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As filed with the Securities and Exchange Commission on July 27, 2012

Securities Act File No. 333-180267

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form N-2

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

þ Pre-Effective Amendment No. 1

^¨ Post-Effective Amendment No. 

 

 

Fifth Street Finance Corp.

(Exact name of registrant as specified in charter)

10 Bank Street, 12th Floor

White Plains, NY 10606

(914) 286-6800

(Address and telephone number, including area code, of principal executive offices)

Leonard M. Tannenbaum

Fifth Street Finance Corp.

10 Bank Street, 12th Floor

White Plains, NY 10606

(Name and address of agent for service)

 

 

Copies to:

Steven B. Boehm, Esq.

Harry S. Pangas, Esq.

Sutherland Asbill & Brennan LLP

1275 Pennsylvania Avenue, NW

Washington, DC 20004-2415

Tel: (202) 383-0100

Fax: (202) 637-3593

Approximate date of proposed public offering: From time to time after the effective date of this Registration Statement.

If any securities being registered on this form will be offered on a delayed or continuous basis in reliance on Rule 415 under the Securities Act of 1933, other than securities offered in connection with a dividend reinvestment plan, check the following box.    þ

It is proposed that this filing will become effective (check appropriate box):

^¨    when declared effective pursuant to Section 8(c).

CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933

Title of Securities Being Registered		Proposed Maximum Aggregate Offering Price(1)				Amount of Registration Fee(5)
Common Stock, $0.01 par value per share(2)
Debt Securities(3)
Warrants(2)
Total(4)		$	500,000,000	(4)		$	57,300

 

 

(1)

Estimated pursuant to Rule 457(o) under the Securities Act of 1933 solely for the purpose of determining the registration fee. The proposed maximum offering price per security will be determined, from time to time, by the Registrant in connection with the sale by the Registrant of the securities registered under this Registration Statement.

(2)	Subject to Note 4 below, there is being registered hereunder an indeterminate number of shares of common stock or warrants as may be sold, from time to time. Warrants represent rights to purchase common stock or debt securities.

(3)

Subject to Note 4 below, there is being registered hereunder an indeterminate number of debt securities as may be sold, from time to time. If any debt securities are issued at an original issue discount, then the offering price shall be in such greater principal amount as shall result in an aggregate price to investors not to exceed $500,000,000.

(4)	In no event will the aggregate offering price of all securities issued from time to time pursuant to this Registration Statement exceed $500,000,000.

(5)	Previously paid.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

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The information in this prospectus is not complete and may be changed. The securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED JULY 27, 2012

$500,000,000

Fifth Street Finance Corp.

Common Stock

Debt Securities

Warrants

We may offer, from time to time in one or more offerings, up to $500,000,000 of shares of our common stock, debt securities or warrants to purchase common stock or debt securities, which we refer to, collectively, as the “securities.” Our securities may be offered at prices and on terms to be disclosed in one or more supplements to this prospectus. You should read this prospectus and the applicable prospectus supplement carefully before you invest in our securities.

Our securities may be offered directly to one or more purchasers through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will identify any agents or underwriters involved in the sale of our securities, and will disclose any applicable purchase price, fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “Plan of Distribution.” We may not sell any of our securities through agents, underwriters or dealers without delivery of a prospectus supplement describing the method and terms of the offering of such securities.

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

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

On July 26, 2012 and March 31, 2012, the last reported sale price of our common stock on the NASDAQ Global Select Market was $10.05 and $10.15, respectively. We are required to determine the net asset value per share of our common stock on a quarterly basis. Our net asset value per share of our common stock as of March 31, 2012 was $9.87.

Investing in our securities involves a high degree of risk, and should be considered highly speculative. See “Risk Factors” beginning on page 15 to read about factors you should consider, including the risk of leverage, before investing in our securities.

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

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

Prospectus dated                  , 2012

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PROSPECTUS SUMMARY			1
THE OFFERING			7
FEES AND EXPENSES			12
SELECTED FINANCIAL AND OTHER DATA			14
RISK FACTORS			15
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS			34
USE OF PROCEEDS			35
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS			36
RATIOS OF EARNINGS TO FIXED CHARGES			38
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			39
SENIOR SECURITIES			70
BUSINESS			71
PORTFOLIO COMPANIES.			83
MANAGEMENT			89
PORTFOLIO MANAGEMENT			98
INVESTMENT ADVISORY AGREEMENT			100
ADMINISTRATION AGREEMENT			107
LICENSE AGREEMENT			107
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS			108
CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS			109
DIVIDEND REINVESTMENT PLAN			111
DESCRIPTION OF OUR CAPITAL STOCK			112
DESCRIPTION OF OUR DEBT SECURITIES			115
DESCRIPTION OF OUR WARRANTS			127
MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS			129
REGULATION			137
PLAN OF DISTRIBUTION			142
CUSTODIAN, TRANSFER AND DISTRIBUTION PAYING AGENT AND REGISTRAR			144
BROKERAGE ALLOCATION AND OTHER PRACTICES			144
LEGAL MATTERS			144
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			144
CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			144
AVAILABLE INFORMATION			145
PRIVACY NOTICE			145
INDEX TO FINANCIAL STATEMENTS			F-1

 

 

ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission, or SEC, using the “shelf” registration process. Under the shelf registration process, we may offer, from time to time, up to $500,000,000 of our securities on terms to be determined at the time of the offering. This prospectus provides you with a general description of the securities that we may offer. Each time we use this prospectus to offer securities, we will provide a prospectus supplement that will contain specific information about the terms of that offering. The prospectus supplement may also add, update or change information contained in this prospectus. Please carefully read this prospectus and any accompanying prospectus supplement together with the additional information described under “Risk Factors” and “Available Information” before you make an investment decision.

 

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No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus or any accompanying supplement to this prospectus. You must not rely on any unauthorized information or representations not contained in this prospectus or any accompanying prospectus supplement as if we had authorized it. This prospectus and any accompanying prospectus supplement do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus and any accompanying prospectus supplement is accurate as of the dates on their covers. Our financial condition, results of operations and prospects may have changed since that date. To the extent required by law, we will amend or supplement the information contained in this prospectus and any accompanying prospectus supplement to reflect any material changes to such information subsequent to the date of the prospectus and any accompanying prospectus supplement and prior to the completion of any offering pursuant to the prospectus and any accompanying prospectus supplement.

 

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SELECTED FINANCIAL AND OTHER DATA

The following selected financial data should be read together with our consolidated financial statements and the related notes and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this prospectus. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp. The financial information as of and for the period from inception (February 15, 2007) to September 30, 2007 and for the fiscal years ended September 30, 2008, 2009, 2010, and 2011, set forth below was derived from the audited consolidated financial statements and related notes for Fifth Street Mezzanine Partners III, L.P. and Fifth Street Finance Corp., respectively. The financial information at and for the six months ended March 31, 2012 and 2011 was derived from our unaudited financial statements and related notes. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The historical financial information below may not be indicative of our future performance. Our results for the interim period may not be indicative of our results for the full year.

 

		At and for the Six Months Ended								At and for the Year Ended																At September 30, 2007 and for the period February 15, 2007 through September 30, 2007
(dollars in thousands, except per share amounts)		March 31, 2012				March 31, 2011				September 30, 2011				September 30, 2010				September 30, 2009				September 30, 2008
Statement of Operations data:
Total investment income		$	81,576			$	55,036			$	125,165			$	70,538			$	49,828			$	33,219			$	4,296
Base management fee, net			11,132				8,565				19,656				9,275				5,889				4,258				1,564
Incentive fee			10,945				7,653				16,782				10,756				7,841				4,118				—
All other expenses			17,061				8,206				23,080				7,483				4,736				4,699				1,773
Gain on extinguishment of convertible senior notes			1,341				—				1,480				—				—				—				—
Net investment income			43,779				30,612				67,127				43,024				31,362				20,144				959
Unrealized appreciation (depreciation) on interest rate swap			—				971				773				(773	)			—				—				—
Realized loss on interest rate swap			—				—				(1,335	)			—				—				—				—
Unrealized appreciation (depreciation) on investments			13,881				15,499				(7,299	)			(1,054	)			(10,795	)			(16,948	)			123
Realized gain (loss) on investments			(27,420	)			(13,963	)			(29,059	)			(18,781	)			(14,373	)			62				—
Net increase in partners’ capital/net assets resulting from operations			30,240				33,119				30,207				22,416				6,194				3,258				1,082
Per share data:
Net asset value per common share at period end		$	9.87			$	10.68			$	10.07			$	10.43			$	10.84			$	13.02			$	N/A
Market price at period end			9.76				13.35				9.32				11.14				10.93				10.05				N/A
Net investment income			0.58				0.52				1.05				0.95				1.27				1.29				N/A
Net realized and unrealized loss on investments and interest rate swap			(0.18	)			0.04				(0.58	)			(0.46	)			(1.02	)			(1.08	)			N/A
Net increase in partners’ capital/net assets resulting from operations			0.40				0.56				0.47				0.49				0.25				0.21				N/A
Dividends paid per share			0.61				0.64				1.28				0.99				1.20				0.61				N/A
Balance Sheet data at period end:
Total investments at fair value		$	1,056,223			$	939,749			$	1,119,837			$	563,821			$	299,611			$	273,759			$	88,391
Cash and cash equivalents			115,178				38,556				67,644				76,765				113,205				22,906				17,654
Other assets			22,029				17,443				22,236				11,340				3,071				2,484				1,285
Total assets			1,193,430				995,749				1,209,717				651,926				415,887				299,149				107,330
Total liabilities			380,108				284,000				481,090				82,754				5,331				4,813				514
Total net assets			813,322				711,748				728,627				569,172				410,556				294,336				106,816
Other data:
Weighted average yield on debt investments(1)			12.4	%			12.8	%			12.4	%			14.0	%			15.7	%			16.2	%			16.8	%
Number of investments at period end			67				55				65				38				28				24				10

 

 

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

 

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RISK FACTORS

Investing in our securities involves a number of significant risks. In addition to the other information contained in this prospectus and any accompanying prospectus supplement, you should consider carefully the following information before making an investment in our securities. The risks set out below are not the only risks we face; however, they discuss the presently known principal risks of investing in our securities. Additional risks and uncertainties not presently known to us might also impair our operations and performance. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, our net asset value and the trading price of our common stock could decline or the value of our debt securities or warrants may decline, and you may lose part or all of your investment.

Risks Relating to Economic Conditions

The current state of the economy and financial markets increases the likelihood of adverse effects on our financial position and results of operations.

The U.S. capital markets experienced extreme volatility and disruption over the past several years, leading to recessionary conditions and depressed levels of consumer and commercial spending. Disruptions in the capital markets increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. While recent indicators suggest modest improvement in the capital markets, we cannot provide any assurance that these conditions will not worsen. If these conditions continue or worsen, the prolonged period of market illiquidity may have a material adverse effect on our business, financial condition and results of operations. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could limit our investment originations, limit our ability to grow and negatively impact our operating results.

In addition, to the extent that recessionary conditions return, the financial results of small to mid-sized companies, like those in which we invest, will likely experience deterioration, which could ultimately lead to difficulty in meeting debt service requirements and an increase in defaults. Additionally, the end markets for certain of our portfolio companies’ products and services have experienced, and continue to experience, negative economic trends. The performances of certain of our portfolio companies have been, and may continue to be, negatively impacted by these economic or other conditions, which may ultimately result in our receipt of a reduced level of interest income from our portfolio companies and/or losses or charge offs related to our investments, and, in turn, may adversely affect distributable income.

Economic recessions or downturns could impair the ability of our portfolio companies to repay loans, which, in turn, could increase our non-performing assets, decrease the value of our portfolio, reduce our volume of new loans and harm our operating results, which would have an adverse effect on our results of operations.

Many of our portfolio companies are and may be susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions also may

decrease the value of collateral securing some of our loans and the value of our equity investments. In this regard, as a result of recent economic conditions and their impact on certain of our portfolio companies, we have agreed to modify the payment terms of our investments in nine of our portfolio companies as of March 31, 2012. Such modified terms include changes in payment-in-kind interest provisions and/or cash interest rates. These modifications, and any future modifications to our loan agreements as a result of the recent economic conditions or otherwise, 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 and have a material adverse effect on our results of operations.

 

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The recent downgrade of the U.S. credit rating and the economic crisis in Europe could negatively impact our liquidity, financial condition and earnings.

Recent U.S. debt ceiling and budget deficit concerns, together with signs of deteriorating sovereign debt conditions in Europe, have increased the possibility of additional credit-rating downgrades and economic slowdowns. Although U.S. lawmakers passed legislation to raise the federal debt ceiling, Standard & Poor’s Ratings Services lowered its long-term sovereign credit rating on the United States from “AAA” to “AA+” in August 2011. The impact of this or any further downgrades to the U.S. government’s sovereign credit rating, or its perceived creditworthiness, and the impact of the current crisis in Europe with respect to the ability of certain European Union countries to continue to service their sovereign debt obligations is inherently unpredictable and could adversely effect the U.S. and global financial markets and economic conditions. There can be no assurance that governmental or other measures to aid economic recovery will be effective. These developments, and the government’s credit concerns in general, could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms. In addition, the decreased credit rating could create broader financial turmoil and uncertainty, which may weigh heavily on our stock price. Continued adverse economic conditions could have a material adverse effect on our business, financial condition and results of operations.

Risks Relating to Our Business and Structure

Changes in interest rates may affect our cost of capital and net investment income.

Because we may borrow to fund our investments, a portion of our net investment income may be dependent upon the difference between the interest rate at which we borrow funds and the interest rate at which we invest these funds. A portion of our investments will have fixed interest rates, while a portion of our borrowings will likely have floating interest rates. As a result, a significant change in market interest rates could have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds could increase, which would reduce our net investment income. We may hedge against such interest rate fluctuations by using standard hedging instruments such as interest rate swap agreements, futures, options and forward contracts, subject to applicable legal requirements, including without limitation, all necessary registrations (or exemptions from registration) with the Commodity Futures Trading Commission. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged borrowings. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations.

A significant portion of our investment portfolio is and will continue to be recorded at fair value as determined in good faith by our Board of Directors and, as a result, there is and will continue to be uncertainty as to the value of our portfolio investments.

Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined by our Board of Directors. Typically, there is not a public market for the securities of the privately held companies in which we have invested and will generally continue to invest. As a result, we value these securities quarterly at fair value as determined in good faith by our Board of Directors.

Certain factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to comparable publicly-traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Due to this uncertainty, our fair value determinations may cause our net asset value on a given date to materially understate or overstate the value that we may ultimately realize upon the sale of one or more of our investments. As a result, investors purchasing our common stock based on an overstated net asset value would pay a higher price than the realizable value of our investments might warrant.

 

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Our ability to achieve our investment objective depends on our investment adviser’s ability to support our investment process; if our investment adviser were to lose any of its principals, our ability to achieve our investment objective could be significantly harmed.

We depend on the investment expertise, skill and network of business contacts of the principals of our investment adviser. The principals of our investment adviser evaluate, negotiate, structure, execute, monitor and service our investments. Our future success will depend to a significant extent on the continued service and coordination of the principals of our investment adviser. The departure of any of these individuals could have a material adverse effect on our ability to achieve our investment objective.

Our ability to achieve our investment objective depends on our investment adviser’s ability to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. Our investment adviser’s capabilities in structuring the investment process, providing competent, attentive and efficient services to us, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our investment objective, our investment adviser may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. Our investment adviser may not be able to find investment professionals in a timely manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.

Our business model depends to a significant extent upon strong referral relationships with private equity sponsors, and the inability of the principals of our investment adviser to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.

We expect that the principals of our investment adviser will maintain and develop their relationships with private equity sponsors, and we will rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the principals of our investment adviser fail to maintain their existing relationships or develop new relationships with other sponsors or sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the principals of our investment adviser have relationships are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.

We may face increasing competition for investment opportunities, which could reduce returns and result in losses.

We compete for investments with other business development companies and investment funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial banks and other sources of funding. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than we are able to do. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ pricing, terms and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. A significant part of our competitive advantage stems from the fact that the market for investments in small and mid-sized companies is underserved by traditional commercial banks and other financial sources. A significant increase in the number and/or the size of our competitors in this target market could force us to accept less attractive investment terms. Furthermore, many of our competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a business development company.

 

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Our incentive fee may induce our investment adviser to make speculative investments.

The incentive fee payable by us to our investment adviser may create an incentive for it to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement, which could result in higher investment losses, particularly during cyclical economic downturns. The way in which the incentive fee payable to our investment adviser is determined, which is calculated separately in two components as a percentage of the income (subject to a hurdle rate) and as a percentage of the realized gain on invested capital, may encourage our investment adviser to use leverage to increase the return on our investments or otherwise manipulate our income so as to recognize income in quarters where the hurdle rate is exceeded. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor the holders of our securities.

The incentive fee payable by us to our investment adviser also may create an incentive for our investment adviser to invest on our behalf in instruments that have a deferred interest feature. Under these investments, we would accrue the interest over the life of the investment but would not receive the cash income from the investment until the end of the investment’s term, if at all. Our net investment income used to calculate the income portion of our incentive fee, however, includes accrued interest. Thus, a portion of the incentive fee would be based on income that we have not yet received in cash and may never receive in cash if the portfolio company is unable to satisfy such interest payment obligation to us. While we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a formal “claw back” right against our investment adviser per se, the amount of accrued income written off in any period will reduce the income in the period in which such write-off was taken and thereby reduce such period’s incentive fee payment.

In addition, our investment adviser receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on income, there is no performance threshold applicable to the portion of the incentive fee based on net capital gains. As a result, our investment adviser may have a tendency to invest more in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.

Given the subjective nature of the investment decisions made by our investment adviser on our behalf, we will be unable to monitor these potential conflicts of interest between us and our investment adviser.

Our base management fee may induce our investment adviser to incur leverage.

The fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may create an incentive for our investment adviser to use more leverage to make investments on our behalf than would be the case in the absence of such arrangement. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which would disfavor holders of our securities. Our Board of Directors reviews conflicts of interest in connection with its review of the performance of our investment adviser.

Because we borrow money, the potential for loss on amounts invested in us will be magnified and may increase the risk of investing in us.

Borrowings, also known as leverage, magnify the potential for loss on invested equity capital. If we continue to use leverage to partially finance our investments, which we have increasingly done over the years, you will experience increased risks of investing in our securities. We, through our SBIC subsidiary, issue debt securities guaranteed by the SBA and sold in the capital markets. As a result of its guarantee of the debt securities, the SBA has fixed dollar claims on the assets of our SBIC subsidiary that are superior to the claims of our common stockholders. We also borrow under our credit facilities, have issued unsecured convertible senior notes and may issue debt securities or enter into other types of borrowing arrangements in the future. If the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock distributions or scheduled debt payments. Leverage is generally considered a speculative investment technique and we only intend to use leverage if expected returns will exceed the cost of borrowing.

 

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As of March 31, 2012, we, through our SBIC subsidiary, had $150.0 million of outstanding indebtedness guaranteed by the SBA, $87.5 million of outstanding indebtedness under our credit facilities and $124.0 million of outstanding unsecured convertible senior notes (the “Convertible Notes”). Our aggregate outstanding indebtedness at March 31, 2012 represented an increase of $89.2 million, or 33%, as compared to March 31, 2011, and our aggregate outstanding indebtedness at September 30, 2011 represented an increase of $390 million, or 534%, as compared to September 30, 2010. The debentures, our credit facilities and Convertible Notes require periodic payments of interest. The weighted average interest rate charged on our borrowings as of March 31, 2012 was 4.24% (exclusive of deferred financing costs). We will need to generate sufficient cash flow to make these required interest payments. In order for us to cover our annual interest payments on indebtedness, we must achieve annual returns on our March 31, 2012 total assets of at least 1.28%. If we are unable to meet the financial obligations under the debentures, the SBA, as a creditor, will have a superior claim to the assets of our SBIC subsidiary over our stockholders in the event we liquidate or the SBA exercises its remedies under such debentures as the result of a default by us. If we are unable to meet the financial obligations under our credit facilities, the lenders under the credit facilities will have a superior to claim to our assets over our stockholders. If we are unable to meet the financial obligations under the Convertible Notes, the holders thereof will have the right to declare the principal amount and accrued and unpaid interest on the outstanding Convertible Notes to be due and payable immediately.

We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. As a result of our receipt of this relief, we have the ability to incur leverage in excess of the amounts set forth in the 1940 Act. If we incur additional leverage in excess of the amounts set forth in the 1940 Act, our net asset value will decline more sharply if the value of our assets declines than if we had not incurred such additional leverage and the effects of leverage described above will be magnified.

Illustration.    The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below.

Assumed Return on Our Portfolio(1)

(net of expenses)

 

		-10.0%				-5.0%				0.0%				5.0%				10.0%
Corresponding net return to common stockholder			-16.55	%			-9.21	%			-1.88	%			5.46	%			12.80	%

 

 

(1)	Assumes $1,193.4 million in total assets, $361.5 million in debt outstanding, $813.3 million in net assets, and a weighted average interest rate of 4.22%. Actual interest payments may be different.

Substantially all of our assets are subject to security interests under secured credit facilities or claims of the SBA with respect to our SBA-guaranteed debentures and if we default on our obligations thereunder, we may suffer adverse consequences, including the lenders and/or the SBA foreclosing on our assets.

As of March 31, 2012, substantially all of our assets were pledged as collateral under our credit facilities or subject to a superior claim over our stockholders by the SBA. If we default on our obligations under these facilities or our SBA-guaranteed debentures, the lenders and/or the SBA may have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests or their superior claim. In such event, we may be forced to sell our investments to raise funds to repay our outstanding borrowings in order to avoid foreclosure and these forced sales may be at times and at prices we would not consider advantageous. In connection with any such foreclosure and our subsequent liquidation, our lenders would receive proceeds therefrom before our stockholders and, as a result, our stockholders may not receive any proceeds upon our liquidation. Moreover, such deleveraging of our company could significantly impair our ability to effectively operate our business in the manner in which we have historically operated. As a result, we could be forced to curtail or cease new investment activities and lower or eliminate the dividends that we have historically paid to our stockholders.

In addition, if the lenders exercise their right to sell the assets pledged under our credit facilities, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the credit facilities.

 

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Because we intend to distribute between 90% and 100% of our income to our stockholders in connection with our election to be treated as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow will be impaired.

In order to qualify for the tax benefits available to RICs and to minimize corporate-level taxes, we intend to distribute to our stockholders between 90% and 100% of our annual taxable income, except that we may retain certain net capital gains for investment, and treat such amounts as deemed distributions to our stockholders. If we elect to treat any amounts as deemed distributions, we must pay income taxes at the corporate rate on such deemed distributions on behalf of our stockholders. As a result of these requirements, we will likely need to raise capital from other sources to grow our business. 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 includes all of our borrowings and any outstanding preferred stock, of at least 200%. These requirements limit the amount that we may borrow. Because we will continue to need capital to grow our investment portfolio, these limitations may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so.

While we expect to be able to issue additional equity securities, we cannot assure you that equity financing will be available to us on favorable terms, or at all. Also, as a business development company, we generally are not permitted to issue equity securities priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new investment activities, and our net asset value and share price could decline.

Our ability to enter into transactions with our affiliates is restricted.

We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of the members of our independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any securities (other than our securities) from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we are prohibited from buying or selling any security (other than any security of which we are the issuer) from or to such person or certain of that person’s affiliates, or entering into prohibited joint transactions with such person, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security (other than any security of which we are the issuer) from or to any portfolio company of a private equity fund managed by our investment adviser without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.

There are significant potential conflicts of interest which could adversely impact our investment returns.

Our executive officers and directors, and certain members of our investment adviser, serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders. For example, Mr. Tannenbaum, our chief executive officer and managing partner of our investment adviser, is the managing partner of Fifth Street Capital LLC, a private investment firm. Additionally, Mr. Berman, our president, chief compliance officer and secretary, Mr. Frank, our chief financial officer, and Mr. Dimitrov, our chief investment officer, are also partners of our investment adviser. Although the other investment funds managed by Fifth Street Capital LLC and its affiliates generally are fully committed and, other than follow-on investments in existing portfolio companies, are no longer making investments, in the future, the principals of our investment adviser may manage other funds which may from time to time have overlapping investment objectives with those of us and accordingly invest in, whether principally or secondarily, asset classes similar to those targeted by us. If this should occur, the principals of our investment adviser may face conflicts of interest in the allocation of investment opportunities to us and such other funds. Although our investment professionals will endeavor to allocate investment opportunities in a fair and

 

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equitable manner, we and the holders of our securities could be adversely affected in the event investment opportunities are allocated among us and other investment vehicles managed or sponsored by, or affiliated with, our executive officers, directors and members of our investment adviser.

The incentive fee we pay to our investment adviser relating to capital gains may be effectively greater than 20%.

As a result of the operation of the cumulative method of calculating the capital gains portion of the incentive fee we pay to our investment adviser, the cumulative aggregate capital gains fee received by our investment adviser could be effectively greater than 20%, depending on the timing and extent of subsequent net realized capital losses or net unrealized depreciation. For additional information on this calculation, see the disclosure in footnote 2 to Example 2 under the caption Investment Advisory Agreement — Management Fee — Incentive Fee.” We cannot predict whether, or to what extent, this payment calculation would affect your investment in our stock.

A failure on our part to maintain our qualification as a business development company would significantly reduce our operating flexibility.

If we fail to continuously qualify as a business development company, we might be subject to regulation as a registered closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility. In addition, failure to comply with the requirements imposed on business development companies by the 1940 Act could cause the SEC to bring an enforcement action against us. For additional information on the qualification requirements of a business development company, see the disclosure under the caption “Regulation — Business Development Company Regulations.”

Regulations governing our operation as a business development company and RIC affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.

As a result of the annual distribution requirement to qualify for tax free treatment at the corporate level on income and gains distributed to stockholders, we need to periodically access the capital markets to raise cash to fund new investments. We generally are not able to issue or sell our common stock at a price below net asset value per share, which may be a disadvantage as compared with other public companies or private investment funds. If our common stock trades at a discount to net asset value, this restriction could adversely affect our ability to raise capital. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors and independent directors determine that such sale is in our best interests and the best interests of our stockholders, and our stockholders as well as those stockholders that are not affiliated with us approve such sale. See “— Stockholders may incur dilution if we issue securities to subscribe to, convert to or purchase shares of our common stock” for a discussion of a proposal approved by our stockholders that permits us to issue warrants, options or rights to acquire our common stock at a price below the current net asset value per share.

We also may make rights offerings to our stockholders at prices less than net asset value, subject to applicable requirements of the 1940 Act. If we raise additional funds by issuing more shares of our common stock or issuing senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our stockholders may decline at that time and such stockholders may experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity securities in the future, on terms favorable to us or at all.

In addition, we may issue “senior securities,” including borrowing money from banks or other financial institutions only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. Our ability to issue different types of securities is also limited. Compliance with these requirements may unfavorably limit our investment opportunities and reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend. As a business development company, therefore, we may need to issue equity more frequently than our privately owned competitors, which may lead to greater stockholder dilution.

 

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We expect to continue to borrow for investment purposes. If the value of our assets declines, we may be unable to satisfy the asset coverage test, which could prohibit us from paying dividends and could prevent us from qualifying as a RIC. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales may be disadvantageous.

In addition, we may in the future seek to securitize our portfolio securities to generate cash for funding new investments. 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. An inability to successfully securitize our loan portfolio could limit our ability to grow our business or fully execute our business strategy and may decrease our earnings, if any. The securitization market is subject to changing market conditions and we may not be able to access this market when we would otherwise deem appropriate. Moreover, the successful securitization of our portfolio might expose us to losses as the residual investments in which we do not sell interests will tend to be those that are riskier and more apt to generate losses. The 1940 Act also may impose restrictions on the structure of any securitization.

Our SBIC subsidiary’s investment adviser has no prior experience managing an SBIC and any failure to comply with SBA regulations, resulting from our SBIC subsidiary’s investment adviser’s lack of experience or otherwise, could have an adverse effect on our operations.

On February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P., 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 and is regulated by the SBA. In addition, on May 27, 2011, we received a letter from the Investment Division of the SBA that invited us to continue moving forward with our application to obtain an SBIC license for another one of our wholly-owned subsidiaries. Although our application for this license is subject to the SBA’s approval, we remain cautiously optimistic that we will complete the licensing process. However, there can be no assurance that the SBA will approve the issuance of an SBIC license to another one of our wholly-owned subsidiaries.

The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBIC requirements may cause our SBIC subsidiary to forego attractive investment opportunities that are not permitted under SBA regulations.

Further, SBA regulations require that an SBIC be periodically examined and audited by the SBA to determine its compliance with the relevant SBA regulations. The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of an SBIC. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiary is our wholly-owned subsidiary. Our SBIC subsidiary’s investment adviser does not have any prior experience managing an SBIC. Its lack of experience in complying with SBA regulations may hinder its ability to take advantage of our SBIC subsidiary’s access to SBA-guaranteed debentures.

Any failure to comply with SBA regulations could have an adverse effect on our operations.

We may experience fluctuations in our quarterly results.

We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our market and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

 

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Our Board of Directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval, the effects of which may be adverse.

Our Board of Directors has the authority to modify or waive our current investment objective, operating policies and strategies without prior notice and without stockholder approval. We cannot predict the effect any changes to our current investment objective, operating policies and strategies would have on our business, net asset value, operating results and value of our stock. However, the effects might be adverse, which could negatively impact our ability to pay you distributions and cause you to lose part or all of your investment.

We will be subject to corporate-level income tax if we are unable to maintain our qualification as a RIC under Subchapter M of the Code or do not satisfy the annual distribution requirement.

To maintain RIC status and be relieved of federal taxes on income and gains distributed to our stockholders, we must meet the following annual distribution, income source and asset diversification requirements.

 

•

The annual distribution requirement for a RIC will be satisfied if we distribute to our stockholders on an annual basis at least 90% of our net taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and we may be subject to certain financial covenants under our debt arrangements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

 

•

The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.

 

•

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.

If we fail to qualify for or maintain RIC status or to meet the annual distribution requirement for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.

We may not be able to pay you distributions, our distributions may not grow over time and a portion of our distributions may be a return of capital.

We intend to pay distributions to our stockholders out of assets legally available for distribution. We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be adversely affected by, among other things, the impact of one or more of the risk factors described in this prospectus. In addition, the inability to satisfy the asset coverage test applicable to us as a business development company can limit our ability to pay distributions. All distributions will be paid at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our RIC status, compliance with applicable business development company regulations and such other factors as our Board of Directors may deem relevant from time to time. We cannot assure you that we will pay distributions to our stockholders in the future.

When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain.

 

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We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.

For federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as original issue discount or accruals on a contingent payment debt instrument, which may occur if we receive warrants in connection with the origination of a loan or possibly in other circumstances. Such original issue discount is included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we do not receive in cash.

Since, in certain cases, we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the annual distribution requirement necessary to be relieved of federal taxes on income and gains distributed to our stockholders. Accordingly, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to satisfy the annual distribution requirement and thus become subject to corporate-level income tax.

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.

We may distribute taxable dividends that are payable in part in our stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our stock.

In addition, as discussed elsewhere in this prospectus, our loans typically contain payment-in-kind (“PIK”) interest provisions. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To avoid the imposition of corporate-level tax on us, this non-cash source of income needs to be paid out to stockholders in cash distributions or, in the event that we determine to do so, in shares of our common stock, even though we have not yet collected and may never collect the cash relating to the PIK interest.

Our wholly-owned SBIC subsidiary may be unable to make distributions to us that will enable us to maintain RIC status, which could result in the imposition of an entity-level tax.

In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we are required to distribute substantially all of our net taxable income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiary. We are partially dependent on our SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary 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 maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiary to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver and if our SBIC subsidiary is unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC tax treatment and a consequent imposition of an entity-level tax on us.

Changes in laws or regulations governing our operations may adversely affect our business or cause us to alter our business strategy.

We and our portfolio companies are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make or that impose limits on our ability to pledge a significant amount of our assets to secure loans, any of which could harm us and our stockholders, potentially with retroactive effect.

 

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Additionally, any changes to the laws and regulations governing our operations relating to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth in this prospectus and may result in our investment focus shifting from the areas of expertise of our investment adviser to other types of investments in which our investment adviser may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.

We have identified deficiencies in our internal control over financial reporting from time to time. Future control deficiencies could prevent us from accurately and timely reporting our financial results.

We have identified deficiencies in our internal control over financial reporting from time to time, including significant deficiencies and material weaknesses. A “significant deficiency” is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of a company’s financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Our failure to identify deficiencies in our internal control over financial reporting in a timely manner or remediate any deficiencies, or the identification of material weaknesses or significant deficiencies in the future could prevent us from accurately and timely reporting our financial results.

Risks Relating to Our Investments

Our investments in portfolio companies may be risky, and we could lose all or part of our investment.

Investing in small and mid-sized companies involves a number of significant risks. Among other things, these companies:

 

•

may have limited financial resources and may be unable to meet their obligations under their debt instruments that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing any guarantees from subsidiaries or affiliates of our portfolio companies that we may have obtained in connection with our investments, as well as a corresponding decrease in the value of the equity components of our investments;

 

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may have shorter operating histories, narrower product lines, smaller market shares and/or significant customer concentrations than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns;

 

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are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;

 

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generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position; and

 

•

generally have less publicly available information about their businesses, operations and financial condition. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and as a result may lose part or all of our investment.

In addition, in the course of providing significant managerial assistance to certain of our portfolio companies, certain of our officers and directors may serve as directors on the boards of such companies. To the extent that litigation arises out of our investments in these companies, our officers and directors may be named as defendants in such litigation, which could result in an expenditure of funds (through our indemnification of such officers and directors) and the diversion of management time and resources.

 

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An investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about these companies.

We invest primarily in privately held companies. Generally, little public information exists about these companies, including typically a lack of audited financial statements and ratings by third parties. We must therefore rely on the ability of our investment adviser to obtain adequate information to evaluate the potential risks of investing in these companies. These companies and their financial information may not be subject to the Sarbanes-Oxley Act and other rules that govern public companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. These factors could affect our investment returns.

If we make unsecured debt investments, we may lack adequate protection in the event our portfolio companies become distressed or insolvent and will likely experience a lower recovery than more senior debtholders in the event our portfolio companies defaults on their indebtedness.

We have made, and may in the future make, unsecured debt investments in portfolio companies. Unsecured debt investments are unsecured and junior to other indebtedness of the portfolio company. As a consequence, the holder of an unsecured debt investment may lack adequate protection in the event the portfolio company becomes distressed or insolvent and will likely experience a lower recovery than more senior debtholders in the event the portfolio company defaults on its indebtedness. In addition, unsecured debt investments of small and mid-sized companies are often highly illiquid and in adverse market conditions may experience steep declines in valuation even if they are fully performing.

If we invest in the securities and obligations of distressed or bankrupt companies, such investments may be subject to significant risks, including lack of income, extraordinary expenses, uncertainty with respect to satisfaction of debt, lower-than expected investment values or income potentials and resale restrictions.

We are authorized to invest in the securities and other obligations of distressed or bankrupt companies. At times, distressed debt obligations may not produce income and may require us to bear certain extraordinary expenses (including legal, accounting, valuation and transaction expenses) in order to protect and recover our investment. Therefore, to the extent we invest in distressed debt, our ability to achieve current income for our stockholders may be diminished.

We also will be subject to significant uncertainty as to when and in what manner and for what value the distressed debt we invest in will eventually be satisfied (e.g., through a liquidation of the obligor’s assets, an exchange offer or plan of reorganization involving the distressed debt securities or a payment of some amount in satisfaction of the obligation). In addition, even if an exchange offer is made or plan of reorganization is adopted with respect to distressed debt held by us, there can be no assurance that the securities or other assets received by us in connection with such exchange offer or plan of reorganization will not have a lower value or income potential than may have been anticipated when the investment was made.

Moreover, any securities received by us upon completion of an exchange offer or plan of reorganization may be restricted as to resale. As a result of our participation in negotiations with respect to any exchange offer or plan of reorganization with respect to an issuer of distressed debt, we may be restricted from disposing of such securities.

The lack of liquidity in our investments may adversely affect our business.

We invest, and will continue to invest, in companies whose securities are not publicly traded, and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. In fact, all of our assets may be invested in illiquid securities. The illiquidity of these investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. Our investments are usually subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market for such investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.

 

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We may not have the funds or ability to make additional investments in our portfolio companies.

After our initial investment in a portfolio company, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment through the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio company in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected yield on the investment.

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

We invest primarily in first and second lien debt issued by small and mid-sized companies. Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payments of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt instruments in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.

The disposition of our investments may result in contingent liabilities.

Most of our investments will involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

Even though we have structured some of our investments as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or instances where we exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken in rendering significant managerial assistance.

Second priority liens on collateral securing loans that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.

Certain loans that we make to portfolio companies will be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the

 

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value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the company’s remaining assets, if any.

The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken with respect to the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.

Our investments in the healthcare sector face considerable uncertainties including substantial regulatory challenges.

Our investments in portfolio companies that operate in the healthcare sector represent approximately 30% of our total portfolio. Our investments in the healthcare sector are subject to substantial risks. The laws and rules governing the business of healthcare companies and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Existing or future laws and rules could force our portfolio companies engaged in healthcare to change how they do business, restrict revenue, increase costs, change reserve levels and change business practices.

Healthcare companies often must obtain and maintain regulatory approvals to market many of their products, change prices for certain regulated products and consummate some of their acquisitions and divestitures. Delays in obtaining or failing to obtain or maintain these approvals could reduce revenue or increase costs. Policy changes on the local, state and federal level, such as the expansion of the government’s role in the healthcare arena and alternative assessments and tax increases specific to the healthcare industry or healthcare products as part of federal health care reform initiatives, could fundamentally change the dynamics of the healthcare industry.

We generally do not and will not control our portfolio companies.

We do not, and do not expect to, control most of our portfolio companies, even though we may have board representation or board observation rights, and our debt agreements may contain certain restrictive covenants. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as a debt investor. Due to the lack of liquidity for our investments in non-traded companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.

Defaults by our portfolio companies would harm our operating results.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.

 

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We may not realize gains from our equity investments.

Certain investments that we have made in the past and may make in the future include warrants or other equity securities. In addition, we have made in the past and may make in the future direct equity investments in companies. Our goal is ultimately to realize gains upon our disposition of such equity interests. However, the equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We also may be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which would allow us to sell the underlying equity interests. We often seek puts or similar rights to give us the right to sell our equity securities back to the portfolio company issuer. We may be unable to exercise these puts rights for the consideration provided in our investment documents if the issuer is in financial distress.

We are subject to certain risks associated with foreign investments.

We may make investments in foreign companies. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in foreign exchange rates, exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the U.S., higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility.

Our success will depend, in part, on our ability to anticipate and effectively manage these and other risks. We cannot assure you that these and other factors will not have a material adverse effect on our business as a whole.

We may expose ourselves to risks if we engage in hedging transactions.

We have and may in the future enter into hedging transactions, which may expose us to risks associated with such transactions. We may utilize instruments such as forward contracts and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions and amounts due under our credit facilities from changes in market interest rates. Use of these hedging instruments may include counterparty credit risk. Utilizing such hedging instruments does not eliminate the possibility of fluctuations in the values of such positions and amounts due under our credit facilities or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.

The success of our hedging transactions will depend on our ability to correctly predict movements and interest rates. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings or credit facilities being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. See also “— Changes in interest rates may affect our cost of capital and net investment income.”

Risks Relating to Our Securities

Shares of closed-end investment companies, including business development companies, may trade at a discount to their net asset value.

Shares of closed-end investment companies, including business development companies, may trade at a discount from net asset value. This characteristic of closed-end investment companies and business development companies is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our common stock will trade at, above or below net asset value.

 

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We may be unable to invest a significant portion of the net proceeds from an offering of our securities on acceptable terms within an attractive timeframe.

Delays in investing the net proceeds raised in an offering of our securities may cause our performance to be worse than that of other fully invested business development companies or other lenders or investors pursuing comparable investment strategies. We cannot assure you that we will be able to identify any investments that meet our investment objective or that any investment that we make will produce a positive return. We may be unable to invest the net proceeds of any offering on acceptable terms within the time period that we anticipate or at all, which could harm our financial condition and operating results.

We anticipate that, depending on market conditions, it may take us a substantial period of time to invest substantially all of the net proceeds of any offering in securities meeting our investment objective. During this period, we will invest the net proceeds of an offering primarily in cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, which may produce returns that are significantly lower than the returns which we expect to achieve when our portfolio is fully invested in securities meeting our investment objective. As a result, any distributions that we pay during this period may be substantially lower than the distributions that we may be able to pay when our portfolio is fully invested in securities meeting our investment objective. In addition, until such time as the net proceeds of an offering are invested in securities meeting our investment objective, the market price for our common stock may decline. Thus, the initial return on your investment may be lower than when, if ever, our portfolio is fully invested in securities meeting our investment objective.

Investing in our securities may involve an above average degree of risk.

The investments we make in accordance with our investment objective may result in a higher amount of risk than alternative investment options and a higher risk of volatility or loss of principal. Our investments in portfolio companies involve higher levels of risk, and therefore, an investment in our securities may not be suitable for someone with lower risk tolerance.

The market price of our common stock may fluctuate significantly.

The market price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:

 

•

significant volatility in the market price and trading volume of securities of business development companies or other companies in our sector, which are not necessarily related to the operating performance of these companies;

 

•

inability to obtain any exemptive relief that may be required by us from the SEC;

 

•

changes in regulatory policies, accounting pronouncements or tax guidelines, particularly with respect to RICs, business development companies and SBICs;

 

•

loss of our business development company or RIC status or our SBIC subsidiary’s status as an SBIC;

 

•

changes in earnings or variations in operating results;

 

•

changes in the value of our portfolio of investments;

 

•

any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;

 

•

departure of our investment adviser’s key personnel; and

 

•

general economic trends and other external factors.

Certain provisions of our restated certificate of incorporation and amended and restated bylaws as well as the Delaware General Corporation Law could deter takeover attempts and have an adverse impact on the price of our common stock.

Our restated certificate of incorporation and our amended and restated bylaws as well as the Delaware General Corporation Law contain provisions that may have the effect of discouraging a third party from making an

 

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acquisition proposal for us. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price for our common stock.

Stockholders may incur dilution if we issue securities to subscribe to, convert to or purchase shares of our common stock.

The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value per share of such stock with certain exceptions. One such exception is prior stockholder approval of issuances of securities to subscribe to, convert to or purchase shares of our common stock even if the subscription, conversion or purchase price per share of our common stock is below the net asset value per share of our common stock at the time of any such subscription, conversion or purchase. At our 2011 annual meeting of stockholders, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings, including under such circumstance. Such authorization has no expiration. Any decision to sell securities to subscribe to, convert to, or purchase shares of our common stock will be subject to the determination by our board of directors that such issuance is in our and our stockholders’ best interests. If we issue securities to subscribe to, convert to or purchase shares of common stock, the exercise or conversion of such securities would increase the number of outstanding shares of our common stock. Any such exercise or conversion would be dilutive on the voting power of existing stockholders, and could be dilutive with regard to dividends and our net asset value, and other economic aspects of the common stock.

Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted; however, the table below illustrates the impact on the net asset value per common share of a business development company that would be experienced upon the exercise of a warrant to acquire shares of common stock of the business development company.

Example of Impact of Exercise of Warrant to Acquire Common Stock on Net Asset Value Per Share

The example assumes that the business development company has 1,000,000 shares of common stock outstanding, $15,000,000 in total assets and $5,000,000 in total liabilities at the time of the exercise of the warrant. As a result, the net asset value and net asset value per common share of the business development company are $10,000,000 and $10.00, respectively.

Further, the example assumes that the warrant permits the holder thereof to acquire 250,000 common shares under the following three different scenarios: (i) with an exercise price equal to a 10% premium to the business development company’s net asset value per share at the time of exercise, or $11.00 per share, (ii) with an exercise price equal to the business development company’s net asset value per share at the time of exercise, or $10.00 per share, and (iii) with an exercise price equal to a 10% discount to the business development company’s net asset value per share at the time of exercise, or $9.00 per share.

 

Warrant Exercise Price		Net Asset Value Per Share Prior To Exercise				Net Asset Value Per Share After Exercise
10% premium to net asset value per common share		$	10.00			$	10.20
Net asset value per common share		$	10.00			$	10.00
10% discount to net asset value per common share		$	10.00			$	9.80

Although have we chosen to demonstrate the impact on the net asset value per common share of a business development company that would be experienced by existing stockholders of the business development company upon the exercise of a warrant to acquire shares of common stock of the business development company, the results noted above would be similar in connection with the exercise or conversion of other securities exercisable or convertible into shares of the business development company’s common stock. In addition, the example does not take into account the impact of other securities that may be issued in connection with the issuance of exercisable or convertible securities (e.g., the issuance of shares of common stock in conjunction with the issuance of warrants to acquire shares of common stock).

 

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Risks Related to Our Convertible Senior Notes

Our stockholders may experience dilution upon the conversion of our convertible senior notes.

Our convertible senior notes are convertible into shares of our common stock beginning January 1, 2016 or, under certain circumstances, earlier. Upon conversion, we must deliver shares of our common stock. The conversion rate of our convertible senior notes was initially, and currently is, 67.7415 shares of our common stock per $1,000 principal amount of our convertible senior notes (equivalent to a conversion price of approximately $14.76 per share of common stock), subject to adjustment in certain circumstances. 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 debt currently outstanding 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 senior 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 have, or have the ability to raise, the funds necessary to repurchase our convertible senior notes upon a fundamental change, and our debt may contain limitations on our ability to deliver shares of our common stock upon conversion or pay cash upon repurchase of our convertible senior notes.

