69

Healthcare equipment

     6.98     6.42

Internet software & services

     6.35     3.91

Diversified support services

     6.21     5.02

Oil & gas equipment services

     5.20     7.38

Leisure products

     4.67     1.22

Advertising

     3.49     1.80

Pharmaceuticals

     3.41     2.46

Apparel, accessories & luxury goods

     3.35     3.00

Diversified financial services

     3.29     1.19

Electronic equipment & instruments

     2.99     3.11

Specialty stores

     2.85     3.14

Construction and engineering

     2.75     3.20

Integrated telecommunication services

     2.70     2.36

Leisure facilities

     2.57     3.43

Household products

     2.52     2.67

IT consulting & other services

     2.17     4.42

Home improvement retail

     2.09     2.46

Environmental & facilities services

     1.93     1.78

Industrial machinery

     1.81     0.97

Auto parts & equipment

     1.72     1.70

Restaurants

     1.71     1.06

Human resources & employment services

     1.70     1.87

Distributors

     1.64     1.69

Food distributors

     1.49     1.88

Research & consulting services

     1.20     0.00

Air freight & logistics

     1.19     1.54

Electronic manufacturing services

     0.70     0.77

Construction materials

     0.59     0.61

Multi-sector holdings

     0.19     0.11

Building products

     0.18     0.43

Housewares & specialties

     0.06     0.23

Movies & entertainment

     0.02     0.02

Fertilizers & agricultural chemicals

     0.00     2.61

Healthcare technology

     0.00     1.87

Data processing & outsourced services

     0.00     0.31
  

 

 

   

 

 

 

Total

     100.00     100.00
  

 

 

   

 

 

 

 

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Portfolio Asset Quality

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

The following table shows the distribution of our investments on the 1 to 5 investment ranking scale at fair value, as of June 30, 2012 and September 30, 2011:

 

     June 30, 2012      September 30, 2011  
   Fair Value      Percentage of
Total Portfolio
    Leverage
Ratio
     Fair Value      Percentage of
Total Portfolio
    Leverage
Ratio
 

1

   $ 44,925         3.75     2.07       $ 81,335         7.26     3.16   

2

     1,133,015         94.57     3.89         1,021,990         91.26     3.87   

3

     3,549         0.30     NM(1)         8,660         0.77     NM(1)   

4

     11,518         0.96     NM(1)                 0.00       

5

     5,090         0.42     NM(1)         7,852         0.71     NM(1)   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,198,097         100.00     3.83       $ 1,119,837         100.00     3.82   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Due to operating performance this ratio is not measurable and, as a result, is excluded from the total portfolio calculation.

We may from time to time modify the payment terms of our investments, either in response to current economic conditions and their impact on certain of our portfolio companies or in accordance with tier pricing provisions in certain loan agreements. As of June 30, 2012, we had modified the payment terms of our investments in 14 portfolio companies. Such modified terms may include increased PIK interest provisions and reduced cash interest rates. These modifications, and any future modifications to our loan agreements, may limit the amount of interest income that we recognize from the modified investments, which may, in turn, limit our ability to make distributions to our stockholders.

Loans and Debt Securities on Non-Accrual Status

As of June 30, 2012, we had stopped accruing cash and/or PIK interest and original issue discount (“OID”) on four investments, three of which had not paid all of their scheduled cash interest payments for the period ended June 30, 2012. As of June 30, 2011, we had stopped accruing cash interest, PIK interest and OID on two investments that had not paid all of their scheduled cash interest payments for the period ended June 30, 2011.

 

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Cash non-accrual status is inclusive of PIK and other noncash income, where applicable. The percentage of our portfolio investments at cost and fair value by accrual status as of June 30, 2012, September 30, 2011 and June 30, 2011 was as follows:

 

    June 30, 2012     September 30, 2011     June 30, 2011  
    Cost     % of
Portfolio
    Fair
Value
    % of
Portfolio
    Cost     % of
Portfolio
    Fair
Value
    % of
Portfolio
    Cost     % of
Portfolio
    Fair
Value
    % of
Portfolio
 

Accrual

  $ 1,168,495        95.75   $ 1,181,490        98.61   $ 1,116,762        96.60   $ 1,111,986        99.30   $ 1,025,169        97.86   $ 1,046,526        99.34

PIK non-accrual

    15,637        1.28     3,454        0.29            0.00            0.00            0.00            0.00

Cash non-accrual

    36,260        2.97     13,153        1.10     39,320        3.40     7,851        0.70     22,383        2.14     6,953        0.66
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,220,392        100.00   $ 1,198,097        100.00   $ 1,156,082        100.00   $ 1,119,837        100.00   $ 1,047,552        100.00   $ 1,053,479        100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

     June 30, 2012      September 30, 2011      June 30, 2011  

Lighting by Gregory, LLC

     Cash non-accrual         Cash non-accrual         Cash non-accrual   

O’Currance, Inc.(1)

             Cash non-accrual           

Premier Trailer Leasing, Inc.(1)

             Cash non-accrual         Cash non-accrual   

Repechage Investments Limited

     Cash non-accrual         Cash non-accrual           

Rail Acquisition Corp.