Holders of our convertible senior notes will have the right to require us to repurchase their notes upon the occurrence of certain significant corporate events involving us, including if our common stock ceases to trade on any national securities exchange or we consolidate or merge into another entity in certain circumstances, at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any. We refer to such a corporate event as a “fundamental change.” However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of convertible senior notes surrendered therefor. In addition, our ability to repurchase our convertible senior notes or deliver shares of our common stock upon conversions of the convertible senior notes may be limited by law, by regulatory authority or by agreements governing our indebtedness, including our credit facilities. In this regard, the ING facility prohibits us from repurchasing our convertible senior notes in certain circumstances upon the occurrence of a fundamental change. Our failure to repurchase the notes at a time when the repurchase is required by the indenture relating to the convertible senior notes or to deliver any shares of our common stock deliverable on future conversions of the convertible senior notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the occurrence of a fundamental change itself could also lead to a default under agreements governing our indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase our convertible senior notes.

Provisions of our convertible senior notes could discourage an acquisition of us by a third party.

Certain provisions of our convertible senior notes could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of a fundamental change, the holders of our convertible senior notes will have the right, at their option, to require us to repurchase all or a portion of their convertible senior notes, plus accrued and unpaid interest. We may also be required to increase the conversion rate of the convertible senior notes in certain other circumstances, including in the event of certain fundamental changes. These provisions could discourage an acquisition of us by a third party.

Certain adverse consequences could result if our convertible senior notes are treated as equity interests in us for purposes of regulations under the Employee Retirement Income Security Act of 1974.

Pursuant to regulations under the Employee Retirement Income Security Act of 1974 (“ERISA”), it is possible that, due to their convertibility feature, our convertible senior notes could be treated as equity interests in us. In that event, if employee benefit plans subject to Title I of ERISA, plans that are not subject to ERISA but that are subject to Section 4975 of the Internal Revenue Code (the “Code”), such as individual retirement accounts, and entities that

 

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are deemed to hold the assets of such plans or accounts (such plans, accounts, and entities, “Benefit Plan Investors”) were to acquire 25% or more of the aggregate value of our convertible senior notes, among other consequences, we and our management would be subject to ERISA fiduciary duties, and certain transactions we might enter into, or may have entered into, in the ordinary course of our business might constitute non-exempt “prohibited transactions” under Section 406 of ERISA or Section 4975 of the Code and might have to be rescinded at significant cost to us. Moreover, if our underlying assets were deemed to be assets constituting plan assets, (i) our assets could be subject to ERISA’s reporting and disclosure requirements, (ii) a fiduciary causing a Benefit Plan Investor to make an investment in our equity interests could be deemed to have delegated its responsibility to manage the assets of the Benefit Plan Investor, and (iii) various providers of fiduciary or other services to us, and any other parties with authority or control with respect to our assets, could be deemed to be plan fiduciaries or otherwise parties in interest or disqualified persons by virtue of their provision of such services.

We do not believe that our convertible senior notes should be treated as equity interests in us for purposes of ERISA in light of the relevant regulations. No assurance can be given, however, that our convertible senior notes will not be so treated.

The accounting for convertible debt securities is complex and subject to uncertainty.

The accounting for convertible debt securities is complex and subject to frequent scrutiny by the accounting regulatory bodies and is subject to change. The issuance of our convertible senior notes reduced our earnings per share on a fully diluted basis for our fiscal year ended September 30, 2011 and fiscal quarter ended March 31, 2012, and, to the extent such notes remain outstanding, may continue to have such an effect on our earnings per share on a fully diluted basis. Further, we cannot predict if or when changes in the accounting for convertible debt securities could be made and whether any such change could have an adverse impact on our reported or future financial results. Any such impacts could adversely affect the price or value of our securities.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements in this prospectus and any accompanying prospectus supplement constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this prospectus and any accompanying prospectus supplement 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” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this prospectus, and any accompanying prospectus supplement, 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” and elsewhere in this prospectus and any accompanying prospectus supplement. Other factors that could cause actual results to differ materially include:

 

•

changes in the economy;

 

•

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

 

•

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, RICs and SBICs.

We have based the forward-looking statements included in this prospectus and will base the forward-looking statements included in any accompanying prospectus supplement on information available to us on the date of this prospectus and any accompanying prospectus supplement, as appropriate, and we assume no obligation to update any such forward-looking statements, except as required by law. 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. The forward-looking statements contained in this prospectus and any accompanying prospectus supplement are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933 and the forward looking statements contained in our periodic reports are excluded from the safe-harbor protection provided by Section 21E of the Securities Exchange Act of 1934, or the “Exchange Act.”

 

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USE OF PROCEEDS

We intend to use substantially all of the net proceeds from selling our securities to make investments in small and mid-sized companies in accordance with our investment objective and strategies described in this prospectus or any prospectus supplement, and for general corporate purposes. We may also use a portion of the net proceeds to reduce any of our outstanding borrowings, including borrowings under the Wells Fargo facility, ING facility and Sumitomo facility, and to repurchase the Convertible Notes. The Wells Fargo facility has a maturity date of April 25, 2016 and bears interest at a rate of LIBOR plus 2.75% per annum with no LIBOR floor. The ING facility has a maturity date of February 29, 2016 and bears interest at a rate of LIBOR plus 3.25% per annum with no LIBOR floor, or, when the facility is drawn more than 35%, LIBOR plus 3.0% per annum with no LIBOR floor. The Sumitomo facility has a maturity date of September 16, 2018 and bears interest at a rate of LIBOR plus 2.25% per annum with no LIBOR floor. The Convertible Notes mature on April 1, 2016, unless previously converted or repurchased in accordance with their terms, and bear interest at a rate of 5.375% per annum. If the repurchase and cancellation of any Convertible Notes provides us with a net gain on extinguishment of debt, such net gain will be 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. We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within six to twelve months. Pending such use, we will invest the net proceeds primarily in high quality, short-term debt securities consistent with our business development company election and our election to be taxed as a RIC. See “Regulation — Business Development Company Regulations — Temporary Investments.” Our ability to achieve our investment objective may be limited to the extent that the net proceeds from an offering, pending full investment, are held in interest-bearing deposits or other short-term instruments. See “Risk Factors — Risks Relating to an Offering of our Securities — We may be unable to invest a significant portion of the net proceeds from an offering of our securities on acceptable terms within an attractive timeframe” for additional information regarding this matter. The supplement to this prospectus relating to an offering will more fully identify the use of proceeds from such an offering.

 

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PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our common stock traded on the New York Stock Exchange under the symbol “FSC” until November 28, 2011. On November 28, 2011, our common stock began trading on the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.” The following table sets forth, for each fiscal quarter during the last two most recently completed fiscal years and for the current fiscal year through July 26, 2012, the range of high and low sales prices of our common stock as reported on the New York Stock Exchange and NASDAQ Global Select Market, as applicable, the premium (discount) of sales price to our net asset value (NAV) and the dividends declared by us for each fiscal quarter.

 

						Price Range								Premium (Discount) of High Sales Price to NAV(2)				Premium (Discount) of Low Sales Price to NAV(2)				Cash Dividend per Share(3)
		NAV(1)				High				Low
Year ended September 30, 2010
First Quarter		$	10.82			$	10.99			$	9.35				2	%			(14	)%		$	0.27
Second Quarter.		$	10.70			$	12.13			$	10.45				13	%			(2	)%		$	0.30
Third Quarter		$	10.43			$	13.64			$	10.49				31	%			1	%		$	0.32
Fourth Quarter		$	10.43			$	11.30			$	9.79				8	%			(6	)%		$	0.42
Year ending September 30, 2011
First Quarter		$	10.44			$	12.35			$	10.94				19	%			5	%		$	0.3198	(4)
Second Quarter		$	10.68			$	13.95			$	11.83				31	%			11	%		$	0.3198
Third Quarter		$	10.72			$	13.45			$	11.42				25	%			7	%		$	0.3198
Fourth Quarter		$	10.07			$	11.84			$	8.38				18	%			(17	)%		$	0.3198
Year ending September 30, 2012
First Quarter		$	9.89			$	10.24			$	8.60				4	%			(13	)%		$	0.2874
Second Quarter		$	9.87			$	10.60			$	9.54				7	%			(3	)%			$0.2874(5)
Third Quarter			*			$	10.00			$	8.99				*				*				$0.2874(6)
Fourth Quarter (through July 26, 2012)			*			$	10.37			$	9.93				*				*				*

 

 

*	Not determinable at the time of filing.

 

(1)	Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low sales prices. The net asset values shown are based on outstanding shares at the end of each period.

 

(2)	Calculated as the respective high or low sales price less net asset value, divided by net asset value.

 

(3)

Represents the dividend declared in the specified quarter. We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a cash dividend, then stockholders’ cash dividends will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash dividends. See “Dividend Reinvestment Plan.”

 

(4)

From our initial public offering through the fourth fiscal quarter of 2010, we paid quarterly dividends, but in the first fiscal quarter of 2011 we began paying, and we intend to continue paying, monthly dividends to our stockholders. Our monthly dividends, if any, will be determined by our Board of Directors on a quarterly basis.

 

(5)

On February 7, 2012, our Board of Directors declared the following monthly dividends: $0.0958 per share, payable on April 30, 2012 to stockholders of record on April 13, 2012; $0.0958 per share, payable on May 31, 2012 to stockholders of record on May 15, 2012; and $0.0958 per share, payable on June 29, 2012 to stockholders of record on June 15, 2012.

 

(6)

On May 7, 2012, our Board of Directors declared the following dividends: $0.0958 per share, payable on July 31, 2012 to stockholders of record on July 13, 2012; $0.0958 per share, payable on August 31, 2012 to stockholders of record on August 15, 2012; and $0.0958 per share, payable on September 28, 2012 to stockholders of record on September 14, 2012.

 

 

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The last reported price for our common stock on July 26, 2012 was $10.15 per share.

Shares of business development companies may trade at a market price that is less than the value of the net assets attributable to those shares. The possibilities that our shares of common stock will trade at a discount from net asset value or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value will decrease. It is not possible to predict whether the common stock offered hereby will trade at, above, or below net asset value. Since our initial public offering in June 2008, our shares of common stock have at times traded at prices significantly less than our net asset value.

Our dividends, if any, are determined by our Board of Directors. We have elected to be treated for federal income tax purposes 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.

To maintain RIC tax treatment, we must, among other things, distribute at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income. Any such carryover taxable income must be distributed through a dividend declared prior to filing the final tax return related to the year which generated such taxable income. Please refer to “Material U.S. Federal Income Tax Considerations” for further information regarding the consequences of our retention of net capital gains. We may, in the future, make actual distributions to our stockholders of our net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. See “Regulation” and “Material U.S. Federal Income Tax Considerations.”

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we make a cash distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions.

On May 7, 2012, our Board of Directors authorized a stock repurchase program to acquire up to $30 million of our outstanding common stock. Stock repurchases under this program are to be made through the open market at times and in such amounts as our management deems appropriate, provided that the price is below the most recent net asset value per share. As of the date of this prospectus, we have not made any stock repurchases under this program. Unless extended by our 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.

 

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RATIOS OF EARNINGS TO FIXED CHARGES

The following table contains our ratio of earnings to fixed charges for the periods indicated, computed as set forth below. You should read these ratios of earnings to fixed charges in connection with our consolidated financial statements, including the notes to those statements, included in this prospectus. Although our earnings have generally increased in recent periods, our ratio of earnings to fixed charges has decreased due to greater levels of borrowing.

 

		For The Six Months Ended March 31, 2012				For The Year Ended September 30, 2011				For The Year Ended September 30, 2010				For The Year Ended September 30, 2009				For The Year Ended September 30, 2008				For The Period February 15, 2007 through September 30, 2007
Earnings to Fixed Charges(1)			3.67				3.00				12.65				10.74				4.55				3.07

 

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

 

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

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information in this section contains forward-looking statements that involve risks and uncertainties. Please see “Risk Factors” and “Special Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion in conjunction with the financial statements and related notes and other financial information appearing elsewhere in this prospectus.

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.

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”.

Current Market Conditions

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

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

As evidenced by our recent investment activities, we expect to grow the business in part by increasing the average investment size when and where appropriate. Although we believe that we currently have sufficient capital available to fund investments, a prolonged period of market disruptions may cause us to reduce the volume of loans we originate and/or fund, which could have an adverse effect on our business, financial condition and results of operations. In this regard, because our common stock has at times traded at a price below our then current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

Critical Accounting Policies

Basis of Presentation

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the Consolidated Financial Statements. We have identified

 

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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 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.

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.

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 March 31, 2012, September 30, 2011, and September 30, 2010, 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	%

 

(1)	96.0% excluding our investment in IZI Medical Products, Inc., which closed on December 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 March 31, 2012, September 30, 2011 and September 30, 2010, approximately 88.5%, 92.6% and 86.5%, respectively, of our total assets represented investments in portfolio companies valued at fair value.

Revenue Recognition

Interest and Dividend Income

Interest income, adjusted for amortization of premium and 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.

 

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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.

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 March 31, 2012, we had structured $6.4 million in aggregate exit fees across 9 portfolio investments upon the future exit of those investments.

Payment-in-Kind (PIK) Interest

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

For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required 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 $27.2 million and represented 2.6% of the fair value of our portfolio of investments as of March 31, 2012, $22.7 million or 2.0% as of September 30, 2011 and $19.3 million or 3.4% as of September 30, 2010. The net increase in loan balances as a result of contracted PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

 

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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.

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:

 

		March 31, 2012				September 30, 2011
Cost:
First lien debt			69.54	%			77.05	%
Second lien debt			12.06	%			13.97	%
Subordinated debt			16.31	%			7.40	%
Purchased equity			1.39	%			0.97	%
Equity grants			0.51	%			0.53	%
Limited partnership interests			0.19	%			0.08	%
Total			100.00	%			100.00	%
		March 31, 2012				September 30, 2011
Fair value:
First lien debt			69.70	%			78.14	%
Second lien debt			11.58	%			12.80	%
Subordinated debt			16.21	%			7.25	%
Purchased equity			1.77	%			1.12	%
Equity grants			0.54	%			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:

 

		March 31, 2012				September 30, 2011
Cost:
Healthcare services			13.67	%			19.65	%
Healthcare equipment			7.67	%			6.16	%
Internet software & services			6.85	%			3.79	%
Diversified support services			6.84	%			4.80	%
Oil & gas equipment & services			5.64	%			7.11	%
Construction & engineering			4.12	%			3.74	%
Pharmaceuticals			3.73	%			2.36	%
Leisure facilities			3.40	%			3.29	%
Electronic equipment & instruments			3.29	%			3.01	%
Specialty stores			3.18	%			2.99	%
Diversified financial services			3.00	%			1.15	%
Education services			2.89	%			2.57	%
Apparel, accessories & luxury goods			2.81	%			2.68	%
Household products			2.75	%			2.70	%
Advertising			2.70	%			1.72	%
Home improvement retail			2.57	%			2.42	%
IT consulting & other services			2.34	%			4.23	%

 

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		March 31, 2012				September 30, 2011
Restaurants			2.18	%			1.21	%
Integrated telecommunication services			2.05	%			2.25	%
Industrial machinery			1.93	%			0.90	%
Electronic manufacturing services			1.85	%			1.75	%
Human resources & employment services			1.85	%			1.77	%
Auto parts & equipment			1.77	%			1.63	%
Distributors			1.75	%			1.61	%
Air freight & logistics			1.70	%			1.56	%
Environmental & facilities services			1.66	%			1.41	%
Food distributors			1.40	%			1.80	%
Research & consulting services			1.32	%			0.00	%
Leisure products			1.30	%			1.17	%
Construction materials			0.63	%			0.58	%
Housewares & specialties			0.49	%			0.46	%
Building products			0.45	%			0.58	%
Multi-sector holdings			0.20	%			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	%
Fair Value:
Healthcare services			14.25	%			20.67	%
Healthcare equipment			7.86	%			6.42	%
Diversified support services			7.11	%			5.02	%
Internet software & services			7.10	%			3.91	%
Oil & gas equipment & services			5.80	%			7.38	%
Pharmaceuticals			3.87	%			2.46	%
Leisure facilities			3.52	%			3.43	%
Specialty stores			3.34	%			3.14	%
Electronic equipment & instruments			3.34	%			3.11	%
Diversified financial services			3.05	%			1.19	%
Education services			3.02	%			2.69	%
Apparel, accessories & luxury goods			3.02	%			3.00	%
Household products			2.80	%			2.67	%
Advertising			2.79	%			1.80	%
Construction & engineering			2.69	%			3.20	%
IT consulting & other services			2.43	%			4.42	%
Home improvement retail			2.36	%			2.46	%
Environmental & facilities services			2.23	%			1.78	%
Integrated telecommunication services			2.12	%			2.36	%
Restaurants			2.04	%			1.06	%
Industrial machinery			2.04	%			0.97	%
Human resources & employment services			1.95	%			1.87	%
Distributors			1.84	%			1.69	%
Auto parts & equipment			1.82	%			1.70	%
Food distributors			1.46	%			1.88	%
Air freight & logistics			1.42	%			1.54	%
Research & consulting services			1.37	%			0.00	%
Leisure products			1.34	%			1.22	%
Electronic manufacturing services			0.71	%			0.77	%
Construction materials			0.67	%			0.61	%
Building products			0.26	%			0.43	%

 

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		March 31, 2012				September 30, 2011
Multi-sector holdings			0.21	%			0.11	%
Housewares & specialties			0.15	%			0.23	%
Movies & entertainment			0.02	%			0.02	%
Data processing & outsourced services			0.00	%			0.31	%
Fertilizers & agricultural chemicals			0.00	%			2.61	%
Healthcare technology			0.00	%			1.87	%
Total			100.00	%			100.00	%

Portfolio Asset Quality

We employ a ranking system to assess and monitor the credit risk of our investment portfolio. We rank all investments on a scale from 1 to 5. The system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loan, and other factors considered relevant to making a credit judgment.

We have determined that there should be an individual ranking assigned to each tranche of securities in the same portfolio company where appropriate. This may arise when the perceived risk of loss on the investment varies significantly between tranches due to their respective seniority in the capital structure.

 

•

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

 

•

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 March 31, 2012 and September 30, 2011:

 

		March 31, 2012										September 30, 2011
		Fair Value				Percentage of Total Portfolio				Leverage Ratio		Fair Value				Percentage of Total Portfolio				Leverage Ratio
1		$	82,607				7.82	%		2.73		$	81,335				7.26	%		3.16
2			950,996				90.04	%		3.91			1,021,990				91.26	%		3.87
3			5,102				0.48	%		NM(1)			8,660				0.77	%		NM(1)
4			10,918				1.03	%		NM(1)			—				0.00	%		—
5			6,600				0.63	%		NM(1)			7,852				0.71	%		NM(1)
Total		$	1,056,223				100.00	%		3.82		$	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

 

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provisions in certain loan agreements. As of March 31, 2012, we had modified the payment terms of our investments in 9 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 March 31, 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 March 31, 2012. As of March 31, 2011, we had stopped accruing cash interest, PIK interest and OID on three investments that had not paid all of their scheduled cash interest payments for the period ended March 31, 2011.

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 March 31, 2012, September 30, 2011 and March 31, 2011 was as follows:

 

		March 31, 2012																September 30, 2011																March 31, 2011
		Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio
Accrual		$	1,027,219				95.23	%		$	1,038,705				98.34	%		$	1,116,762				96.60	%		$	1,111,986				99.30	%		$	916,768				96.18	%		$	931,796				99.15	%
PIK non-accrual			15,637				1.45	%			3,082				0.29	%			—				0.00	%			—				0.00	%			—				0.00	%			—				0.00	%
Cash non-accrual			35,841				3.32	%			14,436				1.37	%			39,320				3.40	%			7,851				0.70	%			36,425				3.82	%			7,953				0.85	%
Total		$	1,078,697				100.00	%		$	1,056,223				100.00	%		$	1,156,082				100.00	%		$	1,119,837				100.00	%		$	953,193				100.00	%		$	939,749				100.00	%

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

 

March 31, 2012

September 30, 2011

March 31, 2011

Lighting by Gregory, LLC

Cash non-accrual

Cash non-accrual

Cash non-accrual

MK Network, LLC(1)

—

—

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 & Subordinated Term Loans

Cash non-accrual

—

—

 

(1)	We no longer hold this investment. See “— Discussion and Analysis of Results and Operations — Comparison of the three and six months ended March 31, 2012 and March 31, 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 six months ended March 31, 2012 and March 31, 2011 were as follows:

 

		Three months ended March 31, 2012				Three months ended March 31, 2011				Six months ended March 31, 2012				Six months ended March 31, 2011
Cash interest income		$	967			$	1,460			$	2,157			$	3,566
PIK interest income			1,217				146				2,044				387
OID income			6				30				96				60
Total		$	2,190			$	1,636			$	4,297			$	4,013

 

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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 six months ended March 31, 2012 and March 31, 2011

Total Investment Income

Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, 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 March 31, 2012 and March 31, 2011 was $42.1 million and $29.7 million, respectively. For the three months ended March 31, 2012, this amount primarily consisted of $32.0 million of interest income from portfolio investments (which included $2.9 million of PIK interest) and $10.1 million of fee income. For the three months ended March 31, 2011, this amount primarily consisted of $25.8 million of interest income from portfolio investments (which included $3.5 million of PIK interest) and $3.9 million of fee income.

Total investment income for the six months ended March 31, 2012 and March 31, 2011 was $81.6 million and $55.0 million, respectively. For the six months ended March 31, 2012, this amount primarily consisted of $65.5 million of interest income from portfolio investments (which included $6.3 million of PIK interest) and $16.0 million of fee income. For the six months ended March 31, 2011, this amount primarily consisted of $46.6 million of interest income from portfolio investments (which included $6.6 million of PIK interest) and $8.4 million of fee income.

The increase in our total investment income for the three and six months ended March 31, 2012 as compared to the three and six months ended March 31, 2011 was primarily attributable to a higher average level of outstanding debt investments, which was principally due to a net increase of seven debt investments in our portfolio and fee income related to debt payoffs, partially offset by amortization payments received and a decrease in the weighted average yield on our debt investments from 12.84% to 12.37% during the year-over-year period.

Expenses

Expenses for the three months ended March 31, 2012 and March 31, 2011 were $19.3 million and $13.1 million, respectively. Expenses increased for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011 by $6.2 million. This was due primarily to increases in:

 

•

Base management fee, which was attributable to a 12.4% 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 37.7% increase in pre-incentive fee net investment income for the year-over-year period; and

 

•

Interest expense, which was attributable to an 86.2% increase in weighted average debt outstanding for the year-over-year period.

 

 

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Expenses for the six months ended March 31, 2012 and March 31, 2011 were $39.1 million and $24.4 million, respectively. Expenses increased for the six months ended March 31, 2012 as compared to the six months ended March 31, 2011 by $14.7 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 43.0% increase in pre-incentive fee net investment income for the year-over-year period; and

 

•

Interest expense, which was attributable to an 162.8% increase in weighted average debt outstanding for the year-over-year period. The significant increase in debt outstanding for the three and six months ended March 31, 2012 as compared to the three and six months ended March 31, 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 six months ended March 31, 2012, we repurchased $0.5 million and $11.0 million, respectively, of our Convertible Notes in the open market and surrendered them to the Trustee for cancellation. The aggregate purchase price of these Convertible Notes was $9.4 million because they were trading at a discount due to what we believe were volatile market conditions. As such, we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded was $1.3 million for the six months ended March 31, 2012. 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. We believe that paying an incentive fee on this type of net gain is permissible under, and contemplated by, our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we intend to seek 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. If approved by our Board of Directors, this type of net gain, and corresponding income incentive fee, may occur again in the future. If our Board of Directors does not approve or ratify the payment of such fees, our investment adviser has agreed to cease charging such fees and reimburse such fees already paid.

Net Investment Income

As a result of the $12.4 million increase in total investment income as compared to the $6.2 million increase in total expenses, net investment income for the three months ended March 31, 2012 reflected a $6.2 million, or 37.7%, increase compared to the three months ended March 31, 2011.

As a result of the $26.6 million increase in total investment income and the $1.3 million gain on extinguishment of debt, as compared to the $14.7 million increase in total expenses, net investment income for the six months ended March 31, 2012 reflected a $13.2 million, or 43.0%, increase compared to the six months ended March 31, 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 six months ended March 31, 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.;

 

 

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•

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 above par (including associated 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 above par (including associated fees) and no realized gain or loss was recorded on this transaction;

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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 above par (including associated 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 above par (including associated 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 above par (including associated 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 above par (including associated 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 above par (including associated fees) and no realized gain or loss was recorded on this transaction; and

 

•

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 (including associated fees) and no realized gain or loss was recorded on this transaction.

During the six months ended March 31, 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 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;

 

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•

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 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; and

 

•

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.

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 March 31, 2012, we recorded net unrealized appreciation of $8.0 million. This consisted of $10.6 million of net reclassifications from unrealized depreciation to realized losses on our investments and $0.4 million of net unrealized appreciation on equity investments, offset by $3.0 million of net unrealized depreciation on debt investments. During the three months ended March 31, 2011, we recorded net unrealized depreciation of $0.4 million. This consisted of $1.4 million of net unrealized depreciation of equity investments, offset by $0.2 million of net unrealized appreciation on debt investments, $0.6 million of net reclassifications from unrealized depreciation to realized losses and $0.2 million of net unrealized appreciation on our interest rate swap.

During the six months ended March 31, 2012, we recorded net unrealized appreciation of $13.9 million. This consisted of $27.7 million of net reclassifications from unrealized depreciation to realized losses on our investments and $1.8 million of net unrealized appreciation on equity investments, offset by $15.6 million of net unrealized depreciation on debt investments. During the six months ended March 31, 2011, we recorded net unrealized appreciation of $16.5 million. This consisted of $10.9 million of net reclassifications from unrealized depreciation to realized losses on our investments, $5.7 million of net unrealized appreciation on debt investments and $1.0 million of net unrealized appreciation on our interest rate swap, offset by $1.1 million of net unrealized depreciation on equity investments.

Comparison of years ended September 30, 2011 and September 30, 2010

Total Investment Income

Total investment income for the years ended September 30, 2011 and September 30, 2010 was $125.2 million and $70.5 million, respectively. For the year ended September 30, 2011, this amount primarily consisted of $108.3 million of interest income from portfolio investments (which included $13.7 million of PIK interest) and $16.7 million of fee income. For the year ended September 30, 2010, this amount primarily consisted of $63.9 million of interest income from portfolio investments (which included $10.0 million of PIK interest) and

 

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$6.0 million of fee income. For the year ended September 30, 2011, PIK interest increased by approximately 37% due primarily to the year-over-year growth in our debt investments, including debt investments generating PIK interest. For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments”. Notwithstanding this fact, PIK interest decreased as a percentage of our total interest income from 15.6% for 2010 to 12.7% for 2011.

The increase in our total investment income for the year ended September 30, 2011 as compared to the year ended September 30, 2010 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of 21 debt investments in our portfolio, partially offset by scheduled amortization repayments received and other debt payoffs and a decrease in the weighted average yield of our debt investments during the year over year period.

Expenses

Expenses for the years ended September 30, 2011 and September 30, 2010 were $59.5 million and $27.5 million, respectively. Expenses increased for the year ended September 30, 2011 as compared to the year ended September 30, 2010 by $32.0 million. This was due primarily to increases in:

 

•

Base management fee, which was attributable to a 98.6% increase in the fair value of the investment portfolio during the year due to an increase in new investment originations, partially offset by our investment advisor’s decision to permanently waive the base management fee on cash and cash equivalents beginning for the quarter ended March 31, 2010;

 

•

Incentive fee, which was attributable to a 56.0% increase in pre-incentive fee net investment income for the year-over-year period; and

 

•

Interest expense, which was attributable to a 995.7% increase in weighted average debt outstanding for the year-over-year period. The significant increase in interest expense for the year ended September 30, 2011 as compared to the year ended September 30, 2010 is attributable to our ability to obtain attractively priced debt to finance our investment operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Borrowings” for additional information regarding the terms of our borrowings. We intend to continue to use leverage to finance our investments when we expect that the returns derived from our debt-financed investments will exceed the costs of our debt and within the parameters discussed elsewhere in this prospectus, including the 200% asset coverage test applicable to us as a business development company and our targeted debt to targeted debt to equity ratio (excluding SBA debentures) of 0.6x. As a result, we expect that our interest expense will continue to increase in future periods, although not at the same pace as experienced during the year ended September 30, 2011, and such interest expense will be offset by the investment income generated by the investments financed with the related debt.

Gain on Extinguishment of Convertible Senior Notes

During the year ended September 30, 2011, we repurchased $17.0 million of our Convertible Notes in the open market and surrendered them to the Trustee for cancellation. The aggregate purchase price of these Convertible Notes was $15.1 million. As such we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded was $1.5 million.

Net Investment Income

As a result of the $54.6 million increase in total investment income as compared to the $32.0 million increase in total expenses, net investment income for the year ended September 30, 2011 reflected a $24.1 million, or 56.0%, increase compared to the year ended September 30, 2010.

 

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Realized Gain (Loss) on Investments and Interest Rate Swap

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

During the year ended September 30, 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 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 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;

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

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•

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

During the year ended September 30, 2010, we recorded investment realization events, including the following:

 

•

In October 2009, we received a cash payment in the amount of $0.1 million representing a payment in full of all amounts due in connection with the cancellation of our loan agreement with American Hardwoods Industries, LLC. We recorded a $0.1 million reduction to the previously recorded $10.4 million realized loss on the investment in American Hardwoods;

 

•

In October 2009, we received a cash payment of $3.9 million from Elephant & Castle, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

 

•

In March 2010, we recorded a realized loss in the amount of $2.9 million in connection with the sale of a portion of our interest in CPAC, Inc.;

 

•

In August 2010, we received a cash payment of $7.6 million from Storyteller Theaters Corporation 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 September 2010, we restructured our investment in Rail Acquisition Corp. Although the full amount owed under the loan agreement remained intact, 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 $2.6 million in accordance with EITF Abstract Issue No. 96-19;

 

•

In September 2010, we sold our investment in Martini Park, LLC and received a cash payment in the amount of $0.1 million. We recorded a realized loss on this investment in the amount of $4.0 million; and

 

•

In September 2010, we exited our investment in Rose Tarlow, Inc. and received a cash payment in the amount of $3.6 million in full settlement of the debt investment. We recorded a realized loss on this investment in the amount of $9.3 million.

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

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

During the year ended September 30, 2011, we recorded net unrealized depreciation of $6.5 million. This consisted of $34.6 million of net unrealized depreciation on debt investments, offset by $25.6 million of net reclassifications to realized losses on our investments and interest rate swaps (resulting in unrealized appreciation) and $2.5 million of net unrealized appreciation on equity investments. During the year ended September 30, 2010, we recorded net unrealized depreciation of $1.8 million. This consisted of $19.1 million of net unrealized depreciation on debt investments and $0.8 million of net unrealized depreciation on interest rate swaps, offset by $17.6 million of reclassifications to realized losses on our investments (resulting in unrealized appreciation) and $0.5 million of net unrealized appreciation on equity investments.

Comparison of years ended September 30, 2010 and September 30, 2009

Total Investment Income

Total investment income for the years ended September 30, 2010 and September 30, 2009 was $70.5 million and $49.8 million, respectively. For the year ended September 30, 2010, this amount primarily consisted of $63.9 million of interest income from portfolio investments (which included $10.0 million of PIK interest), and $6.0 million of fee income. For the year ended September 30, 2009, this amount primarily consisted of $46.0 million of interest income from portfolio investments (which included $7.4 million of PIK interest), and $3.5 million of fee income.

 

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The increase in our total investment income for the year ended September 30, 2010 as compared to the year ended September 30, 2009 was primarily attributable to a net increase of eight debt investments in our portfolio in the year-over-year period, partially offset by scheduled amortization repayments received and other debt payoffs during the same period.

Expenses

Expenses (net of the permanently waived portion of the base management fee) for the years ended September 30, 2010 and September 30, 2009 were $27.5 million and $18.4 million, respectively. Expenses increased for the year ended September 30, 2010 as compared to the year ended September 30, 2009 by $9.1 million. This was due primarily to increases in:

 

•

Base management fee, which was attributable to a 88.2% increase in the fair value of the investment portfolio during the year, partially offset by our investment advisor’s decision to permanently waive the base management fee on cash and cash equivalents beginning for the quarter ended March 31, 2010;

 

•

Incentive fee, which was attributable to a 37.2% increase in pre-incentive fee net investment income for the year-over-year period; and

 

•

Interest expense, which was attributable to a 350.1% increase in weighted average debt outstanding for the year-over-year period.

Net Investment Income

As a result of the $20.7 million increase in total investment income as compared to the $9.1 million increase in total expenses, net investment income for the year ended September 30, 2010 reflected a $11.6 million, or 37.2%, increase compared to the year ended September 30, 2009.

Realized Gain (Loss) on Investments and Interest Rate Swap

During the year ended September 30, 2010, we recorded investment realization events, including the following:

 

•

In October 2009, we received a cash payment in the amount of $0.1 million representing a payment in full of all amounts due in connection with the cancellation of our loan agreement with American Hardwoods Industries, LLC. We recorded a $0.1 million reduction to the previously recorded $10.4 million realized loss on the investment in American Hardwoods;

 

•

In October 2009, we received a cash payment of $3.9 million from Elephant & Castle, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

 

•

In March 2010, we recorded a realized loss in the amount of $2.9 million in connection with the sale of a portion of our interest in CPAC, Inc.;

 

•

In August 2010, we received a cash payment of $7.6 million from Storyteller Theaters Corporation 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 September 2010, we restructured our investment in Rail Acquisition Corp. Although the full amount owed under the loan agreement remained intact, 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 $2.6 million in accordance with EITF Abstract Issue No. 96-19;

 

•

In September 2010, we sold our investment in Martini Park, LLC and received a cash payment in the amount of $0.1 million. We recorded a realized loss on this investment in the amount of $4.0 million; and

 

•

In September 2010, we exited our investment in Rose Tarlow, Inc. and received a cash payment in the amount of $3.6 million in full settlement of the debt investment. We recorded a realized loss on this investment in the amount of $9.3 million.

 

 

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During the year ended September 30, 2009, we exited our investment in American Hardwoods Industries, LLC and recorded a realized loss of $10.4 million, and recorded a $4.0 million realized loss on our investment in CPAC, Inc. in connection with our determination that the investment was permanently impaired based on, among other things, our analysis of changes in the portfolio company’s business operations and prospects.

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

During the year ended September 30, 2010, we recorded net unrealized depreciation of $1.8 million. This consisted of $19.1 million of net unrealized depreciation on debt investments and $0.8 million of net unrealized depreciation on interest rate swaps, offset by $17.6 million of reclassifications to realized losses on our investments (resulting in unrealized appreciation) and $0.5 million of net unrealized appreciation on equity investments. During the year ended September 30, 2009, we recorded net unrealized depreciation of $10.8 million. This consisted of $23.1 million of net unrealized depreciation on debt investments and $2.0 million of net unrealized depreciation on equity investments, offset by $14.3 million of reclassifications to realized losses on our investments (resulting in unrealized appreciation).

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 six months ended March 31, 2012, we experienced a net increase in cash and cash equivalents of $47.5 million. During that period, we had $94.8 million of cash provided by operating activities, primarily from $265.3 million of principal payments, PIK payments and sale proceeds received and $43.8 million of net investment income, offset by the funding of $204.3 million of investments and net revolvers. During the same period cash used by financing activities was $47.3 million, primarily consisting of $90.5 million of net repayments under our credit facilities, $45.4 million of cash dividends paid, $9.4 million of net repurchases of our convertible senior notes and $2.0 million of deferred financing costs paid, partially offset by $100.7 million of proceeds from the issuance of our common stock.

For the six months ended March 31, 2011, we experienced a net decrease in cash and cash equivalents of $38.2 million. During that period, we used $342.6 million of cash in operating activities, primarily for the funding of $452.7 million of investments and net revolvers, partially offset by $79.1 million of principal payments and PIK payments received and $30.6 million of net investment income. During the same period, cash provided by financing activities was $304.4 million, primarily consisting of $134.0 million of net borrowings under our credit facilities, $65.3 million of SBA borrowings and $143.9 million of proceeds from the issuance of our common stock, partially offset by $34.0 million of cash dividends paid and $4.3 million of deferred financing costs paid.

For the year ended September 30, 2011, we experienced a net decrease in cash and cash equivalents of $9.1 million. During that period, we used $517.9 million of cash in operating activities, primarily for the funding of $703.5 million of investments and net revolvers, partially offset by $120.4 million of principal and PIK payments received and $67.1 million of net investment income. During the same period cash provided by financing activities was $508.8 million, primarily consisting of $206.8 million of proceeds from issuances of our common stock, $77.0 million of SBA borrowings, $136.9 million of proceeds from the issuance of our convertible senior notes (net of repurchases) and $178.0 million of net borrowings under our credit facilities, partially offset by $76.7 million of cash dividends paid, $0.8 million of offering costs paid and $12.4 million of deferred financing costs paid.

As of March 31, 2012, we had $115.2 million in cash and cash equivalents, portfolio investments (at fair value) of $1.06 billion, $6.8 million of interest and fees receivable, $150.0 million of SBA debentures payable, $87.5 million of borrowings outstanding under our credit facilities, $124.0 million of convertible senior notes payable and unfunded commitments of $94.4 million.

 

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

In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. See “Regulated Investment Company Status and 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 March 31, 2012, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment 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 a wholly-owned subsidiary, we sought and obtained a license from the SBA to operate an SBIC. In this regard, on February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P., 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. 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 license allows our SBIC subsidiary 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

 

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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 our SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of March 31, 2012, our SBIC subsidiary had $75 million in regulatory capital. The SBA has issued a capital commitment to our SBIC subsidiary in the amount of $150 million, and $150.0 million of SBA debentures were outstanding as of March 31, 2012 that 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 (in  thousands)				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	%

We have received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit us to exclude the debt of the SBIC subsidiary 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 $150 million more than we would otherwise be able to absent the receipt of this exemptive relief.

We have also submitted an application to the SBA for a second SBIC license. On May 27, 2011, we received a letter from the Investment Division of the SBA that invited us to continue moving forward with this application. If approved, this license would provide us with the capability to issue an additional $75 million of SBA-guaranteed debentures beyond the $150 million of SBA-guaranteed debentures we, through our wholly-owned subsidiary, currently have the ability to issue. However, there are no assurances that we will be successful in obtaining a second SBIC license from the SBA. If we are able to successfully obtain such an additional SBIC license, we would have similar relief from the 200% asset coverage ratio limitation as described above with respect to the SBIC debt securities issued by such SBIC subsidiary.

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

 

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Date Declared

Record Date

Payment Date

Amount per Share

Cash Distribution

DRIP Shares Issued

DRIP Shares Value

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

42,071

(1)

0.4 million

February 7, 2012

April 13, 2012

April 30, 2012

0.0958

7.3 million

43,531

(1)

0.4 million

 

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

The following table reflects share transactions that occurred from October 1, 2010 through March 31, 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.

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

 

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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 March 31, 2012, we had $7.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $7.0 million. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.130% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $0.6 million and $1.3 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 subsidiary 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 subsidiary, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

On February 22, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion

 

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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 March 31, 2012, we had $80.5 million of borrowings outstanding under the ING facility that had a fair value of $80.5 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of 3.403% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $1.4 million and $2.8 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,

 

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and the failure by Funding II or us to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of March 31, 2012, we had no borrowings outstanding under the Sumitomo facility. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.773% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $0.2 million and $0.4 million, respectively, related to the Sumitomo facility.

As of March 31, 2012, except for assets that were funded through our SBIC subsidiary, 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 subsidiary, the SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over our stockholders.

Interest expense for the three and six months ended March 31, 2012 was $5.6 million and $11.3 million, respectively. Interest expense for the three and six months ended March 31, 2011 was $2.7 million and $4.7 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		$541 million		$716 million
		Minimum shareholders’ equity (exclusive of affiliates)		Net assets exclusive of affiliates other than Funding shall not be less than $250 million		$250 million		$557 million
		Asset coverage ratio		Asset coverage ratio shall not be less than 2.00:1		2.00:1		3.14:1
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		$670 million		$716 million
		Asset coverage ratio		Asset coverage ratio shall not be less than 2.25:1		2.25:1		3.14:1
		Interest coverage ratio		Interest coverage ratio shall not be less than 2.50:1		2.50:1		6.81:1

 

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Facility		Financial Covenant		Description		Target Value		Reported Value(1)
		Eligible portfolio investments test		Aggregate value of (a) Cash and cash equivalents and (b) Portfolio investments rated 1, 2 or 3 shall not be less than $175 million		$175 million		$687 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 December 31, 2011. We were also in compliance with all financial covenants under these credit facilities based on the financial information contained in our Form 10-Q for the quarter ended March 31, 2012.

We and our SBIC subsidiary 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.

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 March 31, 2012:

 

Facility

Date

Transaction

Total Facility Amount

Upfront fee Paid

Total Facility Availability

Amount Drawn

Remaining Availability

Interest Rate

Wells Fargo facility

11/16/2009

Entered into credit facility

$

50 million

$

0.8 million

LIBOR + 4.00%

5/26/2010

Expanded credit facility

100 million

0.9 million

LIBOR + 3.50%

2/28/2011

Amended credit facility

100 million

0.4 million

LIBOR + 3.00%

11/30/2011

Amended credit facility

100 million

—

LIBOR + 2.75%

4/23/2012

Amended credit facility

150 million

1.2 million

$

41 million

(1)

$

7 million

$

34 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

81 million

149 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)

Sumitomo facility

9/16/2011

Entered into credit facility

200 million

2.5 million

52 million

(1)

—

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

The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per 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.

 

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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 $124.0 million convertible debt outstanding at March 31, 2012 is 8,399,946. 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 senior notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

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

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

For the three and six months ended March 31, 2012, we recorded interest expense of $1.8 million and $3.7 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 six months ended March 31, 2012, we repurchased $0.5 million and $11.0 million principal, respectively, of the Convertible Notes in the open market for an aggregate purchase price of $9.4 million and surrendered them to the Trustee for cancellation.

As of March 31, 2012, there were $124.0 million Convertible Notes outstanding, which had a fair value of $118.0 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 March 31, 2012, our only off-balance sheet arrangements consisted of $94.4 million of unfunded commitments, which was comprised of $85.5 million to provide debt financing to certain of our portfolio companies and $8.9 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

 

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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 March 31, 2012 and September 30, 2011 is shown in the table below:

 

		March 31, 2012				September 30, 2011
JTC Education, Inc		$	11,825			$	14,000
Welocalize, Inc.			10,000				750
Charter Brokerage, LLC			7,353				6,176
Rail Acquisition Corp.			5,630				5,446
Refac Optical Group			5,500				5,500
Phoenix Brands Merger Sub LLC			4,286				3,000
Enhanced Recovery Company, LLC			4,000				4,000
DISA, Inc.			4,000				4,000
Specialty Bakers, LLC			4,000				2,000
World 50, Inc.			4,000				—
Miche Bag, LLC			3,500				5,000
Titan Fitness, LLC			3,500				2,957
Discovery Practice Management, Inc.			3,000				3,000
Cardon Healthcare Network, LLC			3,000				2,000
Traffic Control & Safety Corp.			2,514				3,014
Riverside Fund V, LP (limited partnership interest)			2,000				—
Mansell Group, Inc.			2,000				2,000
Physicians Pharmacy Alliance, Inc.			2,000				2,000
Tegra Medical, LLC			1,500				1,500
Milestone Partners IV, LP (limited partnership interest)			1,475				2,000
Eagle Hospital Physicians, Inc.			1,400				2,500
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)			1,000				—
Bunker Hill Capital II (QP), LP (limited partnership interest)			934				960
Riverlake Equity Partners II, LP (limited partnership interest)			760				878
HealthDrive Corporation			750				2,000
RCPDirect, LP (limited partnership interest)			703				—
Baird Capital Partners V, LP (limited partnership interest)			614				701
Riverside Fund IV, LP (limited partnership interest)			402				555
Saddleback Fence and Vinyl Products, Inc.			401				400
Advanced Pain Management			400				267
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		$	94,447			$	108,804

 

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Contractual Obligations

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

 

		Debt Outstanding as of September 30, 2011				Debt Outstanding as of March 31, 2012				Weighted average debt outstanding for the six months ended March 31, 2012				Maximum debt outstanding for the six months ended March 31, 2012
SBA debentures payable		$	150,000			$	150,000			$	150,000			$	150,000
Wells Fargo facility			39,524				7,000				38,074			$	48,269
ING facility			133,500				80,500				103,287			$	145,000
Sumitomo facility			5,000				—				11,399			$	29,000
Convertible Notes			135,000				124,000				125,344			$	135,000
Total debt		$	463,024			$	361,500			$	428,104			$	490,769

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 March 31, 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			7,000				—				7,000				—				—
Interest due on Wells Fargo facility			399				209				190				—				—
ING facility			80,500				—				—				80,500				—
Interest due on ING facility			10,243				2,616				5,233				2,394				—
Sumitomo facility			—				—				—				—				—
Interest due on Sumitomo facility			—				—				—				—				—
Convertible senior notes payable			124,000				—				—				124,000				—
Interest due on convertible senior notes			26,697				6,665				13,330				6,702				—
Total		$	449,792			$	15,268			$	37,309			$	225,168			$	172,047

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.

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

 

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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 subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary 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 subsidiary to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility could, under certain circumstances, restrict Fifth Street Funding, LLC from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net 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

 

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from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee.

The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and six months ended March 31, 2012, we have incurred expenses that are due to our investment adviser of $11.1 million and $22.1 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 six months ended March 31, 2012, we have incurred expenses that are due to FSC, Inc. of $1.0 million and $2.2 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

In April 2012, we repurchased $9.0 million principal of our Convertible Notes in the open market for an aggregate purchase price of $8.6 million.

On April 20, 2012, Traffic Control & Safety Corporation filed for Chapter 11 bankruptcy protection in the state of Delaware.

On April 23, 2012, we amended the terms of 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.