     PIK non-accrual                   

Traffic Control & Safety Corp. — Second Lien and Subordinated Debt

     Cash non-accrual                   

 

(1) We no longer hold this investment. See “— Discussion and Analysis of Results and Operations — Comparison of the three and nine months ended June 30, 2012 and June 30, 2011 — Realized Gain (Loss) on Investments and Interest Rate Swaps” for a discussion of our recent realization events.

Income non-accrual amounts related to the above investments for the three and nine months ended June 30, 2012 and June 30, 2011 were as follows:

 

     Three months ended
June 30, 2012
     Three months ended
June 30, 2011
     Nine months ended
June 30, 2012
     Nine months ended
June 30, 2011
 

Cash interest income

   $ 524       $ 917       $ 2,681       $ 4,484   

PIK interest income

     1,033         155         3,078         541   

OID income

                     95         60   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,557       $ 1,072       $ 5,854       $ 5,085   
  

 

 

    

 

 

    

 

 

    

 

 

 

Discussion and Analysis of Results and Operations

Results of Operations

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

Comparison of the three and nine months ended June 30, 2012 and June 30, 2011

Total Investment Income

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

Total investment income for the three months ended June 30, 2012 and June 30, 2011 was $41.0 million and $32.4 million, respectively. For the three months ended June 30, 2012, this amount primarily consisted of $32.6 million of interest income from portfolio investments (which included $3.9 million of PIK interest) and $8.3 million of fee income. For the three months ended June 30, 2011, this amount primarily consisted of $29.0 million of interest income from portfolio investments (which included $3.6 million of PIK interest) and $3.3 million of fee income.

 

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Total investment income for the nine months ended June 30, 2012 and June 30, 2011 was $122.6 million and $87.5 million, respectively. For the nine months ended June 30, 2012, this amount primarily consisted of $98.1 million of interest income from portfolio investments (which included $10.2 million of PIK interest) and $24.4 million of fee income. For the nine months ended June 30, 2011, this amount primarily consisted of $75.6 million of interest income from portfolio investments (which included $10.2 million of PIK interest) and $11.7 million of fee income.

The increase in our total investment income for the three and nine months ended June 30, 2012 as compared to the three and nine months ended June 30, 2011 was primarily attributable to a higher average level of outstanding debt investments, which was principally due to a net increase of 10 debt investments in our portfolio and fee income related to debt payoffs, partially offset by amortization payments received on our debt investments and a decrease in the weighted average yield on our debt investments from 12.64% to 12.13% during the year-over-year period.

Expenses

Expenses for the three months ended June 30, 2012 and June 30, 2011 were $19.3 million and $15.9 million, respectively. Expenses increased for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 by $3.4 million. This was due primarily to increases in:

 

   

Base management fee, which was attributable to a 13.7% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;

 

   

Incentive fee, which was attributable to a 32.6% increase in pre-incentive fee net investment income for the year-over-year period; and

 

   

Interest expense, which was attributable to a 26.1% increase in weighted average debt outstanding for the year-over-year period.

Expenses for the nine months ended June 30, 2012 and June 30, 2011 were $58.5 million and $40.3 million, respectively. Expenses increased for the nine months ended June 30, 2012 as compared to the nine months ended June 30, 2011 by $18.2 million. This was due primarily to increases in:

 

   

Base management fee, which was attributable to the increase in the fair value of the investment portfolio discussed above;

 

   

Incentive fee, which was attributable to a 39.4% increase in pre-incentive fee net investment income for the year-over-year period; and

 

   

Interest expense, which was attributable to a 97.9% increase in weighted average debt outstanding for the year-over-year period. The significant increase in debt outstanding for the three and nine months ended June 30, 2012 as compared to the three and nine months ended June 30, 2011 is attributable to our ability to obtain attractively priced debt to finance our investment operations.