On May 7, 2012, our Board of Directors declared the following dividends:

 

•

$0.0958 per share, payable on July 31, 2012 to stockholders of record on July 13, 2012;

 

•

$0.0958 per share, payable on August 31, 2012 to stockholders of record on August 15, 2012; and

 

•

$0.0958 per share, payable on September 28, 2012 to stockholders of record on September 14, 2012.

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.

 

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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.

As of March 31, 2012, 65.9% of our debt investment portfolio (at fair value) and 63.2% of our debt investment portfolio (at cost) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of March 31, 2012 and September 30, 2011 was as follows:

 

		March 31, 2012								September 30, 2011
		Fair Value				% of Floating Rate Portfolio				Fair Value				% of Floating Rate Portfolio
Under 1%		$	91,190				13.45	%		$	125,453				16.96	%
1% to under 2%			301,794				44.50	%			261,878				35.40	%
2% to under 3%			112,363				16.57	%			168,928				22.83	%
3% to under 4%			167,342				24.67	%			176,976				23.92	%
4% to under 5%			378				0.06	%			757				0.10	%
5% and over			5,125				0.75	%			5,843				0.79	%
Total		$	678,192				100.00	%		$	739,835				100.00	%

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

 

Basis point increase(1)		Interest income				Interest expense				Net increase
100		$	1,000			$	(1,000	)		$	—
200			4,000				(2,000	)			2,000
300			9,000				(3,000	)			6,000
400			16,000				(4,000	)			12,000
500			23,000				(4,000	)			19,000

 

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

 

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We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of March 31, 2012 and September 30, 2011:

 

		March 31, 2012								September 30, 2011
		Interest Bearing Cash and Investments				Borrowings				Interest Bearing Cash and Investments				Borrowings
Money market rate		$	115,178			$	—			$	67,644			$	—
Prime rate			706				—				38,890				53,000
LIBOR
30 day			51,658				87,500				51,368				125,024
90 day			627,996				—				654,932				—
Fixed rate			398,292				274,000				418,981				285,000
Total		$	1,193,830			$	361,500			$	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 March 31, 2012, we were no longer party to any interest rate swap agreements.

 

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SENIOR SECURITIES

(dollar amounts in thousands, except per share data)

Information about our senior securities (including debt securities and other indebtedness) is shown in the following tables as of the fiscal year ended September 30, 2011. We had no senior securities outstanding as of September 30 of any prior fiscal years. The report of our independent registered public accounting firm, PricewaterhouseCoopers LLP, on the senior securities table as of September 30, 2011, is attached as an exhibit to the registration statement of which this prospectus is a part. The “—” indicates information that the SEC expressly does not require to be disclosed for certain types of senior securities.

 

Class and Year		Total Amount Outstanding Exclusive of Treasury Securities(1)				Asset Coverage Per Unit(2)				Involuntary Liquidating Preference Per Unit(3)				Average Market Value Per Unit(4)
ING Facility
Fiscal 2011		$	133,500			$	3,328			$	—				N/A
Well Fargo Facility
Fiscal 2011		$	39,524			$	3,328			$	—				N/A
Sumitomo Facility
Fiscal 2011		$	5,000			$	3,328			$	—				N/A
Convertible Notes
Fiscal 2011		$	135,000			$	3,328			$	—				N/A

 

 

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

 

(2)

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

 

(3)	The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it.

 

(4)	This column is not applicable.

 

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BUSINESS

General

We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We define small and mid-sized companies as those with annual revenues between $25 million and $250 million. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments. We are externally managed and advised by Fifth Street Management LLC, which we also refer to as our “investment adviser.”

As of March 31, 2012, we had originated $1.60 billion of funded debt and equity investments and our portfolio totaled $1.1 billion at fair value and was comprised of 67 investments, 58 of which were in operating companies and 9 of which were in private equity funds. The 9 investments in private equity funds represented less than 1% of the fair value of our assets at March 31, 2012. The 55 debt investments in our portfolio as of March 31, 2012 had a weighted average debt to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) multiple of 3.5x calculated at the time of origination of the investment. The weighted average annual yield of our debt investments as of March 31, 2012 was approximately 12.37%, of which 11.17% represented cash payments and 1.20% represented payment-in-kind, or PIK, interest and other non-cash items. As of March 31, 2012, we had stopped accruing cash interest, PIK interest and/or OID on 4 investments, 3 of which had not paid all of their scheduled cash interest payments for the period ended March 31, 2012.

Our investments generally range in size from $5 million to $75 million and are principally in the form of first and second lien debt investments, which may also include an equity component. We invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “high yield” or “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. Although our focus could change, we are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection. As of March 31, 2012, 81.3% of our portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of our portfolio companies. Moreover, we held equity investments consisting of common stock, preferred stock or other equity interests in 26 out of our 67 portfolio companies as of March 31, 2012.

Fifth Street Mezzanine Partners III, L.P., our predecessor fund, commenced operations as a private partnership on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into us. We were formed in late 2007 for the purpose of acquiring Fifth Street Mezzanine Partners III, L.P. and continuing its business as a public entity. We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, or the 1940 Act.

As a business development company, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our investments through borrowings. However, as a business development company, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of our securities 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. We are currently targeting a debt to equity ratio (excluding SBA) of 0.6x (i.e., we aim to have one dollar of equity for each $0.60 of non-SBA debt outstanding). As of March 31, 2012, we had a debt to equity ratio (excluding SBA debentures) of 0.26x. See “Regulation — Business Development Company Regulations.”

We have also elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code, or the Code. See “Material U.S. Federal Income Tax

 

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Considerations — Taxation as a Regulated Investment Company.” As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders if we meet certain source-of-income, distribution and asset diversification requirements.

In addition, we maintain a wholly-owned subsidiary that is licensed as a small business investment company, or SBIC, and regulated by the Small Business Administration, or the SBA. See “Regulation — Small Business Investment Company Regulations.” The SBIC license allows us, through our wholly-owned subsidiary, to issue SBA-guaranteed debentures. We have received exemptive relief from the Securities and Exchange Commission, or SEC, to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. Pursuant to the 200% asset coverage ratio limitation, we are permitted to borrow one dollar for every dollar we have in assets less all liabilities and indebtedness not represented by debt securities issued by us or loans obtained by us. For example, as of March 31, 2012, we had approximately $1.0 billion in assets less all liabilities and indebtedness not represented by debt securities issued by us or loans obtained by us, which would permit us to borrow up to approximately $1.0 billion, notwithstanding other limitations on our borrowings pursuant to our credit facilities.

As a result of our receipt of an exemption from the SEC for our SBA debt, we have increased capacity to fund up to $150 million (the maximum amount of SBA-guaranteed debentures an SBIC may currently have outstanding once certain conditions have been met) of investments with SBA-guaranteed debentures in addition to being able to fund investments with borrowings up to the maximum amount of debt that the 200% asset coverage ratio limitation would allow us to incur. As a result, we, in effect, are permitted to have a lower asset coverage ratio than the 200% asset coverage ratio limitation under the 1940 Act and, therefore, we can have more debt outstanding than assets to cover such debt. For example, we are able to borrow up to $150 million more than the approximately $1.0 billion permitted under the 200% asset coverage ratio limit as of March 31, 2012. For additional information on SBA regulations that affect our access to SBA-guaranteed debentures, see “Risk Factors — Risks Relating to Our Business and Structure — Our SBIC subsidiary’s investment adviser has no prior experience managing an SBIC and any failure to comply with SBA regulations, resulting from our SBIC subsidiary’s investment adviser’s lack of experience or otherwise, could have a material adverse effect on our operations.”

Our SBIC subsidiary held approximately $236.2 million, or 19.7%, of our total assets at March 31, 2012.

On May 27, 2011, we received a letter from the Investment Division of the SBA that invited us to continue moving forward with our application to obtain an SBIC license for another one of our wholly-owned subsidiaries. Although our application for this license is subject to the SBA’s approval, we remain cautiously optimistic that we will complete the licensing process. However, there can be no assurance that the SBA will approve the issuance of an SBIC license to another one of our wholly-owned subsidiaries. If we are able to successfully obtain such an additional SBIC license, we would have similar relief from the 200% asset coverage ratio limitation as described above with respect to the SBIC debt securities issued by such SBIC subsidiary.

The Investment Adviser

Our investment adviser is affiliated with Fifth Street Capital LLC, a private investment firm founded and managed by Leonard M. Tannenbaum who has led the investment of over $2.0 billion in small and mid-sized companies, including the investments made by us, since 1998. Mr. Tannenbaum and his respective private investment firms have originated over 100 investment transactions. The other investment funds managed by these private investment firms generally are fully committed and, other than follow-on investments in existing portfolio companies, are no longer making investments.

We benefit from our investment adviser’s ability to identify attractive investment opportunities, conduct diligence on and value prospective investments, negotiate investments and manage a diversified portfolio of those investments. The principals of our investment adviser have broad investment backgrounds, with prior experience at investment funds, investment banks and other financial services companies and have developed a broad network of contacts within the private equity community. This network of contacts provides our principal source of investment opportunities.

The key principals and members of senior management of our investment adviser are Mr. Tannenbaum, our chief executive officer and our investment adviser’s managing partner, Bernard D. Berman, our president, chief

 

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compliance officer and secretary and a partner of our investment adviser, Ivelin M. Dimitrov, our chief investment officer and a partner of our investment adviser, Juan E. Alva, a partner of our investment adviser, Casey J. Zmijeski, a partner of our investment adviser and Alexander C. Frank, our chief financial officer and a partner of our investment adviser.

Business Strategy

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 have adopted the following business strategy to achieve our investment objective:

 

•

Capitalize on our investment adviser’s strong relationships with private equity sponsors.    Our investment adviser has developed an extensive network of relationships with private equity sponsors that invest in small and mid-sized companies. We believe that the strength of these relationships is due to a common investment philosophy, a consistent market focus, a rigorous approach to diligence and a reputation for delivering on commitments. In addition to being our principal source of originations, we believe that private equity sponsors provide significant benefits including incremental due diligence, additional monitoring capabilities and a potential source of capital and operational expertise for our portfolio companies.

 

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Focus on established small and mid-sized companies.    We believe that there are fewer finance companies focused on transactions involving small and mid-sized companies than larger companies, and that this is one factor that allows us to negotiate favorable investment terms. Such favorable terms include higher debt yields and lower leverage levels, more significant covenant protection and greater equity grants than typical of transactions involving larger companies. We generally invest in companies with established market positions, seasoned management teams, proven products and services and strong regional or national operations. We believe that these companies possess better risk-adjusted return profiles than newer companies that are in the early stages of building management teams and/or a revenue base.

 

•

Continue our growth of direct originations.    Over the last several years, the principals of our investment adviser have developed an origination strategy that allows us to directly originate a significant portion of our investments. We believe that the benefits of direct originations include, among other things, our ability to control the structuring of investment protections and to generate origination and exit fees.

 

•

Employ disciplined underwriting policies and rigorous portfolio management.    Our investment adviser has developed an extensive underwriting process which includes a review of the prospects, competitive position, financial performance and industry dynamics of each potential portfolio company. In addition, we perform substantial diligence on potential investments, and seek to invest along side private equity sponsors who have proven capabilities in building value. As part of the monitoring process, our investment adviser will analyze monthly and quarterly financial statements versus the previous periods and year, review financial projections, meet with management, attend board meetings and review all compliance certificates and covenants.

 

•

Structure our debt investments to minimize risk of loss and achieve attractive risk-adjusted returns.    We structure our debt investments on a conservative basis with high cash yields, cash origination fees, low leverage levels and strong investment protections. As of March 31, 2012, the weighted average annualized yield of our debt investments was approximately 12.37%, which includes a cash component of 11.17%. Our debt investments have strong protections, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. We believe these protections, coupled with the other features of our investments described above, should allow us to reduce our risk of capital loss and achieve attractive risk adjusted returns; however, there can be no assurance that we will be able to successfully structure our investments to minimize risk of loss and achieve attractive risk-adjusted returns.

 

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Benefit from lower, fixed, long-term cost of capital.    The SBIC license held by our wholly-owned subsidiary allows it to issue SBA-guaranteed debentures. SBA-guaranteed debentures carry long-term fixed rates that are generally lower than rates on comparable bank and other debt. Because lower cost SBA

 

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leverage is a significant part of our capital base, our relative cost of debt capital may be lower than many of our competitors. In addition, the SBIC leverage represents a stable, long-term component of our capital structure that should permit the proper matching of duration and cost compared to our portfolio investments. We are currently seeking to obtain an SBIC license for another one of our wholly-owned subsidiaries that would allow us to issue up to an additional $75 million of SBA-guaranteed debt.

 

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Leverage the skills and experience of our investment adviser.    The principals of our investment adviser have broad investment backgrounds, with prior experience at private investment funds, investment banks and other financial services companies and they also have experience managing distressed companies. We believe that our investment adviser’s expertise in valuing, structuring, negotiating and closing transactions provides us with a competitive advantage by allowing us to provide financing solutions that meet the needs of our portfolio companies while adhering to our underwriting standards.

Investment Criteria

The principals of our investment adviser have identified the following investment criteria and guidelines for use in evaluating prospective portfolio companies and they use these criteria and guidelines in evaluating investment opportunities for us. However, not all of these criteria and guidelines were, or will be, met in connection with each of our investments.

 

•

Established companies with a history of positive operating cash flow.    We seek to invest in established companies with sound historical financial performance. We typically focus on companies with a history of profitability on an operating cash flow basis. We do not intend to invest in start-up companies or companies with speculative business plans.

 

•

Ability to exert meaningful influence.    We target investment opportunities in which we will be the lead/sole investor in our tranche and in which we can add value through active participation in the direction of the company, often through advisory positions.

 

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Private equity sponsorship.    We generally seek to invest in companies in connection with private equity sponsors who have proven capabilities in building value. We believe that a private equity sponsor can serve as a committed partner and advisor that will actively work with the company and its management team to meet company goals and create value. We assess a private equity sponsor’s commitment to a portfolio company by, among other things, the capital contribution it has made or will make in the portfolio company.

 

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Seasoned management team.    We generally will require that our portfolio companies have a seasoned management team, with strong corporate governance. We also seek to invest in companies that have proper incentives in place, including having significant equity interests, to motivate management to act in accordance with our interests.

 

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Defensible and sustainable business.    We seek to invest in companies with proven products and/or services and strong regional or national operations.

 

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Exit strategy.    We generally seek to invest in companies that we believe possess attributes that will provide us with the ability to exit our investments. We expect to exit our investments typically through one of three scenarios: (i) the sale of the company resulting in repayment of all outstanding debt, (ii) the recapitalization of the company through which our loan is replaced with debt or equity from a third party or parties or (iii) the repayment of the initial or remaining principal amount of our loan then outstanding at maturity. In some investments, there may be scheduled amortization of some portion of our loan which would result in a partial exit of our investment prior to the maturity of the loan.

Deal Origination

Our deal originating efforts are focused on building relationships with private equity sponsors that are focused on investing in the small and mid-sized companies that we target. We divide the country geographically into Eastern, Central and Western regions and emphasize active, consistent sponsor coverage. The investment professionals of our investment adviser have developed an extensive network of relationships with these private equity sponsors. We

 

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estimate that there are approximately 1,300 of such private equity firms and our investment adviser has active relationships with approximately 250 of them. An active relationship is one through which our investment adviser has received at least one investment opportunity from the private equity sponsor within the last year.

Our investment adviser reviewed over 800 potential investment transactions with private equity sponsors for the year ended September 30, 2011. A significant portion of the investment transactions that we have completed to date were originated through our investment adviser’s relationships with private equity sponsors. We believe that our investment adviser has a reputation as a reliable, responsive and efficient source of funding to support private equity investments. We believe that this reputation and the relationships of our investment adviser with private equity sponsors will provide us with significant investment opportunities.

Our origination process is designed to efficiently evaluate a large number of opportunities and to identify the most attractive of such opportunities. A significant number of opportunities that clearly do not fit our investment criteria are screened by the partners of our investment adviser when they are initially identified. If an originator believes that an opportunity fits our investment criteria and merits consideration, the investment is presented to our investment adviser’s Investment Committee. This is the first stage of our origination process, the “Review” stage. During this stage, the originator gives a preliminary description of the opportunity. This is followed by preliminary due diligence, from which an investment summary is created. The opportunity may be discussed several times by the full Investment Committee of our investment adviser, or subsets of that Committee. At any point in this stage, we may reject the opportunity, and, indeed, we have historically decided not to proceed with more than 80% of the investment opportunities reviewed by our investment adviser’s Investment Committee.

For the subset of opportunities that we decide to pursue, we issue preliminary term sheets and classify them in the “Term Sheet Issued” stage. This term sheet serves as a basis for negotiating the critical terms of a transaction. At this stage we begin our underwriting and investment approval process, as more fully described below. After the term sheet for a potential transaction has been fully negotiated, the transaction is presented to our investment adviser’s Investment Committee for approval. If the deal is approved, the term sheet is signed. Approximately half of the term sheets we issue result in an executed term sheet. Our underwriting and investment approval process is ongoing during this stage, during which we begin documentation of the loan. The final stage, “Closings,” culminates with the funding of an investment only after all due diligence is satisfactorily completed and all closing conditions, including the sponsor’s funding of its investment in the portfolio company, have been satisfied.

Underwriting

Underwriting Process and Investment Approval

We make our investment decisions only after consideration of a number of factors regarding the potential investment including, but not limited to: (i) historical and projected financial performance; (ii) company and industry specific characteristics, such as strengths, weaknesses, opportunities and threats; (iii) composition and experience of the management team; and (iv) track record of the private equity sponsor leading the transaction. Our investment adviser uses a proprietary scoring system that evaluates each opportunity. This methodology is employed to screen a high volume of potential investment opportunities on a consistent basis.

If an investment is deemed appropriate to pursue, a more detailed and rigorous evaluation is made along a variety of investment parameters, not all of which may be relevant or considered in evaluating a potential investment opportunity. The following outlines the general parameters and areas of evaluation and due diligence for investment decisions, although not all will necessarily be considered or given equal weighting in the evaluation process.

Management assessment

Our investment adviser makes an in-depth assessment of the management team, including evaluation along several key metrics:

 

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The number of years in their current positions;

 

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Track record;

 

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•

Industry experience;

 

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Management incentive, including the level of direct investment in the enterprise;

 

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Background investigations; and

 

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Completeness of the management team (lack of positions that need to be filled).

Industry dynamics

An evaluation of the industry is undertaken by our investment adviser that considers several factors. If considered appropriate, industry experts will be consulted or retained. The following factors are analyzed by our investment adviser:

 

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Sensitivity to economic cycles;

 

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Competitive environment, including number of competitors, threat of new entrants or substitutes;

 

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Fragmentation and relative market share of industry leaders;

 

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Growth potential; and

 

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Regulatory and legal environment.

Business model and financial assessment

Prior to making an investment decision, our investment adviser will undertake a review and analysis of the financial and strategic plans for the potential investment. There is significant evaluation of and reliance upon the due diligence performed by the private equity sponsor and third party experts including accountants and consultants. Areas of evaluation include:

 

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Historical and projected financial performance;

 

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Quality of earnings, including source and predictability of cash flows;

 

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Customer and vendor interviews and assessments;

 

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Potential exit scenarios, including probability of a liquidity event;

 

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Internal controls and accounting systems; and

 

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Assets, liabilities and contingent liabilities.

Private equity sponsor

Among the most critical due diligence investigations is the evaluation of the private equity sponsor making the investment. A private equity sponsor is typically the controlling shareholder upon completion of an investment and as such is considered critical to the success of the investment. The private equity sponsor is evaluated along several key criteria, including:

 

•

Investment track record;

 

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Industry experience;

 

•

Capacity and willingness to provide additional financial support to the company through additional capital contributions, if necessary; and

 

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Reference checks.

Investments

We target debt investments that will yield meaningful current income and provide the opportunity for capital appreciation through equity securities. We typically structure our debt investments with the maximum seniority and collateral that we can reasonably obtain while seeking to achieve our total return target. In most cases, our debt

 

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investment will be collateralized by a first or second lien on the assets of the portfolio company. As of March 31, 2012, 81.3% of our portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of the portfolio company.

Debt Investments

We tailor the terms of our debt investments to the facts and circumstances of the transaction and prospective portfolio company, negotiating a structure that seeks to protect our rights and manage our risk while creating incentives for the portfolio company to achieve its business plan. A substantial source of return is monthly cash interest that we collect on our debt investments. As of March 31, 2012, we had directly originated a majority of our debt investments. 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.

 

•

First Lien Loans.    Our first lien loans generally have terms of four to six years, provide for a variable or fixed interest rate, contain prepayment penalties and are secured by a first priority security interest in all existing and future assets of the borrower. Our first lien loans may take many forms, including revolving lines of credit, term loans and acquisition lines of credit.

 

•

Second Lien Loans.    Our second lien loans generally have terms of four to six years, primarily provide for a fixed interest rate, contain prepayment penalties and are secured by a second priority security interest in all existing and future assets of the borrower. Our second lien loans often include payment-in-kind, or PIK, interest, which represents contractual interest accrued and added to the principal that generally becomes due at maturity.

 

•

Unsecured Loans.    Our unsecured investments generally have terms of five to six years and provide for a fixed interest rate. We may make unsecured investments on a stand-alone basis, or in connection with a senior secured loan, a junior secured loan or a “one-stop” financing. Our unsecured investments may include payment-in-kind, or PIK, interest, which represents contractual interest accrued and added to the principal that generally becomes due at maturity, and an equity component, such as warrants to purchase common stock in the portfolio company.

We typically structure our debt investments to include covenants that seek to minimize our risk of capital loss. Our debt investments have strong protections, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. Our debt investments also have substantial prepayment penalties designed to extend the life of the average loan, which we believe will help to grow our portfolio.

Equity Investments

When we make a debt investment, we may be granted equity in the company in the same class of security as the sponsor receives upon funding. In addition, we may from time to time make non-control, equity co-investments in connection with private equity sponsors. We generally seek to structure our equity investments, such as direct equity co-investments, to provide us with minority rights provisions and event-driven put rights. We also seek to obtain limited registration rights in connection with these investments, which may include “piggyback” registration rights.

Private Equity Fund Investments

We make investments in the private equity funds of certain of our equity sponsors. In general, we make these investments where we have a long term relationship and are comfortable with the sponsor’s business model and investment strategy. As of March 31, 2012, we had investments in nine private equity funds, which represented less than 1% of the fair value of our assets as of such date.

 

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Portfolio Management

Active Involvement in our Portfolio Companies

As a business development company, we are obligated to offer to provide managerial assistance to our portfolio companies and to provide it if requested. In fact, we provide managerial assistance to our portfolio companies as a general practice and we seek investments where such assistance is appropriate. We monitor the financial trends of each portfolio company to assess the appropriate course of action for each company and to evaluate overall portfolio quality. We have several methods of evaluating and monitoring the performance of our investments, including but not limited to, the following:

 

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review of monthly and quarterly financial statements and financial projections for portfolio companies;

 

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periodic and regular contact with portfolio company management to discuss financial position requirements and accomplishments;

 

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attendance at board meetings;

 

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periodic formal update interviews with portfolio company management and, if appropriate, the private equity sponsor; and

 

•

assessment of business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan.

Ranking Criteria

In addition to various risk management and monitoring tools, we use an investment ranking system to characterize and monitor the credit profile and our expected level of returns on each investment in our portfolio. We use a five-level numeric ranking scale. The following is a description of the conditions associated with each investment ranking:

 

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

 

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

 

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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.

 

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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.

 

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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.

In the event that we determine that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, we will undertake more aggressive monitoring of the effected portfolio company. While our investment ranking system identifies the relative risk for each investment, the ranking alone does not dictate the scope and/or frequency of any monitoring that we perform. The frequency of our monitoring of an investment is determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing our investment, if any.

 

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

 

Investment Ranking		Fair Value (thousands)				% of Portfolio
1		$	82,607				7.82	%
2			950,996				90.04	%
3			5,102				0.48	%
4			10,918				1.03	%
5			6,600				0.63	%
Total		$	1,056,223				100.00	%

Valuation of Portfolio Investments and Net Asset Value Determinations

As a business development company, we generally invest in illiquid securities including debt and equity investments of small and mid-sized companies. All of our investments are recorded at fair value as determined in good faith by our Board of Directors.

Authoritative accounting guidance defines fair value as 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. 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.

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

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, 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 projections of the future free cash flows of the business.

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.

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

 

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

 

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

 

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

 

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•

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

 

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

 

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

 

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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;

 

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

 

•

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

The fair value of all of our investments at March 31, 2012, September 30, 2011 and September 30, 2010 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 a 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 process each quarter, the independent valuation firms provide us with a written report 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.

The percentages of our portfolio at fair value for which independent valuation firms provided us with valuation assistance by period were as follows:

 

		Percentage of Portfolio at Fair Value
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	%

 

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

 

(2)	24.8% excluding four investments that closed in December 2009 and therefore were not part of the independent valuation process

 

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We intend to have independent valuation firms provide us with valuation assistance on a portion of our portfolio on a quarterly basis and a substantial portion of our portfolio on an annual basis.

Determination of fair values involves subjective judgments and estimates. The notes to our financial statements refer to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

Quarterly Net Asset Value Determination

We determine the net asset value per share of our common stock on a quarterly basis. The net asset value per share of our common stock is equal to the value of our total assets minus liabilities divided by the total number of shares of common stock outstanding.

Determinations in Connection with Certain Offerings

In connection with certain offerings of shares of our common stock, our board of directors or one of its committees will be required to make the determination that we are not selling shares of our common stock at a price below the then current net asset value per share of our common stock at the time at which the sale is made. Our board of directors or the applicable committee will consider the following factors, among others, in making such determination:

 

•

the net asset value per share of our common stock most recently disclosed by us in the most recent periodic report that we filed with the SEC;

 

•

our management’s assessment of whether any material change in the net asset value per share of our common stock has occurred (including through the realization of gains on the sale of our portfolio securities) during the period beginning on the date of the most recently disclosed net asset value per share of our common stock and ending two days prior to the date of the sale of our common stock; and

 

•

the magnitude of the difference between the net asset value per share of our common stock most recently disclosed by us and our management’s assessment of any material change in the net asset value per share of our common stock since that determination, and the offering price of the shares of our common stock in the proposed offering.

This determination will not require that we calculate the net asset value per share of our common stock in connection with such offerings of shares of our common stock, but instead it will involve the determination by our board of directors or a committee thereof that we are not selling shares of our common stock at a price below the then current net asset value per share of our common stock at the time at which the sale is made.

Competition

We compete for investments with a number of business development companies and investment funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial banks and other sources of financing. Many of these entities have greater financial and managerial resources than we do. We believe we are able to be competitive with these entities primarily on the basis of the experience and contacts of our management team, our responsive and efficient investment analysis and decision-making processes, the investment terms we offer, and our willingness to make smaller investments.

We believe that some of our competitors make loans with interest rates and returns that are comparable to or lower than the rates and returns that we target. Therefore, we do not seek to compete solely on the interest rates and returns that we offer to potential portfolio companies. For additional information concerning the competitive risks we face, see “Risk Factors — Risks Relating to Our Business and Structure — We may face increasing competition for investment opportunities, which could reduce returns and result in losses.”

Employees

We do not have any employees. Our day-to-day investment operations are managed by our investment adviser. See “Investment Advisory Agreement.” Our investment adviser employs a total of 21 investment professionals, including its principals. In addition, we reimburse our administrator, FSC, Inc., for the allocable portion of overhead

 

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and other expenses incurred by it in performing its obligations under an administration agreement, including the compensation of our chief financial officer and chief compliance officer, and their staff. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. For a more detailed discussion of the administration agreement, see “Administration Agreement.”

Properties

We do not own any real estate or other physical properties materially important to our operation; however, we lease office space for our executive office at 10 Bank Street, 12th Floor, White Plains, NY 10606. Our investment adviser also maintains additional office space at 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831. We believe that our current office facilities are adequate for our business as we intend to conduct it.

Legal Proceedings

Although 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 but we believe that these legal claims are immaterial, frivolous and without merit, and we intend to vigorously defend ourselves against them.

 

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PORTFOLIO COMPANIES

The following table sets forth certain information as of March 31, 2012, for each portfolio company in which we had a debt or equity investment. Other than these investments, our only formal relationships with our portfolio companies are the managerial assistance ancillary to our investments and the board observation or participation rights we may receive.

 

Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
Lighting by Gregory, LLC
158 Bowery New York, NY 10012		Housewares & specialties		First Lien Term Loan A, 9.75% PIK due 2/28/2013						$	4,586,397			$	3,996,187			$	1,609,625
				First Lien Bridge Loan, 8% PIK due 3/31/2012							112,500				112,500				—
				97.38% Membership Interest			97.4	%							1,210,000				—
															5,318,687				1,609,625
Coll Materials Group LLC
4005 All American Way Zanesville, OH 43701		Environmental & facilities services		Second Lien Term Loan, 12% cash due 11/1/2014							6,885,084				6,885,084				6,879,992
				50% Interest in CD HOLDCO, LLC			50.0	%							3,127,500				8,708,765
															10,012,584				15,588,757
Caregiver Services, Inc.
10541 NW 17th Avenue Miami, FL 33122		Healthcare services		Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013							4,997,083				4,879,726				5,124,791
				Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013							15,402,942				15,166,107				15,402,507
				1,080,399 shares of Series A Preferred Stock			3.3	%							1,080,398				1,640,619
															21,126,231				22,167,917
Repechage Investments Limited
50 Congress Street, Suite 900 Boston, MA 02109		Restaurants		First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011							3,607,592				3,412,404				1,907,766
				7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.			4.3	%							750,000				—
															4,162,404				1,907,766
Traffic Control & Safety Corporation
815 Waiakamilo Road, # C Honolulu, HI 96817		Construction and engineering		Senior Term Loan A, LIBOR+9.0% cash due 06/29/2012							5,000,000				4,956,598				5,000,141
				Senior Revolver, LIBOR+9.0% cash due 06/29/2012							12,486,208				12,408,892				12,514,416
				Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015							21,760,178				20,828,527				10,918,494
				Subordinated Loan, 15% PIK due 5/28/2015							5,772,486				5,531,372				—
				24,750 shares of Series B Preferred Stock			0.6	%							247,500				—
				43,494 shares of Series D Preferred Stock											434,937				—
				25,000 shares of Common Stock											2,500				—
															44,410,326				28,433,051
TBA Global, LLC
21700 Oxhard Street Woodland Hills, CA 91367		Advertising		53,994 Senior Preferred Shares											215,975				387,682
				191,977 Shares A Shares			2.0	%							191,977				75,062
															407,952				462,744
Fitness Edge, LLC
1100 Kings Highway Fairfield, CT 06825		Leisure facilities		First Lien Term Loan A, LIBOR+5.25% (4.75% floor) cash due 7/31/2012							375,000				374,699				377,540
				First Lien Term Loan B, 12% cash 2.5% PIK due 7/31/2012							5,849,753				5,839,406				6,007,529
				1,000 Common Units			1.0	%							42,908				179,355
															6,257,013				6,564,424
Capital Equipment Group, Inc.
714 Walnut Street Mount Carmel, IL 62863		Industrial machinery		Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013							10,382,947				10,270,854				10,443,870
				33,463 shares of Common Stock			3.4	%							344,513				717,234
															10,615,367				11,161,104
Rail Acquisition Corp.
1791 West Dairy Tucson, AZ 85705		Electronic manufacturing services		First Lien Term Loan, 8% cash 4% PIK due 9/1/2013							19,567,761				15,636,582				3,082,663
				First Lien Revolver, 7.85% cash due 9/1/2013							4,369,615				4,369,615				4,369,615
															20,006,197				7,452,278
Western Emulsions, Inc.
3450 East 36th Street Tucson, AZ 85713		Construction materials		Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014							6,931,256				6,842,641				7,085,468
															6,842,641				7,085,468
Storyteller Theaters Corporation
2209 Miguel Chavez Road Sante Fe, NM 87505		Movies & entertainment		1,692 shares of Common Stock											169				61,613
				20,000 shares of Preferred Stock			3.4	%							200,000				200,000
															200,169				261,613

 

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Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
HealthDrive Corporation
25 Needham Stteet Newtown, MA 02461		Healthcare services		First Lien Term Loan A, 10% cash due 7/17/2013							5,762,970				5,610,838				5,706,106
				First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013							10,334,787				10,284,787				10,329,425
				First Lien Revolver, 12% cash due 7/17/2013							1,250,000				1,245,000				1,265,246
															17,140,625				17,300,777
idX Corporation
3541 Reir Trail South St. Louis, MO 63045		Distributors		Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014							19,088,229				18,872,359				19,406,831
															18,872,359				19,406,831
Cenegenics, LLC
851 South Rampart Boulevard Las Vegas, NV 89145		Healthcare services		414,419 Common Units			3.5	%							598,382				1,342,121
															598,382				1,342,121
Trans-Trade, Inc.
1040 Trade Avenue, Suite 106DFW Airport, TX 75261		Air freight and logistics		First Lien Term Loan A, 13% cash 2.5% PIK due 9/10/2014							12,681,659				12,508,496				12,639,630
				First Lien Term Loan B, 12% cash due 9/10/2014							5,859,933				5,789,318				2,364,641
															18,297,814				15,004,271
Riverlake Equity Partners II, LP
699 Boylston Street, 8th Floor — One Exeter Plaza Boston, MA 02116		Multi-sector holdings		1.89% limited partnership interest			1.9	%							240,451				240,451
															240,451				240,451
Riverside Fund IV, LP
699 Boylston Street, 8th Floor — One Exeter Plaza Boston, MA 02116		Multi-sector holdings		0.33% limited partnership interest			0.3	%							597,549				597,549
															597,549				597,549
Ambath/Rebath Holdings, Inc.
421 West Alameda Drive Tempe, AZ 85282		Home improvement retail		First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014							3,000,000				2,988,750				2,850,807
				First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014							23,292,585				23,267,835				20,686,835
				First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014							1,500,000				1,500,000				1,356,386
															27,756,585				24,894,028
JTC Education, Inc.
6602 E. 75th Street, Suite 200 Indianapolis, IN 46250		Education services		First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014							29,404,023				28,838,995				29,295,201
				First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014							2,175,000				1,875,095				2,310,132
				17,391 Shares of Series A-1 Preferred Stock											313,038				313,038
				17,391 Shares of Common Stock			0.6	%							186,953				10,127
															31,214,081				31,928,498
Tegra Medical, LLC
421 West Almeda Drive Tempe, AZ 85282		Healthcare equipment		First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014							20,853,636				20,619,428				20,808,081
				First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014							22,897,396				22,660,196				22,678,931
				First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014							2,500,000				2,457,333				2,473,327
															45,736,957				45,960,339
Psilos Group Partners IV, LP
140 Broadway, 51st Floor New York, NY 10005		Multi-sector holdings		2.52% limited partnership interest			2.5	%							—				—
															—				—
Mansell Group, Inc.
2 Securities Center, 3500 Piedmont+A5 Road, Suite 320 Altnata, GA 30305		Advertising		First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015							10,122,500				9,988,440				10,136,551
				First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015							9,211,772				9,090,502				9,173,033
				First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015							—				(24,667	)			—
															19,054,275				19,309,584
NDSSI Holdings, LLC
5750 Hellyer Avenue San Jose, CA 95138		Electronic equipment & instruments		First Lien Term A, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012							21,863,894				21,604,448				21,380,071
				First Lien Term Loan B, LIBOR+9.75% (3% floor) cash 3.75% PIK due 12/31/2012							8,076,073				8,076,073				8,095,457
				First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012							3,500,000				3,461,058				3,458,717
				2,000 Series D Preferred Units			3.3	%							2,379,298				2,379,298
															35,520,877				35,313,543
Eagle Hospital Physicians, Inc.
5901 C Peachtree, Dunwoody Road, Site 350 Atlanta, GA 30328		Healthcare services		First Lien Term, LIBOR+8.75% (3% floor) cash due 8/11/2015							24,978,000				24,561,477				24,927,168
				First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015							1,100,000				1,065,076				1,112,760
															25,626,553				26,039,928

 

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Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
Enhanced Recovery Company, LLC
8014 Bayberry Road Jacksonville, FL 32256		Diversified support services		First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015							13,380,009				13,188,613				13,356,155
				First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015							11,070,781				10,916,060				10,986,470
				First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015							—				(56,262	)			—
															24,048,411				24,342,625
Specialty Bakers LLC
450 South Slate Road Marysville, LA 17053		Food distributors		First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015							4,650,000				4,416,485				4,586,538
				First Lien Term Loan B, LIBOR + 11% (2.5% floor) cash due 9/15/2015							11,000,000				10,803,551				10,836,694
				First Lien Revolver, LIBOR+8.5% cash due 9/15/2015							—				(71,436	)			—
															15,148,600				15,423,232
Welocalize, Inc.
241 East 4th St. Suite 207 Frederick, MD 21701		Internet software & services		First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015							20,842,732				20,516,393				20,914,537
				First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015							23,932,699				23,560,843				24,014,486
				First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015							—				(189,572	)			—
				2,086,163 Common Units			4.0	%			—				3,346,558				3,065,396
															47,234,222				47,994,419
Miche Bag, LLC
10808 S. River Front Pkwy, Suite 150 South Jordan, UT 84095		Apparel, accessories & luxury goods		First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013							11,125,000				10,876,745				11,108,513
				First Lien Term Loan B, LIBOR + 10% (3% floor) cash 3% PIK due 12/7/2015							17,692,897				15,543,741				17,356,916
				First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015							1,500,000				1,407,112				1,498,927
				10,371 shares of preferred equity units in Miche Holdings, LLC											1,037,112				1,169,293
				146,289 shares of series D common equity units in Miche Holdings, LLC			3.4	%							1,462,888				725,118
															30,327,598				31,858,767
Bunker Hill Capital II (QP), L.P.
260 Franklin Street, Suite 1860 Boston, MA 02110		Multi-sector holdings		0.50% limited partnership interest			0.5	%							65,645				65,645
															65,645				65,645
Advanced Pain Management
4131 W. Loomis Road, Suite 300 Greenfield, WI 53221		Healthcare services		First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015							7,380,000				7,270,888				7,382,603
				First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015							—				(4,400	)			—
															7,266,488				7,382,603
DISA, Inc.
12600 Northborough Drive, Suite 300 Houston, TX 77067		Human resources & employment services
				First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015							11,865,000				11,670,730				11,970,465
				First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015							8,459,458				8,332,038				8,633,749
				First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015							—				(61,407	)			—
															19,941,361				20,604,214
Saddleback Fence and Vinyl Products, Inc.
3120 Pullman St. #B Costa Mesa, CA 92626		Building Products		First Lien Term Loan, 8% cash due 11/30/2013							647,768				647,768				647,768
				First Lien Revolver, 8% cash due 11/30/2013							—				—				—
															647,768				647,768
Best Vinyl Fence & Deck, LLC
2844 Croddy Way Santa Ana, CA 92704		Building Products		First Lien Term Loan B, 8% PIK due 6/30/2012							4,190,079				4,190,079				2,089,618
															4,190,079				2,089,618
Physicians Pharmacy Alliance, Inc.
118 MacKenan Drive, Suite 200 Cary, NC 27511		Healthcare services		First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016							16,361,866				16,066,331				16,160,750
				First Lien Revolver, LIBOR+6% cash due 1/4/2016							—				(34,500	)			—
															16,031,831				16,160,750

 

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Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
Cardon Healthcare Network, LLC
4185 Technology Forest Boulevard, Suite 200 The Woodlands, TX 77381		Diversified support services		First Lien Term Loan A, LIBOR+10% (1.75% floor) cash due 1/24/2017							10,665,000				10,478,202				10,969,742
				First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 1/24/2017							22,282,938				22,054,994				22,315,931
				First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/24/2017							—				(43,592	)			—
				65,903 Class A Units			0.6	%			—				250,000				341,839
															32,739,604				33,627,512
US Retirement Partners, Inc.
99 Wood Avenue South, Suite 301 Iselin, NJ 08830		Diversified financial services		First Lien Term Loan, LIBOR+9.5% (2.5% floor) cash due 1/6/2016							32,850,000				32,400,981				32,255,122
															32,400,981				32,255,122
Phoenix Brands Merger Sub LLC
1 Landmark Square, Suite 1810 Stamford, CT 06901		Household products		Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016							7,446,429				7,287,960				7,417,951
				Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017							20,788,520				20,372,647				19,900,264
				First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016							2,142,857				2,014,221				2,204,316
															29,674,828				29,522,531
U.S. Collections, Inc.
190 Carondelet Plaza, Suite 1590 St. Louis, MO 63105		Diversified support services		First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016							8,542,608				8,410,710				8,510,427
															8,410,710				8,510,427
CCCG, LLC
1640 South 101st E. Avenue Tulsa, OK 74128		Oil & gas equipment services		First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015							34,746,803				34,004,041				34,377,471
															34,004,041				34,377,471
Maverick Healthcare Group, LLC
2546 West Birchwood Avenue, Suite 101-104 Mesa, AZ 85202		Healthcare equipment		First Lien Term Loan, LIBOR+9% cash (1.75% floor) cash due 12/31/2016							24,687,500				24,205,354				24,162,980
															24,205,354				24,162,980
Refac Optical Group
1 Harmon Drive Blackwood, NJ 08012		Specialty stores		First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016							13,929,600				13,628,289				13,934,342
				First Lien Term Loan B, LIBOR+8.5% cash, 1.75% PIK due 3/23/2016							20,241,573				19,795,731				20,332,949
				First Lien Revolver, LIBOR+7.5% cash due 3/23/2016							—				(116,616	)			—
				1,000 Shares of Common Stock in Refac Holdings, Inc.							—				1,000				63,622
				1,000 Shares of Series A Preferred Stock in Refac Holdings, Inc.			1.7	%			—				999,000				999,000
															34,307,404				35,329,913
Pacific Architects & Engineers, Inc.
1525 Wilson Boulevard, Suite 900 Arlington, VA 22209		Diversified support services		First Lien Term Loan A, LIBOR+5% (1.5% floor) cash due 4/4/2017							3,993,750				3,936,286				3,932,425
				First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017							4,700,000				4,635,343				4,634,032
															8,571,629				8,566,457
Securus Technologies Holdings, Inc.
14651 Dallas Parkway, Suite 600 Dallas, TX 75254		Integrated Telecommunication Services		Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018							22,500,000				22,085,779				22,339,262
															22,085,779				22,339,262
Gundle/SLT Environmental, Inc.
19103 Gundle Road Houston, TX 77073		Environmental & facilities services		First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016							7,940,000				7,853,622				7,989,531
															7,853,622				7,989,531
Titan Fitness, LLC
8200 Greensboro Drive, Suite 900 McLean, VA 22102		Leisure facilities		First Lien Term Loan A, LIBOR+8.75% (1.25% floor) cash due 6/30/2016							16,125,000				15,969,583				16,041,557
				First Lien Term Loan B, LIBOR+10.75% cash (1.25% floor) cash 1.5% PIK due 6/30/2016							11,632,758				11,523,669				11,643,070
				First Lien Term Loan C, 18% PIK due 6/30/2016							2,975,557				2,950,893				2,969,555
				First Lien Revolver, L+8.75%, (1.25% floor) cash due 6/30/2016							—				(33,201	)			—
															30,410,944				30,654,182
Baird Capital Partners V, LP
777 East Wisconsin Avenue Milwaukee, WI 53202		Multi-sector holdings		0.4% limited partnership interest			0.4	%							385,518				385,518
															385,518				385,518

 

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Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
Charter Brokerage, LLC
30 S. Wacker Drive, Suite 3700 Chicago, IL 60606		Oil & gas equipment services		Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016							16,938,025				16,787,861				16,915,440
				Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017							10,144,018				10,059,018				9,926,537
				Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016							—				(62,499	)			—
															26,784,380				26,841,977
Stackpole Powertrain International ULC
Nine Greenway Plaza, Suite 2400 Houston, TX 77046		Auto parts & equipment		Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018							18,243,066				18,080,209				18,164,363
				1,000 Common Units			0.9	%			—				1,000,000				1,062,524
															19,080,209				19,226,887
Discovery Practice Management, Inc.
4281 Katella Avenue, Suite 111 Los Alamitos, CA 90720		Healthcare services		Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016							6,722,275				6,651,746				6,690,746
				Senior Term Loan B, 12% cash 3% PIK due 8/8/2016							6,343,677				6,280,970				6,269,340
				Senior Revolver, LIBOR+7% cash due 8/8/2016							—				(31,485	)			—
															12,901,231				12,960,086
CTM Group, Inc.
104 Styles Road, Suite 201 Salem, NH 03079		Leisure products		Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017							10,637,278				10,534,488				10,562,446
				Mezzanine Term Loan B, 18.4% PIK due 2/10/2017							3,481,298				3,450,951				3,559,892
															13,985,439				14,122,338
Bojangles
9432 Southern Pine Boulevard Charlotte, NC 28273		Restaurants		First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017							5,789,474				5,685,960				5,832,811
															5,685,960				5,832,811
Milestone Partners IV, L.P.
555 East Lancaster Avenue, Suite 500 Radnor, PA 19087		Multi-sector holdings		3.07% limited partnership interest			3.1	%							524,731				524,731
															524,731				524,731
Insight Pharmaceuticals LLC
1170 Wheeler Way, Suite 150 Langhorne, PA 19047		Pharmaceuticals		First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016							9,950,000				9,882,761				10,192,656
				Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017							17,500,000				17,346,954				17,659,980
															27,229,715				27,852,636
National Spine and Pain Centers, LLC
330 Madison Avenue, 27th Floor New York, NY 10017		Healthcare services		Mezzanine Term Loan, 11% cash 1.6% PIK due 9/27/2017							26,830,045				26,583,019				26,842,192
				299,292.94 Class A Units			0.6	%							299,293				222,489
															26,882,312				27,064,681
RCPDirect, L.P.
100 N. Riverside Plaza Suite 2400 Chicago, IL 60606		Multi-sector holdings		0.91% limited partnership interest			0.9	%			—				296,553				296,553
															296,553				296,553
The MedTech Group, Inc.
6 Century Road South Plainfield, NJ 07080		Healthcare equipment		Senior Term Loan, L+5.5% (1.5% floor) cash due 9/7/2016							12,935,000				12,831,056				12,921,419
															12,831,056				12,921,419
Digi-Star Acquisition Holdings, Inc.
W5527 State Highway 106 Fort Atkinson, WI 53538		Industrial machinery		Mezzanine Term Loan, 12% cash 1.5% PIK due 11/18/2017							10,055,956				9,939,636				10,121,355
				225 Class A Preferred Units											225,000				225,000
				2,500 Class A Common Units			1.0	%							25,000				43,856
															10,189,636				10,390,211
CPASS Acquisition Company
130 West Canal Street Winooski, VM 05404		Internet software & services		Senior Term Loan, L+9% (1.5% floor) cash 1% PIK due 11/21/2016							4,955,719				4,849,469				5,029,018
				Senior Revolver, L+9% (1.5% floor) cash due 11/21/2016											(18,333	)			—
															4,831,136				5,029,018
Genoa Healthcare Holdings, LLC
18300 Cascade Ave. South Suite 251 Tukwila, WA 98188		Pharmaceuticals		Mezzanine Term Loan, 12% cash 2% PIK due 6/1/2017							12,584,133				12,466,709				12,554,690
				500,000 Preferred Units											475,000				487,007
				500,000 Class A Common Units			0.8	%							25,000				31,874
															12,966,709				13,073,571
SolutionSet, Inc.
100 Montgomery Street Suite 1500 San Francisco, CA 94104		Advertising		Senior Term Loan, LIBOR+6% (1% floor) cash due 12/21/2016							9,739,130				9,645,931				9,687,136
															9,645,931				9,687,136

 

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Name and Address of Portfolio Company		Principal Business		Titles of Securities Held by Us		Percentage of Ownership				Loan Principal				Cost of Investment				Fair Value of Investment
Slate Pharmaceuticals Acquisition Corp.
150 S. Saunders Rd. Suite 120 Lake Forest, IL 60045		Healthcare services		Subordinated Term Loan, 12% cash 1.5% PIK due 12/29/2017							20,077,506				19,888,617				20,107,417
															19,888,617				20,107,417
ACON Equity Partners III, LP
1133 Connecticut Avenue, NW Suite 700 Washington, DC 20036		Multi-sector holdings		0.31% limited partnership interest			0.3	%			—				—				—
															—				—
Blue Coat Systems, Inc.
420 North Mary Avenue Sunnyvale, CA 94085		Internet software & services		First Lien Term Loan, L+6% (1.5% floor) cash due 2/15/2018							15,000,000				14,852,621				15,000,000
				Second Lien Term Loan, L+10% (1.5% floor) cash due 8/15/2018							7,000,000				6,931,795				7,000,000
															21,784,416				22,000,000
CRGT, Inc.
8150 Leesburg Pike, Suite 405 Vienna, VA 22182		IT consulting & other services		Mezzanine Term Loan, 12.5% cash 3% PIK due 3/9/2018							25,546,750				25,295,292				25,618,082
															25,295,292				25,618,082
Riverside Fund V, L.P.
699 Boylston Street, 8th Floor — One Exeter Plaza Boston, MA 02116		Multi-sector holdings		0.4% limited parnership interest			0.4	%			—				—				—
															—				—
World 50, Inc.
3525 Piedmont Road, NE Atlanta, GA 30305		Research & consulting services		Senior Term Loan A, L+6.25% (1.5% floor) cash due 3/30/2017							9,000,000				8,858,390				9,000,000
				Senior Term Loan B, 12.5% cash due 3/30/2017							5,500,000				5,414,787				5,500,000
				Senior Revolver, L+6.25% (1.5% floor) cash due 3/30/2017							—				(61,973	)			—
															14,211,204				14,500,000
Huddle House, Inc.
5901-B Peachtree Dunwoody Rd, NE Suite 450 Atlanta, GA 30328		Restaurants		Subordinated Term Loan, 11% cash 1.6% PIK due 3/30/2018							13,850,616				13,714,039				13,850,616
															13,714,039				13,850,616
TOTAL														$	1,078,697,062			$	1,056,223,384

 

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MANAGEMENT

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

Board of Directors and Executive Officers

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

Directors

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

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

 

Name		Age				Director Since				Expiration of Term
Independent Directors
Brian S. Dunn			40				2007				2014
Richard P. Dutkiewicz			56				2010				2013
Byron J. Haney			51				2007				2014
Frank C. Meyer			68				2007				2013
Douglas F. Ray			44				2007				2013
Interested Directors
Leonard M. Tannenbaum			40				2007				2015
Bernard D. Berman			41				2009				2015

Executive Officers

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

 

Name		Age				Position(s) Held
Leonard M. Tannenbaum			40			Chief Executive Officer
Bernard D. Berman			41			President, Chief Compliance Officer and Secretary
Alexander C. Frank			54			Chief Financial Officer
Ivelin M. Dimitrov			34			Chief Investment Officer

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

 

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Biographical Information

Independent Directors

 

•

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

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

 

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

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

 

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Byron J. Haney.    Mr. Haney has been a member of our Board of Directors since December 2007. From October 2010 through October 2011, Mr. Haney served as a principal of Duggan Asset Management, L.L.C. where he was director of research. Prior to that, he served as chief operating officer of VSO Capital Management from March 2010 to October 2010. From 1994 until 2009, Mr. Haney worked for Resurgence Asset Management LLC, during which time he most recently served as managing director and chief investment officer. Mr. Haney previously served on the Board of Directors of Sterling Chemicals, Inc., and Furniture.com. Mr. Haney has more than 25 years of business experience, including having served as chief financial officer of a private retail store chain and as an auditor with Touche Ross & Co., a predecessor of Deloitte & Touche LLP. Mr. Haney earned his B.S. in Business Administration from the University of California at Berkeley and his M.B.A. from the Wharton School of the University of Pennsylvania.