Gain on Extinguishment of Convertible Senior Notes

During the three and nine months ended June 30, 2012, we repurchased $9.0 million and $20.0 million in principal amount, respectively, of our unsecured convertible notes (“Convertible Notes”) in the open market and surrendered them to the Trustee for cancellation. The aggregate purchase price of these Convertible Notes was $17.9 million because they were trading at a discount due to what we believe were volatile market conditions. As such we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt recorded for the three and nine months ended June 30, 2012 was $0.2 million and $1.6 million, respectively. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such a fee in the future and ratify the payment of such fees we have already paid. This type of net gain, and corresponding income incentive fee, may occur again in the future.

 

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Net Investment Income

As a result of the $8.6 million increase in total investment income and the $0.2 million gain on extinguishment of debt, as compared to the $3.4 million increase in total expenses, net investment income for the three months ended June 30, 2012 reflected a $5.4 million, or 32.6%, increase compared to the three months ended June 30, 2011.

As a result of the $35.1 million increase in total investment income and the $1.6 million gain on extinguishment of debt, as compared to the $18.2 million increase in total expenses, net investment income for the nine months ended June 30, 2012 reflected a $18.5 million, or 39.4%, increase compared to the nine months ended June 30, 2011.

Realized Gain (Loss) on Investments and Interest Rate Swap

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

During the nine months ended June 30, 2012, we recorded investment realization events, including the following:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

 

   

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

 

   

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

During the nine months ended June 30, 2011, we recorded investment realization events, including the following:

 

   

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

 

   

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

 

   

In November 2010, we restructured our investment in Vanguard Vinyl, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $1.7 million in accordance with ASC 470-50;

 

   

In December 2010, we restructured our investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $3.9 million in accordance with ASC 470-50;

 

   

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

 

   

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

 

   

In December 2010, we restructured our investment in Lighting by Gregory, LLC. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $7.8 million in accordance with ASC 470-50;

 

   

In March 2011, we received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $0.3 million in accordance with ASC 470-50; and

 

   

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

Net Unrealized Appreciation or Depreciation on Investments and Interest Rate Swap

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

During the three months ended June 30, 2012, we recorded net unrealized appreciation of $0.2 million. This consisted of $0.1 million of net unrealized appreciation on debt investments and $0.1 million of net unrealized appreciation on equity investments. During the three months ended June 30, 2011, we recorded net unrealized appreciation of $18.5 million. This consisted of $14.0 million of net reclassifications to realized losses and $7.1 million of net unrealized appreciation on equity investments, offset by $1.7 million of net unrealized depreciation on debt investments and $0.9 million of net unrealized depreciation on our interest rate swap.

 

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During the nine months ended June 30, 2012, we recorded net unrealized appreciation of $14.1 million. This consisted of $1.9 million of net unrealized appreciation on equity investments and $27.7 million of net reclassifications to realized losses, offset by $15.5 million of net unrealized depreciation on debt investments. During the nine months ended June 30, 2011, we recorded net unrealized appreciation of $34.9 million. This consisted of $24.9 million of net reclassifications to realized losses, $4.0 million of net unrealized appreciation on debt investments and $6.0 million of net unrealized appreciation on equity investments.

Financial Condition, Liquidity and Capital Resources

Cash Flows

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

For the nine months ended June 30, 2012, we experienced a net increase in cash and cash equivalents of $38.1 million. During that period, we used $22.4 million of cash in operating activities, primarily for the funding of $407.9 million of investments and net revolvers, partially offset by $333.3 million of principal payments, PIK payments received and investment sale proceeds received and $65.7 million of net investment income. During the same period, cash provided by financing activities was $60.4 million, primarily consisting of $50.5 million of net borrowings under our credit facilities and $100.7 million of proceeds from the issuance of our common stock, partially offset by $68.7 million of cash dividends paid, $17.9 million of net repurchases of our convertible senior notes and $3.3 million of deferred financing costs paid.

For the nine months ended June 30, 2011, we experienced a net decrease in cash and cash equivalents of $59.2 million. During that period, we used $431.5 million of cash in operating activities, primarily for the funding of $566.8 million of investments and net revolvers, partially offset by $89.0 million of principal payments and PIK payments received and $47.1 million of net investment income. During the same period, cash provided by financing activities was $372.3 million, primarily consisting of $77.0 million of SBA borrowings, $206.8 million of proceeds from the issuance of our common stock and $152.0 million of proceeds from the issuance of our convertible senior notes, partially offset by $53.6 million of cash dividends paid and $9.2 million of deferred financing costs paid.

As of June 30, 2012, we had $105.7 million in cash and cash equivalents, portfolio investments (at fair value) of $1.20 billion, $5.9 million of interest and fees receivable, $150.0 million of SBA debentures payable, $228.5 million of borrowings outstanding under our credit facilities, $115.0 million of convertible senior notes payable and unfunded commitments of $96.0 million.

As of September 30, 2011, we had $67.6 million in cash and cash equivalents, portfolio investments (at fair value) of $1.12 billion, $6.8 million of interest and fees receivable, $150.0 million of SBA debentures payable, $178.0 million of borrowings outstanding under our credit facilities, $135.0 million of convertible senior notes payable and unfunded commitments of $108.8 million.

Other Sources of Liquidity

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

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

 

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

Also, as a business development company, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. As of June 30, 2012, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.

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

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

SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when it has at least $112.5 million in regulatory capital. As of June 30, 2012, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $126.2 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:

 

Rate Fix Date

   Debenture
Amount
     Fixed
Interest
Rate
    SBA
Annual
Charge
 

September 2010

   $ 73,000         3.215 %     0.285 %

March 2011

     65,300         4.084 %     0.285 %

September 2011

     11,700         2.877 %     0.285 %

As of June 30, 2012, FSMP V had $37.5 million in regulatory capital, but did not yet have any SBA-guaranteed debentures outstanding.

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

 

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Significant capital transactions that occurred since October 1, 2010

The following table reflects the dividend distributions per share that our Board of Directors has declared and we have paid, including shares issued under our DRIP, on our common stock since October 1, 2010:

 

Date Declared

 

Record Date

   

Payment Date

    Amount per
Share
    Cash
Distribution
    DRIP Shares
Issued
    DRIP Shares
Value
 

November 30, 2010

    January 4, 2011        January 31, 2011      $ 0.1066      $ 5.4 million        36,038      $ 0.5 million   

November 30, 2010

    February 1, 2011        February 28, 2011        0.1066        5.4 million        29,072        0.4 million   

November 30, 2010

    March 1, 2011        March 31, 2011        0.1066        6.5 million        43,766        0.6 million   

January 30, 2011

    April 1, 2011        April 29, 2011        0.1066        6.5 million        45,193        0.6 million   

January 30, 2011

    May 2, 2011        May 31, 2011        0.1066        6.5 million        48,870        0.6 million   

January 30, 2011

    June 1, 2011        June 30, 2011        0.1066        6.5 million        55,367        0.6 million   

May 2, 2011

    July 1, 2011        July 29, 2011        0.1066        7.1 million        58,829        0.6 million   

May 2, 2011

    August 1, 2011        August 31, 2011        0.1066        7.1 million        64,431        0.6 million   

May 2, 2011

    September 1, 2011        September 30, 2011        0.1066        7.2 million        52,487        0.5 million   

August 1, 2011

    October 14, 2011        October 31, 2011        0.1066        7.3 million        40,388 (1)     0.4 million   

August 1, 2011

    November 15, 2011        November 30, 2011        0.1066        7.3 million        43,034 (1)      0.4 million   

August 1, 2011

    December 13, 2011        December 23, 2011        0.1066        7.3 million        43,531 (1)     0.4 million   

November 10, 2011

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

November 10, 2011

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

November 10, 2011

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

February 7, 2012

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

February 7, 2012

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

February 7, 2012

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

May 7, 2012

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

 

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

The following table reflects share transactions that occurred from October 1, 2010 through June 30, 2012:

 

Date

  

Transaction

  Shares      Share Price     Gross Proceeds  

December 2010

   At-the-market offering     429,110       $ 11.87 (3)   $ 5.1 million   

February 4, 2011

   Public offering(1)     11,500,000         12.65        145.5 million   

June 24, 2011

   Public offering(2)     5,558,469         11.72        65.1 million   

January 26, 2012

   Public offering     10,000,000         10.07        100.7 million   

 

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

Borrowings

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

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

 

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On November 5, 2010, we amended the Wells Fargo facility to, among other things, provide for the issuance from time to time of letters of credit for the benefit of our portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million. On February 28, 2011, we amended the Wells Fargo facility to, among other things, (i) reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, (ii) extend the period during which we may make new borrowings under the facility to February 25, 2013 and (iii) extend the maturity date of the facility to February 25, 2014. The facility may be extended for up to two additional years upon the mutual consent of Wells Fargo and each of the lender parties thereto. On November 30, 2011, we amended the Wells Fargo facility to, among other things, reduce the interest rate to LIBOR plus 2.75% per annum, with no LIBOR floor. On April 23, 2012, we amended the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which we may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

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

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

The Wells Fargo facility is secured by all of the assets of Funding, and all of our equity interest in Funding. We use the Wells Fargo facility to fund a portion of our loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of June 30, 2012, we had $26.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $26.0 million. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.120% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, we recorded interest expense of $0.7 million and $2.0 million, respectively, related to the Wells Fargo facility.