 

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

 

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

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

 

•

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

Through his broad experience as an officer and director of several companies, in addition to skills acquired with firms engaged in investment banking, banking and financial services, Mr. Ray brings to our Company extensive financial and risk assessment abilities. Mr. Ray’s previous service on the Board also provides him with a specific understanding of our Company, its operations, and the business and regulatory issues facing business development companies. Mr. Ray’s expertise and experience also qualify him to serve as chairman of the Compensation Committee. The foregoing qualifications led to our conclusion that Mr. Ray should serve as a member of our Board.

 

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Interested Directors

 

•

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

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

 

•

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

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

Non-Director Executive Officers

 

•

Alexander C. Frank. Mr. Frank has been our chief financial officer since September 2011. Prior to joining the Company, he served as a managing director and chief financial officer of Chilton Investment Company LLC, a global investment management firm, from September 2008 to March 2011. Mr. Frank was responsible for finance and operations infrastructure. Prior to that, Mr. Frank spent over 22 years at Morgan Stanley, having served as global head of institutional operations as well as global corporate controller and chief financial officer of U.S. broker/dealer operations. In his roles, he oversaw various securities infrastructure services, creating efficiencies throughout the organization, and managed all aspects of the

 

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internal and external financial control and reporting functions. He also oversaw the firm’s financing, capital planning, cash management and rating agency functions. Mr. Frank began his career at Arthur Andersen LLP before joining Morgan Stanley in 1985. He received an M.B.A. from the University of Michigan and a B.A. from Dartmouth College.

 

•

Ivelin M. Dimitrov, CFA. Mr. Dimitrov has been our chief investment officer and the chief investment officer of our investment adviser since August 2011, and served as co-chief investment officer in these capacities since November 2010 and June 2010, respectively. He is also a partner of our investment adviser and serves on its investment committee. Mr. Dimitrov has over six years of experience structuring small and mid-cap transactions. Mr. Dimitrov joined our investment adviser in May 2005 and is responsible for the evaluation of new investment opportunities, deal structuring and portfolio monitoring, in addition to managing the investment adviser’s associate and analyst team. He has substantial experience in financial analysis, valuation and investment research. Mr. Dimitrov graduated from the Carroll Graduate School of Management at Boston College with an M.S. in Finance and has a B.S. in Business Administration from the University of Maine. He is also a holder of the Chartered Financial Analyst designation.

Board Leadership Structure

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

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

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

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

 

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Board’s Role In Risk Oversight

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

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

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

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

Committees of the Board of Directors

Our Board of Directors met eight times during our 2011 fiscal year. Each director attended at least 75% of the total number of meetings of the Board and committees on which the director served that were held while the director was a member. Our Board of Directors has established the committees described below. Our Corporate Governance Policy, Code of Business Conduct and Ethics, our and our investment adviser’s Code of Ethics as required by the 1940 Act and our Board Committee charters are available at our corporate governance webpage at http://ir.fifthstreetfinance.com/governance.cfm and are also available to any stockholder who requests them by writing to our secretary, Bernard Berman, at Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606, Attention: Corporate Secretary.

Audit Committee

The Audit Committee is responsible for selecting, engaging and discharging our independent accountants, reviewing the plans, scope and results of the audit engagement with our independent accountants, approving professional services provided by our independent accountants (including compensation therefore), reviewing the independence of our independent accountants and reviewing the adequacy of our internal control over financial reporting. The members of the Audit Committee are Messrs. Dunn, Dutkiewicz, Haney and Meyer, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ

 

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corporate governance regulations. Mr. Haney serves as the chairman of the Audit Committee. Our Board of Directors has determined that Mr. Haney is an “audit committee financial expert” as defined under SEC rules. The Audit Committee met four times during the 2011 fiscal year.

Nominating and Corporate Governance Committee

The Nominating and Corporate Governance Committee is responsible for determining criteria for service on the Board, identifying, researching and nominating directors for election by our stockholders, selecting nominees to fill vacancies on our Board or a committee of the Board of Directors, developing and recommending to the Board a set of corporate governance principles and overseeing the self-evaluation of the Board and its committees and evaluation of our management. The Nominating and Corporate Governance Committee considers nominees properly recommended by our stockholders. The members of the Nominating and Corporate Governance Committee are Messrs. Dunn, Haney and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Dunn serves as the chairman of the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee met one time during the 2011 fiscal year.

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

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

 

•

the appropriate size and composition of our Board;

 

•

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

 

•

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

 

•

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

 

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experience with accounting rules and practices; and

 

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

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

Other than the foregoing, there are no stated minimum criteria for director nominees, although the Nominating and Corporate Governance Committee may also consider such other factors as it may deem are in our best interests and those of our stockholders. The Nominating and Corporate Governance Committee also believes it appropriate for certain key members of our management to participate as members of the Board. The Nominating and Corporate Governance Committee does not assign specific weights to particular criteria and no particular criterion is necessarily applicable to all prospective nominees. We believe that the backgrounds and qualifications of the

 

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directors, considered as a group, should provide a significant composite mix of experience, knowledge and abilities that will allow the Board to fulfill its responsibilities. Our Board does not have a specific diversity policy, but considers diversity of race, religion, national origin, gender, sexual orientation, disability, cultural background and professional experiences in evaluating candidates for Board membership.

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

Valuation Committee

The Valuation Committee establishes guidelines and makes recommendations to our Board regarding the valuation of our loans and investments. The Valuation Committee is presently composed of Messrs. Dutkiewicz, Haney, Meyer and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Meyer serves as the chairman of the Valuation Committee. The Valuation Committee met on six occasions during the 2011 fiscal year.

Compensation Committee

The Compensation Committee is responsible for reviewing and approving the reimbursement by us of the compensation of our chief financial officer and his staff, and the staff of our chief compliance officer. The current members of the Compensation Committee are Messrs. Dunn, Meyer and Ray, each of whom is not an interested person of us for purposes of the 1940 Act and is independent for purposes of the NASDAQ corporate governance regulations. Mr. Ray serves as the chairman of the Compensation Committee. As discussed below, currently, none of our executive officers are compensated by us. The Compensation Committee met one time during our 2011 fiscal year.

Executive Compensation

Compensation of Directors

The following table sets forth compensation of our directors for the year ended September 30, 2011.

 

Name		Fees Earned or Paid in Cash(1)(2)				Total
Interested Directors
Bernard D. Berman			—				—
Leonard M. Tannenbaum			—				—
Independent Directors
Brian S. Dunn		$	91,500			$	91,500
Richard P. Dutkiewicz		$	72,000			$	72,000
Byron J. Haney		$	110,000			$	110,000
Frank C. Meyer		$	90,000			$	90,000
Douglas F. Ray		$	88,500			$	88,500

 

 

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

 

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

 

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For the fiscal year ended September 30, 2011 the independent directors received an annual retainer fee of (i) $20,000, if the director was not on any committee and attended at least 75% of the meetings held during the year, (ii) $40,000, if the director was on one committee and attended at least 75% of the meetings held during the year, (iii) $50,000, if the director was on two committees and attended at least 75% of the meetings held during the year, or (iv) $60,000, if the director was on three committees and attended at least 75% of the meetings held during the year. In addition, the independent directors received $2,500 for each Board meeting in which the director attended in person and $1,000 for each Board meeting in which the director participated other than in person, and reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each Board meeting. The independent directors also received $1,000 for each Board committee meeting in which they attended in person and $500 for each Board committee meeting in which they participated other than in person, plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting not held concurrently with a Board meeting.

In addition, the Chairman of the Audit Committee and the Chairman of the Valuation Committee each received an annual retainer of $20,000, while the Chairman of the Nominating and Corporate Governance Committee and the Compensation Committee each received an annual retainer of $5,000. No compensation was paid to directors who are interested persons of us as defined in the 1940 Act.

Effective as of October 1, 2011, the annual retainer fee received by the independent directors was amended to (i) $20,000, payable once per year if an independent director not on any committee attends at least 75% of the meetings held during the previous year, (ii) $50,000, payable once per year if an independent director on one committee attends at least 75% of the meetings held the previous year, (iii) $65,000, payable once per year if an independent director on two committees attends at least 75% of the meetings held the previous year, and (iv) $75,000, payable once per year if an independent director on three committees attends at least 75% of the meetings held the previous year. In addition, the annual retainer for the Chairman of the Audit Committee and the Chairman of the Valuation Committee was reduced to $15,000.

Compensation of Executive Officers

None of our executive officers receive direct compensation from us. The compensation of the principals and other investment professionals of our investment adviser are paid by our investment adviser. Compensation paid to our chief financial officer, is set by our administrator, FSC, Inc., and is subject to reimbursement by us of an allocable portion of such compensation for services rendered to us. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. During fiscal year 2011, we reimbursed FSC, Inc. approximately $1.7 million for the allocable portion of compensation expenses incurred by FSC, Inc. on behalf of our chief financial officer and other support personnel, pursuant to the administration agreement with FSC, Inc.

 

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PORTFOLIO MANAGEMENT

The management of our investment portfolio is the responsibility of our investment adviser, and its Investment Committee, which currently consists of Leonard M. Tannenbaum, our chief executive officer and managing partner of our investment adviser, Bernard D. Berman, our president, chief compliance officer and secretary and a partner of our investment adviser and Ivelin M. Dimitrov, our chief investment officer and a partner of our investment adviser. For more information regarding the business experience of Messrs. Tannenbaum, Berman, Dimitrov and Frank, see “Business — The Investment Adviser,” “Management — Biographical Information — Interested Directors” and “— Non-Director Executive Officers.”

Investment Personnel

Our investment adviser’s investment personnel consists of its portfolio managers and principals, Messrs. Tannenbaum, Berman, Dimitrov, Alva, Zmijeski and Frank, who, in addition to our investment adviser’s Investment Committee, are primarily responsible for the day-to-day management of our portfolio.

The portfolio managers of our investment adviser will not be employed by us, and will receive no compensation from us in connection with their activities. The portfolio managers receive compensation that includes an annual base salary, an annual individual performance bonus, contributions to 401(k) plans, and a portion of the incentive fee or carried interest earned in connection with their services.

As of March 31, 2012, the portfolio managers of our investment adviser were also responsible for the day-to-day portfolio management of Fifth Street Mezzanine Partners II, L.P., a private investment fund that as of that date had total commitments of $157.1 million and assets of approximately $28.5 million. Fifth Street Mezzanine Partners II, L.P. and Fifth Street have similar investment objectives, however, Fifth Street Mezzanine Partners II, L.P. generally is fully committed and, other than follow-on investments in existing portfolio companies, is no longer making investments. However, the portfolio managers of our investment adviser could face conflicts of interest in the allocation of investment opportunities to Fifth Street and Fifth Street Mezzanine Partners II, L.P. in certain circumstances.

Below are the biographies for the portfolio managers whose biographies are not included elsewhere in this prospectus.

 

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Juan E. Alva.     Mr. Alva is a partner of our investment adviser. Mr. Alva joined our investment adviser in January 2007 and is responsible for deal origination in the Western United States. From March 1993 to January 2000, he worked at Goldman, Sachs & Co., in its investment banking division, focusing on mergers & acquisitions and corporate finance transactions. Mr. Alva was also chief financial officer of ClickServices.com, Inc., a software company, from 2000 to 2002, and most recently, from 2003 to 2006 he was a senior investment banker at Trinity Capital LLC, a boutique investment bank focused on small-cap transactions. Mr. Alva graduated from the University of Pennsylvania with a B.S. from the Wharton School and a B.S.E. from the School of Engineering and Applied Science.

 

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Casey J. Zmijeski.     Mr. Zmijeski has been a partner of our investment adviser since June 2010. Mr. Zmijeski is responsible for developing private equity sponsor relationships and originating loans in the Eastern Region of the United States. Mr. Zmijeski joined our investment adviser in September 2009 after spending nearly four years at Churchill Financial in New York where he was responsible for originating and structuring debt financing opportunities for middle market private equity firms from 2006 to 2009. Mr. Zmijeski held similar responsibilities with CapitalSource in New York from 2003 to 2006. From 1999 to 2003, Mr. Zmijeski worked at Heller Financial and GE Capital in their middle market leveraged finance groups. Prior to this time, Mr. Zmijeski spent over seven years with ING as a member of their Merchant Banking Group and Corporate Finance Advisory Group. Mr. Zmijeski graduated from Emory University with an M.B.A. in Finance and has an A.B. in Anthropology from Duke University.

 

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The table below shows the dollar range of shares of common stock beneficially owned by each portfolio manager of our investment adviser as of June 30, 2012.

 

Name of Portfolio Manager		Dollar Range of Equity Securities in Fifth Street(1)(2)(3)
Leonard M. Tannenbaum		Over $1,000,000
Bernard D. Berman		$100,001 — $500,000
Ivelin M. Dimitrov		$100,001 — $500,000
Juan E. Alva		$100,001 — $500,000
Casey J. Zmijeski		$100,001 — $500,000
Alexander C. Frank		$100,001 — $500,000

 

 

(1)	Beneficial ownership has been determined in accordance with Rule 16a-1(a)(2) of the Exchange Act.

 

(2)	The dollar range of equity securities beneficially owned is based on a stock price of $9.98 per share as of June 30, 2012.

 

(3)	The dollar range of equity securities beneficially owned are: none, $1-$10,000, $10,001-$50,000, $50,001-$100,000, $100,001-$500,000, $500,001-$1,000,000, or over $1,000,000.

 

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INVESTMENT ADVISORY AGREEMENT

Overview of Our Investment Adviser

Management Services

Our investment adviser, Fifth Street Management, is registered as an investment adviser under the Investment Advisers Act of 1940, or the “Advisers Act.” Our investment adviser serves pursuant to the investment advisory agreement in accordance with the 1940 Act. Subject to the overall supervision of our Board of Directors, our investment adviser manages our day-to-day operations and provides us with investment advisory services. Under the terms of the investment advisory agreement, our investment adviser:

 

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determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

 

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determines what securities we purchase, retain or sell;

 

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identifies, evaluates and negotiates the structure of the investments we make; and

 

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executes, monitors and services the investments we make.

Our investment adviser’s services under the investment advisory agreement may not be exclusive and it is free to furnish similar services to other entities so long as its services to us are not impaired.

Management Fee

We pay our investment adviser a fee for its services under the investment advisory agreement consisting of two components — a base management fee and an incentive fee. The cost of both the base management fee payable to our investment adviser and any incentive fees earned by our investment adviser will ultimately be borne by our common stockholders.

Base Management Fee

The base management fee is calculated at an annual rate of 2% of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). The base management fee is payable quarterly in arrears, and is calculated based on the value of our 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 will be appropriately pro rated.

Incentive Fee

The incentive fee has two parts. The first part is calculated and payable quarterly in arrears based on our “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 we receive from portfolio companies), (ii) any gain realized on the extinguishment of our own debt and (iii) any other income of any kind that we are required to distribute to our stockholders in order to maintain our RIC status) accrued during the fiscal quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding 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 we have 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 our 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. Our net investment income used to calculate this

 

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part of the incentive fee is also included in the amount of our gross assets used to calculate the 2% base management fee. The operation of the incentive fee with respect to our Pre-Incentive Fee Net Investment Income for each quarter is as follows:

 

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no incentive fee is payable to the investment adviser in any fiscal quarter in which our Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);

 

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100% of our 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. We refer to this portion of our 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 our investment adviser with an incentive fee of 20% on all of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when our Pre- Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and

 

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20% of the amount of our 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.

The following is a graphical representation of the calculation of the income-related portion of the incentive fee:

 

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) and equals 20% of our 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, provided that, the incentive fee determined as of September 30, 2008 was calculated for a period of shorter than twelve calendar months to take into account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation from inception.

Example 1: Income Related Portion of Incentive Fee for Each Fiscal Quarter

Alternative 1

Assumptions

Investment income (including interest, dividends, fees, etc.) = 1.25%

Hurdle rate(1) = 2%

Management fee(2) = 0.5%

Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%

Pre-Incentive Fee Net Investment Income

(investment income – (management fee + other expenses) = 0.55%

 

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Pre-Incentive Fee Net Investment Income does not exceed hurdle rate, therefore there is no income-related incentive fee.

Alternative 2

Assumptions

Investment income (including interest, dividends, fees, etc.) = 2.9%

Hurdle rate(1) = 2%

Management fee(2) = 0.5%

Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%

Pre-Incentive Fee Net Investment Income

(investment income – (management fee + other expenses) = 2.2%

 

Pre-Incentive Fee Net Investment Income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision, therefore the income related portion of the incentive fee is 0.2%.

Alternative 3

Assumptions

Investment income (including interest, dividends, fees, etc.) = 3.5%

Hurdle rate(1) = 2%

Management fee(2) = 0.5%

Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%

Pre-Incentive Fee Net Investment Income

(investment income – (management fee + other expenses) = 2.8%

Incentive fee = 100% × Pre-Incentive Fee Net Investment Income (subject to “catch-up”)(4)

Incentive fee = 100% × “catch-up” + (20% × (Pre-Incentive Fee Net Investment Income – 2.5%))

 

 

Pre-Incentive Fee Net Investment Income exceeds the hurdle rate, and fully satisfies the “catch-up” provision, therefore the income related portion of the incentive fee is 0.56%.

 

 

(1)	Represents 8% annualized hurdle rate.

 

(2)	Represents 2% annualized base management fee.

 

(3)	Excludes organizational and offering expenses.

 

(4)	The “catch-up” provision is intended to provide our investment adviser with an incentive fee of 20% on all Pre- Incentive Fee Net Investment Income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter.

 

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Example 2: Capital Gains Portion of Incentive Fee(*):

Alternative 1:

Assumptions

Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment B”)

Year 2: Investment A sold for $50 million and fair market value (“FMV”) of Investment B determined to be $32 million

Year 3: FMV of Investment B determined to be $25 million

Year 4: Investment B sold for $31 million

The capital gains portion of the incentive fee would be:

Year 1: None

Year 2: Capital gains incentive fee of $6 million — ($30 million realized capital gains on sale of Investment A multiplied by 20%)

Year 3: None — $5 million (20% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital depreciation)) less $6 million (previous capital gains fee paid in Year 2)

Year 4: Capital gains incentive fee of $200,000 — $6.2 million ($31 million cumulative realized capital gains multiplied by 20%) less $6 million (capital gains incentive fee taken in Year 2)

Alternative 2

Assumptions

Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”) and $25 million investment made in Company C (“Investment C”)

Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million

Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million

Year 4: FMV of Investment B determined to be $24 million

Year 5: Investment B sold for $20 million

The capital gains incentive fee, if any, would be:

Year 1: None

Year 2: $5 million capital gains incentive fee — 20% multiplied by $25 million ($30 million realized capital gains on Investment A less unrealized capital depreciation on Investment B)

Year 3: $1.4 million capital gains incentive fee(1) — $6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains less $3 million unrealized capital depreciation)) less $5 million capital gains incentive fee received in Year 2

Year 4: None

 

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Year 5: None — $5 million (20% multiplied by $25 million (cumulative realized capital gains of $35 million less realized capital losses of $10 million)) less $6.4 million cumulative capital gains incentive fee paid in Year 2 and Year 3(2)

 

 

*	The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those shown in this example.

 

(1)

As illustrated in Year 3 of Alternative 1 above, if Fifth Street were to be wound up on a date other than its fiscal year end of any year, Fifth Street may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if Fifth Street had been wound up on its fiscal year end of such year.

 

(2)	As noted above, it is possible that the cumulative aggregate capital gains fee received by our investment adviser ($6.4 million) is effectively greater than $5 million (20% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($25 million)).

Payment of Our Expenses

Our primary operating expenses are the payment of a base management fee and any incentive fees under the investment advisory agreement and the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement. Our investment management fee compensates our investment adviser for its work in identifying, evaluating, negotiating, executing and servicing our investments. We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:

 

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offering expenses;

 

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the investigation and monitoring of our investments;

 

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the cost of calculating our net asset value;

 

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the cost of effecting sales and repurchases of shares of our common stock and other securities;

 

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management and incentive fees payable pursuant to the investment advisory agreement;

 

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fees payable to third parties relating to, or associated with, making investments and valuing investments (including third-party valuation firms);

 

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transfer agent and custodial fees;

 

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fees and expenses associated with marketing efforts (including attendance at investment conferences and similar events);

 

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federal and state registration fees;

 

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any exchange listing fees;

 

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federal, state and local taxes;

 

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independent directors’ fees and expenses;

 

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brokerage commissions;

 

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costs of proxy statements, stockholders’ reports and notices;

 

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costs of preparing government filings, including periodic and current reports with the SEC;

 

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fidelity bond, liability insurance and other insurance premiums; and

 

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printing, mailing, independent accountants and outside legal costs and all other direct expenses incurred by either our investment adviser or us in connection with administering our business, including payments under the administration agreement that will be based upon our allocable portion of overhead and other expenses

 

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incurred by FSC, Inc. in performing its obligations under the administration agreement and the compensation of our chief financial officer and chief compliance officer, and their staff. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future.

Duration and Termination

The investment advisory agreement was first approved by our Board of Directors on December 13, 2007 and by a majority of the limited partners of Fifth Street Mezzanine Partners III, L.P. through a written consent first solicited on December 14, 2007. On March 14, 2008, our Board of Directors, including all of the directors who are not “interested persons” as defined in the 1940 Act, approved an amendment to the investment advisory agreement that revised the investment advisory agreement to clarify the calculation of the base management fee. Such amendment was also approved by a majority of our outstanding voting securities through a written consent first solicited on April 7, 2008. At a meeting of the Board held on March 1, 2011, the Board, including a majority of the independent directors, approved the annual continuation of the investment advisory agreement, and then on May 2, 2011, the investment advisory agreement was further amended, as approved by the Board, to memorialize our investment adviser’s waiver of management fees on any assets held in the form of cash and cash equivalents. Unless earlier terminated as described below, the investment advisory agreement, as amended, will remain in effect for a period of two years from the date it was approved by the Board of Directors and will remain in effect from year-to-year thereafter if approved annually by the Board of Directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case, approval by a majority of our directors who are not interested persons. The investment advisory agreement will automatically terminate in the event of its assignment. The investment advisory agreement may be terminated by either party without penalty upon not more than 60 days’ written notice to the other. The investment advisory agreement may also be terminated, without penalty, upon the vote of a majority of our outstanding voting securities.

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, our 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 us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our investment adviser’s services under the investment advisory agreement or otherwise as our investment adviser.

Organization of our Investment Adviser

Our investment adviser is a Delaware limited liability company that registered as an investment adviser under the Advisers Act. The principal address of our investment adviser is 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831.

Board Approval of the Investment Advisory Agreement

At a meeting of our Board of Directors held on March 1, 2011, our Board of Directors unanimously voted to approve the investment advisory agreement. In reaching a decision to approve the investment advisory agreement, the Board of Directors reviewed a significant amount of information and considered, among other things:

 

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the nature, quality and extent of the advisory and other services to be provided to us by Fifth Street Management;

 

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the fee structures of comparable externally managed business development companies that engage in similar investing activities;

 

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our projected operating expenses and expense ratio compared to business development companies with similar investment objectives;

 

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•

any existing and potential sources of indirect income to Fifth Street Management from its relationship with us and the profitability of that relationship, including through the investment advisory agreement;

 

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information about the services to be performed and the personnel performing such services under the investment advisory agreement;

 

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the organizational capability and financial condition of Fifth Street Management and its affiliates; and

 

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various other matters.

Based on the information reviewed and the discussions detailed above, the Board of Directors, including all of the directors who are not “interested persons” as defined in the 1940 Act, concluded that the investment advisory fee rates and terms are reasonable in relation to the services provided and approved the investment advisory agreement and the administration agreement as being in the best interests of our stockholders.

 

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ADMINISTRATION AGREEMENT

We have also entered into an administration agreement with FSC, Inc. under which FSC, Inc. provides administrative services to us, including office facilities and equipment and clerical, bookkeeping and record-keeping services at such facilities. Under the administration agreement, FSC, Inc. also performs, or oversees the performance of, our required administrative services, which includes being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, FSC, Inc. assists us in determining and publishing our net asset value, overseeing the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others. For providing these services, facilities and personnel, we reimburse 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 our allocable portion of the costs of compensation and related expenses of our chief financial officer and chief compliance officer, and their staff. 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. 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 offer to provide on our behalf managerial assistance to our portfolio companies. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.

The administration 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, FSC, Inc. and its officers, managers, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of services under the administration agreement or otherwise as administrator for us.

LICENSE 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 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.

 

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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

We have entered into an investment advisory agreement with Fifth Street Management, our investment adviser. Fifth Street Management is controlled by Leonard M. Tannenbaum, its managing member and the chairman of our Board and our chief executive officer. In addition, Bernard D. Berman, our president, chief compliance officer and secretary, and Ivelin M. Dimitrov, our chief investment officer, are partners of our investment adviser. 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. 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 we receive from portfolio companies), (ii) any gain realized on the extinguishment of our own debt and (iii) any other income of any kind that we are required to distribute to our stockholders in order to maintain our RIC status) accrued during the fiscal quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding 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 we have not yet received in cash. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee.

The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. Since we entered into the investment advisory agreement in December 2007, we have paid our investment adviser $8.4 million, $13.7 million, $20.0 million and $36.5 million for the fiscal years ended September 30, 2008, 2009, 2010 and 2011 respectively, under the investment advisory agreement.

Pursuant to the administration agreement with FSC, Inc., which is controlled by Mr. Tannenbaum, FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will pay FSC, Inc. our allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and our chief compliance officer, and their staff. 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. 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. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. Since we entered into the administration agreement in December 2007, we have paid FSC, Inc. $1.6 million, $1.3 million, $2.0 million and $2.9 million for the fiscal years ended September 30, 2008, 2009, 2010 and 2011 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.

 

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CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS

The following table sets forth, as of June 30, 2012, the beneficial ownership of each director, each executive officer, each person known to us to beneficially own 5% or more of the outstanding shares of our common stock, and the executive officers and directors as a group. Percentage of beneficial ownership is based on 82,462,402 shares of common stock outstanding as of June 30, 2012.

Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. Ownership information for those persons who beneficially own 5% or more of our shares of common stock is based upon filings by such persons with the SEC and other information obtained from such persons, if available.

Unless otherwise indicated, the company believes that each beneficial owner set forth in the table has sole voting and investment power and has the same address as the company. The company’s directors are divided into two groups — interested directors and independent directors. Interested directors are “interested persons” of Fifth Street Finance Corp. as defined in Section 2(a)(19) of the Investment Company Act of 1940 (the “1940 Act”). Unless otherwise indicated, the address of all executive officers and directors is c/o Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606.

 

Name		Number of Shares Owned Beneficially				Percentage
Interested Directors:
Leonard M. Tannenbaum(1)			1,909,169				2.32	%
Bernard D. Berman(2)			17,968				*
Independent Directors:
Brian S. Dunn(3)			9,000				*
Richard P. Dutkiewicz(3)			5,456				*
Byron J. Haney(4)			10,000				*
Frank C. Meyer			132,728				*
Douglas F. Ray.			3,414				*
Executive Officers:
Alexander C. Frank			10,399				*
Ivelin M. Dimitrov			15,022				*
All officers and directors as a group (nine persons)			2,113,156				2.56	%

 

 

*	Represents less than 1%.

 

(1)

The total number of shares reported includes 1,854,169 shares of which Mr. Tannenbaum is the direct beneficial owner (including 581,301 shares held in margin accounts) and 55,000 shares owned by the Leonard M. Tannenbaum Foundation, a 501(c)(3) corporation for which Mr. Tannenbaum serves as the President. With respect to the shares held by the Leonard M. Tannenbaum Foundation, Mr. Tannenbaum has sole voting and investment power over all such shares, but has no pecuniary interest therein.

 

(2)	Includes 15,600 shares held in margin accounts.

 

(3)	Shares are held in a brokerage account and may be used as security on a margin basis.

 

(4)	Includes 5,000 shares held in a margin account.

 

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The following table sets forth, as of June 30, 2012, the dollar range of our equity securities that is beneficially owned by each of our directors. We are not part of a “family of investment companies,” as that term is defined in the 1940 Act.

 

		Dollar Range of Equity Securities Beneficially Owned(1)(2)(3)
Interested Directors:
Leonard M. Tannenbaum		Over $1,000,000
Bernard D. Berman		$100,001 — $500,000
Independent Directors:
Brian S. Dunn		$50,001 — $100,000
Richard P. Dutkiewicz		$50,001 — $100,000
Byron J. Haney		$50,001 — $100,000
Frank C. Meyer		Over $1,000,000
Douglas F. Ray		$10,001 — $50,000

 

 

(1)	Beneficial ownership has been determined in accordance with Rule 16a-1(a)(2) of the Exchange Act.

 

(2)	The dollar range of equity securities beneficially owned in us is based on the price for our common stock of $9.98 on June 30, 2012 on the NASDAQ Global Select Market.

 

(3)	The dollar range of equity securities beneficially owned are: none, $1 — $10,000, $10,001 — $50,000, $50,001 — $100,000, $100,001 — $500,000, $500,001 — $1,000,000, or over $1,000,000.

 

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DIVIDEND REINVESTMENT PLAN

We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder elects to receive cash as provided below. As a result, if our Board of Directors authorizes, and we declare, a cash distribution, then our stockholders who have not “opted out” of our dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares of our common stock, rather than receiving the cash distributions.

No action will be required on the part of a registered stockholder to have their cash distributions reinvested in shares of our common stock. A registered stockholder may elect to receive an entire distribution in cash by notifying American Stock Transfer & Trust Company LLC, the plan administrator and our transfer agent and registrar, in writing so that such notice is received by the plan administrator no later than 3 days prior to the dividend payment date for distributions to stockholders. The plan administrator will set up an account for shares acquired through the plan for each stockholder who has not elected to receive distributions in cash and hold such shares in non-certificated form. Upon request by a stockholder participating in the plan, received in writing not less than 3 days prior to the dividend payment date, the plan administrator will, instead of crediting shares to the participant’s account, issue a certificate registered in the participant’s name for the number of whole shares of our common stock and a check for any fractional share. Those stockholders whose shares are held by a broker or other financial intermediary may receive distributions in cash by notifying their broker or other financial intermediary of their election. If the stockholder request is received less than 3 days prior to the dividend payment date then that dividend will be reinvested. However, all subsequent dividends will be paid out in cash on all balances.

We intend to use newly issued shares to implement the plan when our shares are trading at a premium to net asset value. Under such circumstances, the number of shares to be issued to a stockholder is determined by dividing the total dollar amount of the distribution payable to such stockholder by the greater of (a) the current net asset value per share of our common stock, and (b) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our Board of Directors. Market price per share on that date will be the closing price for such shares on the NASDAQ Global Select Market or, if no sale is reported for such day, at the average of their reported bid and asked prices. We reserve the right to purchase shares in the open market in connection with our implementation of the plan if either (1) the price at which newly-issued shares are to be credited does not exceed 110% of the last determined net asset value of the shares; or (2) we have advised the plan administrator that since such net asset value was last determined, we have become aware of events that indicate the possibility of a material change in the per share net asset value as a result of which the net asset value of the shares on the payment date might be higher than the price at which the plan administrator would credit newly-issued shares to stockholders. Shares purchased in open market transactions by the plan administrator will be allocated to a stockholder based on the average purchase price, excluding any brokerage charges or other charges, of all shares of common stock purchased in the open market.

There will be no brokerage charges or other charges for dividend reinvestment to stockholders who participate in the plan. We will pay the plan administrator’s fees under the plan. If a participant elects by written notice to the plan administrator to have the plan administrator sell part or all of the shares held by the plan administrator in the participant’s account and remit the proceeds to the participant, the plan administrator is authorized to deduct a $15.00 transaction fee plus a $0.10 per share brokerage commissions from the proceeds.

Stockholders who receive distributions in the form of stock generally are subject to the same federal, state and local tax consequences as are stockholders who elect to receive their distributions in cash; however, since their cash dividends will be reinvested, such stockholders will not receive cash with which to pay any applicable taxes on reinvested dividends. A stockholder’s basis for determining gain or loss upon the sale of stock received in a distribution from us will be equal to the total dollar amount of the distribution payable to the stockholder. Any stock received in a distribution will have a holding period for tax purposes commencing on the day following the day on which the shares are credited to the stockholder’s account.

Participants may terminate their accounts under the plan by notifying the plan administrator via its website at www.amstock.com, by filling out the transaction request form located at the bottom of their statement and sending it to the plan administrator at P.O. Box 922, Wall Street Station, New York, New York, 10269-0560, or by calling the plan administrators at 1-866-665-2281.

We may terminate the plan upon notice in writing mailed to each participant at least 30 days prior to any record date for the payment of any distribution by us. All correspondence concerning the plan should be directed to the plan administrator by mail at 6201 15th Avenue, Brooklyn, New York, 11219, or by telephone at 1-866-665-2281.

 

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DESCRIPTION OF OUR CAPITAL STOCK

The following description summarizes material provisions of the Delaware General Corporation Law and our restated certificate of incorporation and amended and restated bylaws. This summary is not necessarily complete, and we refer you to the Delaware General Corporation Law and our restated certificate of incorporation and amended and restated bylaws for a more detailed description of the provisions summarized below.

Capital Stock

Our authorized capital stock consists of 150,000,000 shares of common stock, par value $0.01 per share, of which 82,462,402 shares were outstanding as of June 30, 2012.

Our common stock is listed on the NASDAQ Global Select Market under the ticker symbol “FSC.” No stock has been authorized for issuance under any equity compensation plans. Under Delaware law, our stockholders generally will not be personally liable for our debts or obligations.

Set forth below is chart describing the classes of our equity securities outstanding as of March 31, 2012:

 

(1)		(2)				(3)				(4)
Title of Class		Amount Authorized				Amount Held by us or for Our Account				Amount Outstanding Exclusive of Amount Under Column 3
Common Stock			150,000,000				—				82,462,402

Under the terms of our restated certificate of incorporation, all shares of our common stock will have equal rights as to earnings, assets, dividends and voting and, when they are issued, will be duly authorized, validly issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our Board of Directors and declared by us out of funds legally available therefore. Shares of our common stock will have no preemptive, exchange, conversion or redemption rights and will be freely transferable, except where their transfer is restricted by federal and state securities laws or by contract. In the event of our liquidation, dissolution or winding up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for distribution after we pay all debts and other liabilities. Each share of our common stock will be entitled to one vote on all matters submitted to a vote of stockholders, including the election of directors. The holders of our common stock will possess exclusive voting power. There will be no cumulative voting in the election of directors, which means that holders of a majority of the outstanding shares of common stock will be able to elect all of our directors, and holders of less than a majority of such shares will be unable to elect any director.

Limitation on Liability of Directors and Officers; Indemnification and Advance of Expenses

Under our restated certificate of incorporation, we will fully indemnify any person who was or is involved in any actual or threatened action, suit or proceeding (whether civil, criminal, administrative or investigative) by reason of the fact that such person is or was one of our directors or officers or is or was serving at our request as a director or officer of another corporation, partnership, limited liability company, joint venture, trust or other enterprise, including service with respect to an employee benefit plan, against expenses (including attorney’s fees), judgments, fines and amounts paid or to be paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding. Our restated certificate of incorporation also provides that our directors will not be personally liable for monetary damages to us for breaches of their fiduciary duty as directors, except for a breach of their duty of loyalty to us or our stockholders, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, or for any transaction from which the director derived an improper personal benefit. So long as we are regulated under the 1940 Act, the above indemnification and limitation of liability will be limited by the 1940 Act or by any valid rule, regulation or order of the SEC thereunder. The 1940 Act provides, among other things, that a company may not indemnify any director or officer against liability to it or its stockholders to which he or she might otherwise be subject by reason of his or her willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her

 

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office unless a determination is made by final decision of a court, by vote of a majority of a quorum of directors who are disinterested, non-party directors or by independent legal counsel that the liability for which indemnification is sought did not arise out of the foregoing conduct.

Delaware law also provides that indemnification permitted under the law shall not be deemed exclusive of any other rights to which the directors and officers may be entitled under the corporation’s bylaws, any agreement, a vote of stockholders or otherwise.

Our restated certificate of incorporation permits us to secure insurance on behalf of any person who is or was or has agreed to become a director or officer of Fifth Street or is or was serving at our request as a director or officer of another enterprise for any liability arising out of his or her actions, regardless of whether the Delaware General Corporation Law would permit indemnification. We have obtained liability insurance for our officers and directors.

Delaware Law and Certain Certificate of Incorporation and Bylaw Provisions; Anti-Takeover Measures

We are subject to the provisions of Section 203 of the General Corporation Law of Delaware. In general, the statute prohibits a publicly held Delaware corporation from engaging in a “business combination” with “interested stockholders” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A “business combination” includes certain mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to exceptions, an “interested stockholder” is a person who, together with his, her or its affiliates and associates, owns, or within three years did own, 15% or more of the corporation’s voting stock.

Our restated certificate of incorporation and amended and restated bylaws provide that:

 

•

the Board of Directors be divided into three classes, as nearly equal in size as possible, with staggered three- year terms;

 

•

directors may be removed only for cause by the affirmative vote of the holders of two-thirds of the shares of our capital stock entitled to vote; and

 

•

any vacancy on the Board of Directors, however the vacancy occurs, including a vacancy due to an enlargement of the Board of Directors, may only be filled by vote of the directors then in office.

The classification of our Board of Directors and the limitations on removal of directors and filling of vacancies could have the effect of making it more difficult for a third party to acquire us, or of discouraging a third party from acquiring us.

Our restated certificate of incorporation and amended and restated bylaws also provide that:

 

•

any action required or permitted to be taken by the stockholders at an annual meeting or special meeting of stockholders may only be taken if it is properly brought before such meeting and may not be taken by written action in lieu of a meeting; and

 

•

special meetings of the stockholders may only be called by our Board of Directors, chairman or chief executive officer.

Our amended and restated bylaws provide that, in order for any matter to be considered “properly brought” before a meeting, a stockholder must comply with requirements regarding advance notice to us. These provisions could delay until the next stockholders’ meeting stockholder actions which are favored by the holders of a majority of our outstanding voting securities. These provisions may also discourage another person or entity from making a tender offer for our common stock, because such person or entity, even if it acquired a majority of our outstanding voting securities, would be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders meeting, and not by written consent.

Delaware’s corporation law provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation’s certificate of incorporation or bylaws, unless a corporation’s certificate of incorporation or bylaws requires a greater percentage. Under our amended and restated bylaws and our

 

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restated certificate of incorporation, the affirmative vote of the holders of at least 66 ²/₃% of the shares of our capital stock entitled to vote will be required to amend or repeal any of the provisions of our amended and restated bylaws.

However, the vote of at least 66 ²/₃% of the shares of our capital stock then outstanding and entitled to vote in the election of directors, voting together as a single class, will be required to amend or repeal any provision of our restated certificate of incorporation pertaining to the Board of Directors, limitation of liability, indemnification, stockholder action or amendments to our certificate of incorporation. In addition, our restated certificate of incorporation permits our Board of Directors to amend or repeal our amended and restated bylaws by a majority vote.

 

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DESCRIPTION OF OUR DEBT SECURITIES

We may issue debt securities in one or more series. The specific terms of each series of debt securities will be described in the particular prospectus supplement relating to that series. The prospectus supplement may or may not modify the general terms found in this prospectus and will be filed with the SEC. For a complete description of the terms of a particular series of debt securities, you should read both this prospectus and the prospectus supplement relating to that particular series.

As required by federal law for all bonds and notes of companies that are publicly offered, the debt securities are governed by a document called an “indenture.” An indenture is a contract between us and a financial institution acting as trustee on your behalf, and is subject to and governed by the Trust Indenture Act of 1939, as amended. The trustee has two main roles. First, the trustee can enforce your rights against us if we default. There are some limitations on the extent to which the trustee acts on your behalf, described in the second paragraph under “Events of Default — Remedies if an Event of Default Occurs.” Second, the trustee performs certain administrative duties for us with respect to the debt securities.

This section is a summary of the material provisions of the indenture, including the general terms of our debt securities and your rights as a holder of such securities. Any accompanying prospectus supplement will describe any other material terms of the debt securities being offered thereunder. This section does not describe every aspect of the debt securities and the indenture. We urge you to read the indenture because it, and not this description, defines your rights as a holder of debt securities. A copy of the form of indenture is attached to the registration statement of which this prospectus is a part. We will file a supplemental indenture with the SEC in connection with any debt offering, at which time the supplemental indenture would be publicly available. See “Available Information” for information on how to obtain a copy of the indenture.

The prospectus supplement, which will accompany this prospectus, will describe the particular series of debt securities being offered by including:

 

•

the designation or title of the series of debt securities;

 

•

the total principal amount of the series of debt securities;

 

•

the percentage of the principal amount at which the series of debt securities will be offered;

 

•

the date or dates on which principal will be payable;

 

•

the rate or rates (which may be either fixed or variable) and/or the method of determining such rate or rates of interest, if any;

 

•

the date or dates from which any interest will accrue, or the method of determining such date or dates, and the date or dates on which any interest will be payable;

 

•

whether any interest may be paid by issuing additional securities of the same series in lieu of cash (and the terms upon which any such interest may be paid by issuing additional securities);

 

•

the terms for redemption, extension or early repayment, if any;

 

•

the currencies in which the series of debt securities are issued and payable;

 

•

whether the amount of payments of principal, premium or interest, if any, on a series of debt securities will be determined with reference to an index, formula or other method (which could be based on one or more currencies, commodities, equity indices or other indices) and how these amounts will be determined;

 

•

the place or places, if any, other than or in addition to the Borough of Manhattan in the City of New York, of payment, transfer, conversion and/or exchange of the debt securities;

 

•

the denominations in which the offered debt securities will be issued (if other than $1,000 and any integral multiple thereof);

 

•

the provision for any sinking fund;

 

•

any restrictive covenants;

 

•

any Events of Default;

 

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•

whether the series of debt securities are issuable in certificated form;

 

•

any provisions for defeasance or covenant defeasance;

 

•

any special federal income tax implications, including, if applicable, federal income tax considerations relating to original issue discount;

 

•

whether and under what circumstances we will pay additional amounts in respect of any tax, assessment or governmental charge and, if so, whether we will have the option to redeem the debt securities rather than pay the additional amounts (and the terms of this option);

 

•

any provisions for convertibility or exchangeability of the debt securities into or for any other securities;

 

•

whether the debt securities are subject to subordination and the terms of such subordination;

 

•

whether the debt securities are secured and the terms of any security interests;

 

•

the listing, if any, on a securities exchange; and

 

•

any other terms.

The debt securities may be secured or unsecured obligations. Under the provisions of the 1940 Act, we are permitted, as a BDC, to issue debt only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of debt. Unless the prospectus supplement states otherwise, principal (and premium, if any) and interest, if any, will be paid by us in immediately available funds.

General

The indenture provides that any debt securities proposed to be sold under this prospectus and the accompanying prospectus supplement (“offered debt securities”) may be issued under the indenture in one or more series.

For purposes of this prospectus, any reference to the payment of principal of or premium or interest, if any, on debt securities will include additional amounts if required by the terms of the debt securities.

The indenture does not limit the amount of debt securities that may be issued thereunder from time to time. Debt securities issued under the indenture, when a single trustee is acting for all debt securities issued under the indenture, are called the “indenture securities”. The indenture also provides that there may be more than one trustee thereunder, each with respect to one or more different series of indenture securities. See “Resignation of Trustee” below. At a time when two or more trustees are acting under the indenture, each with respect to only certain series, the term “indenture securities” means the one or more series of debt securities with respect to which each respective trustee is acting. In the event that there is more than one trustee under the indenture, the powers and trust obligations of each trustee described in this prospectus will extend only to the one or more series of indenture securities for which it is trustee. If two or more trustees are acting under the indenture, then the indenture securities for which each trustee is acting would be treated as if issued under separate indentures.

The indenture does not contain any provisions that give you protection in the event we issue a large amount of debt or we are acquired by another entity.

The holders of our debt securities will not have veto power or a vote in approving any changes to our investment or operational policies.

We refer you to the prospectus supplement for information with respect to any deletions from, modifications of or additions to the Events of Default or our covenants that are described below, including any addition of a covenant or other provision providing event risk protection or similar protection.

We have the ability to issue indenture securities with terms different from those of indenture securities previously issued and, without the consent of the holders thereof, to reopen a previous issue of a series of indenture securities and issue additional indenture securities of that series unless the reopening was restricted when that series was created.

 

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Conversion and Exchange

If any debt securities are convertible into or exchangeable for other securities, the prospectus supplement will explain the terms and conditions of the conversion or exchange, including the conversion price or exchange ratio (or the calculation method), the conversion or exchange period (or how the period will be determined), if conversion or exchange will be mandatory or at the option of the holder or us, provisions for adjusting the conversion price or the exchange ratio and provisions affecting conversion or exchange in the event of the redemption of the underlying debt securities. These terms may also include provisions under which the number or amount of other securities to be received by the holders of the debt securities upon conversion or exchange would be calculated according to the market price of the other securities as of a time stated in the prospectus supplement.

Issuance of Securities in Registered Form

We may issue the debt securities in registered form, in which case we may issue them either in book-entry form only or in “certificated” form. Debt securities issued in book-entry form will be represented by global securities. We expect that we will usually issue debt securities in book-entry only form represented by global securities.

Book-Entry Holders

We will issue registered debt securities in book-entry form only, unless we specify otherwise in the applicable prospectus supplement. This means debt securities will be represented by one or more global securities registered in the name of a depositary that will hold them on behalf of financial institutions that participate in the depositary’s book-entry system. These participating institutions, in turn, hold beneficial interests in the debt securities held by the depositary or its nominee. These institutions may hold these interests on behalf of themselves or customers.

Under the indenture, only the person in whose name a debt security is registered is recognized as the holder of that debt security. Consequently, for debt securities issued in book-entry form, we will recognize only the depositary as the holder of the debt securities and we will make all payments on the debt securities to the depositary. The depositary will then pass along the payments it receives to its participants, which in turn will pass the payments along to their customers who are the beneficial owners. The depositary and its participants do so under agreements they have made with one another or with their customers; they are not obligated to do so under the terms of the debt securities.

As a result, investors will not own debt securities directly. Instead, they will own beneficial interests in a global security, through a bank, broker or other financial institution that participates in the depositary’s book-entry system or holds an interest through a participant. As long as the debt securities are represented by one or more global securities, investors will be indirect holders, and not holders, of the debt securities.

Street Name Holders

In the future, we may issue debt securities in certificated form or terminate a global security. In these cases, investors may choose to hold their debt securities in their own names or in “street name.” Debt securities held in street name are registered in the name of a bank, broker or other financial institution chosen by the investor, and the investor would hold a beneficial interest in those debt securities through the account he or she maintains at that institution.

For debt securities held in street name, we will recognize only the intermediary banks, brokers and other financial institutions in whose names the debt securities are registered as the holders of those debt securities and we will make all payments on those debt securities to them. These institutions will pass along the payments they receive to their customers who are the beneficial owners, but only because they agree to do so in their customer agreements or because they are legally required to do so. Investors who hold debt securities in street name will be indirect holders, and not holders, of the debt securities.

Legal Holders

Our obligations, as well as the obligations of the applicable trustee and those of any third parties employed by us or the applicable trustee, run only to the legal holders of the debt securities. We do not have obligations to

 

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investors who hold beneficial interests in global securities, in street name or by any other indirect means. This will be the case whether an investor chooses to be an indirect holder of a debt security or has no choice because we are issuing the debt securities only in book-entry form.

For example, once we make a payment or give a notice to the holder, we have no further responsibility for the payment or notice even if that holder is required, under agreements with depositary participants or customers or by law, to pass it along to the indirect holders but does not do so. Similarly, if we want to obtain the approval of the holders for any purpose (for example, to amend an indenture or to relieve us of the consequences of a default or of our obligation to comply with a particular provision of an indenture), we would seek the approval only from the holders, and not the indirect holders, of the debt securities. Whether and how the holders contact the indirect holders is up to the holders.

When we refer to you in this “Description of Our Debt Securities,” we mean those who invest in the debt securities being offered by this prospectus, whether they are the holders or only indirect holders of those debt securities. When we refer to your debt securities, we mean the debt securities in which you hold a direct or indirect interest.

Special Considerations for Indirect Holders

If you hold debt securities through a bank, broker or other financial institution, either in book-entry form or in street name, we urge you to check with that institution to find out:

 

•

how it handles securities payments and notices,

 

•

whether it imposes fees or charges,

 

•

how it would handle a request for the holders’ consent, if ever required,

 

•

whether and how you can instruct it to send you debt securities registered in your own name so you can be a holder, if that is permitted in the future for a particular series of debt securities,

 

•

how it would exercise rights under the debt securities if there were a default or other event triggering the need for holders to act to protect their interests, and

 

•

if the debt securities are in book-entry form, how the depositary’s rules and procedures will affect these matters.

Global Securities

As noted above, we usually will issue debt securities as registered securities in book-entry form only. A global security represents one or any other number of individual debt securities. Generally, all debt securities represented by the same global securities will have the same terms.

Each debt security issued in book-entry form will be represented by a global security that we deposit with and register in the name of a financial institution or its nominee that we select. The financial institution that we select for this purpose is called the depositary. Unless we specify otherwise in the applicable prospectus supplement, The Depository Trust Company, New York, New York, known as DTC, will be the depositary for all debt securities issued in book-entry form.

A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination situations arise. We describe those situations below under “Special Situations when a Global Security Will Be Terminated”. As a result of these arrangements, the depositary, or its nominee, will be the sole registered owner and holder of all debt securities represented by a global security, and investors will be permitted to own only beneficial interests in a global security. Beneficial interests must be held by means of an account with a broker, bank or other financial institution that in turn has an account with the depositary or with another institution that has an account with the depositary. Thus, an investor whose security is represented by a global security will not be a holder of the debt security, but only an indirect holder of a beneficial interest in the global security.

Special Considerations for Global Securities

As an indirect holder, an investor’s rights relating to a global security will be governed by the account rules of the investor’s financial institution and of the depositary, as well as general laws relating to securities transfers. The depositary that holds the global security will be considered the holder of the debt securities represented by the global security.

 

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If debt securities are issued only in the form of a global security, an investor should be aware of the following:

 

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An investor cannot cause the debt securities to be registered in his or her name, and cannot obtain certificates for his or her interest in the debt securities, except in the special situations we describe below.

 

•

An investor will be an indirect holder and must look to his or her own bank or broker for payments on the debt securities and protection of his or her legal rights relating to the debt securities, as we describe under “Issuance of Securities in Registered Form” above.

 

•

An investor may not be able to sell interests in the debt securities to some insurance companies and other institutions that are required by law to own their securities in non-book-entry form.

 

•

An investor may not be able to pledge his or her interest in a global security in circumstances where certificates representing the debt securities must be delivered to the lender or other beneficiary of the pledge in order for the pledge to be effective.

 

•

The depositary’s policies, which may change from time to time, will govern payments, transfers, exchanges and other matters relating to an investor’s interest in a global security. We and the trustee have no responsibility for any aspect of the depositary’s actions or for its records of ownership interests in a global security. We and the trustee also do not supervise the depositary in any way.

 

•

If we redeem less than all the debt securities of a particular series being redeemed, DTC’s practice is to determine by lot the amount to be redeemed from each of its participants holding that series.

 

•

An investor is required to give notice of exercise of any option to elect repayment of its debt securities, through its participant, to the applicable trustee and to deliver the related debt securities by causing its participant to transfer its interest in those debt securities, on DTC’s records, to the applicable trustee.

 

•

DTC requires that those who purchase and sell interests in a global security deposited in its book-entry system use immediately available funds. Your broker or bank may also require you to use immediately available funds when purchasing or selling interests in a global security.

 

•

Financial institutions that participate in the depositary’s book-entry system, and through which an investor holds its interest in a global security, may also have their own policies affecting payments, notices and other matters relating to the debt securities. There may be more than one financial intermediary in the chain of ownership for an investor. We do not monitor and are not responsible for the actions of any of those intermediaries.

Special Situations when a Global Security will be Terminated

If a global security is terminated, interests in it will be exchanged for certificates in non-book-entry form (certificated securities). After that exchange, the choice of whether to hold the certificated debt securities directly or in street name will be up to the investor. Investors must consult their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they will be holders. We have described the rights of legal holders and street name investors under “Issuance of Securities in Registered Form” above.

The prospectus supplement may list situations for terminating a global security that would apply only to the particular series of debt securities covered by the prospectus supplement. If a global security is terminated, only the depositary, and not we or the applicable trustee, is responsible for deciding the names of the investors in whose names the debt securities represented by the global security will be registered and, therefore, who will be the holders of those debt securities.

Payment and Paying Agents

We will pay interest (either in cash or by delivery of additional indenture securities, as applicable) to the person listed in the applicable trustee’s records as the owner of the debt security at the close of business on a particular day in advance of each due date for interest, even if that person no longer owns the debt security on the interest due date. That day, usually about two weeks in advance of the interest due date, is called the “record date.”

 

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Because we will pay all the interest for an interest period to the holders on the record date, holders buying and selling debt securities must work out between themselves the appropriate purchase price. The most common manner is to adjust the sales price of the debt securities to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular interest period. This prorated interest amount is called “accrued interest.”

Payments on Global Securities

We will make payments on a global security in accordance with the applicable policies of the depositary as in effect from time to time. Under those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own beneficial interests in the global security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its participants, as described under “— Special Considerations for Global Securities.”

Payments on Certificated Securities

We will make payments on a certificated debt security as follows. We will pay interest that is due on an interest payment date to the holder of debt securities as shown on the trustee’s records as of the close of business on the regular record date. We will make all payments of principal and premium, if any, by check at the office of the applicable trustee and/or at other offices that may be specified in the prospectus supplement or in a notice to holders against surrender of the debt security.

Alternatively, at our option, we may pay any cash interest that becomes due on the debt security by mailing a check to the holder at his or her address shown on the trustee’s records as of the close of business on the regular record date or by transfer to an account at a bank in the United States, in either case, on the due date.

Payment When Offices Are Closed

If any payment is due on a debt security on a day that is not a business day, we will make the payment on the next day that is a business day. Payments made on the next business day in this situation will be treated under the indenture as if they were made on the original due date, except as otherwise indicated in the attached prospectus supplement. Such payment will not result in a default under any debt security or the indenture, and no interest will accrue on the payment amount from the original due date to the next day that is a business day.

Book-entry and other indirect holders should consult their banks or brokers for information on how they will receive payments on their debt securities.

Events of Default

You will have rights if an Event of Default occurs in respect of the debt securities of your series and is not cured, as described later in this subsection.

The term “Event of Default” in respect of the debt securities of your series means any of the following:

 

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We do not pay the principal of, or any premium on, a debt security of the series on its due date;

 

•

We do not pay interest on a debt security of the series within 30 days of its due date;

 

•

We do not deposit any sinking fund payment in respect of debt securities of the series within 2 business days of its due date;

 

•

We remain in breach of a covenant in respect of debt securities of the series for 60 days after we receive a written notice of default stating we are in breach. The notice must be sent by either the trustee or holders of at least 25% of the principal amount of debt securities of the series;

 

•

We file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur;

 

•

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

 

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•

Any other Event of Default in respect of debt securities of the series described in the prospectus supplement occurs.

An Event of Default for a particular series of debt securities does not necessarily constitute an Event of Default for any other series of debt securities issued under the same or any other indenture. The trustee may withhold notice to the holders of debt securities of any default, except in the payment of principal, premium, interest or sinking or purchase fund installment, if it in good faith considers the withholding of notice to be in the interest of the holders.

Remedies if an Event of Default Occurs

If an Event of Default has occurred and has not been cured, the trustee or the holders of at least 25% in principal amount of the debt securities of the affected series may (and the trustee shall at the request of such holders) declare the entire principal amount of all the debt securities of that series to be due and immediately payable. This is called a declaration of acceleration of maturity. A declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the debt securities of the affected series if (1) we have deposited with the trustee all amounts due and owing with respect to the securities (other than principal that has become due solely by reason of such acceleration) and certain other amounts, and (2) all Events of Default have been cured or waived.

Except in cases of default, where the trustee has some special duties, the trustee is not required to take any action under the indenture at the request of any holders unless the holders offer the trustee reasonable protection from expenses and liability (called an “indemnity”). If reasonable indemnity is provided, the holders of a majority in principal amount of the outstanding debt securities of the relevant series may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or remedy will be treated as a waiver of that right, remedy or Event of Default.

Before you are allowed to bypass your trustee and bring your own lawsuit or other formal legal action or take other steps to enforce your rights or protect your interests relating to the debt securities, the following must occur:

 

•

You must give your trustee written notice that an Event of Default with respect to the relevant series of debt securities has occurred and remains uncured;

 

•

The holders of at least 25% in principal amount of all outstanding debt securities of the relevant series must make a written request that the trustee take action because of the default and must offer reasonable indemnity to the trustee against the cost and other liabilities of taking that action;

 

•

The trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity; and

 

•

The holders of a majority in principal amount of the debt securities of that series must not have given the trustee a direction inconsistent with the above notice during that 60-day period.

However, you are entitled at any time to bring a lawsuit for the payment of money due on your debt securities on or after the due date.

Holders of a majority in principal amount of the debt securities of the affected series may waive any past defaults other than

 

•

in respect of the payment of principal, any premium or interest; or

 

•

in respect of a covenant that cannot be modified or amended without the consent of each holder.

Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request of the trustee and how to declare or cancel an acceleration of maturity.

Each year, we will furnish to each trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the indenture and the debt securities or else specifying any default.

 

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Merger or Consolidation

Under the terms of the indenture, we are generally permitted to consolidate or merge with another entity. We are also permitted to sell all or substantially all of our assets to another entity. However, we may not take any of these actions unless all the following conditions are met:

 

•

Where we merge out of existence or sell our assets, the resulting entity must agree to be legally responsible for our obligations under the debt securities;

 

•

The merger or sale of assets must not cause a default on the debt securities and we must not already be in default (unless the merger or sale would cure the default). For purposes of this no-default test, a default would include an Event of Default that has occurred and has not been cured, as described under “Events of Default” above. A default for this purpose would also include any event that would be an Event of Default if the requirements for giving us a notice of default or our default having to exist for a specific period of time were disregarded;

 

•

We must deliver certain certificates and documents to the trustee; and

 

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We must satisfy any other requirements specified in the prospectus supplement relating to a particular series of debt securities.

Modification or Waiver

There are three types of changes we can make to the indenture and the debt securities issued thereunder.

Changes Requiring Your Approval

First, there are changes that we cannot make to your debt securities without your specific approval. The following is a list of those types of changes:

 

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change the stated maturity of the principal of, or interest on, a debt security or the terms of any sinking fund with respect to any security;

 

•

reduce any amounts due on a debt security;

 

•

reduce the amount of principal payable upon acceleration of the maturity of an original issue discount or indexed security following a default or upon the redemption thereof or the amount thereof provable in a bankruptcy proceeding;

 

•

adversely affect any right of repayment at the holder’s option;

 

•

change the place (except as otherwise described in the prospectus or prospectus supplement) or currency of payment on a debt security;

 

•

impair your right to sue for payment;

 

•

adversely affect any right to convert or exchange a debt security in accordance with its terms;

 

•

modify the subordination provisions in the indenture in a manner that is adverse to holders of the outstanding debt securities;

 

•

reduce the percentage of holders of debt securities whose consent is needed to modify or amend the indenture;

 

•

reduce the percentage of holders of debt securities whose consent is needed to waive compliance with certain provisions of the indenture or to waive certain defaults or reduce the percentage of holders of debt securities required to satisfy quorum or voting requirements at a meeting of holders;

 

•

modify any other aspect of the provisions of the indenture dealing with supplemental indentures with the consent of holders, waiver of past defaults, or the waiver of certain covenants; and

 

•

change any obligation we have to pay additional amounts.

 

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Changes Not Requiring Approval

The second type of change does not require any vote by the holders of the debt securities. This type is limited to clarifications, establishment of the form or terms of new securities of any series as permitted by the indenture and certain other changes that would not adversely affect holders of the outstanding debt securities in any material respect. We also do not need any approval to make any change that affects only debt securities to be issued under the indenture after the change takes effect.

Changes Requiring Majority Approval

Any other change to the indenture and the debt securities would require the following approval:

 

•

If the change affects only one series of debt securities, it must be approved by the holders of a majority in principal amount of that series.

 

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If the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this purpose.

In each case, the required approval must be given by written consent.

The holders of a majority in principal amount of a series of debt securities issued under the indenture, voting together as one class for this purpose, may waive our compliance with some of our covenants applicable to that series of debt securities. However, we cannot obtain a waiver of a payment default or of any of the matters covered by the bullet points included above under “ — Changes Requiring Your Approval.”

Further Details Concerning Voting

When taking a vote, we will use the following rules to decide how much principal to attribute to a debt security:

 

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For original issue discount securities, we will use the principal amount that would be due and payable on the voting date if the maturity of these debt securities were accelerated to that date because of a default.

 

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For debt securities whose principal amount is not known (for example, because it is based on an index), we will use the principal face amount at original issuance or a special rule for that debt security described in the prospectus supplement.

 

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For debt securities denominated in one or more foreign currencies, we will use the U.S. dollar equivalent.

Debt securities will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or redemption or if we, any other obligor, or any affiliate of us or any obligor own such debt securities. Debt securities will also not be eligible to vote if they have been fully defeased as described later under “Defeasance — Full Defeasance.”

We will generally be entitled to set any day as a record date for the purpose of determining the holders of outstanding indenture securities that are entitled to vote or take other action under the indenture. However, the record date may not be more than 30 days before the date of the first solicitation of holders to vote on or take such action. If we set a record date for a vote or other action to be taken by holders of one or more series, that vote or action may be taken only by persons who are holders of outstanding indenture securities of those series on the record date and must be taken within eleven months following the record date.

Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if we seek to change the indenture or the debt securities or request a waiver.

Defeasance

The following provisions will be applicable to each series of debt securities unless we state in the applicable prospectus supplement that the provisions of covenant defeasance and full defeasance will not be applicable to that series.

 

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Covenant Defeasance

Under current United States federal tax law and the indenture, we can make the deposit described below and be released from some of the restrictive covenants in the indenture under which the particular series was issued. This is called “covenant defeasance”. In that event, you would lose the protection of those restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay your debt securities. If applicable, you also would be released from the subordination provisions described under “Indenture Provisions — Subordination” below. In order to achieve covenant defeasance, we must do the following:

 

•

We must deposit in trust for the benefit of all holders of a series of debt securities a combination of cash (in such currency in which such securities are then specified as payable at stated maturity) or government obligations applicable to such securities (determined on the basis of the currency in which such securities are then specified as payable at stated maturity) that will generate enough cash to make interest, principal and any other payments on the debt securities on their various due dates and any mandatory sinking fund payments or analogous payments.

 

•

We must deliver to the trustee a legal opinion of our counsel confirming that, under current United States federal income tax law, we may make the above deposit without causing you to be taxed on the debt securities any differently than if we did not make the deposit.

 

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We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with.

 

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Defeasance must not result in a breach or violation of, or result in a default under, the indenture or any of our other material agreements or instruments.

 

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No default or event of default with respect to such debt securities shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.

 

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Satisfy the conditions for covenant defeasance contained in any supplemental indentures.

If we accomplish covenant defeasance, you can still look to us for repayment of the debt securities if there were a shortfall in the trust deposit or the trustee is prevented from making payment. In fact, if one of the remaining Events of Default occurred (such as our bankruptcy) and the debt securities became immediately due and payable, there might be a shortfall. Depending on the event causing the default, you may not be able to obtain payment of the shortfall.

Full Defeasance

If there is a change in United States federal tax law, as described below, we can legally release ourselves from all payment and other obligations on the debt securities of a particular series (called “full defeasance”) if we put in place the following other arrangements for you to be repaid:

 

•

We must deposit in trust for the benefit of all holders of a series of debt securities a combination of cash (in such currency in which such securities are then specified as payable at stated maturity) or government obligations applicable to such securities (determined on the basis of the currency in which such securities are then specified as payable at stated maturity) that will generate enough cash to make interest, principal and any other payments on the debt securities on their various due dates and any mandatory sinking fund payments or analogous payments.

 

•

We must deliver to the trustee a legal opinion confirming that there has been a change in current United States federal tax law or an IRS ruling that allows us to make the above deposit without causing you to be taxed on the debt securities any differently than if we did not make the deposit. Under current United States federal tax law, the deposit and our legal release from the debt securities would be treated as though we paid you your share of the cash and notes or bonds at the time the cash and notes or bonds were deposited in trust in exchange for your debt securities and you would recognize gain or loss on the debt securities at the time of the deposit.

 

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•

We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with.

 

•

Defeasance must not result in a breach or violation of, or constitute a default under, of the indenture or any of our other material agreements or instruments.

 

•

No default or event of default with respect to such debt securities shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.

 

•

Satisfy the conditions for full defeasance contained in any supplemental indentures.

If we ever did accomplish full defeasance, as described above, you would have to rely solely on the trust deposit for repayment of the debt securities. You could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from claims of our lenders and other creditors if we ever became bankrupt or insolvent. If applicable, you would also be released from the subordination provisions described later under “Indenture Provisions — Subordination”.

Form, Exchange and Transfer of Certificated Registered Securities

If registered debt securities cease to be issued in book-entry form, they will be issued:

 

•

only in fully registered certificated form,

 

•

without interest coupons, and

 

•

unless we indicate otherwise in the prospectus supplement, in denominations of $1,000 and amounts that are multiples of $1,000.

Holders may exchange their certificated securities for debt securities of smaller denominations or combined into fewer debt securities of larger denominations, as long as the total principal amount is not changed and as long as the denomination is greater than the minimum denomination for such securities.

Holders may exchange or transfer their certificated securities at the office of the trustee. We have appointed the trustee to act as our agent for registering debt securities in the names of holders transferring debt securities. We may appoint another entity to perform these functions or perform them ourselves.

Holders will not be required to pay a service charge to transfer or exchange their certificated securities, but they may be required to pay any tax or other governmental charge associated with the transfer or exchange. The transfer or exchange will be made only if our transfer agent is satisfied with the holder’s proof of legal ownership.

If we have designated additional transfer agents for your debt security, they will be named in your prospectus supplement. We may appoint additional transfer agents or cancel the appointment of any particular transfer agent. We may also approve a change in the office through which any transfer agent acts.

If any certificated securities of a particular series are redeemable and we redeem less than all the debt securities of that series, we may block the transfer or exchange of those debt securities during the period beginning 15 days before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders to prepare the mailing. We may also refuse to register transfers or exchanges of any certificated securities selected for redemption, except that we will continue to permit transfers and exchanges of the unredeemed portion of any debt security that will be partially redeemed.

If a registered debt security is issued in book-entry form, only the depositary will be entitled to transfer and exchange the debt security as described in this subsection, since it will be the sole holder of the debt security.

Resignation of Trustee

Each trustee may resign or be removed with respect to one or more series of indenture securities provided that a successor trustee is appointed to act with respect to these series and has accepted such appointment. In the event that two or more persons are acting as trustee with respect to different series of indenture securities under the indenture, each of the trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.

 

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Indenture Provisions — Subordination

Upon any distribution of our assets upon our dissolution, winding up, liquidation or reorganization, the payment of the principal of (and premium, if any) and interest, if any, on any indenture securities denominated as subordinated debt securities is to be subordinated to the extent provided in the indenture in right of payment to the prior payment in full of all Designated Senior Indebtedness (as defined below), but our obligation to you to make payment of the principal of (and premium, if any) and interest, if any, on such subordinated debt securities will not otherwise be affected. In addition, no payment on account of principal (or premium, if any), sinking fund or interest, if any, may be made on such subordinated debt securities at any time unless full payment of all amounts due in respect of the principal (and premium, if any), sinking fund and interest on Designated Senior Indebtedness has been made or duly provided for in money or money’s worth.

In the event that, notwithstanding the foregoing, any payment by us is received by the trustee in respect of subordinated debt securities or by the holders of any of such subordinated debt securities, upon our dissolution, winding up, liquidation or reorganization before all Designated Senior Indebtedness is paid in full, the payment or distribution must be paid over to the holders of the Designated Senior Indebtedness or on their behalf for application to the payment of all the Designated Senior Indebtedness remaining unpaid until all the Designated Senior Indebtedness has been paid in full, after giving effect to any concurrent payment or distribution to the holders of the Designated Senior Indebtedness. Subject to the payment in full of all Designated Senior Indebtedness upon this distribution by us, the holders of such subordinated debt securities will be subrogated to the rights of the holders of the Designated Senior Indebtedness to the extent of payments made to the holders of the Designated Senior Indebtedness out of the distributive share of such subordinated debt securities.

By reason of this subordination, in the event of a distribution of our assets upon our insolvency, certain of our senior creditors may recover more, ratably, than holders of any subordinated debt securities or the holders of any indenture securities that are not Designated Senior Indebtedness or subordinated debt securities. The indenture provides that these subordination provisions will not apply to money and securities held in trust under the defeasance provisions of the indenture.

Designated Senior Indebtedness is defined in the indenture as the principal of (and premium, if any) and unpaid interest on:

 

•

our indebtedness (including indebtedness of others guaranteed by us), whenever created, incurred, assumed or guaranteed, for money borrowed, that we have designated as “Designated Senior Indebtedness” for purposes of the indenture and in accordance with the terms of the indenture (including any indenture securities designated as Designated Senior Indebtedness), and

 

•

renewals, extensions, modifications and refinancings of any of this indebtedness.

If this prospectus is being delivered in connection with the offering of a series of indenture securities denominated as subordinated debt securities, the accompanying prospectus supplement will set forth the approximate amount of our Designated Senior Indebtedness and of our other indebtedness outstanding as of a recent date.

Secured Indebtedness

Certain of our indebtedness, including certain series of indenture securities, may be secured. The prospectus supplement for each series of indenture securities will describe the terms of any security interest for such series and will indicate the approximate amount of our secured indebtedness as of a recent date. In the event of a distribution of our assets upon our insolvency, the holders of unsecured indenture securities may recover less, ratably, than holders of any of our secured indebtedness.

The Trustee under the Indenture

Deutsche Bank Trust Company Americas serves as the trustee under the indenture.

Certain Considerations Relating to Foreign Currencies

Debt securities denominated or payable in foreign currencies may entail significant risks. These risks include the possibility of significant fluctuations in the foreign currency markets, the imposition or modification of foreign exchange controls and potential illiquidity in the secondary market. These risks will vary depending upon the currency or currencies involved and will be more fully described in the applicable prospectus supplement.

 

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DESCRIPTION OF WARRANTS

The following is a general description of the terms of the warrants we may issue from time to time. Particular terms of any warrants we offer will be described in the prospectus supplement relating to such warrants and will be subject to compliance with the 1940 Act.

We may issue warrants to purchase shares of our common stock or debt securities. Such warrants may be issued independently or together with shares of common stock or debt securities and may be attached or separate from such securities. We will issue each series of warrants under a separate warrant agreement to be entered into between us and a warrant agent. The warrant agent will act solely as our agent and will not assume any obligation or relationship of agency for or with holders or beneficial owners of warrants.

A prospectus supplement will describe the particular terms of any series of warrants we may issue, including the following:

 

•

the title and aggregate number of such warrants;

 

•

the price or prices at which such warrants will be issued;

 

•

the currency or currencies, including composite currencies, in which the price of such warrants may be payable;

 

•

if applicable, the designation and terms of the securities with which the warrants are issued and the number of warrants issued with each such security or each principal amount of such security;

 

•

in the case of warrants to purchase debt securities, the principal amount of debt securities purchasable upon exercise of one warrant and the price at which and the currency or currencies, including composite currencies, in which this principal amount of debt securities may be purchased upon such exercise;

 

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in the case of warrants to purchase common stock, the number of shares of common stock purchasable upon exercise of one warrant and the price at which and the currency or currencies, including composite currencies, in which these shares may be purchased upon such exercise;

 

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the date on which the right to exercise such warrants shall commence and the date on which such right will expire (subject to any extension);

 

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whether such warrants will be issued in registered form or bearer form;

 

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if applicable, the minimum or maximum amount of such warrants that may be exercised at any one time;

 

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if applicable, the date on and after which such warrants and the related securities will be separately transferable;

 

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the terms of any rights to redeem, or call such warrants;

 

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information with respect to book-entry procedures, if any;

 

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the terms of the securities issuable upon exercise of the warrants;

 

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if applicable, a discussion of certain U.S. federal income tax considerations; and

 

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any other terms of such warrants, including terms, procedures and limitations relating to the exchange and exercise of such warrants.

We and the warrant agent may amend or supplement the warrant agreement for a series of warrants without the consent of the holders of the warrants issued thereunder to effect changes that are not inconsistent with the provisions of the warrants and that do not materially and adversely affect the interests of the holders of the warrants.

Each warrant will entitle the holder to purchase for cash such common stock at the exercise price or such principal amount of debt securities as shall in each case be set forth in, or be determinable as set forth in, the prospectus supplement relating to the warrants offered thereby. Warrants may be exercised as set forth in the prospectus supplement beginning on the date specified therein and continuing until the close of business on the expiration date set forth in the prospectus supplement. After the close of business on the expiration date, unexercised warrants will become void.

 

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Upon receipt of payment and a warrant certificate properly completed and duly executed at the corporate trust office of the warrant agent or any other office indicated in the prospectus supplement, we will, as soon as practicable, forward the securities purchasable upon such exercise. If less than all of the warrants represented by such warrant certificate are exercised, a new warrant certificate will be issued for the remaining warrants. If we so indicate in the applicable prospectus supplement, holders of the warrants may surrender securities as all or part of the exercise price for warrants.

Prior to exercising their warrants, holders of warrants will not have any of the rights of holders of the securities purchasable upon such exercise, including, in the case of warrants to purchase debt securities, the right to receive principal, premium, if any, or interest payments, on the debt securities purchasable upon exercise or to enforce covenants in the applicable indenture or, in the case of warrants to purchase common stock, the right to receive dividends or other distributions, if any, or payments upon our liquidation, dissolution or winding up or to exercise any voting rights.

Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in the best interests of us and our stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities. At our 2011 annual meeting of stockholders, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings, including under such circumstance. Such authorization has no expiration.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of the material U.S. federal income tax considerations applicable to us and to an investment in our shares. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, we have not described tax consequences that may be relevant to certain types of holders subject to special treatment under U.S. federal income tax laws, including stockholders subject to the alternative minimum tax, tax-exempt organizations, insurance companies, dealers in securities, a trader in securities that elects to use a market-to-market method of accounting for its securities holdings, pension plans and trusts, and financial institutions. This summary assumes that investors hold our common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as of the date of this prospectus and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. We have not sought and will not seek any ruling from the IRS regarding this offering. This summary does not discuss any aspects of U.S. estate or gift tax or foreign, state or local tax. It does not discuss the special treatment under U.S. federal income tax laws that could result if we invested in tax-exempt securities or certain other investment assets.

This summary does not discuss the consequences of an investment in our debt securities or warrants representing rights to purchase shares of our common stock or debt securities. The U.S. federal income tax consequences of such an investment will be discussed in the relevant prospectus supplement.

A “U.S. stockholder” generally is a beneficial owner of shares of our common stock who is for U.S. federal income tax purposes:

 

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A citizen or individual resident of the United States;

 

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A corporation or other entity treated as a corporation, for U.S. federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof;

 

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A trust if a court within the United States is asked to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantive decisions of the trust; or

 

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An estate, the income of which is subject to U.S. federal income taxation regardless of its source.

A “Non-U.S. stockholder” generally is a beneficial owner of shares of our common stock who is for U.S. federal income tax purposes:

 

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A nonresident alien individual;

 

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A foreign corporation; or

 

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An estate or trust that in either case is not subject to U.S. federal income tax on a net income basis on income or gain from a note.

If a partnership (including an entity treated as a partnership for U.S. federal income tax purposes) holds shares of our common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A prospective stockholder that is a partner of a partnership holding shares of our common stock should consult his, her or its tax advisers with respect to the purchase, ownership and disposition of shares of our common stock.

Tax matters are very complicated and the tax consequences to an investor of an investment in our shares will depend on the facts of his, her or its particular situation. We encourage investors to consult their own tax advisers regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of federal, state, local and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws.

Election to be Taxed as a RIC

As a business development company, we have elected to be treated, and intend to qualify annually, as a RIC under Subchapter M of the Code, beginning with our 2008 taxable year. As a RIC, we generally will not have to pay

 

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corporate-level U.S. federal income taxes on any income that we distribute to our stockholders as dividends. To continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).

Taxation as a Regulated Investment Company

For any taxable year in which we:

 

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qualify as a RIC; and

 

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satisfy the Annual Distribution Requirement,

we generally will not be subject to U.S. federal income tax on the portion of our income we distribute (or are deemed to distribute) to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.

We will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (3) any income recognized, but not distributed, in preceding years (the “Excise Tax Avoidance Requirement”). We generally will endeavor in each taxable year to make sufficient distributions to our stockholders to avoid any U.S. federal excise tax on our earnings.

In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:

 

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continue to qualify as a business development company under the 1940 Act at all times during each taxable year;

 

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derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to loans of certain securities, gains from the sale of stock or other securities, net income from certain “qualified publicly traded partnerships,” or other income derived with respect to our business of investing in such stock or securities (the “90% Income Test”); and

 

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diversify our holdings so that at the end of each quarter of the taxable year:

 

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at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and

 

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no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification Tests”).

Qualified earnings may exclude such income as management fees received in connection with our SBIC or other potential outside managed funds and certain other fees.

Pursuant to a recent revenue procedure issued by the IRS, the IRS has indicated that it will treat distributions from certain publicly traded RICs (including BDCs) that are paid part in cash and part in stock as dividends that would satisfy the RIC’s annual distribution requirements and qualify for the dividends paid deduction for income tax purposes. In order to qualify for such treatment, the revenue procedure requires that at least 10% of the total distribution be paid in cash and that each stockholder have a right to elect to receive its entire distribution in cash. If the number of stockholders electing to receive cash would cause cash distributions in excess of 10%, then each stockholder electing to receive cash would receive a proportionate share of the cash to be distributed (although no stockholder electing to receive cash may receive less than 10% of such stockholder’s distribution in cash). This

 

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revenue procedure applies to distributions made with respect to taxable years ending prior to January 1, 2012. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income (or as long-term capital gain to the extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. In situations where this revenue procedure is not applicable, the Internal Revenue Service has also issued private letter rulings on cash/stock dividends paid by RICs and real estate investment trusts using a 20% cash standard (instead of the 10% cash standard of the revenue procedure) if certain requirements are satisfied. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale.

We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as PIK interest, deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock, or certain income with respect to equity investments in foreign corporations. Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount.

Gain or loss realized by us from the sale or exchange of warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such gain or loss generally will be long-term or short-term, depending on how long we held a particular warrant.

Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous. If we are prohibited from making distributions or are unable to obtain cash from other sources to make the distributions, we may fail to qualify as a RIC, which would result in us becoming subject to corporate-level federal income tax.

In addition, we will be partially dependent on our SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary 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 maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiary to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. If our SBIC subsidiary is unable to obtain a waiver, compliance with the SBA regulations may cause us to fail to qualify as a RIC, which would result in us becoming subject to corporate-level federal income tax.

The remainder of this discussion assumes that we qualify as a RIC and have satisfied the Annual Distribution Requirement.

Any transactions in options, futures contracts, constructive sales, hedging, straddle, conversion or similar transactions, and forward contracts will be subject to special tax rules, the effect of which may be to accelerate income to us, defer losses, cause adjustments to the holding periods of our investments, convert long-term capital gains into short-term capital gains, convert short-term capital losses into long-term capital losses or have other tax consequences. These rules could affect the amount, timing and character of distributions to stockholders. We do not currently intend to engage in these types of transactions.

 

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A RIC is limited in its ability to deduct expenses in excess of its “investment company taxable income” (which is, generally, ordinary income plus net realized short-term capital gains in excess of net realized long-term capital losses). If our expenses in a given year exceed gross taxable income (e.g., as the result of large amounts of equity-based compensation), we would experience a net operating loss for that year. However, a RIC is not permitted to carry forward net operating losses to subsequent years. In addition, expenses can be used only to offset investment company taxable income, not net capital gain. Due to these limits on the deductibility of expenses, we may for tax purposes have aggregate taxable income for several years that we are required to distribute and that is taxable to our stockholders even if such income is greater than the aggregate net income we actually earned during those years. Such required distributions may be made from our cash assets or by liquidation of investments, if necessary. We may realize gains or losses from such liquidations. In the event we realize net capital gains from such transactions, you may receive a larger capital gain distribution than you would have received in the absence of such transactions.

Investment income received from sources within foreign countries, or capital gains earned by investing in securities of foreign issuers, may be subject to foreign income taxes withheld at the source. In this regard, withholding tax rates in countries with which the United States does not have a tax treaty are often as high as 35% or more. The United States has entered into tax treaties with many foreign countries that may entitle us to a reduced rate of tax or exemption from tax on this related income and gains. The effective rate of foreign tax cannot be determined at this time since the amount of our assets to be invested within various countries is not now known. We do not anticipate being eligible for the special election that allows a RIC to treat foreign income taxes paid by such RIC as paid by its stockholders.

If we acquire stock in certain foreign corporations that receive at least 75% of their annual gross income from passive sources (such as interest, dividends, rents, royalties or capital gain) or hold at least 50% of their total assets in investments producing such passive income (“passive foreign investment companies”), We could be subject to federal income tax and additional interest charges on “excess distributions” received from such companies or gain from the sale of stock in such companies, even if all income or gain actually received by us is timely distributed to our stockholders. We would not be able to pass through to our stockholders any credit or deduction for such a tax. Certain elections may, if available, ameliorate these adverse tax consequences, but any such election requires us to recognize taxable income or gain without the concurrent receipt of cash. We intend to limit and/or manage our holdings in passive foreign investment companies to minimize our tax liability.

Foreign exchange gains and losses realized by us in connection with certain transactions involving non-dollar debt securities, certain foreign currency futures contracts, foreign currency option contracts, foreign currency forward contracts, foreign currencies, or payables or receivables denominated in a foreign currency are subject to Code provisions that generally treat such gains and losses as ordinary income and losses and may affect the amount, timing and character of distributions to our stockholders. Any such transactions that are not directly related to our investment in securities (possibly including speculative currency positions or currency derivatives not used for hedging purposes) could, under future Treasury regulations, produce income not among the types of “qualifying income” from which a RIC must derive at least 90% of its annual gross income.

Taxation of U.S. Stockholders

Distributions by us generally are taxable to U.S. stockholders as ordinary income or capital gains. Distributions of our “investment company taxable income” (which is, generally, our net ordinary income plus realized net short-term capital gains in excess of realized net long-term capital losses) will be taxable as ordinary income to U.S. stockholders to the extent of our current or accumulated earnings and profits, whether paid in cash or reinvested in additional common stock. To the extent such distributions paid by us in taxable years beginning before January 1, 2013 to non-corporate stockholders (including individuals) are attributable to dividends from U.S. corporations and certain qualified foreign corporations, such distributions (“Qualifying Dividends”) may be eligible for a maximum tax rate of 15%, provided holding period and other requirements are met at both the stockholder and company levels. In this regard, it is anticipated that distributions paid by us will generally not be attributable to dividends and, therefore, generally will not qualify for the 15% maximum rate applicable to Qualifying Dividends. Distributions of our net capital gains (which are generally our realized net long-term capital gains in excess of realized net short-term capital losses) made in taxable years beginning before January 1, 2013 and properly reported by us as “capital gain dividends” in written statements furnished to our stockholders will be taxable to a U.S. stockholder as

 

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long-term capital gains that are currently taxable at a maximum rate of 15% in the case of individuals, trusts or estates, regardless of the U.S. stockholder’s holding period for his, her or its common stock and regardless of whether paid in cash or reinvested in additional common stock. Distributions in excess of our earnings and profits first will reduce a U.S. stockholder’s adjusted tax basis in such stockholder’s common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such U.S. stockholder.

We may retain some or all of our realized net long-term capital gains in excess of realized net short-term capital losses, but designate the retained net capital gain as a “deemed distribution.” In that case, among other consequences, we will pay tax on the retained amount, each U.S. stockholder will be required to include his, her or its share of the deemed distribution in income as if it had been actually distributed to the U.S. stockholder, and the U.S. stockholder will be entitled to claim a credit equal to his, her or its allocable share of the tax paid thereon by us. Because we expect to pay tax on any retained capital gains at our regular corporate tax rate, and because that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual U.S. stockholders will be treated as having paid will exceed the tax they owe on the capital gain distribution and such excess generally may be refunded or claimed as a credit against the U.S. stockholder’s other U.S. federal income tax obligations or may be refunded to the extent it exceeds a stockholder’s liability for federal income tax. A stockholder that is not subject to federal income tax or otherwise required to file a federal income tax return would be required to file a federal income tax return on the appropriate form in order to claim a refund for the taxes we paid. The amount of the deemed distribution net of such tax will be added to the U.S. stockholder’s cost basis for his, her or its common stock. In order to utilize the deemed distribution approach, we must provide written notice to our stockholders prior to the expiration of 60 days after the close of the relevant taxable year. We cannot treat any of our investment company taxable income as a “deemed distribution.”

For purposes of determining (1) whether the Annual Distribution Requirement is satisfied for any year and (2) the amount of the deduction for ordinary income and capital gain dividends paid for that year, we may, under certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable year in question. If we make such an election, the U.S. stockholder will still be treated as receiving the dividend in the taxable year in which the distribution is made. However, any dividend declared by us in October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following year, will be treated as if it had been received by our U.S. stockholders on December 31 of the year in which the dividend was declared.

If an investor purchases shares of our common stock shortly before the record date of a distribution, the price of the shares will include the value of the distribution and the investor will be subject to tax on the distribution even though economically it may represent a return of his, her or its investment.