On May 27, 2010, we entered into a three-year secured syndicated revolving credit facility (“ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allowed for us to borrow money at a rate of either (i) LIBOR plus 3.5% per annum or (ii) 2.5% per annum plus an alternate base rate based on the greatest of the Prime Rate, Federal Funds Rate plus 0.5% per annum or LIBOR plus 1% per annum, and had a maturity date of May 27, 2013. The ING facility also allowed us to request letters of credit from ING Capital LLC, as the issuing bank. The initial commitment under the ING facility was $90 million, and the ING facility included an accordion feature that allows for potential future expansion of the facility up to a total of $150 million. The ING facility is secured by substantially all of our assets, as well as the assets of our wholly-owned subsidiary, FSFC Holdings, Inc., and our indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC, subject to certain exclusions for, among other things, equity interests in our SBIC subsidiaries and equity interests in Funding and Fifth Street Funding II, LLC as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and us. Fifth Street Fund of Funds LLC and FSFC Holdings, Inc. were formed to hold certain of our portfolio companies for tax purposes and have no other operations. None of our SBIC subsidiaries, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

 

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On February 22, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion up to a total of $300 million and the maturity date was extended to February 22, 2014. On July 8, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $230 million and increase the accordion feature to allow for potential future expansion up to a total of $350 million. In addition, the ING facility’s interest rate was reduced to LIBOR plus 3.0% per annum, with no LIBOR floor, when the facility is drawn more than 35%. Otherwise, the interest rate will be LIBOR plus 3.25% per annum, with no LIBOR floor.

On February 29, 2012, we amended the ING facility to, among other things, (i) extend the period during which we may make and repay borrowings under the ING facility to February 27, 2015, (ii) extend the maturity date to February 29, 2016 and (iii) increase the accordion feature to allow for potential future expansion up to a total of $450 million.

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

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

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the ING facility at any particular time or at all.

As of June 30, 2012, we had $151.5 million of borrowings outstanding under the ING facility that had a fair value of $151.5 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of 3.390% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, we recorded interest expense of $1.3 million and $4.1 million, respectively, related to the ING facility.

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

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

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

 

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The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of June 30, 2012, we had $51.0 million of borrowings outstanding under the Sumitomo facility that had a fair value of $51.0 million. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.885% during the nine months ended June 30, 2012. For the three and nine months ended June 30, 2012, we recorded interest expense of $0.3 million and $0.7 million, respectively, related to the Sumitomo facility.

As of June 30, 2012, except for assets that were funded through our SBIC subsidiaries, substantially all of our assets were pledged as collateral under the Wells Fargo facility, ING facility or the Sumitomo facility. With respect to the assets funded through our SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over our stockholders.

Interest expense for the three and nine months ended June 30, 2012 was $5.6 million and $16.9 million, respectively. Interest expense for the three and nine months ended June 30, 2011 was $5.0 million and $9.6 million, respectively.

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

 

Facility

  

Financial Covenant

 

Description

  Target Value    Reported Value(1)

Wells Fargo facility

   Minimum shareholders’ equity (inclusive of affiliates)   Net assets shall not be less than $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 25, 2011   $592 million    $812 million
   Minimum shareholders’ equity (exclusive of affiliates)   Net assets exclusive of affiliates other than Funding shall not be less than $250 million   $250 million    $619 million
   Asset coverage ratio   Asset coverage ratio shall not be less than 2.00:1   2.00:1    4.85:1

ING facility

  

Minimum

shareholders’ equity

  Net assets shall not be less than the greater of (a) 55% of total assets; and (b) $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 22, 2011   $592 million    $812 million
   Asset coverage ratio   Asset coverage ratio shall not be less than 2.25:1   2.25:1    4.85:1
   Interest coverage ratio   Interest coverage ratio shall not be less than 2.50:1   2.50:1    6.67:1
   Eligible portfolio investments test   Aggregate value of (a) Cash and cash equivalents and (b) Portfolio investments ranked 1, 2 or 3 shall not be less than $175 million   $175 million    $626 million

 

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

We and our SBIC subsidiaries are also subject to certain regulatory requirements relating to our borrowings. For a discussion of such requirements, see “Item 1. Business — Regulation — Business Development Company Regulations” and “— Small Business Investment Company Regulations” in our Annual Report on Form 10-K for the year ended September 30, 2011.