A U.S. stockholder generally will recognize taxable gain or loss if the U.S. stockholder sells or otherwise disposes of his, her or its shares of our common stock. The amount of gain or loss will be measured by the difference between such U.S. stockholder’s adjusted tax basis in the common stock sold and the amount of the proceeds received in exchange. Any gain arising from such sale or disposition generally will be treated as long-term capital gain or loss if the U.S. stockholder has held his, her or its shares for more than one year. Otherwise, it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.

In general, U.S. stockholders taxed at individual rates currently are subject to a maximum U.S. federal income tax rate of 15% on their net capital gain (i.e., the excess of realized net long-term capital gains over realized net short-term capital losses) recognized in taxable years beginning before January 1, 2013, including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by such U.S. stockholders. The maximum rate on long-term capital gains for U.S. stockholders taxed at individual rates is scheduled to return to 20% for tax years beginning after December 31, 2012. In addition,

 

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for taxable years beginning after December 31, 2012, individuals with income in excess of $200,000 ($250,000 in the case of married individuals filing jointly) and certain estates and trusts are subject to an additional 3.8% tax on their “net investment income,” which generally includes net income from interest, dividends, annuities, royalties, and rents, and net capital gains (other than certain amounts earned from trades or businesses). Corporate U.S. stockholders currently are subject to U.S. federal income tax on net capital gain at the maximum 35% rate also applied to ordinary income. Non-corporate U.S. stockholders with net capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year any net capital losses of a non-corporate U.S. stockholder in excess of $3,000 generally may be carried forward and used in subsequent years as provided in the Code. Corporate U.S. stockholders generally may not deduct any net capital losses for a year, but may carry back such losses for three years or carry forward such losses for five years.

We will send to each of our U.S. stockholders, as promptly as possible after the end of each calendar year, a notice reporting, on a per share and per distribution basis, the amounts includible in such U.S. stockholder’s taxable income for such year as ordinary income and as long-term capital gain. In addition, the federal tax status of each year’s distributions generally will be reported to the IRS (including the amount of dividends, if any, eligible for the 15% maximum rate). Dividends paid by us generally will not be eligible for the dividends-received deduction or the preferential tax rate applicable to Qualifying Dividends because our income generally will not consist of dividends. Distributions may also be subject to additional state, local and foreign taxes depending on a U.S. stockholder’s particular situation.

In some taxable years, we may be subject to the alternative minimum tax (“AMT”). If we have tax items that are treated differently for AMT purposes than for regular tax purposes, we may apportion those items between us and our stockholders, and this may affect our stockholder’s AMT liabilities. Although regulations explaining the precise method of apportionment have not yet been issued by the Internal Revenue Service, we may apportion these items in the same proportion that dividends paid to each stockholder bear to our taxable income (determined without regard to the dividends paid deduction), unless we determine that a different method for a particular item is warranted under the circumstances. You should consult your own tax advisor to determine how an investment in our stock could affect your AMT liability.

We may be required to withhold U.S. federal income tax (“backup withholding”) from all distributions to any U.S. stockholder (other than a stockholder that otherwise qualifies for an exemption) (1) who fails to furnish us with a correct taxpayer identification number or a certificate that such stockholder is exempt from backup withholding or (2) with respect to whom the IRS notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individual’s taxpayer identification number is his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the U. S. stockholder’s federal income tax liability, provided that proper information is provided to the IRS.

U.S. stockholders that hold their common stock through foreign accounts or intermediaries will be subject to U.S. withholding tax at a rate of 30% on dividends and proceeds of sale of our common stock paid after December 31, 2012 if certain disclosure requirements related to U.S. accounts are not satisfied.

Dividend Reinvestment Plan    We have adopted a dividend reinvestment plan through which all dividend distributions are paid to our stockholders in the form of additional shares of our common stock, unless a stockholder elects to receive cash in accordance with the terms of the plan. See “Dividend Reinvestment Plan”. Any distributions made to a U.S. stockholder that are reinvested under the plan will nevertheless remain taxable to the U.S. stockholder. The U.S. stockholder will have an adjusted tax basis in the additional shares of our common stock purchased through the plan equal to the amount of the reinvested distribution. The additional shares will have a new holding period commencing on the day following the day on which the shares are credited to the U.S. stockholder’s account.

Taxation of Non-U.S. Stockholders

Whether an investment in the shares is appropriate for a Non-U.S. stockholder will depend upon that person’s particular circumstances. An investment in the shares by a Non-U.S. stockholder may have adverse tax consequences. Non-U.S. stockholders should consult their tax advisers before investing in our common stock.

 

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Distributions of our “investment company taxable income” to Non-U.S. stockholders (including interest income and realized net short-term capital gains in excess of realized long-term capital losses, which generally would be free of withholding if paid to Non-U.S. stockholders directly) will be subject to withholding of federal tax at a 30% rate (or lower rate provided by an applicable treaty) to the extent of our current and accumulated earnings and profits unless an applicable exception applies. If the distributions are effectively connected with a U.S. trade or business of the Non-U.S. stockholder, we will not be required to withhold federal tax if the Non-U.S. stockholder complies with applicable certification and disclosure requirements, although the distributions will be subject to U.S. federal income tax at the rates applicable to U.S. persons. (Special certification requirements apply to a Non-U.S. stockholder that is a foreign partnership or a foreign trust, and such entities are urged to consult their own tax advisers.)

However, for taxable years beginning before January 1, 2012, no withholding was required with respect to certain distributions if (i) the distributions were properly reported to our stockholders as “interest-related dividends” or “short-term capital gain dividends” in written statements to our stockholders, (ii) the distributions were derived from sources specified in the Code for such dividends and (iii) certain other requirements were satisfied. Currently, we do not anticipate that any significant amount of our distributions would be reported as eligible for this exemption from withholding if extended. No assurance can be provided that this exemption will be extended for tax years beginning after December 31, 2011.

Actual or deemed distributions of our net capital gains to a Non-U.S. stockholder, and gains realized by a Non-U.S. stockholder upon the sale of our common stock, will not be subject to federal withholding tax and generally will not be subject to federal income tax unless the distributions or gains, as the case may be, are effectively connected with a U.S. trade or business of the Non-U.S. stockholder.

The tax consequences to Non-U.S. stockholders entitled to claim the benefits of an applicable tax treaty or that are individuals that are present in the United States for 183 days or more during a taxable year may be different from those described herein. Non-U.S. stockholders are urged to consult their tax advisers with respect to the procedure for claiming the benefit of a lower treaty rate and the applicability of foreign taxes.

If we distribute our net capital gains in the form of deemed rather than actual distributions, a Non-U.S. stockholder will be entitled to a U.S. federal income tax credit or tax refund equal to the stockholder’s allocable share of the tax we pay on the capital gains deemed to have been distributed. In order to obtain the refund, the Non-U.S. stockholder must obtain a U.S. taxpayer identification number and file a U.S. federal income tax return even if the Non-U.S. stockholder would not otherwise be required to obtain a U.S. taxpayer identification number or file a U.S. federal income tax return. For a corporate Non-U.S. stockholder, distributions (both actual and deemed), and gains realized upon the sale of our common stock that are effectively connected to a U.S. trade or business may, under certain circumstances, be subject to an additional “branch profits tax” at a 30% rate (or at a lower rate if provided for by an applicable treaty). Accordingly, investment in the shares may not be appropriate for a Non-U.S. stockholder.

A Non-U.S. stockholder who is a non-resident alien individual, and who is otherwise subject to withholding of federal tax, may be subject to information reporting and backup withholding of U.S. federal income tax on dividends unless the Non-U.S. stockholder provides us or the dividend paying agent with an IRS Form W-8BEN (or an acceptable substitute form) or otherwise meets documentary evidence requirements for establishing that it is a Non-U.S. stockholder or otherwise establishes an exemption from backup withholding.

Recently enacted legislation generally imposes a 30% withholding tax on payments of certain types of income to foreign financial institutions that fail to enter into an agreement with the U.S. Treasury to report certain required information with respect to accounts held by U.S. persons (or held by foreign entities that have U.S. persons as substantial owners). The types of income subject to the tax include U.S. source interest and dividends paid after December 31, 2013 and the gross proceeds from the sale of any property that could produce U.S.-source interest or dividends paid after December 31, 2014. The information required to be reported includes the identity and taxpayer identification number of each account holder that is a U.S. person and transaction activity within the holder’s account. In addition, subject to certain exceptions, this legislation also imposes a 30% withholding on payments to foreign entities that are not financial institutions unless the foreign entity certifies that it does not have a greater than 10% U.S. owner or provides the withholding agent with identifying information on each greater than 10% U.S. owner. When these provisions become effective, depending on the status of a Non-U.S. Holder and the status of the

 

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intermediaries through which they hold their shares, Non-U.S. Holders could be subject to this 30% withholding tax with respect to distributions on their shares and proceeds from the sale of their shares. Under certain circumstances, a Non-U.S. Holder might be eligible for refunds or credits of such taxes.

Non-U.S. persons should consult their own tax advisers with respect to the U.S. federal income tax and withholding tax, and state, local and foreign tax consequences of an investment in the shares.

Failure to Qualify as a Regulated Investment Company

If we fail to satisfy the 90% Income Test or the Diversification Tests for any taxable year, we may nevertheless continue to qualify as a RIC for such year if certain relief provisions are applicable (which may, among other things, require us to pay certain corporate-level federal taxes or to dispose of certain assets).

If we were unable to qualify for treatment as a RIC and the foregoing relief provisions are not applicable, we would be subject to tax on all of our taxable income at regular corporate rates, regardless of whether we make any distributions to our stockholders. Distributions would not be required, and any distributions made in taxable years beginning on or before December 31, 2012 would be taxable to our stockholders as ordinary dividend income that, subject to certain limitations, may be eligible for the 15% maximum rate to the extent of our current and accumulated earnings and profits provided certain holding period and other requirements were met. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. To requalify as a RIC in a subsequent taxable year, we would be required to satisfy the RIC qualification requirements for that year and dispose of any earnings and profits from any year in which we failed to qualify as a RIC. Subject to a limited exception applicable to RICs that qualified as such under Subchapter M of the Code for at least one year prior to disqualification and that requalify as a RIC no later than the second year following the nonqualifying year, we could be subject to tax on any unrealized net built-in gains in the assets held by us during the period in which we failed to qualify as a RIC that are recognized within the subsequent 10 years, unless we made a special election to pay corporate-level tax on such built-in gain at the time of our requalification as a RIC.

 

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REGULATION

Business Development Company Regulations

We have elected to be regulated as a business development company under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates, principal underwriters and affiliates of those affiliates or underwriters. The 1940 Act requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a business development company unless approved by a majority of our outstanding voting securities.

The 1940 Act defines “a majority of the outstanding voting securities” as the lesser of (i) 67% or more of the voting securities present at a meeting if the holders of more than 50% of our outstanding voting securities are present or represented by proxy or (ii) 50% of our voting securities.

As a business development company, we will not generally be permitted to invest in any portfolio company in which our investment adviser or any of its affiliates currently have an investment or to make any co-investments with our investment adviser or its affiliates without an exemptive order from the SEC. We currently do not intend to apply for an exemptive order that would permit us to co-invest with vehicles managed by our investment adviser or its affiliates.

Qualifying Assets

Under the 1940 Act, a business development company may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are any of the following:

(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:

(a) is organized under the laws of, and has its principal place of business in, the United States;

(b) is not an investment company (other than a small business investment company wholly owned by the business development company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

(c) satisfies any of the following:

(i) does not have any class of securities that is traded on a national securities exchange;

(ii) has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million;

(iii) is controlled by a business development company or a group of companies including a business development company and the business development company has an affiliated person who is a director of the eligible portfolio company; or

(iv) is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million.

(2) Securities of any eligible portfolio company that we control.

(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

 

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(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.

(6) Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.

In addition, a business development company must be operated for the purpose of making investments in the types of securities described in (1), (2) or (3) above.

Managerial Assistance to Portfolio Companies

In order to count portfolio securities as qualifying assets for the purpose of the 70% test, we must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where we purchase such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the business development company, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.

Temporary Investments

Pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement (which is substantially similar to a secured loan) involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests in order to qualify as a RIC for U.S. federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Our investment adviser will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.

Senior Securities

We are permitted, under specified conditions, to issue multiple classes of debt and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we may be prohibited from making distribution to our stockholders or repurchasing such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a business development company and RIC affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth” and “ — Because we borrow money, the potential for loss on amounts invested in us will be magnified and may increase the risk of investing in us.”

 

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Common Stock

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in our best interests and that of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount). We may also make rights offerings to our stockholders at prices per share less than the net asset value per share, subject to applicable requirements of the 1940 Act. See “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a business development company affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.”

Code of Ethics

We have adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act and we have also approved the investment adviser’s code of ethics that was adopted by it under Rule 17j-1 under the 1940 Act and Rule 204A-1 of the Advisers Act. These codes establish procedures for personal investments and restrict certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. You may also read and copy the codes of ethics at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the codes of ethics are available on the EDGAR Database on the SEC’s Internet site at http://www.sec.gov. and are available at our corporate governance webpage at http://ir.fifthstreetfinance.com/governance.cfm.

Compliance Policies and Procedures

We and our investment adviser have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws and are required to review these compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Our chief compliance officer is responsible for administering these policies and procedures.

Proxy Voting Policies and Procedures

We have delegated our proxy voting responsibility to our investment adviser. The proxy voting policies and procedures of our investment adviser are set forth below. The guidelines are reviewed periodically by our investment adviser and our non-interested directors, and, accordingly, are subject to change.

Introduction

As an investment adviser registered under the Investment Advisers Act of 1940, our investment adviser has a fiduciary duty to act solely in the best interests of its clients. As part of this duty, it recognizes that it must vote client securities in a timely manner free of conflicts of interest and in the best interests of its clients.

These policies and procedures for voting proxies for the investment advisory clients of our investment adviser are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.

Proxy policies

Our investment adviser will vote proxies relating to our securities in the best interest of our stockholders. It will review on a case-by-case basis each proposal submitted for a stockholder vote to determine its impact on the portfolio securities held by us. Although our investment adviser will generally vote against proposals that may have a negative impact on our portfolio securities, it may vote for such a proposal if there exists compelling long-term reasons to do so.

 

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The proxy voting decisions of our investment adviser are made by the officers who are responsible for monitoring each of our investments. To ensure that its vote is not the product of a conflict of interest, our investment adviser will require that: (a) anyone involved in the decision-making process disclose to its chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (b) employees involved in the decision-making process or vote administration are prohibited from revealing how our investment adviser intends to vote on a proposal in order to reduce any attempted influence from interested parties.

Proxy voting records

You may obtain information, without charge, regarding how we voted proxies with respect to our portfolio securities by making a written request for proxy voting information to: Chief Compliance Officer, 10 Bank Street, 12th Floor, White Plains, NY 10606.

Other

We will be subject to periodic examination by the SEC for compliance with the 1940 Act.

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

Securities Exchange Act and Sarbanes-Oxley Act Compliance

We are subject to the reporting and disclosure requirements of the Exchange Act, including the filing of quarterly, annual and current reports, proxy statements and other required items. In addition, we are subject to the Sarbanes-Oxley Act, which imposes a wide variety of regulatory requirements on publicly-held companies and their insiders. For example:

 

•

pursuant to Rule 13a-14 of the Exchange Act, our chief executive officer and chief financial officer are required to certify the accuracy of the financial statements contained in our periodic reports;

 

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pursuant to Item 307 of Regulation S-K, our periodic reports are required to disclose our conclusions about the effectiveness of our disclosure controls and procedures; and

 

•

pursuant to Rule 13a-15 of the Exchange Act, our management will be required to prepare a report regarding its assessment of our internal control over financial reporting. Our independent registered public accounting firm will be required to audit our internal control over financial reporting.

The Sarbanes-Oxley Act requires us to review our current policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We intend to monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.

Small Business Investment Company Regulations

In August 2009, we formed Fifth Street Mezzanine Partners IV, L.P. In February 2010, Fifth Street Mezzanine Partners IV, L.P. received final approval to be licensed by the United States Small Business Administration, or SBA, as a small business investment company, or SBIC.

The SBIC license allows our SBIC subsidiary 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.

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businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $18 million and have average annual fully taxed net income not exceeding $6 million for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller” concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6 million and has average annual fully taxed net income not exceeding $2 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.

SBA regulations currently limit the amount that our SBIC subsidiary may borrow up to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of March 31, 2012, our SBIC subsidiary had $75 million in regulatory capital and the SBA had issued a capital commitment to our SBIC subsidiary in the amount of $150 million.

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, our SBIC subsidiary may also be limited in its ability to make distributions to us if it does not have sufficient capital, in accordance with SBA regulations.

Our SBIC subsidiary is 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 our SBIC subsidiary will receive SBA guaranteed debenture funding, which is dependent upon our SBIC subsidiary continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will have a superior claim to our SBIC subsidiary’s assets over our stockholders in the event we liquidate our SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by our SBIC subsidiary upon an event of default.

On May 27, 2011, we received a letter from the Investment Division of the SBA that invited us to continue moving forward with our application to obtain an SBIC license for another one of our wholly-owned subsidiaries. Although our application for this license is subject to the SBA’s approval, we remain cautiously optimistic that we will complete the licensing process. However, there can be no assurance that the SBA will approve the issuance of an SBIC license to another one of our wholly-owned subsidiaries. If we are able to successfully obtain such an additional SBIC license, we would have similar relief from the 200% asset coverage ratio limitation as described above with respect to the SBIC debt securities issued by such SBIC subsidiary.

The NASDAQ Global Select Market Corporate Governance Regulations

The NASDAQ Global Select Market has adopted corporate governance regulations that listed companies must comply with. We are in compliance with such corporate governance regulations applicable to business development companies.

 

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PLAN OF DISTRIBUTION

We may offer, from time to time, in one or more offerings or series, up to $500,000,000 of our common stock, debt securities or warrants to purchase common stock or debt securities, in one or more underwritten public offerings, at-the-market offerings, negotiated transactions, block trades, best efforts offerings or a combination of these methods. We may sell the securities through underwriters or dealers, directly to one or more purchasers through agents or through a combination of any such methods of sale. Any underwriter or agent involved in the offer and sale of the securities will be named in the applicable prospectus supplement. A prospectus supplement or supplements will also describe the terms of the offering of the securities, including: the purchase price of the securities and the proceeds we will receive from the sale; any over-allotment options under which underwriters may purchase additional securities from us; any agency fees or underwriting discounts and other items constituting agents’ or underwriters’ compensation; the public offering price; any discounts or concessions allowed or re-allowed or paid to dealers; and any securities exchange or market on which the securities may be listed. Only underwriters named in the prospectus supplement will be underwriters of the securities offered by the prospectus supplement.

The distribution of our securities may be effected from time to time in one or more transactions at a fixed price or prices, which may be changed, at prevailing market prices at the time of sale, at prices related to such prevailing market prices, or at negotiated prices, provided, however, that the offering price per share of our common stock, less any underwriting commissions and discounts or agency fees paid by us, must equal or exceed the net asset value per share of our common stock.

In connection with the sale of our securities, underwriters or agents may receive compensation from us or from purchasers of our securities, for whom they may act as agents, in the form of discounts, concessions or commissions. Our common stockholders will bear, directly or indirectly, the expenses of any offering of our securities, including debt securities.

Underwriters may sell our securities to or through dealers and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or commissions from the purchasers for whom they may act as agents. Underwriters, dealers and agents that participate in the distribution of our securities may be deemed to be underwriters under the Securities Act, and any discounts and commissions they receive from us and any profit realized by them on the resale of our securities may be deemed to be underwriting discounts and commissions under the Securities Act. Any such underwriter or agent will be identified and any such compensation received from us will be described in the applicable prospectus supplement.

We may enter into derivative transactions with third parties, or sell securities not covered by this prospectus to third parties in privately negotiated transactions. If the applicable prospectus supplement indicates, in connection with those derivatives, the third parties may sell securities covered by this prospectus and the applicable prospectus supplement, including in short sale transactions. If so, the third party may use securities pledged by us or borrowed from us or others to settle those sales or to close out any related open borrowings of stock, and may use securities received from us in settlement of those derivatives to close out any related open borrowings of stock. The third parties in such sale transactions will be underwriters and, if not identified in this prospectus, will be identified in the applicable prospectus supplement (or a post-effective amendment).

Any underwriter may engage in over-allotment, stabilizing transactions, short-covering transactions and penalty bids in accordance with Regulation M under the Exchange Act. Over-allotment involves sales in excess of the offering size, which create a short position. Stabilizing transactions permit bids to purchase the underlying security so long as the stabilizing bids do not exceed a specified maximum price. Syndicate-covering or other short-covering transactions involve purchases of the securities, either through exercise of the over-allotment option or in the open market after the distribution is completed, to cover short positions. Penalty bids permit the underwriters to reclaim a selling concession from a dealer when the securities originally sold by the dealer are purchased in a stabilizing or covering transaction to cover short positions. Those activities may cause the price of the securities to be higher than it would otherwise be. If commenced, the underwriters may discontinue any of the activities at any time.

Any underwriters that are qualified market makers on the NASDAQ Global Select Market may engage in passive market making transactions in our common stock on the NASDAQ Global Select Market in accordance

 

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with Regulation M under the Exchange Act, during the business day prior to the pricing of the offering, before the commencement of offers or sales of our common stock. Passive market makers must comply with applicable volume and price limitations and must be identified as passive market makers. In general, a passive market maker must display its bid at a price not in excess of the highest independent bid for such security; if all independent bids are lowered below the passive market maker’s bid, however, the passive market maker’s bid must then be lowered when certain purchase limits are exceeded. Passive market making may stabilize the market price of the securities at a level above that which might otherwise prevail in the open market and, if commenced, may be discontinued at any time.

We may sell securities directly or through agents we designate from time to time. We will name any agent involved in the offering and sale of securities and we will describe any commissions we will pay the agent in the prospectus supplement. Unless the prospectus supplement states otherwise, our agent will act on a best-efforts basis for the period of its appointment.

Unless otherwise specified in the applicable prospectus supplement, each class or series of securities will be a new issue with no trading market, other than our common stock, which is traded on the NASDAQ Global Select Market. We may elect to list any other class or series of securities on any exchanges, but we are not obligated to do so. We cannot guarantee the liquidity of the trading markets for any securities.

Under agreements into which we may enter, underwriters, dealers and agents who participate in the distribution of our securities may be entitled to indemnification by us against certain liabilities, including liabilities under the Securities Act. Underwriters, dealers and agents may engage in transactions with, or perform services for, us in the ordinary course of business.

If so indicated in the applicable prospectus supplement, we will authorize underwriters or other persons acting as our agents to solicit offers by certain institutions to purchase our securities from us pursuant to contracts providing for payment and delivery on a future date. Institutions with which such contracts may be made include commercial and savings banks, insurance companies, pension funds, investment companies, educational and charitable institutions and others, but in all cases such institutions must be approved by us. The obligations of any purchaser under any such contract will be subject to the condition that the purchase of our securities shall not at the time of delivery be prohibited under the laws of the jurisdiction to which such purchaser is subject. The underwriters and such other agents will not have any responsibility in respect of the validity or performance of such contracts. Such contracts will be subject only to those conditions set forth in the prospectus supplement, and the prospectus supplement will set forth the commission payable for solicitation of such contracts.

In order to comply with the securities laws of certain states, if applicable, our securities offered hereby will be sold in such jurisdictions only through registered or licensed brokers or dealers. In addition, in certain states, our securities may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with.

The maximum commission or discount to be received by any member of the Financial Industry Regulatory Authority, Inc. will not be greater than 10% for the sale of any securities being registered.

 

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CUSTODIAN, TRANSFER AND DISTRIBUTION PAYING AGENT AND REGISTRAR

Our portfolio securities are held under a custody agreement by U.S. Bank National Association. The address of the custodian is: U.S. Bank National Association, 214 N Tryon Street, 27th Floor, Charlotte, NC 28202. American Stock Transfer & Trust Company acts as our transfer agent, distribution paying agent and registrar for our common stock. The principal business address of our transfer agent is 6201 15th Avenue, Brooklyn, NY 11219, telephone number: (866) 665-2281.

BROKERAGE ALLOCATION AND OTHER PRACTICES

Since we intend to generally acquire and dispose of our investments in privately negotiated transactions, we expect to infrequently use brokers in the normal course of our business. Subject to policies established by our Board of Directors, our investment adviser is primarily responsible for the execution of the publicly-traded securities portion of our portfolio transactions and the allocation of brokerage commissions. Our investment adviser does not execute transactions through any particular broker or dealer, but seeks to obtain the best net results for us, taking into account such factors as price (including the applicable brokerage commission or dealer spread), size of order, difficulty of execution, and operational facilities of the firm and the firm’s risk and skill in positioning blocks of securities. While our investment adviser will generally seek reasonably competitive trade execution costs, we will not necessarily pay the lowest spread or commission available. Subject to applicable legal requirements, our investment adviser may select a broker based partly upon brokerage or research services provided to our investment adviser and us and any other clients. In return for such services, we may pay a higher commission than other brokers would charge if our investment adviser determines in good faith that such commission is reasonable in relation to the services provided.

LEGAL MATTERS

Certain legal matters in connection with the securities offered by this prospectus will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington, D.C. Certain legal matters will be passed upon for the underwriters, if any, by the counsel named in the prospectus supplement, if any.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The financial statements as of September 30, 2011 and 2010 and for each of the two years in the period ended September 30, 2011, included in this prospectus, have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing herein.

The consolidated financial statements as of September 30, 2009 (not included herein) and for the year ended September 30, 2009 included in this registration statement and prospectus, have been audited by Grant Thornton LLP, our former independent registered public accounting firm, as stated in their report appearing herein.

CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

On February 11, 2010, we dismissed Grant Thornton LLP as our independent registered public accounting firm. During the fiscal year ended September 30, 2009 and through February 11, 2010, there were no disagreements between us and Grant Thornton LLP with respect to any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton LLP, would have caused it to make reference to the subject matter of such disagreements in its report on the financial statements for such year.

On February 11, 2010, we engaged PricewaterhouseCoopers LLP as our new independent registered public accounting firm to audit our consolidated financial statements for the fiscal year ending September 30, 2010.

 

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AVAILABLE INFORMATION

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

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

PRIVACY NOTICE

We are committed to protecting your privacy. This privacy notice explains the privacy policies of Fifth Street and its affiliated companies. This notice supersedes any other privacy notice you may have received from Fifth Street.

We will safeguard, according to strict standards of security and confidentiality, all information we receive about you. The only information we collect from you is your name, address, number of shares you hold and your social security number. This information is used only so that we can send you annual reports and other information about us, and send you proxy statements or other information required by law.

We do not share this information with any non-affiliated third party except as described below.

 

•

Authorized Employees of Our Investment Adviser.    It is our policy that only authorized employees of our investment adviser who need to know your personal information will have access to it.

 

•

Service Providers.    We may disclose your personal information to companies that provide services on our behalf, such as recordkeeping, processing your trades, and mailing you information. These companies are required to protect your information and use it solely for the purpose for which they received it.

 

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Courts and Government Officials.    If required by law, we may disclose your personal information in accordance with a court order or at the request of government regulators. Only that information required by law, subpoena, or court order will be disclosed.

 

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Table of Contents

INDEX TO FINANCIAL STATEMENTS

 

		Page
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Assets and Liabilities as of March 31, 2012 and September 30, 2011			F-2
Consolidated Statements of Operations for the three and six months ended March 31, 2012 and March 31, 2011			F-3
Consolidated Statements of Changes in Net Assets for the six months ended March 31, 2012 and March 31, 2011			F-4
Consolidated Statements of Cash Flows for the six months ended March 31, 2012 and March 31, 2011			F-5
Consolidated Schedules of Investments as of March 31, 2012 and September 30, 2011			F-6
Notes to Consolidated Financial Statements			F-22
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms			F-60
Consolidated Statement of Assets and Liabilities as of September 30, 2011 and 2010			F-62
Consolidated Statements of Operations for the Years Ended September 30, 2011, 2010 and 2009			F-63
Consolidated Statements of Changes in Net Assets for the Years Ended September  30, 2011, 2010 and 2009			F-64
Consolidated Statements of Cash Flows for the Years Ended September 30, 2011, 2010 and 2009			F-65
Consolidated Schedules of Investments as of September 30, 2011 and 2010			F-66
Notes to Consolidated Financial Statements			F-80

 

F-1

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Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except per share data)

(unaudited)

 

		March 31, 2012				September 30, 2011
ASSETS
Investments at fair value:
Control investments (cost March 31, 2012: $15,331; cost September 30, 2011: $13,726)		$	17,198			$	14,500
Affiliate investments (cost March 31, 2012: $21,126; cost September 30, 2011: $34,182)			22,168				25,897
Non-control/Non-affiliate investments (cost March 31, 2012: $1,042,240; cost September 30, 2011: $1,108,174)			1,016,857				1,079,440
Total investments at fair value (cost March 31, 2012: $1,078,697; cost September 30, 2011: $1,156,082)			1,056,223				1,119,837
Cash and cash equivalents			115,178				67,644
Interest and fees receivable			6,825				6,752
Due from portfolio company			657				552
Deferred financing costs			14,309				14,668
Collateral posted to bank and other assets			238				264
Total assets		$	1,193,430			$	1,209,717
LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable, accrued expenses and other liabilities		$	1,658			$	1,175
Base management fee payable			5,391				5,710
Incentive fee payable			5,698				4,997
Due to FSC, Inc.			1,417				1,480
Interest payable			4,309				4,669
Payments received in advance from portfolio companies			27				35
Offering costs payable			108				—
Credit facilities payable			87,500				178,024
SBA debentures payable			150,000				150,000
Convertible senior notes payable			124,000				135,000
Total liabilities			380,108				481,090
Net assets:
Common stock, $0.01 par value, 150,000 shares authorized, 82,421 and 72,376 shares issued and outstanding at March 31, 2012 and September 30, 2011			824				724
Additional paid-in-capital			929,841				829,620
Net unrealized depreciation on investments and interest rate swap			(22,095	)			(35,976	)
Net realized loss on investments and interest rate swap			(90,904	)			(63,485	)
Accumulated overdistributed net investment income			(4,344	)			(2,256	)
Total net assets (equivalent to $9.87 and $10.07 per common share at March 31, 2012 and September 30, 2011) (Note 12)			813,322				728,627
Total liabilities and net assets		$	1,193,430			$	1,209,717

See notes to Consolidated Financial Statements.

 

F-2

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Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

		Three  months ended March 31, 2012				Three months ended March 31, 2011				Six months ended March 31, 2012				Six months ended March 31, 2011
Interest income:
Control investments		$	211			$	13			$	432			$	13
Affiliate investments			690				1,128				1,394				2,290
Non-control/Non-affiliate investments			28,183				21,203				57,309				37,692
Interest on cash and cash equivalents			14				4				18				14
Total interest income			29,098				22,348				59,153				40,009
PIK interest income:
Control investments			—				101				38				135
Affiliate investments			155				276				310				557
Non-control/Non-affiliate investments			2,737				3,094				5,959				5,923
Total PIK interest income			2,892				3,471				6,307				6,615
Fee income:
Control investments			—				—				—				126
Affiliate investments			146				133				254				267
Non-control/Non-affiliate investments			9,905				3,741				15,790				8,008
Total fee income			10,051				3,874				16,044				8,401
Dividend and other income:
Non-control/Non-affiliate investments			39				8				72				11
Total dividend and other income			39				8				72				11
Total investment income			42,080				29,701				81,576				55,036
Expenses:
Base management fee			5,391				4,786				11,132				8,565
Incentive fee			5,698				4,139				10,945				7,653
Professional fees			600				508				1,691				1,198
Board of Directors fees			70				36				126				85
Interest expense			5,602				2,724				11,326				4,663
Administrator expense			708				391				1,524				745
General and administrative expenses			1,256				561				2,394				1,515
Total expenses			19,325				13,145				39,138				24,424
Gain on extinguishment of convertible senior notes			36				—				1,341				—
Net investment income			22,791				16,556				43,779				30,612
Unrealized appreciation on interest rate swap			—				234				—				971
Unrealized appreciation (depreciation) on investments:
Control investments			(25	)			(757	)			1,089				7,313
Affiliate investments			10,610				(8,591	)			9,327				(10,171	)
Non-control/Non-affiliate investments			(2,538	)			8,742				3,465				18,357
Net unrealized appreciation (depreciation) on investments			8,047				(606	)			13,881				15,499
Realized loss on investments:
Control investments			—				(41	)			—				(7,806	)
Affiliate investments			(10,693	)			—				(10,620	)			—
Non-control/Non-affiliate investments			(89	)			(472	)			(16,800	)			(6,157	)
Net realized loss on investments			(10,782	)			(513	)			(27,420	)			(13,963	)
Net increase in net assets resulting from operations		$	20,056			$	15,671			$	30,240			$	33,119
Net investment income per common share — basic		$	0.29			$	0.27			$	0.58			$	0.52
Earnings per common share — basic		$	0.25			$	0.25			$	0.40			$	0.57
Weighted average common shares outstanding — basic			79,534				62,120				75,935				58,340
Net investment income per common share — diluted		$	0.28			$	0.27			$	0.54			$	0.52
Earnings per common share — diluted		$	0.24			$	0.25			$	0.38			$	0.57
Weighted average common shares outstanding — diluted			87,943				62,120				84,084				58,340

See notes to Consolidated Financial Statements.

 

F-3

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Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except per share data)

(unaudited)

 

		Six months ended March 31, 2012				Six months ended March 31, 2011
Operations:
Net investment income		$	43,779			$	30,612
Net unrealized appreciation on investments and interest rate swap			13,881				16,470
Net realized loss on investments			(27,420	)			(13,963	)
Net increase in net assets from operations			30,240				33,119
Stockholder transactions:
Distributions to stockholders			(45,867	)			(36,309	)
Net decrease in net assets from stockholder transactions			(45,867	)			(36,309	)
Capital share transactions:
Issuance of common stock, net			99,876				143,430
Issuance of common stock under dividend reinvestment plan			446				2,336
Net increase in net assets from capital share transactions			100,322				145,766
Total increase in net assets			84,695				142,576
Net assets at beginning of period			728,627				569,172
Net assets at end of period		$	813,322			$	711,748
Net asset value per common share		$	9.87			$	10.68
Common shares outstanding at end of period			82,421				66,668

See notes to Consolidated Financial Statements.

 

F-4

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Table of Contents

Fifth Street Finance Corp.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

		Six months ended March 31, 2012				Six months ended March 31, 2011
Cash flows from operating activities:
Net increase in net assets resulting from operations		$	30,240			$	33,119
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			(1,341	)			—
Net unrealized appreciation on investments and interest rate swap			(13,881	)			(16,470	)
Net realized losses on investments and interest rate swap			27,420				13,963
PIK interest income			(6,307	)			(6,615	)
Recognition of fee income			(16,044	)			(8,401	)
Accretion of original issue discount on investments			(914	)			(809	)
Amortization of deferred financing costs			2,051				955
Change in operating assets and liabilities:
Fee income received			12,578				14,011
Increase in interest and fees receivable			(225	)			(1,826	)
(Increase) decrease in due from portfolio company			(105	)			7
Decrease in collateral posted to bank and other assets			26				81
Increase in accounts payable, accrued expenses and other liabilities			483				101
Increase (decrease) in base management fee payable			(319	)			1,910
Increase in incentive fee payable			700				1,280
Decrease in due to FSC, Inc.			(63	)			(275	)
Increase (decrease) in interest payable			(360	)			370
Decrease in payments received in advance from portfolio companies			(8	)			(469	)
Purchases of investments and net revolver activity, net of syndications			(204,346	)			(452,661	)
Principal payments received on investments (scheduled payments)			23,309				10,186
Principal payments received on investments (payoffs)			228,604				62,204
PIK interest income received in cash			1,798				6,711
Proceeds from the sale of investments			11,549				—
Net cash provided (used) by operating activities			94,845				(342,628	)
Cash flows from financing activities:
Dividends paid in cash			(45,421	)			(33,973	)
Borrowings under SBA debentures payable			—				65,300
Borrowings under credit facilities			223,500				378,000
Repayments of borrowings under credit facilities			(314,024	)			(244,000	)
Repurchases of convertible senior notes			(9,378	)			—
Proceeds from the issuance of common stock			100,700				143,922
Deferred financing costs paid			(1,973	)			(4,338	)
Offering costs paid			(715	)			(492	)
Net cash provided (used) by financing activities			(47,311	)			304,419
Net increase (decrease) in cash and cash equivalents			47,534				(38,209	)
Cash and cash equivalents, beginning of period			67,644				76,765
Cash and cash equivalents, end of period		$	115,178			$	38,556
Supplemental Information:
Cash paid for interest		$	9,840			$	3,338
Non-cash financing activities:
Issuance of shares of common stock under dividend reinvestment plan		$	446			$	2,336

See notes to Consolidated Financial Statements.

 

F-5

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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				$	4,586			$	3,996			$	1,610
First Lien Bridge Loan, 8% PIK due 3/31/2012(17)					113				113				—
97.38% membership interest									1,210				—
									5,319				1,610
Coll Materials Group LLC(19)		Environmental & facilities services
Second Lien Term Loan, 12% cash due 11/1/2014					6,885				6,885				6,880
50% Membership interest in CD Holdco, LLC									3,127				8,708
									10,012				15,588
Total Control Investments (2.1% of net assets)								$	15,331			$	17,198
Affiliate Investments(4)
Caregiver Services, Inc.		Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013				$	4,997			$	4,880			$	5,125
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013					15,403				15,166				15,402
1,080,399 shares of Series A Preferred Stock									1,080				1,641
									21,126				22,168
Total Affiliate Investments (2.7% of net assets)								$	21,126			$	22,168
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)				$	3,608			$	3,412			$	1,908
7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.									750				—
									4,162				1,908
Traffic Control & Safety Corporation(9)(14)		Construction & engineering
Senior Term Loan A, LIBOR+9.0% cash due 6/29/2012					5,000				4,956				5,000
Senior Revolver, LIBOR+9.0% cash due 6/29/2012					12,486				12,409				12,514
Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015(13)					21,760				20,829				10,918
Subordinated Loan, 15% PIK due 5/28/2015(13)					5,772				5,531				—
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				—
									44,410				28,432
TBA Global, LLC		Advertising
53,994 Senior Preferred Shares									216				388
191,977 Shares A Shares									192				75
									408				463
Fitness Edge, LLC		Leisure facilities
First Lien Term Loan A, LIBOR+5.25% (4.75% floor), cash due 7/31/2012					375				375				378
First Lien Term Loan B, 12% cash 2.5% PIK due 7/31/2012					5,850				5,839				6,008
1,000 Common Units									43				179
									6,257				6,565
Capital Equipment Group, Inc.(9)		Industrial machinery
Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013					10,383				10,271				10,444
33,463 shares of Common Stock									345				717
									10,616				11,161
Rail Acquisition Corp.(14)		Electronic manufacturing services
First Lien Term Loan, 12% PIK due 9/1/2013					19,568				15,637				3,083
First Lien Revolver, 7.85% cash due 9/1/2013					4,369				4,370				4,370
									20,007				7,453

 

F-6

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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					6,931				6,843				7,085
									6,843				7,085
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					5,763				5,611				5,706
First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013					10,335				10,285				10,329
First Lien Revolver, 12% cash due 7/17/2013					1,250				1,245				1,265
									17,141				17,300
idX Corporation		Distributors
Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014					19,088				18,872				19,407
									18,872				19,407
Cenegenics, LLC		Healthcare services
414,419 Common Units(6)									598				1,342
									598				1,342
Trans-Trade, Inc.		Air freight & logistics
First Lien Term Loan A, 13% cash 2.5% PIK due 9/10/2014					12,682				12,508				12,640
First Lien Term Loan B, 12% cash due 9/10/2014					5,860				5,789				2,365
									18,297				15,005
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.		Home improvement retail
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014					3,000				2,989				2,851
First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014					23,293				23,268				20,687
First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014(10)					1,500				1,500				1,356
									27,757				24,894
JTC Education, Inc.		Education services
First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014					29,404				28,839				29,295
First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014					2,175				1,875				2,310
17,391 Shares of Series A-1 Preferred Stock									313				313
17,391 Shares of Common Stock									187				10
									31,214				31,928
Tegra Medical, LLC(9)		Healthcare equipment
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014					20,854				20,619				20,808
First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014					22,897				22,660				22,679
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014					2,500				2,457				2,473
									45,736				45,960
Psilos Group Partners IV, LP		Multi-sector holdings
2.52% limited partnership interest(12)(15)									—				—
									—				—

 

F-7

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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					10,123				9,988				10,137
First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015					9,212				9,091				9,173
First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)									(25	)			—
									19,054				19,310
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				21,604				21,380
First Lien Term Loan B, LIBOR+9.75% (3% floor) cash 3.75% PIK due 12/31/2012					8,076				8,076				8,095
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012					3,500				3,461				3,459
2,000 Series D Preferred Units									2,379				2,378
									35,520				35,312
Eagle Hospital Physicians, Inc.(9)		Healthcare services
First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015					24,978				24,561				24,927
First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015					1,100				1,065				1,113
									25,626				26,040
Enhanced Recovery Company, LLC		Diversified support services
First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015					13,380				13,189				13,356
First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015					11,071				10,916				10,986
First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015(11)									(56	)			—
									24,049				24,342
Specialty Bakers LLC		Food distributors
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015					4,650				4,416				4,587
First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015					11,000				10,804				10,837
First Lien Revolver, LIBOR+8.5% cash due 9/15/2015(11)									(71	)			—
									15,149				15,424
Welocalize, Inc.		Internet software & services
First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015					20,843				20,516				20,915
First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015					23,933				23,561				24,014
First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015(11)									(190	)			—
2,086,163 Common Units in RPWL Holdings, LLC									3,347				3,065
									47,234				47,994
Miche Bag, LLC		Apparel, accessories & luxury goods
First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013					11,125				10,877				11,109
First Lien Term Loan B, LIBOR+10% (3% floor) cash 3% PIK due 12/7/2015					17,693				15,544				17,357
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015					1,500				1,407				1,499
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				725
									30,328				31,859
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					7,380				7,271				7,383
First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015(11)									(4	)			—
									7,267				7,383

 

F-8

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)

 

Portfolio Company/Type of Investment(1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
DISA, Inc.		Human resources & employment services
First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015					11,865				11,671				11,970
First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015					8,459				8,332				8,634
First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015(11)									(61	)			—
									19,942				20,604
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									—				—
									648				648
Best Vinyl Fence & Deck, LLC		Building products
First Lien Term Loan B, 8% PIK due 6/30/2012					4,190				4,190				2,090
									4,190				2,090
Physicians Pharmacy Alliance, Inc.		Healthcare services
First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016					16,362				16,066				16,161
First Lien Revolver, LIBOR+6% cash due 1/4/2016(11)									(35	)			—
									16,031				16,161
Cardon Healthcare Network, LLC(9)		Diversified support services
First Lien Term Loan A, LIBOR+10% (1.75% floor) cash due 1/24/2017					10,665				10,478				10,970
First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 1/24/2017					22,283				22,055				22,316
First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/24/2017(11)									(44	)			—
65,903 Class A Units									250				342
									32,739				33,628
U.S. Retirement Partners, Inc.		Diversified financial services
First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016					32,850				32,401				32,255
									32,401				32,255
Phoenix Brands Merger Sub LLC(9)		Household products
Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016					7,446				7,288				7,418
Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017					20,789				20,373				19,900
First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016					2,143				2,014				2,204
									29,675				29,522
U.S. Collections, Inc.		Diversified support services
First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016					8,543				8,411				8,510
									8,411				8,510
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				34,004				34,377
									34,004				34,377
Maverick Healthcare Group, LLC		Healthcare equipment
First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016					24,688				24,205				24,163
									24,205				24,163
Refac Optical Group		Specialty stores
First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016					13,930				13,628				13,934
First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016					20,242				19,796				20,333
First Lien Revolver, LIBOR+7.5% cash due 3/23/2016(11)									(117	)			—
1,000 Shares of Common Stock in Refac Holdings, Inc.									1				64
1,000 Shares of Preferred Stock in Refac Holdings, Inc.									999				999
									34,307				35,330

 

F-9

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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				3,936				3,932
First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017					4,700				4,635				4,634
									8,571				8,566
Securus Technologies, Inc.		Integrated telecommunication services
Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018					22,500				22,086				22,339
									22,086				22,339
Gundle/SLT Environmental, Inc.		Environmental & facilities services
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016					7,940				7,854				7,990
									7,854				7,990
Titan Fitness, LLC		Leisure facilities
First Lien Term Loan A, LIBOR+8.75 (1.25% floor) cash due 6/30/2016					16,125				15,970				16,042
First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016					11,633				11,524				11,643
First Lien Term Loan C, 18% PIK due 6/30/2016					2,976				2,951				2,970
First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016(11)									(33	)			—
									30,412				30,655
Baird Capital Partners V, LP		Multi-sector holdings
0.4% limited partnership interest(15)									386				386
									386				386
Charter Brokerage, LLC		Oil & gas equipment services
Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016					16,938				16,788				16,915
Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017					10,143				10,059				9,927
Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016(11)									(62	)			—
									26,785				26,842
Stackpole Powertrain International ULC(15)		Auto parts & equipment
Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018					18,243				18,080				18,164
1,000 Common Units									1,000				1,063
									19,080				19,227
Discovery Practice Management, Inc.		Healthcare services
Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016					6,722				6,652				6,691
Senior Term Loan B, 12% cash 3% PIK due 8/8/2016					6,344				6,281				6,269
Senior Revolver, LIBOR+7% cash due 8/8/2016(11)									(32	)			—
									12,901				12,960
CTM Group, Inc.		Leisure products
Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017					10,637				10,534				10,562
Mezzanine Term Loan B, 18.4% PIK due 2/10/2017					3,480				3,451				3,560
									13,985				14,122
Bojangles		Restaurants
First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017					5,789				5,686				5,833
									5,686				5,833
Milestone Partners IV, LP		Multi-sector holdings
3.07% limited partnership interest(15)									525				525
									525				525
Insight Pharmaceuticals, LLC		Pharmaceuticals
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016					9,950				9,883				10,193
Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017					17,500				17,347				17,660
									27,230				27,853

 

F-10

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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					26,830				26,583				26,842
299,292.94 Class A Units(6)									299				222
									26,882				27,064
RCPDirect, LP.		Multi-sector holdings
0.91% limited partnership interest(15)									297				297
									297				297
The MedTech Group, Inc.		Healthcare equipment
Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 9/7/2016					12,935				12,831				12,921
									12,831				12,921
Digi-Star Acquisition Holdings, Inc.		Industrial Machinery
Mezzanine Term Loan, 12% cash 1.5% PIK due 11/18/2017					10,056				9,940				10,121
225 Class A Preferred Units									225				225
2,500 Class A Common Units									25				44
									10,190				10,390
CPASS Acquisition Company		Internet software & services
Senior Term Loan, LIBOR+9% (1.5% floor) cash 1% PIK due 11/21/2016					4,955				4,848				5,029
Senior Revolver, LIBOR+9% (1.5% floor) cash due 11/21/2016(11)									(18	)			—
									4,830				5,029
Genoa Healthcare Holdings, LLC		Pharmaceuticals
Mezzanine Term Loan, 12% cash 2% PIK due 6/1/2017					12,584				12,467				12,555
500,000 Preferred units									475				487
500,000 Class A Common Units									25				32
									12,967				13,074
SolutionSet, Inc.		Advertising
Senior Term Loan, LIBOR+6% (1% floor) cash due 12/21/2016					9,739				9,646				9,687
									9,646				9,687
Slate Pharmaceuticals Acquisition Corp.		Healthcare services
Subordinated Term Loan, 12% cash 1.5% PIK due 12/29/2017					20,077				19,889				20,107
									19,889				20,107
ACON Equity Partners III, LP		Multi-sector holdings
0.31% limited partnership interest(12)(15)									—				—
									—				—
Blue Coat Systems, Inc.		Internet software & services
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 2/15/2018					15,000				14,853				15,000
Second Lien Term Loan, LIBOR+10% (1.5% floor) cash due 8/15/2018					7,000				6,932				7,000
									21,785				22,000
CRGT, Inc.(18)		IT consulting & other services
Mezzanine Term Loan, 12.5% cash 3% PIK due 3/9/2018					25,547				25,295				25,618
									25,295				25,618
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					9,000				8,858				9,000
Senior Term Loan B, 12.5% cash due 3/30/2017					5,500				5,415				5,500
Senior Revolver, LIBOR+6.25% (1.5% floor) cash due 3/30/2017(11)									(62	)			—
									14,211				14,500

 

F-11

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 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					13,850				13,714				13,851
									13,714				13,851
Total Non-Control/Non-Affiliate Investments (125.0% of net assets)								$	1,042,240			$	1,016,857
Total Portfolio Investments (129.9% of net assets)								$	1,078,697			$	1,056,223

 

(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 maintains 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		January 24, 2012		+ 1.5% on Term Loan A				Per loan amendment
Traffic Control & Safety Corporation		January 1, 2012		+ 3.0% on Senior Term Loan & Senior Revolver		+ 2.0% on Subordinated Term Loan		Default interest per loan agreement
				– 4.0% on Second Lien Term Loan		+ 3.0% on Second Lien Term Loan
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

 

F-12

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)

 

(10)	Revolving credit line has been suspended and is 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 March 31, 2012.

 

(14)	Investment was on PIK non-accrual status as of March 31, 2012.

 

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

 

(16)	Repechage Investments Limited Term Loan is under negotiation and, as such, the maturity date of the loan has been temporarily suspended.

 

(17)	Lighting By Gregory, LLC Bridge Loan is under negotiation and, as such, the maturity date of the loan has been temporarily suspended.

 

(18)	In March 2012, the Company received a cash payment from CRGT, Inc. in full satisfaction of all obligations under the senior loan agreement. As part of this refinancing, the Company closed on a $25.5 million subordinated debt investment in CRGT, Inc.

 

(19)

In November 2011, Nicos Polymers & Grinding, Inc. was merged into Coll Materials Group, LLC. As a result of this transaction, the Company’s 50% membership interest in CD Holdco, LLC now represents a 23.25% membership interest in Coll Materials Group, LLC and the first lien revolver and term loan were consolidated into a $6.9 million second lien term loan with a scheduled maturity of three years that bears monthly cash interest at a rate of 12.0% per annum.

 

F-13

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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

 

F-14

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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

 

F-15

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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

 

F-16

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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

 

F-17

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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

 

F-18

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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)									—				—
									—				—

 

F-19

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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 Investment Company Act of 1940 (“1940 Act”) as investments in companies in which the Company owns more than 25% of the voting securities or maintains 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

 

F-20

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

 

(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.

 

F-21

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Table of Contents

FIFTH STREET FINANCE CORP.

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. Since January 2, 2008, references to the “Company”, “FSC”, “we” or “our” are to Fifth Street Finance Corp., unless the context otherwise requires.

The Company also has certain wholly-owned subsidiaries, including subsidiaries that are not consolidated 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 March 31, 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., 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. 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.

 

F-22

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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 SBIC license allows the Company’s SBIC subsidiary 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.

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 March 31, 2012, the Company’s SBIC subsidiary 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	%

For the three and six months ended March 31, 2012, the Company recorded interest expense of $1.6 million and $3.2 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 subsidiary may also be limited in its ability to make distributions to the Company if it does not have sufficient capital, in accordance with SBA regulations.

The Company’s SBIC subsidiary is 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 subsidiary will receive SBA-guaranteed debenture funding and is dependent upon the SBIC subsidiary continuing to be in compliance with SBA regulations and policies.

The SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary 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 subsidiary 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 $150 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.

 

F-23

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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)

 

Although the Company expects to fund the growth of its investment portfolio through the net proceeds from the recent and future 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.

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 $1.06 billion and $1.12 billion at March 31, 2012 and September 30, 2011, respectively. The portfolio investments represent 129.9% and 153.7% of net assets at March 31, 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.

 

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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)

 

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.

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.

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.

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;

 

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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)

 

•

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 March 31, 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.

Investment Income:

Interest income, adjusted for amortization of premium and accretion of original issue discount, 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.

 

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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)

 

Fee income consists of the monthly collateral management 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 $6.1 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.

Deferred Financing Costs:

Deferred financing costs consist of fees and expenses paid in connection with the closing or amending of credit facilities 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 March 31, 2012, the Company was not party to any interest rate swap agreements.

 

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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)

 

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. $0.8 million of offering costs have been charged to capital during the six months ended March 31, 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.

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 or 2010. 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”).

 

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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)

 

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 March 31, 2012, 129.9% of net assets or $1.06 billion was invested in 67 long-term portfolio investments and 14.2% of net assets or $115.2 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 March 31, 2012, 81.3% 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 six months ended March 31, 2012, the Company recorded net realized losses of $10.8 million and $27.4 million, respectively. During the three and six months ended March 31, 2011, the Company recorded net realized losses on investments of $0.5 million and $14.0 million, respectively. During the three and six months ended March 31, 2012, the Company recorded net unrealized appreciation of $8.0 million and $13.9 million, respectively. During the three and six months ended March 31, 2011, the Company recorded net unrealized depreciation of $0.4 million and net unrealized appreciation of $16.5 million, respectively.

The composition of the Company’s investments as of March 31, 2012 and September 30, 2011 at cost and fair value was as follows:

 

		March 31, 2012								September 30, 2011
		Cost				Fair Value				Cost				Fair Value
Investments in debt securities		$	1,056,115			$	1,029,661			$	1,137,754			$	1,099,708
Investments in equity securities			22,582				26,562				18,328				20,129
Total		$	1,078,697			$	1,056,223			$	1,156,082			$	1,119,837

 

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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 debt investments as of March 31, 2012 and September 30, 2011 at fixed rates and floating rates was as follows:

 

		March 31, 2012								September 30, 2011
		Fair Value				% of Debt Portfolio				Fair Value				% of Debt Portfolio
Fixed rate debt securities		$	351,469				34.13	%		$	359,873				32.72	%
Floating rate debt securities			678,192				65.87	%			739,835				67.28	%
Total		$	1,029,661				100.00	%		$	1,099,708				100.00	%

The following table presents the financial instruments carried at fair value as of March 31, 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)		$	—			$	—			$	736,192			$	736,192
Investments in debt securities (second lien)			—				—				122,261				122,261
Investments in debt securities (subordinated)			—				—				171,208				171,208
Investments in equity securities (preferred)			—				—				7,801				7,801
Investments in equity securities (common)			—				—				18,761				18,761
Total investments at fair value		$	—			$	—			$	1,056,223			$	1,056,223

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 December 31, 2011 to March 31, 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 December 31, 2011		$	834,405			$	139,624			$	123,696			$	7,429			$	14,744			$	1,119,898
New investments & net revolver activity			62,064				7,000				47,016				—				3,747				119,827
Redemptions/repayments			(162,030	)			(25,745	)			—				—				—				(187,775	)
Net accrual of PIK interest income			850				347				857				172				—				2,226
Accretion of original issue discount			248				60				—				—				—				308
Net change in unearned income			2,323				378				(397	)			—				—				2,304
Net unrealized appreciation			6,917				243				36				331				520				8,047
Net change from unrealized to realized			(8,585	)			354				—				(131	)			(250	)			(8,612	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of March 31, 2012		$	736,192			$	122,261			$	171,208			$	7,801			$	18,761			$	1,056,223
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March 31, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended March 31, 2012		$	(1,668	)		$	597			$	36			$	200			$	270			$	(565	)

 

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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 December 31, 2010 to March 31, 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 December 31, 2010		$	642,402			$	84,296			$	5,320			$	3,963			$	6,414			$	742,395
New investments & net revolver activity			196,101				—				20,000				999				905				218,005
Redemptions/repayments			(17,074	)			(1,581	)			—				—				—				(18,655	)
Net accrual of PIK interest income			1,895				(241	)			215				—				—				1,869
Accretion of original issue discount			338				82				—				—				—				420
Net change in unearned income			(2,844	)			119				(389	)			—				—				(3,114	)
Net unrealized appreciation (depreciation)			1,335				(89	)			(799	)			(149	)			(904	)			(606	)
Net change from unrealized to realized			(268	)			—				—				(254	)			(43	)			(565	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of March 31, 2011		$	821,885			$	82,586			$	24,347			$	4,559			$	6,372			$	939,749
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March, 31, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended March 31, 2011		$	1,067			$	(89	)		$	(799	)		$	(403	)		$	(947	)		$	(1,171	)

 

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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 September 30, 2011 to March 31, 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			102,817				7,000				89,516				700				4,313				204,346
Redemptions/repayments			(241,538	)			(23,751	)			—				(713	)			(9	)			(266,011	)
Net accrual of PIK interest income			1,545				908				1,723				333				—				4,509
Accretion of original issue discount			794				120				—				—				—				914
Net change in unearned income			3,424				1,088				(894	)			—				—				3,618
Net unrealized appreciation (depreciation)			1,850				10,223				(370	)			432				1,746				13,881
Net change from unrealized to realized			(7,792	)			(16,710	)			—				(118	)			(251	)			(24,871	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of March 31, 2012		$	736,192			$	122,261			$	171,208			$	7,801			$	18,761			$	1,056,223
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March 31, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the six months ended March 31, 2012		$	(5,942	)		$	(6,487	)		$	(370	)		$	314			$	1,495			$	(10,990	)

 

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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, 2010 to March 31, 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			425,950				—				20,000				2,036				4,728				452,714
Redemptions/repayments			(24,078	)			(51,722	)			—				—				—				(75,800	)
Net accrual of PIK interest income			3,691				(4,214	)			427				—				—				(96	)
Accretion of original issue discount			494				315				—				—				—				809
Net change in unearned income			(7,121	)			918				(389	)			—				—				(6,592	)
Net unrealized appreciation (depreciation)			17,154				283				(1,161	)			(115	)			(662	)			15,499
Net change from unrealized to realized			(10,529	)			220				—				(254	)			(43	)			(10,606	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of March 31, 2011		$	821,885			$	82,586			$	24,347			$	4,559			$	6,372			$	939,749
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March, 31, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the six months ended March 31, 2011		$	6,625			$	503			$	(1,161	)		$	(369	)		$	(705	)		$	4,893

The Company 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) based on the present value of expected cash flows. 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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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 March 31, 2012:

 

Asset		Fair Value				Valuation Technique		Unobservable Input		Range																Weighted Average
First lien debt		$	720,120			Bond yield approach		Capital structure premium			(a	)			0.0%				-				1.0%				0.3%
								Tranche specific risk premium/(discount)			(a	)			(2.5%	)			-				12.5%				3.0%
								Size premium			(a	)			0.0%				-				2.0%				1.3%
								Industry premium/(discount)			(a	)			(1.3%	)			-				3.9%				0.3%
			16,072			Enterprise value approach		Weighted average cost of capital							21.0%				-				22.0%				21.5%
								Company specific risk premium			(a	)			4.0%				-				8.0%				6.1%
								Revenue growth rate							10.0%				-				10.0%				10.0%
								EBITDA multiple			(b	)			3.2x				-				7.5x				5.9x
Second lien & subordinated debt			282,551			Bond yield approach		Capital structure premium			(a	)			2.0%				-				2.0%				2.0%
								Tranche specific risk premium			(a	)			1.5%				-				7.8%				4.4%
								Size premium			(a	)			0.0%				-				2.0%				1.0%
								Industry premium/(discount)			(a	)			(1.3%	)			-				0.8%				(0.2%	)
			10,918			Enterprise value approach		Weighted average cost of capital							24.0%				-				24.0%				24.0%
								Company specific risk premium			(a	)			6.0%				-				6.0%				6.0%
								Revenue growth rate							10.4%				-				10.4%				10.4%
								EBITDA multiple			(b	)			7.6x				-				7.6x				7.6x
Preferred & common equity			26,562			Enterprise value approach		Weighted average cost of capital							10.0%				-				36.0%				24.8%
								Company specific risk premium			(a	)			2.0%				-				21.0%				12.1%
								Revenue growth rate							3.6%				-				26.3%				15.2%
								EBITDA multiple			(b	)			4.6x				-				10.2x				7.8x
Total		$	1,056,223

 

(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.

 

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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)

 

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 March 31, 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		$	87,500			$	87,500			$	—			$	—			$	87,500
SBA debentures payable			150,000				126,200				—				—				126,200
Convertible senior notes payable			124,000				118,000				—				—				118,000
Total		$	361,500			$	331,700			$	—			$	—			$	331,700

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.

 

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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 off-balance sheet arrangements consisted of $94.4 million and $108.8 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of March 31, 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 March 31, 2012 and September 30, 2011 is shown in the table below:

 

		March 31, 2012				September 30, 2011
JTC Education, Inc.		$	11,825			$	14,000
Welocalize, Inc.			10,000				750
Charter Brokerage, LLC			7,353				6,176
Rail Acquisition Corp.			5,630				5,446
Refac Optical Group			5,500				5,500
Phoenix Brands Merger Sub LLC			4,286				3,000
Enhanced Recovery Company, LLC			4,000				4,000
DISA, Inc.			4,000				4,000
Specialty Bakers, LLC			4,000				2,000
World 50, Inc.			4,000				—
Miche Bag, LLC			3,500				5,000
Titan Fitness, LLC			3,500				2,957
Discovery Practice Management, Inc.			3,000				3,000
Cardon Healthcare Network, LLC			3,000				2,000
Traffic Control & Safety Corporation			2,514				3,014
Riverside Fund V, LP (limited partnership interest)			2,000				—
Mansell Group, Inc.			2,000				2,000
Physicians Pharmacy Alliance, Inc.			2,000				2,000
Tegra Medical, LLC			1,500				1,500
Milestone Partners IV, LP (limited partnership interest)			1,475				2,000
Eagle Hospital Physicians, Inc.			1,400				2,500
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)			1,000				—
Bunker Hill Capital II (QP), LP (limited partnership interest)			934				960
Riverlake Equity Partners II, LP (limited partnership interest)			760				878
HealthDrive Corporation			750				2,000
RCPDirect, LP (limited partnership interest)			703				—
Baird Capital Partners V, LP (limited partnership interest)			614				701
Riverside Fund IV, LP (limited partnership interest)			402				555
Saddleback Fence and Vinyl Products, Inc.			401				400
Advanced Pain Management			400				267
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		$	94,447			$	108,804

 

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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)

 

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:

 

		March 31, 2012								September 30, 2011
Cost:
First lien debt		$	750,089				69.54	%		$	890,729				77.05	%
Second lien debt			130,110				12.06	%			161,455				13.97	%
Subordinated debt			175,916				16.31	%			85,570				7.40	%
Purchased equity			14,998				1.39	%			11,263				0.97	%
Equity grants			5,474				0.51	%			6,158				0.53	%
Limited partnership interests			2,110				0.19	%			907				0.08	%
Total		$	1,078,697				100.00	%		$	1,156,082				100.00	%
		March 31, 2012								September 30, 2011
Fair value:
First lien debt		$	736,192				69.70	%		$	875,092				78.14	%
Second lien debt			122,261				11.58	%			143,383				12.80	%
Subordinated debt			171,208				16.21	%			81,233				7.25	%
Purchased equity			18,736				1.77	%			12,548				1.12	%
Equity grants			5,716				0.54	%			6,675				0.60	%
Limited partnership interests			2,110				0.20	%			906				0.09	%
Total		$	1,056,223				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.

 

		March 31, 2012								September 30, 2011
Cost:
Northeast U.S.		$	361,126				33.48	%		$	389,185				33.66	%
Southwest U.S.			219,619				20.36	%			273,513				23.66	%
Southeast U.S.			217,979				20.21	%			244,988				21.19	%
West U.S.			173,642				16.10	%			142,745				12.35	%
Midwest U.S.			87,251				8.09	%			86,768				7.51	%
Canada			19,080				1.76	%			18,883				1.63	%
Total		$	1,078,697				100.00	%		$	1,156,082				100.00	%
		March 31, 2012								September 30, 2011
Fair value:
Northeast U.S.		$	364,477				34.51	%		$	389,898				34.82	%
Southeast U.S.			221,318				20.95	%			248,588				22.20	%
Southwest U.S.			203,631				19.28	%			246,358				22.00	%
West U.S.			158,109				14.97	%			127,522				11.39	%
Midwest U.S.			89,462				8.47	%			88,412				7.90	%
Canada			19,226				1.82	%			19,059				1.69	%
Total		$	1,056,223				100.00	%		$	1,119,837				100.00	%

 

F-38

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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 portfolio by industry at cost and fair value as of March 31, 2012 and September 30, 2011 were as follows:

 

		March 31, 2012								September 30, 2011
Cost:
Healthcare services		$	147,462				13.67	%		$	227,145				19.65	%
Healthcare equipment			82,773				7.67	%			71,254				6.16	%
Internet software & services			73,850				6.85	%			43,846				3.79	%
Diversified support services			73,770				6.84	%			55,472				4.80	%
Oil & gas equipment services			60,788				5.64	%			82,168				7.11	%
Construction and engineering			44,410				4.12	%			43,236				3.74	%
Pharmaceuticals			40,197				3.73	%			27,257				2.36	%
Leisure facilities			36,668				3.40	%			38,041				3.29	%
Electronic equipment & instruments			35,521				3.29	%			34,852				3.01	%
Specialty stores			34,307				3.18	%			34,538				2.99	%
Diversified financial services			32,401				3.00	%			13,311				1.15	%
Education services			31,214				2.89	%			29,662				2.57	%
Apparel, accessories & luxury goods			30,328				2.81	%			30,986				2.68	%
Household products			29,675				2.75	%			31,213				2.70	%
Advertising			29,108				2.70	%			19,892				1.72	%
Home improvement retail			27,757				2.57	%			27,999				2.42	%
IT consulting & other services			25,295				2.34	%			48,943				4.23	%
Restaurants			23,562				2.18	%			13,966				1.21	%
Integrated telecommunication services			22,086				2.05	%			25,995				2.25	%
Industrial machinery			20,805				1.93	%			10,457				0.90	%
Electronic manufacturing services			20,006				1.85	%			20,190				1.75	%
Human resources & employment services			19,941				1.85	%			20,457				1.77	%
Auto parts & equipment			19,080				1.77	%			18,883				1.63	%
Distributors			18,872				1.75	%			18,631				1.61	%
Air freight & logistics			18,298				1.70	%			17,984				1.56	%
Environmental & facilities services			17,866				1.66	%			16,311				1.41	%
Food distributors			15,149				1.40	%			20,834				1.80	%
Research & consulting services			14,211				1.32	%			—				0.00	%
Leisure products			13,986				1.30	%			13,564				1.17	%
Construction materials			6,843				0.63	%			6,736				0.58	%
Housewares & specialties			5,319				0.49	%			5,319				0.46	%
Building products			4,838				0.45	%			6,689				0.58	%
Multi-sector holdings			2,111				0.20	%			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		$	1,078,697				100.00	%		$	1,156,082				100.00	%

 

F-39

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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)

 

		March 31, 2012								September 30, 2011
Fair Value:
Healthcare services		$	150,526				14.25	%		$	231,478				20.67	%
Healthcare equipment			83,045				7.86	%			71,911				6.42	%
Diversified support services			75,047				7.11	%			56,232				5.02	%
Internet software & services			75,023				7.10	%			43,786				3.91	%
Oil & gas equipment services			61,220				5.80	%			82,696				7.38	%
Pharmaceuticals			40,926				3.87	%			27,500				2.46	%
Leisure facilities			37,219				3.52	%			38,447				3.43	%
Specialty stores			35,330				3.34	%			35,198				3.14	%
Electronic equipment & instruments			35,314				3.34	%			34,863				3.11	%
Diversified financial services			32,255				3.05	%			13,329				1.19	%
Education services			31,928				3.02	%			30,176				2.69	%
Apparel, accessories & luxury goods			31,859				3.02	%			33,595				3.00	%
Household products			29,523				2.80	%			29,943				2.67	%
Advertising			29,459				2.79	%			20,183				1.80	%
Construction and engineering			28,433				2.69	%			35,814				3.20	%
IT consulting & other services			25,618				2.43	%			49,528				4.42	%
Home improvement retail			24,894				2.36	%			27,576				2.46	%
Environmental & facilities services			23,578				2.23	%			19,952				1.78	%
Integrated telecommunication services			22,339				2.12	%			26,374				2.36	%
Restaurants			21,591				2.04	%			11,829				1.06	%
Industrial machinery			21,551				2.04	%			10,860				0.97	%
Human resources & employment services			20,604				1.95	%			20,952				1.87	%
Distributors			19,407				1.84	%			18,938				1.69	%
Auto parts & equipment			19,227				1.82	%			19,059				1.70	%
Food distributors			15,423				1.46	%			21,006				1.88	%
Air freight & logistics			15,004				1.42	%			17,243				1.54	%
Research & consulting services			14,500				1.37	%			—				0.00	%
Leisure products			14,122				1.34	%			13,711				1.22	%
Electronic manufacturing services			7,453				0.71	%			8,660				0.77	%
Construction materials			7,085				0.67	%			6,840				0.61	%
Building products			2,737				0.26	%			4,833				0.43	%
Multi-sector holdings			2,111				0.21	%			907				0.11	%
Housewares & specialties			1,610				0.15	%			2,526				0.23	%
Movies & entertainment			262				0.02	%			258				0.02	%
Data processing & outsourced services			—				0.00	%			3,497				0.31	%
Fertilizers & agricultural chemicals			—				0.00	%			29,190				2.61	%
Healthcare technology			—				0.00	%			20,947				1.87	%
Total		$	1,056,223				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 March 31, 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 six months ended March 31, 2012 and March 31, 2011, no individual investment produced income that exceeded 10% of investment income.

 

F-40

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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)

 

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 and collateral management fees, are classified as fee income and recognized as they are earned on a monthly basis.

Accumulated unearned fee income activity for the six months ended March 31, 2012 and March 31, 2011 was as follows:

 

		Six months ended March 31, 2012				Six months ended March 31, 2011
Beginning unearned fee income balance		$	18,333			$	11,901
Net fees received			12,265				10,589
Unearned fee income recognized			(15,883	)			(3,997	)
Ending unearned fee income balance		$	14,715			$	18,493

As of March 31, 2012, the Company had structured $6.4 million in aggregate exit fees across 9 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.

 

F-41

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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)

 

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.

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.

 

F-42

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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 sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10 Earnings per Share, for the three and six months ended March 31, 2012 and March 31, 2011:

 

		Three months ended March 31, 2012				Three months ended March 31, 2011				Six months ended March 31, 2012				Six months ended March 31, 2011
(Amounts in thousands, except per share amounts)
Earnings per common share — basic:
Net increase in net assets resulting from operations		$	20,056			$	15,671			$	30,240			$	33,119
Weighted average common shares outstanding — basic			79,534				62,120				75,935				58,340
Earnings per common share — basic		$	0.25			$	0.25			$	0.40			$	0.57
Earnings per common share — diluted:
Net increase in net assets resulting from operations, before adjustments		$	20,056			$	15,671			$	30,240			$	30,119
Adjustments for interest on convertible senior notes, base management fees, incentive fees and gain on extinguishment of convertible senior notes			1,450				—				1,908				—
Net increase in net assets resulting from operations, as adjusted			21,506			$	15,671				32,148			$	30,119
Weighted average common shares outstanding — basic			79,534				62,120				75,935				58,340
Adjustments for dilutive effect of convertible notes			8,409				—				8,149				—
Weighted average common shares outstanding — diluted			87,943				62,120				84,084				58,340
Earnings per common share — diluted		$	0.24			$	0.25			$	0.38			$	0.57

 

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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 March 31, 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

 

(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 December 2009. In October 2008, the Company repurchased 78,000 shares of common stock on the open market as part of its 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,

 

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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)

 

provided it was below the most recently published net asset value per share. The stock repurchase program expired December 31, 2011, with the Company not repurchasing any shares of its common stock pursuant to the 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

 

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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)

 

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.

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 March 31, 2012, the Company had $7.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $7.0 million. The Company’s borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.130% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $0.6 million and $1.3 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 subsidiary, 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 subsidiary, 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.

 

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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)

 

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.

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 March 31, 2012, the Company had $80.5 million of borrowings outstanding under the ING facility that had a fair value of $80.5 million. The Company’s borrowings under the ING facility bore interest at a weighted average interest rate of 3.403% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $1.4 million and $2.8 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

 

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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)

 

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 March 31, 2012, the Company had no borrowings outstanding under the Sumitomo facility. The Company’s borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.773% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $0.2 million and $0.4 million, respectively, related to the Sumitomo facility.

As of March 31, 2012, except for assets that were funded through the Company’s SBIC subsidiary, 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 subsidiary, the SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over the Company’s stockholders.

Interest expense for the three and six months ended March 31, 2012 was $5.6 million and $11.3 million, respectively. Interest expense for the three and six months ended March 31, 2011 was $2.7 million and $4.7 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 well 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 six months ended March 31, 2012 and March 31, 2011 was as follows:

 

		Six months ended March  31, 2012				Six months ended March  31, 2011
PIK balance at beginning of period		$	22,672			$	19,301
Gross PIK interest accrued			8,351				7,002
PIK income reserves			(2,044	)			(387	)
PIK interest received in cash			(1,798	)			(6,711	)
Loan exits and other PIK adjustments			—				(316	)
PIK balance at end of period		$	27,181			$	18,889

As of March 31, 2012, the Company had stopped accruing cash and/or PIK interest and original issue discount (“OID”) on four investments, including three that had not paid all of their scheduled cash interest payments for the period ended March 31, 2012. As of March 31, 2011, the Company had stopped accruing cash interest, PIK interest and OID on three investments that had not paid all of their scheduled cash interest payments for the period ended March 31, 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 March 31, 2012, September 30, 2011 and March 31, 2011 were as follows:

 

		March 31, 2012																September 30, 2011																March 31, 2011
		Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio
Accrual		$	1,027,219				95.23	%		$	1,038,705				98.34	%		$	1,116,762				96.60	%		$	1,111,986				99.30	%		$	916,768				96.18	%		$	931,796				99.15	%
PIK non-accrual			15,637				1.45	%			3,082				0.29	%			—				0.00	%			—				0.00	%			—				0.00	%			—				0.00	%
Cash non-accrual			35,841				3.32	%			14,436				1.37	%			39,320				3.40	%			7,851				0.70	%			36,425				3.82	%			7,953				0.85	%
Total		$	1,078,697				100.00	%		$	1,056,223				100.00	%		$	1,156,082				100.00	%		$	1,119,837				100.00	%		$	953,193				100.00	%		$	939,749				100.00	%

The non-accrual status of the Company’s portfolio investments as of March 31, 2012, September 30, 2011 and March 31, 2011 was as follows:

 

March 31, 2012

September 30, 2011

March 31, 2011

Lighting by Gregory, LLC

Cash non-accrual

Cash non-accrual

Cash non-accrual

MK Network, LLC(1)

—

—

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

—

—

 

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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)

 

 

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

Income non-accrual amounts related to the above investments for the three and six months ended March 31, 2012 and March 31, 2011 were as follows:

 

		Three months ended March 31, 2012				Three months ended March 31, 2011				Six months ended March 31, 2012				Six months ended March 31, 2011
Cash interest income		$	967			$	1,460			$	2,157			$	3,566
PIK interest income			1,217				146				2,044				387
OID income			6				30				96				60
Total		$	2,190			$	1,636			$	4,297			$	4,013

 

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 interest 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 has 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.

Listed below is a reconciliation of “net increase in net assets resulting from operations” to taxable income for the three and six months ended March 31, 2012.

 

		Three months ended March 31, 2012				Six months ended March 31, 2012
Net increase in net assets resulting from operations		$	20,056			$	30,240
Net change in unrealized appreciation			(8,047	)			(13,881	)
Book/tax difference due to deferred loan origination fees, net			(5,729	)			(7,812	)
Book/tax difference due to organizational and deferred offering costs			(22	)			(43	)
Book/tax difference due to interest income on certain loans			1,662				2,232
Book/tax difference due to capital losses not recognized			10,782				27,420
Other book-tax differences			(39	)			(73	)
Taxable/Distributable Income(1)		$	18,663			$	38,083

 

(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.

 

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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)

 

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.

The Company’s Board of Directors has declared the following distributions from inception to March 31, 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

 

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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)

 

Dividend Type

Date Declared

Record Date

Payment Date

Amount Per Share

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

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. The Company anticipates declaring further distributions to its stockholders to meet the RIC distribution requirements.

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 calender year 2011 and does not expect to incur a federal excise tax for calendar year 2012.

 

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 on investments and interest rate swap 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 six months ended March 31, 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 above par (including associated 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 above par (including associated 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;

 

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

 

•

In December 2011, the Company sold $2.0 million of its $11.5 million debt investment in US Collections, Inc. 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 above par (including associated 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 above par (including associated 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 above par (including associated 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 above par (including associated 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 above par (including associated fees) and no realized gain or loss was recorded on this transaction; and

 

•

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.

During the six months ended March 31, 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 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;

 

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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 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 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; and

 

•

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.

During the six months ended March 31, 2012, the Company recorded net unrealized appreciation of $13.9 million. This consisted of $1.8 million of net unrealized appreciation on equity investments and $27.7 million of net reclassifications from unrealized depreciation to realized losses on our investments, offset by $15.6 million of net unrealized depreciation on debt investments. During the six months ended March 31, 2011, the Company recorded net unrealized appreciation of $16.5 million. This consisted of $10.9 million of net reclassifications from unrealized depreciation to realized losses on our investments, $5.7 million of net unrealized appreciation on debt investments and $1.0 million of net unrealized appreciation on the interest rate swap, offset by $1.1 million of net unrealized depreciation on equity investments.

 

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. The base management fee is payable quarterly in arrears, and will be 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 will be appropriately prorated.

 

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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)

 

For the three and six months ended March 31, 2012, base management fees were $5.4 million and $11.1 million, respectively. For the three and six months ended March 31, 2011, base management fees were $4.8 million and $8.6 million, respectively. At March 31, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.4 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

 

•

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).

 

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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 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 six months ended March 31, 2012, incentive fees were $5.7 million and $10.9 million, respectively. For the three and six months ended March 31, 2011, incentive fees were $4.1 million and $7.7 million, respectively. At March 31, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.7 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 six months ended March 31, 2012, the Company incurred administration expenses of $1.1 million, including $0.3 million of general and administrative expenses, and $2.2 million, including $0.6 million of general and administrative expenses, that are due to FSC, Inc., respectively. At March 31, 2012, $1.4 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

 

(Amounts in thousands, except per share data) Per share data:		Three months ended March 31, 2012				Three months ended March 31, 2011				Six months ended March 31, 2012				Six months ended March 31, 2011
Net asset value at beginning of period		$	9.89			$	10.44			$	10.07			$	10.43
Net investment income			0.29				0.27				0.58				0.52
Net unrealized appreciation (depreciation) on investments and interest rate swap			0.10				(0.01	)			0.18				0.28
Net realized loss on investments and interest rate swap			(0.14	)			(0.01	)			(0.36	)			(0.24	)
Dividends paid			(0.29	)			(0.30	)			(0.61	)			(0.62	)
Issuance of common stock			0.02				0.29				0.01				0.31
Net asset value at end of period		$	9.87			$	10.68			$	9.87			$	10.68
Per share market value at beginning of period		$	9.57			$	12.14			$	9.32			$	11.14
Per share market value at end of period		$	9.76			$	13.35			$	9.76			$	13.35
Total return(1)			5.01	%			12.61	%			11.39	%			26.04	%
Common shares outstanding at beginning of period			72,376				55,059				72,376				54,550
Common shares outstanding at end of period			82,421				66,668				82,421				66,668
Net assets at beginning of period		$	715,665			$	574,920			$	728,627			$	569,172
Net assets at end of period		$	813,322			$	711,748			$	813,322			$	711,748
Average net assets(2)		$	789,909			$	662,783			$	757,445			$	616,969
Ratio of net investment income to average net assets(3)			11.57	%			10.13	%			11.53	%			9.95	%
Ratio of total expenses to average net assets(3)			9.81	%			8.04	%			10.31	%			7.94	%
Ratio of portfolio turnover to average investments at fair value			15.82	%			0.00	%			21.36	%			1.88	%
Weighted average outstanding debt(4)		$	417,952			$	224,511			$	428,104			$	162,925
Average debt per share		$	5.26			$	3.61			$	5.64			$	2.79

 

(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 dividend reinvestment plan. 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.

 

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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 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.

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 $124.0 million convertible debt outstanding at March 31, 2012 is 8,399,946. 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

 

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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)

 

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 six months ended March 31, 2012 was $1.8 million and $3.7 million, respectively, related to the Convertible Notes.

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 six months ended March 31, 2012, the Company repurchased $11.0 million principal of the Convertible Notes in the open market for an aggregate purchase price of $9.4 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 $1.3 million.

As of March 31, 2012, there were $124.0 million Convertible Notes outstanding, which had a fair value of $118.0 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 six months ended March 31, 2012.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Fifth Street Finance Corp.:

In our opinion, the accompanying consolidated statements of assets and liabilities, including the consolidated schedules of investments, and the related consolidated statements of operations, changes in net assets and cash flows, present fairly, in all material respects, the financial position of Fifth Street Finance Corp. (“the Company”) at September 30, 2011 and September 30, 2010, and the results of its operations, its changes in net assets and its cash flows for each of the two years in the period ended September 30, 2011, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities at September 30, 2011 by correspondence with the custodian, and where replies were not received, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinion.

/s/    PricewaterhouseCoopers LLP

New York, New York

November 29, 2011

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders of

Fifth Street Finance Corp.

We have audited the consolidated statement of assets and liabilities, including the consolidated schedule of investments, of Fifth Street Finance Corp. (a Delaware corporation) (the “Company”) as of September 30, 2009 (not included herein), and the related consolidated statements of operations, changes in net assets, and cash flows and the financial highlights (included in Note 12), for the year ended September 30, 2009. These financial statements and financial highlights are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included physical inspection or confirmation of securities owned as of September 30, 2009. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Fifth Street Finance Corp. as of September 30, 2009, and the results of operations, changes in net assets and its cash flows and financial highlights for the year ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America.

/s/    GRANT THORNTON LLP

New York, New York

December 9, 2009

 

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Fifth Street Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except per share amounts)

 

		September 30, 2011				September 30, 2010
ASSETS
Investments at Fair Value:
Control investments (cost September 30, 2011: $13,726; cost September 30, 2010: $12,195)		$	14,500			$	3,700
Affiliate investments (cost September 30, 2011: $34,182; cost September 30, 2010: $50,134)			25,897				47,222
Non-control/Non-affiliate investments (cost September 30, 2011: $1,108,174; cost September 30, 2010: $530,168)			1,079,440				512,899
Total Investments at Fair Value (cost September 30, 2011: $1,156,082; cost September 30, 2010: $592,497)			1,119,837				563,821
Cash and cash equivalents			67,644				76,765
Interest and fees receivable			6,752				3,814
Due from portfolio company			552				103
Deferred financing costs			14,668				5,466
Collateral posted to bank and other assets			264				1,957
Total Assets		$	1,209,717			$	651,926
LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable, accrued expenses and other liabilities		$	1,175			$	1,322
Base management fee payable			5,710				2,876
Incentive fee payable			4,997				2,859
Due to FSC, Inc.			1,480				1,083
Interest payable			4,669				283
Payments received in advance from portfolio companies			35				1,331
Credit facilities payable			178,024				—
SBA debentures payable			150,000				73,000
Convertible senior notes payable			135,000				—
Total Liabilities			481,090				82,754
Net Assets:
Common stock, $0.01 par value, 150,000 shares authorized, 72,376 and 54,550 shares issued and outstanding at September 30, 2011 and September 30, 2010			724				546
Additional paid-in-capital			829,620				619,760
Net unrealized depreciation on investments and interest rate swap			(35,976	)			(29,449	)
Net realized loss on investments and interest rate swap			(63,485	)			(33,091	)
Accumulated undistributed (overdistributed) net investment income			(2,256	)			11,406
Total Net Assets			728,627				569,172
Total Liabilities and Net Assets		$	1,209,717			$	651,926

See notes to Consolidated Financial Statements.

 

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Fifth Street Finance Corp.

Consolidated Statements of Operations

(in thousands, except per share amounts)

 

		Year Ended September  30, 2011				Year Ended September  30, 2010				Year Ended September  30, 2009
Interest income:
Control investments		$	89			$	183			$	—
Affiliate investments			4,265				7,619				10,633
Non-control/Non-affiliate investments			90,224				46,090				27,931
Interest on cash and cash equivalents			19				237				209
Total interest income			94,597				54,129				38,773
PIK interest income:
Control investments			347				—				—
Affiliate investments			989				1,227				1,634
Non-control/Non-affiliate investments			12,339				8,777				5,821
Total PIK interest income			13,675				10,004				7,455
Fee income:
Control investments			127				—				—
Affiliate investments			667				1,433				1,102
Non-control/Non-affiliate investments			15,888				4,538				2,440
Total fee income			16,682				5,971				3,542
Dividend and other income:
Non-control/Non-affiliate investments			211				434				23
Other income			—				—				35
Total dividend and other income			211				434				58
Total investment income			125,165				70,538				49,828
Expenses:
Base management fee			19,656				10,002				6,061
Incentive fee			16,782				10,756				7,841
Professional fees			2,709				1,349				1,493
Board of Directors fees			452				278				310
Interest expense			15,137				1,929				637
Administrator expense			1,699				1,322				796
General and administrative expenses			3,083				2,605				1,500
Total expenses			59,518				28,241				18,638
Base management fee waived			—				(727	)			(172	)
Net expenses			59,518				27,514				18,466
Gain on extinguishment of convertible senior notes			1,480				—				—
Net investment income			67,127				43,024				31,362
Unrealized appreciation (depreciation) on interest rate swap			773				(773	)			—
Realized loss on interest rate swap			(1,335	)			—				—
Unrealized appreciation (depreciation) on investments:
Control investments			9,437				(2,141	)			(1,792	)
Affiliate investments			(5,374	)			3,294				286
Non-control/Non-affiliate investments			(11,362	)			(2,207	)			(9,289	)
Net unrealized depreciation on investments			(7,299	)			(1,054	)			(10,795	)
Realized loss on investments:
Control investments			(7,806	)			—				—
Affiliate investments			(14,146	)			(6,937	)			(4,000	)
Non-control/Non-affiliate investments			(7,107	)			(11,844	)			(10,373	)
Total realized loss on investments			(29,059	)			(18,781	)			(14,373	)
Net increase in net assets resulting from operations		$	30,207			$	22,416			$	6,194
Net Investment Income per common share — basic		$	1.05			$	0.95			$	1.27
Earnings per common share — basic		$	0.47			$	0.49			$	0.25
Weighted average common shares outstanding — basic			64,057				45,441				24,654
Net Investment Income per common share — diluted		$	1.01			$	0.95			$	1.27
Earnings per common share — diluted		$	0.47			$	0.49			$	0.25
Weighted average common shares outstanding — diluted			68,716				45,441				24,654

See notes to Consolidated Financial Statements.

 

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Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except per share amounts)

 

		Year Ended September 30, 2011				Year Ended September 30, 2010				Year Ended September 30, 2009
Operations:
Net investment income		$	67,127			$	43,024			$	31,362
Net unrealized depreciation on investments and interest rate swap			(6,526	)			(1,827	)			(10,795	)
Net realized loss on investments and interest rate swap			(30,394	)			(18,781	)			(14,373	)
Net increase in net assets resulting from operations			30,207				22,416				6,194
Stockholder transactions:
Distributions to stockholders			(80,790	)			(43,737	)			(29,592	)
Net decrease in net assets from stockholder transactions			(80,790	)			(43,737	)			(29,592	)
Capital share transactions:
Issuance of common stock, net			205,947				178,018				137,625
Issuance of common stock under dividend reinvestment plan			4,091				1,919				2,455
Repurchases of common stock			—				—				(462	)
Net increase in net assets from capital share transactions			210,038				179,937				139,618
Total increase in net assets			159,455				158,616				116,220
Net assets at beginning of period			569,172				410,556				294,336
Net assets at end of period		$	728,627			$	569,172			$	410,556
Net asset value per common share		$	10.07			$	10.43			$	10.84
Common shares outstanding at end of period			72,376				54,550				37,879

See notes to Consolidated Financial Statements.

 

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Fifth Street Finance Corp.

Consolidated Statements of Cash Flows

(in thousands, except per share amounts)

 

		Year Ended September 30, 2011				Year Ended September 30, 2010				Year Ended September 30, 2009
Cash flows from operating activities:
Net increase in net assets resulting from operations		$	30,207			$	22,416			$	6,194
Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:
Gain on extinguishment of convertible senior notes			(1,480	)			—				—
Net unrealized depreciation on investments and interest rate swap			6,526				1,827				10,795
Net realized losses on investments and interest rate swap			30,394				18,780				14,373
PIK interest income			(13,675	)			(10,004	)			(7,455	)
Recognition of fee income			(16,681	)			(5,971	)			(3,542	)
Accretion of original issue discount on investments			(2,063	)			(893	)			(843	)
Amortization of deferred financing costs			2,747				798				—
Other income			—				—				(35	)
Changes in operating assets and liabilities:
Fee income received			21,890				11,882				3,896
Increase in interest and fees receivable			(1,715	)			(947	)			(499	)
(Increase) decrease in due from portfolio company			(449	)			51				(74	)
(Increase) decrease in collateral posted to bank and other assets			358				(1,906	)			(15	)
Increase (decrease) in accounts payable, accrued expenses and other liabilities			629				(176	)			156
Increase in base management fee payable			2,834				1,324				171
Increase in incentive fee payable			2,138				915				130
Increase in due to FSC, Inc.			397				379				130
Increase (decrease) in interest payable			4,386				283				(39	)
Increase (decrease) in payments received in advance from portfolio companies			(1,296	)			1,140				57
Purchases of investments and net revolver activity, net of syndications			(703,461	)			(315,777	)			(61,200	)
Principal payments received on investments (scheduled payments)			31,718				12,026				6,452
Principal payments received on investments (payoffs)			78,635				22,768				11,100
PIK interest income received in cash			9,988				1,619				428
Proceeds from the sale of investments			50				306				144
Net cash used in operating activities			(517,923	)			(239,160	)			(19,676	)
Cash flows from financing activities:
Dividends paid in cash			(76,699	)			(41,818	)			(27,136	)
Repurchases of common stock			—				—				(462	)
Borrowings under SBA debentures payable			77,000				73,000				—
Borrowings under credit facilities			658,500				43,000				29,500
Repayments of borrowings under credit facilities			(480,476	)			(43,000	)			(29,500	)
Proceeds from the issuance of convertible senior notes			152,000				—				—
Repurchases of convertible senior notes			(15,070	)			—				—
Proceeds from the issuance of common stock			206,788				179,125				138,578
Deferred financing costs paid			(12,400	)			(6,264	)			—
Offering costs paid			(841	)			(1,323	)			(1,005	)
Net cash provided by financing activities			508,802				202,720				109,975
Net increase (decrease) in cash and cash equivalents			(9,121	)			(36,440	)			90,299
Cash and cash equivalents, beginning of period			76,765				113,205				22,906
Cash and cash equivalents, end of period		$	67,644			$	76,765			$	113,205
Supplemental Information:
Cash paid for interest		$	7,553			$	848			$	426
Non-cash financing activities:
Issuance of shares of common stock under dividend reinvestment plan		$	4,091			$	1,919			$	2,455

 

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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								$	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								$	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 and 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 8/8/2012					750				749				757
First Lien Term Loan B, 12.5% cash 2.5% PIK due 8/8/2012					5,776				5,750				5,814
1,000 Common Units (6)									43				181
								6,542				6,752

 

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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, 8% cash 4% 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

 

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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
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
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

 

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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
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
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

 

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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
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
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

 

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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
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
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 7/13/2016					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

 

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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
Stackpole Powertrain International ULC		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)									—				—
									—				—
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								$	1,108,174			$	1,079,440
Total Portfolio Investments								$	1,156,082			$	1,119,837

 

(1)	All debt investments are income producing. 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 maintains 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.