 

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The following table reflects material credit facility and SBA debenture transactions that have occurred since October 1, 2009. Amounts available and drawn are as of June 30, 2012:

 

Facility

  Date  

Transaction

  Total
Facility
Amount
    Upfront
fee Paid
    Total
Facility
Availability
    Amount
Drawn
    Remaining
Availability
   

Interest Rate

Wells Fargo facility

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

ING facility

  5/27/ 2010   Entered into credit facility     90 million        0.8 million            LIBOR + 3.50%
  2/22/ 2011   Expanded credit facility     215 million        1.6 million            LIBOR + 3.50%
  7/8/ 2011   Expanded credit facility     230 million        0.4 million            LIBOR + 3.00%/3.25%(2)
  2/29/2012   Amended credit facility     230 million        1.5 million        230 million        152 million        78 million      LIBOR + 3.00%/3.25%(2)

SBA

  2/16/ 2010   Received capital commitment     75 million        0.8 million           
  9/21/ 2010   Received capital commitment     150 million        0.8 million        150 million        150 million             3.567%(3)
  7/23/2012   Received capital commitment     75 million        0.8 million        75 million               75 million     

Sumitomo facility

  9/16/2011   Entered into credit facility     200 million        2.5 million        51 million (1)      51 million       

  
  LIBOR + 2.25%

 

(1) Availability to increase upon our decision to further collateralize the facility.
(2) LIBOR plus 3.0% when the facility is drawn more than 35%. Otherwise, LIBOR plus 3.25%.
(3) Weighted average interest rate of 3.567% (excludes the SBA annual charge of 0.285%).

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

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

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when our shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, we will deliver shares of our common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of our common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115.0 million Convertible Notes outstanding at June 30, 2012 is 7,790,273. If we deliver shares of common stock upon a conversion at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our Convertible Notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

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

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

 

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For the three and nine months ended June 30, 2012, we recorded interest expense of $1.7 million and $5.4 million, respectively, related to the Convertible Notes.

We may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any Convertible Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the Indenture. During the three and nine months ended June 30, 2012, we repurchased $9.0 million and $20.0 million in principal amount, respectively, of the Convertible Notes in the open market for an aggregate purchase price of $17.9 million and surrendered them to the Trustee for cancellation.

As of June 30, 2012, there were $115.0 million Convertible Notes outstanding, which had a fair value of $109.4 million.

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of June 30, 2012, our only off-balance sheet arrangements consisted of $96.0 million of unfunded commitments, which was comprised of $87.3 million to provide debt financing to certain of our portfolio companies and $8.7 million related to unfunded limited partnership interests. As of September 30, 2011, our only off-balance sheet arrangements consisted of $108.8 million, which was comprised of $102.7 million to provide debt financing to certain of our portfolio companies and $6.1 million related to unfunded limited partnership interests. Such commitments are subject to our portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on our Consolidated Statement of Assets and Liabilities.

A summary of the composition of unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of June 30, 2012 and September 30, 2011 is shown in the table below:

 

     June 30, 2012      September 30, 2011  

Welocalize, Inc.

   $ 10,000       $ 750   

Yeti Acquisition, LLC

     7,500           

Charter Brokerage, LLC

     6,471         6,176   

Refac Optical Group

     5,500         5,500   

Rail Acquisition Corp.

     5,042         5,446   

I Drive Safely, LLC

     5,000           

Traffic Control & Safety Corporation

     4,876         3,014   

Enhanced Recovery Company, LLC

     4,000         4,000   

Drugtest, Inc.

     4,000         4,000   

World 50, Inc.

     4,000           

Phoenix Brands Merger Sub LLC

     3,857         3,000   

Miche Bag, LLC

     3,500         5,000   

Titan Fitness, LLC

     3,500         2,957   

Cardon Healthcare Network, LLC

     3,000         2,000   

Tegra Medical, LLC

     3,000         1,500   

Discovery Practice Management, Inc.

     2,600         3,000   

Mansell Group, Inc.

     2,000         2,000   

Physicians Pharmacy Alliance, Inc.

     2,000         2,000   

Riverside Fund V, LP (limited partnership interest)

     2,000           

Specialty Bakers, LLC

     1,500         2,000   

Eagle Hospital Physicians, Inc.

     1,400         2,500   

Milestone Partners IV, LP (limited partnership interest)

     1,343         2,000   

Ansira Partners, Inc.

     1,190           

Psilos Group Partners IV, LP (limited partnership interest)

     1,000         1,000   

CPASS Acquisition Company

     1,000           

ACON Equity Partners III, LP (limited partnership interest)

     986           

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

     934         960   

BMC Acquisition, Inc.

     900           

Riverlake Equity Partners II, LP (limited partnership interest)

     760         878   

HealthDrive Corporation

     750         2,000   

RCP Direct, LP (limited partnership interest)

     652           

 

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Baird Capital Partners V, LP (limited partnership interest)

     615         701   

Riverside Fund IV, LP (limited partnership interest)

     402         555   

Advanced Pain Management

     400         267   

Saddleback Fence and Vinyl Products, Inc.

     300         400   

JTC Education, Inc.

             14,000   

CRGT, Inc.

             12,500   

Dominion Diagnostics, LLC

             5,000   

ADAPCO, Inc.

             4,250   

Epic Acquisition, Inc.

             3,000   

IZI Medical Products, Inc.

             2,500   

Flatout, Inc.

             1,500   

IOS Acquisitions, Inc.

             1,250   

Best Vinyl Fence & Deck, LLC

             1,000   

Trans-Trade, Inc.

             200   
  

 

 

    

 

 

 

Total

   $ 95,978       $ 108,804   
  

 

 

    

 

 

 

Contractual Obligations

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

 

      Debt Outstanding
as of September 30,
2011
     Debt Outstanding
as of June 30,
2012
     Weighted average debt
outstanding for the
nine months ended
June 30, 2012
     Maximum debt
outstanding for
the nine months
ended
June 30,
2012
 

SBA debentures payable

   $ 150,000       $ 150,000       $ 150,000       $ 150,000   

Wells Fargo facility

     39,524         26,041         29,651       $ 48,269   

ING facility

     133,500         151,500         96,084       $ 151,500   

Sumitomo facility

     5,000         51,000         11,183       $ 51,000   

Convertible Notes

     135,000         115,000         122,336       $ 135,000   
  

 

 

    

 

 

    

 

 

    

Total debt

   $ 463,024       $ 493,541       $ 409,254       $ 493,541   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     Payments due by period as of June 30, 2012  
     Total      < 1 year      1-3 years      3-5 years      > 5 years  

SBA debentures payable

   $ 150,000       $       $       $       $ 150,000   

Interest due on SBA debentures

     50,953         5,778         11,556         11,572         22,047   

Wells Fargo facility

     26,041                         26,041           

Interest due on Wells Fargo facility

     2,982         780         1,560         642           

ING facility

     151,500                         151,500           

Interest due on ING facility

     18,063         4,924         9,848         3,291           

Sumitomo facility

     51,000                                 51,000   

Interest due on Sumitomo facility

     7,894         1,270         2,540         2,540         1,544   

Convertible senior notes payable

     115,000                         115,000           

Interest due on convertible senior notes

     23,218         6,181         12,363         4,674           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 596,651       $ 18,933       $ 37,867       $ 315,260       $ 224,591   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Regulated Investment Company Status and Distributions

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

 

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

To maintain RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distributive requirements of our taxable income on a calendar year basis (e.g., calendar year 2012). We anticipate timely distribution of our taxable income within the tax rules; however, we incurred a de minimis U.S. federal excise tax for calendar years 2008, 2009 and 2010. We did not incur a federal excise tax for calendar year 2011 and do not expect to incur a federal excise tax for calendar year 2012. We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, we are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to enable us to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility and Sumitomo facility could, under certain circumstances, restrict Funding and Funding II, respectively, from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.

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

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

Related Party Transactions

We have entered into an investment advisory agreement with Fifth Street Management LLC, our investment adviser. Fifth Street Management is controlled by Leonard M. Tannenbaum, its managing member and the chairman of our Board of Directors and our chief executive officer. Pursuant to the investment advisory agreement, fees payable to our investment adviser will be equal to (a) a base management fee of 2.0% of the value of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents, and (b) an incentive fee based on our performance. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee.

 

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The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and nine months ended June 30, 2012, we incurred fees that are due to our investment adviser of $11.6 million and $33.6 million, respectively, under the investment advisory agreement.

Pursuant to the administration agreement with FSC, Inc., which is controlled by Mr. Tannenbaum, FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will reimburse FSC, Inc. the allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and chief compliance officer and their respective staffs. Such reimbursement is at cost with no profit to, or markup by, FSC, Inc. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. Although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and nine months ended June 30, 2012, we have incurred expenses that are due to FSC, Inc. of $1.0 million and $3.2 million, respectively, under the administration agreement.

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

Recent Developments

On August 6, 2012, our Board of Directors declared the following dividends:

 

   

$0.0958 per share, payable on October 31, 2012 to stockholders of record on October 15, 2012;

 

   

$0.0958 per share, payable on November 30, 2012 to stockholders of record on November 15, 2012;

 

   

$0.0958 per share, payable on December 28, 2012 to stockholders of record on December 14, 2012;

 

   

$0.0958 per share, payable on January 31, 2013 to stockholders of record on January 15, 2013; and

 

   

$0.0958 per share, payable on February 28, 2013 to stockholders of record on February 15, 2013.

Recently Issued Accounting Standards

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

 

Item 3. Quantitative and Qualitative Disclosure about Market Risk

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent our debt investments include floating interest rates. In addition, our investments are carried at fair value as determined in good faith by our Board of Directors in accordance with the 1940 Act (See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Investment Valuation”). Our valuation methodology utilizes discount rates in part in valuing our investments, and changes in those discount rates may have an impact on the valuation of our investments.

 

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As of June 30, 2012, 68.1% of our debt investment portfolio (at fair value) and 65.6% of our debt investment portfolio (at cost) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of June 30, 2012 and September 30, 2011 was as follows:

 

     June 30, 2012     September 30, 2011  
     Fair Value      % of Floating
Rate Portfolio
    Fair Value      % of Floating
Rate Portfolio
 

Under 1%

   $ 96,203         12.10   $ 125,453         16.96

1% to under 2%

     455,180         57.23     261,878         35.40

2% to under 3%

     111,185         13.98     168,928         22.83

3% to under 4%

     132,763         16.69     176,976         23.92

4% to under 5%

             0.00     757         0.10

5% and over

             0.00     5,843         0.79
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 795,331         100.00   $ 739,835         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Based on our Consolidated Statement of Assets and Liabilities as of June 30, 2012, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investment and capital structure.

 

Basis point increase(1)

   Interest
income
     Interest
expense
    Net
increase(decrease)
 

100

   $ 1,000       $ (2,300   $ (1,300

200

     5,000         (4,600     400   

300

     12,400         (6,900     5,500   

400

     20,700         (9,100     11,600   

500

     28,900         (11,400     17,500   

 

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

We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of June 30, 2012 and September 30, 2011:

 

     June 30, 2012      September 30, 2011  
     Interest Bearing
Cash and
Investments
     Borrowings
     Interest Bearing
Cash and
Investments
     Borrowings
 

Money market rate

   $ 105,694       $       $ 67,644       $   

Prime rate

     22,931         74,000         38,890         53,000   

LIBOR

           

30 day

     54,440         154,541         51,368         125,024   

90 day

     717,403                 654,932           

Fixed rate

     421,489         265,000         418,981         285,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,321,957       $ 493,541       $ 1,231,815       $ 463,024   
  

 

 

    

 

 

    

 

 

    

 

 

 

On August 16, 2010, we entered into an interest rate swap agreement that was scheduled to expire on August 15, 2013, for a total notional amount of $100 million, for the purposes of hedging the interest rate risk related to the Wells facility and the ING facility. Under the interest rate swap agreement, we paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR. In August 2011, we terminated our interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation. As of June 30, 2012, we were no longer party to any interest rate swap agreements.

 

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Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective in timely identifying, recording, processing, summarizing, and reporting any material information relating to us that is required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934.

There have been no changes in our internal control over financial reporting that occurred during the three months ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings.

We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise. Currently, we are party to pending litigation. In connection with legal claims against us, we believe that those legal claims are frivolous and without merit, and we intend to vigorously defend ourselves against them.

 

Item 1A. Risk Factors.

There have been no material changes during the three months ended June 30, 2012 to the risk factors discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended September 30, 2011 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

While we did not engage in any sales of unregistered securities during the three months ended June 30, 2012, we issued a total of 41,499 shares of common stock under our dividend reinvestment plan (“DRIP”). This issuance was not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value of the shares of our common stock issued under our DRIP was approximately $0.4 million.

 

Item 6. Exhibits.

 

Exhibit
Number

  

Description of Exhibit

31.1*    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2*    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1*    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.2*    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

 

* Submitted herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Fifth Street Finance Corp.
Date: August 8, 2012   /s/    Leonard M. Tannenbaum
  Leonard M. Tannenbaum
  Chairman and Chief Executive Officer
Date: August 8, 2012   /s/    Alexander C. Frank
  Alexander C. Frank
  Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit
Number

  

Description of Exhibit

31.1*    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2*    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1*    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.2*    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

 

* Submitted herewith.

 

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