 

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Consolidated Schedule of Investments

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September 30, 2011

 

(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 has been suspended and is deemed unlikely to be renewed in the future.

 

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

 

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

 

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2010

 

Portfolio Company/Type of Investment (1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
Control Investments(3)
Lighting By Gregory, LLC(13)(14)		Housewares & Specialties
First Lien Term Loan A, 9.75% PIK due 2/28/2013				$	5,419			$	4,729			$	1,504
First Lien Term Loan B, 14.5% PIK due 2/28/2013					8,576				6,906				2,196
First Lien Bridge Loan, 8% cash due 10/15/2010					152				150				—
97.38% membership interest									410				—
									12,195				3,700
Total Control Investments								$	12,195			$	3,700
Affiliate Investments(4)
O’Currance, Inc.		Data Processing & Outsourced Services
First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012					10,961			$	10,869			$	10,806
First Lien Term Loan B, 12.875% cash 4% PIK 3/21/2012					1,854				1,829				1,897
1.75% Preferred Membership interest in O’Currance Holding Co., LLC									130				38
3.3% Membership Interest in O’Currance Holding Co., LLC									250				—
									13,078				12,741
MK Network, LLC(13)(14)		Education services
First Lien Term Loan A, 13.5% cash due 6/1/2012					9,740				9,539				7,913
First Lien Term Loan B, 17.5% cash due 6/1/2012					4,926				4,748				3,939
First Lien Revolver, Prime + 1.5% (8.5% floor) cash due 6/1/2010(10)					—				—				—
11,030 Membership Units(6)									772				—
									15,059				11,852
Caregiver Services, Inc.		Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013					7,141				6,814				7,113
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013					14,692				14,103				14,180
1,080,399 shares of Series A Preferred Stock									1,080				1,336
									21,997				22,629
Total Affiliate Investments								$	50,134			$	47,222
Non-Control/Non-Affiliate Investments(7)
CPAC, Inc.		Household Products
Subordinated Term Loan, 12.5% PIK due 6/1/2012					1,065			$	1,065			$	1,065
									1,065				1,065
Vanguard Vinyl, Inc.(9)(13)(14)		Building Products
First Lien Term Loan, 12% cash due 3/30/2013					7,000				6,827				5,812
First Lien Revolver, LIBOR+7% (3% floor) cash due 3/30/2013					1,250				1,208				1,029
25,641 Shares of Series A Preferred Stock									254				—
25,641 Shares of Common Stock									3				—
									8,292				6,841
Repechage Investments Limited		Restaurants
First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011					3,709				3,476				3,486
7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.									750				354
									4,226				3,840

 

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Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2010

 

Portfolio Company/Type of Investment (1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
Traffic Control & Safety Corporation(9)		Construction and Engineering
Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015					19,970				19,725				19,440
Subordinated Loan, 15% PIK due 5/28/2015					4,578				4,578				4,405
24,750 shares of Series B Preferred Stock									246				—
43,494 shares of Series D Preferred Stock(6)									435				—
25,000 shares of Common Stock									3				—
									24,987				23,845
Nicos Polymers & Grinding Inc.(9)(13)(14)		Environmental & facilities services
First Lien Term Loan A, LIBOR+5% (5% floor) cash due 7/17/2012					3,155				3,041				1,782
First Lien Term Loan B, 12.25% cash 1.25% PIK due 7/17/2012					6,180				5,713				3,348
3.32% Interest in Crownbrook Acquisition I LLC									168				—
									8,922				5,130
TBA Global, LLC(9)		Advertising
Second Lien Term Loan B, 12.5% cash 4% PIK due 8/3/2012					10,840				10,595				10,626
53,994 Senior Preferred Shares									216				216
191,977 Shares A Shares									192				179
									11,003				11,021
Fitness Edge, LLC		Leisure Facilities
First Lien Term Loan A, LIBOR+5.25% (4.75% floor) cash due 8/8/2012					1,250				1,245				1,247
First Lien Term Loan B, 12.5% cash 2.5% PIK due 8/8/2012					5,632				5,575				5,675
1,000 Common Units									43				118
									6,863				7,040
Filet of Chicken(9)		Food Distributors
Second Lien Term Loan, 12.5% cash 2% PIK due 7/31/2012					9,317				9,063				8,965
									9,063				8,965
Boot Barn(9)		Apparel, accessories & luxury goods and Footwear
Second Lien Term Loan, 12.5% cash 2% PIK due 10/3/2013					23,545				23,289				23,478
247.06 shares of Series A Preferred Stock									247				71
1,308 shares of Common Stock									—				—
									23,536				23,549
Premier Trailer Leasing, Inc.(9)(13)(14)		Trucking
Second Lien Term Loan, 13.25% cash 3.25% PIK due 10/23/2012					18,453				17,064				4,597
285 shares of Common Stock									1				—
									17,065				4,597
Pacific Press Technologies, Inc.(9)
Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013		Industrial machinery			10,072				9,799				9,830
33,463 shares of Common Stock									344				403
									10,143				10,233
Goldco, LLC
Second Lien Term Loan, 13.5% cash 4% PIK due 1/31/2013		Restaurants			8,356				8,259				8,259
									8,259				8,259
Rail Acquisition Corp.(9)		Electronic manufacturing services
First Lien Term Loan, 12.5% cash 4.5% PIK due 9/1/2013					16,316				13,537				12,854
First Lien Revolver, 7.85% cash due 9/1/2013					5,201				5,201				5,201
									18,738				18,055

 

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Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2010

 

Portfolio Company/Type of Investment (1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
Western Emulsions, Inc.(9)		Construction materials
Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014					17,865				17,476				17,040
									17,476				17,040
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					6,663				6,324				6,489
First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013					10,179				10,069				9,962
First Lien Revolver, 12% cash due 7/17/2013					500				489				509
									16,882				16,960
idX Corporation		Distributors
Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014					13,589				13,351				13,258
									13,351				13,258
Cenegenics, LLC		Healthcare services
First Lien Term Loan, 12% cash 5% PIK due 10/27/2014					20,172				19,257				19,545
414,419 Common Units(6)									598				1,418
									19,855				20,963
IZI Medical Products, Inc.		Healthcare technology
First Lien Term Loan A, 12% cash due 3/31/2014					4,450				4,388				4,407
First Lien Term Loan B, 13% cash 3% PIK due 3/31/2014					17,258				16,702				17,093
First Lien Revolver, 10% cash due 3/31/2014(11)					—				(35	)			(35	)
453,755 Preferred units of IZI Holdings, LLC(6)									454				676
									21,509				22,141
Trans-Trade, Inc.		Air freight & logistics
First Lien Term Loan, 13% cash 2.5% PIK due 9/10/2014					12,751				12,536				12,549
First Lien Revolver, 12% cash due 9/10/2014					1,500				1,469				1,491
									14,005				14,040
Riverlake Equity Partners II, LP		Multi-sector holdings
1.87% limited partnership interest(15)									34				34
									34				34
Riverside Fund IV, LP		Multi-sector holdings
0.33% limited partnership interest(15)									136				136
									136				136
ADAPCO, Inc.		Fertilizers & agricultural chemicals
First Lien Term Loan A, 10% cash due 12/17/2014					9,000				8,789				8,807
First Lien Term Loan B, 12% cash 2% PIK due 12/17/2014					14,226				13,893				13,898
First Lien Term Revolver, 10% cash due 12/17/2014					4,250				4,012				4,107
									26,694				26,812

 

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Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2010

 

Portfolio Company/Type of Investment (1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
Ambath/Rebath Holdings, Inc.		Home improvement retail
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014					9,500				9,278				9,128
First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014					22,424				21,920				21,913
First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014					1,500				1,433				1,443
									32,631				32,484
JTC Education, Inc.		Education services
First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014					31,055				30,244				30,660
First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014(11)					—				(401	)			(401	)
									29,843				30,259
Tegra Medical, LLC		Healthcare equipment
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014					26,320				25,877				26,251
First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014					22,099				21,729				22,114
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014(11)					—				(67	)			(67	)
									47,539				48,298
Flatout, Inc.		Food retail
First Lien Term Loan A, 10% cash due 12/31/2014					7,300				7,121				7,144
First Lien Term Loan B, 12% cash 3% PIK due 12/31/2014					12,863				12,540				12,644
First Lien Revolver, 10% cash due 12/31/2014(11)					—				(38	)			(38	)
									19,623				19,750
Psilos Group Partners IV, LP		Multi-sector holdings
2.53% limited partnership interest(12)(15)									—				—
									—				—
Mansell Group, Inc.		Advertising
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015					5,000				4,910				4,916
First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015					4,026				3,952				3,947
First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)					—				(37	)			(37	)
									8,825				8,826
NDSSI Holdings, LLC		Electronic equipment & instruments
First Lien Term Loan, LIBOR+9.75% (3% floor) cash 1% PIK due 9/10/2014					30,246				29,685				29,409
First Lien Revolver, LIBOR+7% (3% floor) cash due 9/10/2014					3,500				3,410				3,479
									33,095				32,888
Eagle Hospital Physicians, Inc.		Healthcare services
First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015					8,000				7,784				7,784
First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015(11)					—				(64	)			(64	)
									7,720				7,720
Enhanced Recovery Company, LLC		Diversified support services
First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015					15,500				15,172				15,172
First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015					11,015				10,782				10,782
First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015					377				292				292
									26,246				26,246

 

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2010

 

Portfolio Company/Type of Investment(1)(2)(5)		Industry		Principal(8)				Cost				Fair Value
Epic Acquisition, Inc.		Healthcare services
First Lien Term Loan A, LIBOR+8% (3% floor) cash due 8/13/2015					7,750				7,555				7,555
First Lien Term Loan B, 12.25% cash 3% PIK due 8/13/2015					13,555				13,211				13,211
First Lien Revolver, LIBOR+6.5% (3% floor) cash due 8/13/2015					300				224				224
									20,990				20,990
Specialty Bakers LLC		Food distributors
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015					9,000				8,756				8,756
First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015					11,000				10,704				10,704
First Lien Revolver, LIBOR+8.5% cash due 9/15/2015					2,000				1,892				1,892
									21,352				21,352
Total Non-Control/Non-Affiliate Investments								$	530,168			$	512,899
Total Portfolio Investments								$	592,497			$	563,821

 

 

(1)	All debt investments are income producing. 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 maintains 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:

 

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Table of Contents

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(in thousands, except per share amounts)

September 30, 2010

 

Portfolio Company		Effective date		Cash interest		PIK interest		Reason
Nicos Polymers & Grinding, Inc.		February 10, 2008				+ 2.0% on Term Loan A & B		Per waiver agreement
TBA Global, LLC		February 15, 2008				+ 2.0% on Term Loan B		Per waiver agreement
Vanguard Vinyl, Inc.		April 1, 2008		+ 0.5% on Term Loan				Per loan amendment
Filet of Chicken		January 1, 2009		+ 1.0% on Term Loan				Tier pricing per waiver agreement
Boot Barn		January 1, 2009		+ 1.0% on Term Loan		+ 2.5% on Term Loan		Tier pricing per waiver agreement
HealthDrive Corporation		April 30, 2009		+ 2.0% on Term Loan A				Per waiver agreement
Premier Trailer Leasing, Inc.		August 4, 2009		+ 4.0% on Term Loan				Default interest per credit agreement
Rail Acquisition Corp.		May 1, 2010		– 4.5% on Term Loan		– 0.5% on Term Loan		Per restructuring agreement
Traffic Control & Safety Corp.		June 1, 2010		– 4.0% on Second Lien Term Loan		+ 1.0% on Second Lien Term Loan		Per restructuring agreement
Pacific Press Technologies, Inc.		July 1, 2010		– 2.0% on Term Loan		– 0.75% on Term Loan		Per waiver agreement
Western Emulsions, Inc.		September 30, 2010				+ 3.0% on Term Loan		Per loan agreement

 

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

 

(11)	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, 2010.

 

(14)	Investment was on PIK non-accrual status as of September 30, 2010.

 

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

 

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FIFTH STREET FINANCE CORP.

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. Since January 2, 2008, references to the “Company”, “FSC”, “we” or “our” are to Fifth Street Finance Corp., unless the context otherwise requires.

The Company also has certain wholly-owned subsidiaries, including subsidiaries that are not consolidated 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 since inception:

 

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’ 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’ exercise of over-allotment option)			5,558,469			$	11.72			$	65.1 million

 

 

(1)	Average offering price.

On February 3, 2010, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P., 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

 

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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 other wise indicated)

 

Investment Act of 1958. 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 license allows the Company’s SBIC subsidiary 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.

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 September 30, 2011, the Company’s SBIC subsidiary had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $102.0 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	%

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 subsidiary may also be limited in its ability to make distributions to the Company if it does not have sufficient capital, in accordance with SBA regulations.

The Company’s SBIC subsidiary is 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 subsidiary will receive SBA-guaranteed debenture funding and is dependent upon the SBIC subsidiary continuing to be in compliance with SBA regulations and policies.

The SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary 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 subsidiary 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 $150 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 pursuant to the requirements for reporting on Form 10-K and Regulation S-X. In the opinion of management, all adjustments of a normal recurring

 

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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 other wise indicated)

 

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 the recent and future 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.

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 $1.1 billion and $563.8 million at September 30, 2011 and September 30, 2010, respectively. The portfolio investments represent 153.7% and 99.1% of net assets at September 30, 2011 and September 30, 2010, 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.

 

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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 other wise indicated)

 

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 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.

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.

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.

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;

 

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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 other wise indicated)

 

•

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 September 30, 2011 and September 30, 2010 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.

Investment Income:

Interest income, adjusted for amortization of premium and accretion of original issue discount, 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 collateral management 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

 

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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 other wise indicated)

 

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 a successful exit event for each of the investments. A percentage of these fees are included in net investment income over the life of the loan.

Gain on Extinguishment of Convertible Senior Notes:

The Company may, to the extent permitted by law, repurchase its Convertible Senior Notes in the open market 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 $0.3 million that is held at Wells Fargo Bank, National Association (“Wells Fargo”) in connection with the Company’s three-year 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.

Deferred Financing Costs:

Deferred financing costs consist of fees and expenses paid in connection with the closing or amending of credit facilities 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 consists 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.

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. $0.8 million of offering costs have been charged to capital during the year ended September 30, 2011.

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

 

on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2011). 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. In addition, 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 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.

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 or 2010. 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, which will require 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 ASU 2011-04 is not expected to have a material impact on the Company’s consolidated financial statements, except it will enhance the disclosures around fair value of investments.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

 

In February 2011, the FASB issued Accounting Standards Update 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (“ASU 2011-02”). ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 provides guidance to clarify whether the creditor has granted a concession and whether a debtor is experiencing financial difficulties. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The adoption of ASU 2011-02 did not have a material impact on the Company’s financial condition and results of operations.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Improving Disclosures About Fair Value Measurements (Topic 820), which provides for improving disclosures about fair value measurements, primarily significant transfers in and out of Levels 1 and 2, and activity in Level 3 fair value measurements. The disclosures and clarifications of existing disclosures are effective for the interim and annual reporting periods beginning after December 15, 2009, while the disclosures about the purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements are effective for fiscal years after December 15, 2010 and for the interim periods within those fiscal years. Except for certain detailed Level 3 disclosures, which are effective for fiscal years after December 15, 2010 and interim periods within those years, the new guidance became effective for the Company’s fiscal 2010 second quarter. 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.

In September 2009, the FASB issued Accounting Standards Update 2009-12, Fair Value Measurements and Disclosures (Topic 820) — Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) which provides guidance on estimating the fair value of an alternative investment, amending ASC 820-10. The amendment is effective for interim and annual periods ending after December 15, 2009. The adoption of this guidance did not have a material impact on either the Company’s consolidated financial position or results of operations.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140 (“SFAS 166”). SFAS 166 requires more information about transfers of financial assets, eliminates the qualifying special purpose entity (QSPE) concept, changes the requirements for derecognizing financial assets and requires additional disclosures. SFAS 166 is effective for the first annual reporting period that begins after November 15, 2009. The initial adoption did not have a material impact on the Company’s Consolidated Financial Statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) which provides guidance with respect to consolidation of variable interest entities. This statement retains the scope of Interpretation 46(R) with the addition of entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated in SFAS No. 166, Accounting for Transfers of Financial Assets. This statement replaces the quantitative-based risks and rewards calculation for determining the primary beneficiary of a variable interest entity. The approach focuses on identifying which enterprise has the power to direct activities that most significantly impact the entity’s economic performance and the obligation to absorb the losses or receive the benefits from the entity. It is possible that application of this revised guidance will change an enterprise’s assessment of involvement with variable interest entities. This statement, which has been codified within ASC 810, Consolidations, was effective for the Company as of September 1, 2010. The initial adoption did not have an effect on the Company’s Consolidated Financial Statements.

 

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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 other wise indicated)

 

Note 3.

Portfolio Investments

At September 30, 2011, 153.7% of net assets or $1.1 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. In comparison, at September 30, 2010, 99.1% of net assets or $563.8 million was invested in 38 long-term portfolio investments and 13.5% of net assets or $76.8 million was invested in cash and cash equivalents. As of September 30, 2011, 90.9% 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 years ended September 30, 2011, 2010 and 2009, the Company recorded realized losses of $30.4 million, $18.8 million and $14.4 million, respectively. During the years ended September 30, 2011, 2010 and 2009, the Company recorded unrealized depreciation of $6.5 million, $1.8 million and $10.8 million, respectively.

The composition of the Company’s investments as of September 30, 2011 and September 30, 2010 at cost and fair value was as follows:

 

		September 30, 2011								September 30, 2010
		Cost				Fair Value				Cost				Fair Value
Investments in debt securities		$	1,137,754			$	1,099,708			$	585,529			$	558,580
Investments in equity securities			18,328				20,129				6,968				5,241
Total		$	1,156,082			$	1,119,837			$	592,497			$	563,821

The composition of the Company’s debt investments as of September 30, 2011 and September 30, 2010 at fixed rates and floating rates was as follows:

 

		September 30, 2011								September 30, 2010
		Fair Value				% of Portfolio				Fair Value				% of Portfolio
Fixed rate debt securities		$	359,873				32.72	%		$	375,584				67.24	%
Floating rate debt securities			739,835				67.28	%			182,996				32.76	%
Total		$	1,099,708				100.00	%		$	558,580				100.00	%

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

 

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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 other wise indicated)

 

The following table presents the financial instruments carried at fair value as of September 30, 2010, 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)		$	—			$	—			$	416,324			$	416,324
Investments in debt securities (second lien)			—				—				137,851				137,851
Investments in debt securities (subordinated)			—				—				4,405				4,405
Investments in equity securities (preferred)			—				—				2,892				2,892
Investments in equity securities (common)			—				—				2,349				2,349
Total investments at fair value		$	—			$	—			$	563,821			$	563,821
Interest rate swap			—				773				—				773
Total liabilities at fair value		$	—			$	773			$	—			$	773

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.

The following table provides a roll-forward in the changes in fair value from September 30, 2010 to September 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			$	137,851			$	4,405			$	2,892			$	2,349			$	563,821
New investments & net revolver activity			563,826				76,500				81,665				4,349				8,033				734,373
Redemptions/repayments			(81,382	)			(63,163	)			(1,000	)			—				—				(145,545	)
Net accrual of PIK interest income			5,456				(3,103	)			1,289				47				—				3,689
Accretion of original issue discount			1,510				553				—				—				—				2,063
Net change in unearned income			(5,539	)			67				(961	)			—				—				(6,433	)
Net unrealized appreciation (depreciation)			(1,340	)			(5,322	)			(4,165	)			134				3,394				(7,299	)
Net change from unrealized to realized			(23,763	)			—				—				(255	)			(814	)			(24,832	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of September 30, 2011		$	875,092			$	143,383			$	81,233			$	7,167			$	12,962			$	1,119,837
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at September 30, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the year ended September 30, 2011		$	(15,106	)		$	(5,200	)		$	(4,165	)		$	(121	)		$	2,580			$	(22,012	)

 

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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 other wise indicated)

 

The following table provides a roll-forward in the changes in fair value from September 30, 2009 to September 30, 2010, 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, 2009		$	142,018			$	153,904			$	—			$	2,889			$	800			$	299,611
New investments & net revolver activity			304,369				7,120				4,165				435				688				316,777
Redemptions/repayments			(14,088	)			(23,168	)			—				—				(71	)			(37,327	)
Net accrual of PIK interest income			4,473				3,499				413				—				—				8,385
Accretion of original issue discount			482				411				—				—				—				893
Net change in unearned income			(6,402	)			491				—				—				—				(5,911	)
Net unrealized appreciation (depreciation)			(2,195	)			(3,433	)			(173	)			(432	)			5,179				(1,054	)
Net change from unrealized to realized			(12,333	)			(973	)			—				—				(4,247	)			(17,553	)
Transfer into (out of) Level 3			—				—				—				—				—				—
Fair value as of September 30, 2010		$	416,324			$	137,851			$	4,405			$	2,892			$	2,349			$	563,821
Net unrealized appreciation (depreciation) relating to Level 3 assets still held at September 30, 2010 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the year ended September 30, 2010		$	(4,423	)		$	(4,733	)		$	(173	)		$	(432	)		$	932			$	(8,829	)

Concurrent with its adoption of ASC 820, effective October 1, 2008, the Company augmented the valuation techniques it uses to estimate the fair value of its debt investments where there is not a readily available market value (Level 3). The Company introduced a bond yield model to value these investments based on the present value of expected cash flows. The significant inputs into the model are market interest rates for debt with similar characteristics and an adjustment 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.

The Company’s off-balance sheet arrangements consisted of $108.8 million and $49.5 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of September 30, 2011 and September 30, 2010, respectively. Such commitments are subject to the portfolio companies’ satisfaction of certain financial and nonfinancial convenants 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.

 

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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 other wise indicated)

 

A summary of the composition of the unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of September 30, 2011 and September 30, 2010 is shown in the table below:

 

		September 30, 2011				September 30, 2010
JTC Education, Inc.		$	14,000			$	9,062
CRGT, Inc.			12,500				—
Charter Brokerage, LLC			6,176				—
Refac Optical Group			5,500				—
Rail Acquisition Corp.			5,446				4,799
Miche Bag, LLC			5,000				—
Dominion Diagnostics, LLC			5,000				—
ADAPCO, Inc.			4,250				5,750
Enhanced Recovery Company, LLC			4,000				3,623
DISA, Inc.			4,000				—
Traffic Control & Safety Corporation			3,014				—
Epic Acquisition, Inc.			3,000				2,700
Phoenix Brands Merger Sub LLC			3,000				—
Discovery Practice Management, Inc.			3,000				—
Titan Fitness, LLC			2,957				—
IZI Medical Products, Inc.			2,500				2,500
Eagle Hospital Physicians, Inc.			2,500				2,500
HealthDrive Corporation			2,000				1,500
Mansell Group, Inc.			2,000				2,000
Specialty Bakers, LLC			2,000				2,000
Physicians Pharmacy Alliance, Inc.			2,000				—
Cardon Healthcare Network, LLC			2,000				—
Milestone Partners IV, LP (limited partnership interest)			2,000				—
Tegra Medical, LLC			1,500				4,000
Flatout, Inc.			1,500				1,500
IOS Acquisitions, Inc.			1,250				—
Psilos Group Partners IV, LP (limited partnership interest)			1,000				1,000
Best Vinyl Fence & Deck, LLC			1,000				—
Bunker Hill Capital II (QP), LP (limited partnership interest)			960				—
Riverlake Equity Partners II, LP (limited partnership interest)			878				966
Welocalize, Inc.			750				—
Baird Capital Partners V, LP (limited partnership interest)			701				—
Riverside Fund IV, LP (limited partnership interest)			555				864
Saddleback Fence and Vinyl Products, Inc.			400				—
Advanced Pain Management			267				—
Trans-Trade, Inc.			200				500
AmBath/ReBath Holdings, Inc.			—				1,500
Vanguard Vinyl, Inc.			—				1,250
NDSSI Holdings, LLC			—				1,500
Total		$	108,804			$	49,514

 

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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 other wise 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:

 

		September 30, 2011								September 30, 2010
Cost:
First lien debt		$	890,729				77.05	%		$	430,201				72.61	%
Second lien debt			161,455				13.97	%			150,601				25.42	%
Subordinated debt			85,571				7.40	%			4,728				0.80	%
Purchased equity			11,263				0.97	%			2,330				0.39	%
Equity grants			6,158				0.53	%			4,468				0.75	%
Limited partnership interests			906				0.08	%			169				0.03	%
Total		$	1,156,082				100.00	%		$	592,497				100.00	%
Fair Value:
First lien debt		$	875,092				78.14	%		$	416,324				73.84	%
Second lien debt			143,383				12.80	%			137,851				24.45	%
Subordinated debt			81,233				7.25	%			4,405				0.78	%
Purchased equity			12,548				1.12	%			625				0.11	%
Equity grants			6,675				0.60	%			4,447				0.79	%
Limited partnership interests			906				0.09	%			169				0.03	%
Total		$	1,119,837				100.00	%		$	563,821				100.00	%

The Company primarily invests in portfolio companies located in the United States. 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.

 

		September 30, 2011								September 30, 2010
Cost:
Northeast		$	389,185				33.66	%		$	175,371				29.60	%
Southwest			273,513				23.66	%			121,104				20.44	%
Southeast			244,988				21.19	%			108,805				18.36	%
West			142,745				12.35	%			133,879				22.60	%
Midwest			86,768				7.51	%			53,338				9.00	%
Canada			18,883				1.63	%			—				0.00	%
Total		$	1,156,082				100.00	%		$	592,497				100.00	%
Fair Value:
Northeast		$	389,898				34.82	%		$	161,264				28.60	%
Southeast			248,588				22.20	%			109,457				19.41	%
Southwest			246,358				22.00	%			107,469				19.07	%
West			127,522				11.39	%			131,881				23.39	%
Midwest			88,412				7.90	%			53,750				9.53	%
Canada			19,059				1.69	%			—				0.00	%
Total		$	1,119,837				100.00	%		$	563,821				100.00	%

 

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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 other wise indicated)

 

The composition of the Company’s portfolio by industry at cost and fair value as of September 30, 2011 and September 30, 2010 were as follows:

 

		September 30, 2011								September 30, 2010
Cost:
Healthcare services		$	227,145				19.65	%		$	87,444				14.76	%
Oil & gas equipment & services			82,168				7.11	%			—				0.00	%
Healthcare equipment			71,254				6.16	%			47,540				8.02	%
Diversified support services			55,472				4.80	%			26,246				4.43	%
IT consulting & other services			48,943				4.23	%			—				0.00	%
Internet software & services			43,846				3.79	%			—				0.00	%
Construction and engineering			43,236				3.74	%			24,987				4.22	%
Leisure facilities			38,041				3.29	%			6,864				1.16	%
Electronic equipment & instruments			34,852				3.01	%			33,094				5.59	%
Specialty stores			34,538				2.99	%			—				0.00	%
Household products			31,213				2.70	%			1,065				0.18	%
Apparel, accessories & luxury goods			30,986				2.68	%			23,536				3.97	%
Education services			29,662				2.57	%			44,902				7.58	%
Fertilizers & agricultural chemicals			28,800				2.49	%			26,695				4.51	%
Home improvement retail			27,999				2.42	%			32,631				5.51	%
Pharmaceuticals			27,257				2.36	%			—				0.00	%
Integrated telecommunication services			25,995				2.25	%			—				0.00	%
Food distributors			20,834				1.80	%			30,415				5.13	%
Healthcare technology			20,505				1.77	%			21,509				3.63	%
Human resources & employment services			20,457				1.77	%			—				0.00	%
Electronic manufacturing services			20,190				1.75	%			18,738				3.16	%
Advertising			19,892				1.72	%			19,828				3.35	%
Auto parts & equipment			18,883				1.63	%			—				0.00	%
Distributors			18,631				1.61	%			13,351				2.25	%
Air freight & logistics			17,984				1.56	%			14,005				2.36	%
Trucking			17,065				1.48	%			17,065				2.88	%
Environmental & facilities services			16,311				1.41	%			8,922				1.51	%
Restaurants			13,966				1.21	%			12,485				2.11	%
Leisure products			13,564				1.17	%			—				0.00	%
Diversified financial services			13,311				1.15	%			—				0.00	%
Data processing & outsourced services			12,775				1.10	%			13,078				2.21	%
Industrial machinery			10,457				0.90	%			10,143				1.71	%
Construction materials			6,736				0.58	%			17,476				2.95	%
Building products			6,689				0.58	%			8,292				1.40	%
Housewares & specialties			5,319				0.46	%			12,195				2.06	%
Multi-sector holdings			907				0.09	%			169				0.02	%
Movies & entertainment			199				0.02	%			200				0.03	%
Food retail			—				0.00	%			19,622				3.31	%
Total		$	1,156,082				100.00	%		$	592,497				100.00	%

 

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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 other wise indicated)

 

		September 30, 2011								September 30, 2010
Fair Value:
Healthcare services		$	231,478				20.67	%		$	89,262				15.83	%
Oil & gas equipment services			82,696				7.38	%			—				0.00	%
Healthcare equipment			71,911				6.42	%			48,298				8.57	%
Diversified support services			56,232				5.02	%			26,246				4.66	%
IT consulting & other services			49,528				4.42	%			—				0.00	%
Internet software & services			43,786				3.91	%			—				0.00	%
Leisure facilities			38,447				3.43	%			7,040				1.25	%
Construction and engineering			35,814				3.20	%			23,845				4.23	%
Specialty stores			35,198				3.14	%			—				0.00	%
Electronic equipment & instruments			34,863				3.11	%			32,888				5.83	%
Apparel, accessories & luxury goods			33,595				3.00	%			23,549				4.18	%
Education services			30,176				2.69	%			42,111				7.47	%
Household products			29,943				2.67	%			1,065				0.19	%
Fertilizers & agricultural chemicals			29,190				2.61	%			26,812				4.76	%
Home improvement retail			27,576				2.46	%			32,484				5.76	%
Pharmaceuticals			27,500				2.46	%			—				0.00	%
Integrated telecommunication services			26,374				2.36	%			—				0.00	%
Food distributors			21,006				1.88	%			30,317				5.38	%
Human resources & employment services			20,952				1.87	%			—				0.00	%
Healthcare technology			20,947				1.87	%			22,141				3.93	%
Advertising			20,183				1.80	%			19,847				3.52	%
Environmental & facilities services			19,952				1.78	%			5,130				0.91	%
Auto parts & equipment			19,059				1.70	%			—				0.00	%
Distributors			18,938				1.69	%			13,258				2.35	%
Air freight & logistics			17,243				1.54	%			14,041				2.49	%
Leisure products			13,711				1.22	%			—				0.00	%
Diversified financial services			13,329				1.19	%			—				0.00	%
Restaurants			11,829				1.06	%			12,100				2.15	%
Industrial machinery			10,860				0.97	%			10,233				1.81	%
Electronic manufacturing services			8,660				0.77	%			18,056				3.20	%
Construction materials			6,840				0.61	%			17,040				3.02	%
Building products			4,833				0.43	%			6,841				1.21	%
Data processing & outsourced services			3,497				0.31	%			12,741				2.26	%
Housewares & specialties			2,526				0.23	%			3,700				0.66	%
Multi-sector holdings			907				0.11	%			169				0.01	%
Movies & entertainment			258				0.02	%			260				0.05	%
Trucking			—				0.00	%			4,597				0.82	%
Food retail			—				0.00	%			19,750				3.50	%
Total		$	1,119,837				100.00	%		$	563,821				100.00	%

The Company’s investments are generally in small and mid-sized companies in a variety of industries. At September 30, 2011 and September 30, 2010, 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 years ended September 30, 2011 and September 30, 2010, no individual investment produced income that exceeded 10% of investment income.

 

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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 other wise 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 and collateral management fees, are classified as fee income and recognized as they are earned on a monthly basis.

Accumulated unearned fee income activity for the years ended September 30, 2011 and 2010 was as follows:

 

		Year Ended September 30, 2011				Year Ended September 30, 2010
Beginning accumulated unearned fee income balance		$	11,901			$	5,590
Net fees received			18,160				11,806
Unearned fee income recognized			(11,728	)			(5,495	)
Ending unearned fee income balance		$	18,333			$	11,901

As of September 30, 2011, the Company had structured $7.9 million in aggregate exit fees across 11 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 a successful exit event for each of the investments. A portion of these fees is included in net investment income over the period 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.

 

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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 other wise 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.

The following table sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10 Earnings per Share, for the years ended September 30, 2011, 2010 and 2009:

 

		Year ended September 30, 2011				Year ended September 30, 2010				Year ended September 30, 2009
Earnings per common share — basic:
Net increase in net assets resulting from operations		$	30,207			$	22,416			$	6,194
Weighted average common shares outstanding — basic			64,057				45,441				24,654
Earnings per common share — basic		$	0.47			$	0.49			$	0.25
Earnings per common share — diluted:
Net increase in net assets resulting from operations, before adjustments		$	30,207			$	22,416			$	6,194
Adjustments for interest on convertible senior notes, base management fees, incentive fees and gain on extinguishment of convertible senior notes			2,124				—				—
Net increase in net assets resulting from operations, as adjusted		$	32,331			$	22,416			$	6,194
Weighted average common shares outstanding — basic			64,057				45,441				24,654
Adjustments for dilutive effect of senior convertible notes			4,659				—				—
Weighted average common shares outstanding — diluted			68,716				45,441				24,654
Earnings per common share — diluted		$	0.47			$	0.49			$	0.25

 

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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 other wise 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 September 30, 2011:

 

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

 

 

(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 December 2009. In October 2008, the Company repurchased 78,000 shares of common stock on the open market as part of its 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 are to be made through the open market at times and in such amounts as the Company’s management deems appropriate, provided it is below the most recently published net asset value per share. The stock repurchase program expires December 31, 2011 and may be limited or terminated by the Board of Directors at any time without prior notice.

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

 

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. 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 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, reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, and extend the maturity date of the facility to February 25, 2014.

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 Agreement and other documents entered into in connection with the Wells Fargo facility.

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.

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 September 30, 2011, the Company had $39.5 million of borrowings outstanding under the Wells Fargo facility, which had a fair value of $39.5 million.

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

 

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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 other wise indicated)

 

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 any of the Company’s SBIC subsidiaries, and equity interests in Funding and Funding II 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. 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.

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. On November 29, 2011, the Company amended the ING Credit Agreement to ensure that, based on the Company’s estimate of taxable income for the fiscal year ended September 30, 2011, the Company would remain in compliance with the annual distribution limit provision when it finalizes its taxable income amount upon the filing of its tax return in June 2012.

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 September 30, 2011, the Company had $133.5 million of borrowings outstanding under the ING facility, which had a fair value of $133.5 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 other wise indicated)

 

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, 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.

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 September 30, 2011, there was $5.0 million of borrowings outstanding under the Sumitomo facility, which had a fair value of $5.0 million.

As of September 30, 2011, except for assets that were funded through the Company’s SBIC subsidiary, substantially all of the Company’s assets were pledged as collateral under the Wells Fargo facility, the ING facility or the Sumitomo facility.

Interest expense for the years ended September 30, 2011, 2010 and 2009 was $15.1 million, $1.9 million and $0.6 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

 

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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 other wise indicated)

 

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 well before the Company’s full write-down of such loan or debt security.

Accumulated PIK interest activity for the years ended September 30, 2011 and September 30, 2010 was as follows:

 

		Year Ended September 30, 2011				Year Ended September 30, 2010
PIK balance at beginning of period		$	19,301			$	12,059
Gross PIK interest accrued			14,526				11,907
PIK income reserves			(851	)			(1,903	)
PIK interest received in cash			(9,988	)			(1,619	)
Loan exits			(316	)			(1,143	)
PIK balance at end of period		$	22,672			$	19,301

As of September 30, 2011, the Company had stopped accruing cash interest, PIK interest and original issue discount (“OID”) on four investments that had not paid all of their scheduled cash interest payments for the period ended September 30, 2011. As of September 30, 2010, the Company had stopped accruing cash interest, PIK interest and OID on five investments that had not paid all of their scheduled cash interest payments for the period ended September 30, 2010. As of September 30, 2009, the Company had stopped accruing PIK interest and OID on five investments, including two investments that had not paid all of their scheduled cash interest payments for the period ended September 30, 2009.

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 for the periods ended September 30, 2011, September 30, 2010 and September 30, 2009 were as follows:

 

		September 30, 2011																September 30, 2010																September 30, 2009
		Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio				Cost				% of Portfolio				Fair Value				% of Portfolio
Accrual		$	1,116,762				96.60	%		$	1,111,986				99.30	%		$	530,965				89.61	%		$	531,701				94.30	%		$	277,335				84.75	%		$	271,420				90.59	%
PIK non-accrual			—				0.00	%			—				0.00	%			—				0.00	%			—				0.00	%			20,787				6.35	%			12,639				4.22	%
Cash non-accrual			39,320				3.40	%			7,851				0.70	%			61,532				10.39	%			32,120				5.70	%			29,110				8.90	%			15,552				5.19	%
Total		$	1,156,082				100.00	%		$	1,119,837				100.00	%		$	592,497				100.00	%		$	563,821				100.00	%		$	327,232				100.00	%		$	299,611				100.00	%

 

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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 other wise indicated)

 

The non-accrual status of the Company’s portfolio investments as of September 30, 2011, September 30, 2010, and September 30, 2009 was as follows:

 

September 30, 2011

September 30, 2010

September 30, 2009

Lighting by Gregory, LLC

Cash non-accrual

Cash non-accrual

Cash non-accrual

CPAC, Inc.

—

—

PIK non-accrual

MK Network, LLC

—

Cash non-accrual

—

Martini Park, LLC

—

—

PIK non-accrual

Vanguard Vinyl, Inc.

—

Cash non-accrual

—

Nicos Polymers & Grinding, Inc.

—

Cash non-accrual

PIK non-accrual

Premier Trailer Leasing, Inc.

Cash non-accrual

Cash non-accrual

Cash non-accrual

Repechage Investments Limited

Cash non-accrual

—

—

O’Currance, Inc.

Cash non-accrual

—

—

Income non-accrual amounts related to the above investments for the years ended September 30, 2011, September 30, 2010 and September 30, 2009 were as follows:

 

		Year ended September 30, 2011				Year ended September 30, 2010				Year ended September 30, 2009
Cash interest income		$	5,815			$	5,804			$	2,938
PIK interest income			851				1,903				1,398
OID income			105				329				403
Total		$	6,771			$	8,036			$	4,739

 

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 interest 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 has 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 other wise indicated)

 

Listed below is a reconciliation of “net increase in net assets resulting from operations” to taxable income for the year ended September 30, 2011.

 

Net increase in net assets resulting from operations		$	30,207
Net unrealized depreciation			6,527
Book/tax difference due to deferred loan origination fees, net			6,432
Book/tax difference due to organizational and offering costs			(87	)
Book/tax difference due to interest income on certain loans			(3,572	)
Book/tax difference due to capital losses not recognized			30,394
Other book-tax differences			(127	)
Taxable/Distributable Income(1)		$	69,774

 

 

(1)	The Company’s taxable income for 2011 is an estimate and will not be finally determined until the Company files its tax return for the fiscal year ended September 30, 2011. Therefore, the final taxable income may be different than the estimate.

As of September 30, 2011, the components of accumulated undistributed income on a tax basis were as follows:

 

Undistributed ordinary income, net (RIC status)		$	—
Realized capital losses			(11,810	)
Unrealized losses, net			(38,780	)
Accumulated partnership taxable income not subject to distribution			6,236
Other book-tax differences			(57,363	)

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 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. The Company has recorded a deferred tax asset for the difference in the book and tax basis of certain equity investments and tax net operating losses held by its taxable subsidiaries of $1.4 million. However, this amount has been fully offset by a valuation allowance of $1.4 million, since it is more likely than not that these deferred tax assets will not be realized.

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 regulated investment companies. 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. 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 other wise indicated)

 

To date, the Company’s Board of Directors declared the following distributions:

 

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

For income tax purposes, the Company estimates that its distributions will be composed primarily of ordinary income, and will be reflected as such on the Form 1099-DIV for the calendar year 2011. The Company anticipates declaring further distributions to its stockholders to meet the RIC distribution requirements.

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.

 

Note 9.

Realized Gains or Losses and Net Unrealized Appreciation or Depreciation on Investments and Interest Rate Swaps

Realized gain or loss is the difference between the proceeds received from dispositions of portfolio investments or interest rate swaps and their stated costs. 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.

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 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

 

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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 other wise indicated)

 

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 on investments or interest rate swaps 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 year ended September 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 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 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;

 

•

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;

 

•

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

 

•

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

 

•

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

 

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FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

 

•

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

 

•

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

During the year ended September 30, 2010, the Company recorded investment realization events, including the following:

 

•

In October 2009, the Company received a cash payment in the amount of $0.1 million representing a payment in full of all amounts due in connection with the cancellation of its loan agreement with American Hardwoods Industries, LLC. The Company recorded a $0.1 million reduction to the previously recorded $10.4 million realized loss on the investment in American Hardwoods;

 

•

In October 2009, the Company received a cash payment of $3.9 million from Elephant & Castle, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

 

•

In March 2010, the Company recorded a realized loss in the amount of $2.9 million in connection with the sale of a portion of its interest in CPAC, Inc.;

 

•

In August 2010, the Company received a cash payment of $7.6 million from Storyteller Theaters Corporation 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 September 2010, the Company restructured its investment in Rail Acquisition Corp. Although the full amount owed under the loan agreement remained intact, 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 $2.6 million in accordance with ASC 470-50;

 

•

In September 2010, the Company sold its investment in Martini Park, LLC and received a cash payment in the amount of $0.1 million. The Company recorded a realized loss on this investment in the amount of $4.0 million; and

 

•

In September 2010, the Company exited its investment in Rose Tarlow, Inc. and received a cash payment in the amount of $3.6 million in full settlement of the debt investment. The Company recorded a realized loss on this investment in the amount of $9.3 million.

During the year ended September 30, 2009, the Company exited its investment in American Hardwoods Industries, LLC and recorded a realized loss of $10.4 million, and recorded a $4.0 million realized loss on one of its portfolio company investments in connection with the determination that the investment was permanently impaired based on, among other things, analysis of changes in the portfolio company’s business operations and prospects.

During the years ended September 30, 2011, 2010 and 2009, the Company recorded net unrealized depreciation of $6.5 million, $1.8 million and $10.8 million, respectively. For the year ended September 30, 2011, the Company’s net unrealized depreciation consisted of $34.6 million of net unrealized depreciation on debt investments, offset by $25.6 million of net reclassifications to realized losses on investments and interest rate swaps (resulting in unrealized appreciation) and $2.5 million of net unrealized appreciation on equity investments.

For the year ended September 30, 2010, the Company’s net unrealized depreciation consisted of $19.1 million of net unrealized depreciation on debt investments and $0.8 million of net unrealized depreciation on interest rate swaps, offset by $17.6 million of reclassifications to realized losses on investments (resulting in unrealized appreciation) and $0.5 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 other wise indicated)

 

For the year ended September 30, 2009, the Company’s net unrealized depreciation consisted of $23.1 million of net unrealized depreciation on debt investments and $2.0 million of net unrealized depreciation on equity investments, offset by $14.3 million of reclassifications to realized losses on investments (resulting in unrealized appreciation).

 

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. The base management fee is payable quarterly in arrears, and will be 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 will be appropriately prorated.

In addition to the proration described above, for the year ended September 30, 2009, the Investment Advisor waived $0.2 million of the base management fee on a portion of the proceeds raised in connection with the equity offerings the Company completed in 2009 and which were held in cash or cash equivalents at September 30, 2009.

Also, on January 6, 2010, the Company announced that the Investment Adviser had voluntarily agreed to take the following actions:

 

•

To waive the portion of its base management fee for the quarter ended December 31, 2009 attributable to four new portfolio investments, as well as cash and cash equivalents. The amount of the management fee waived was $0.7 million; and

 

•

To permanently waive that portion of its base management fee attributable to the Company’s assets held in the form of cash and cash equivalents as of the end of each quarter beginning March 31, 2010.

For purposes of the waiver, cash and cash equivalents is as defined elsewhere in the notes to the Company’s Consolidated Financial Statements.

For the years ended September 30, 2011, 2010 and 2009, base management fees were $19.7 million, $9.3 million and $5.9 million, respectively. At September 30, 2011, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.7 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 any other fees (other than fees for providing managerial

 

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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 other wise indicated)

 

assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies) 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

 

•

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 years ended September 30, 2011, 2010 and 2009, incentive fees were $16.8 million, $10.8 million and $7.8 million, respectively. At September 30, 2011, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.0 million reflecting the unpaid portion of the incentive fee payable to the Investment Adviser.

 

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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 other wise indicated)

 

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. 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 year ended September 30, 2011, the Company accrued administrative expenses of $2.8 million, including $1.1 million of general and administrative expenses, which are due to FSC, Inc. At September 30, 2011, $1.5 million was included in Due to FSC, Inc. in the Consolidated Statement of Assets and Liabilities.

 

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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 other wise indicated)

 

Note 12.

Financial Highlights

 

		Year Ended September 30, 2011				Year Ended September 30, 2010				Year Ended September 30, 2009
Net asset value at beginning of period		$	10.43			$	10.84			$	13.02
Net investment income			1.05				0.95				1.27
Net unrealized depreciation on investments and interest rate swap			(0.10	)			(0.04	)			(0.44	)
Net realized loss on investments and interest rate swap			(0.47	)			(0.42	)			(0.58	)
Dividends paid			(1.26	)			(0.96	)			(1.20	)
Issuance of common stock			0.42				0.06				(1.21	)
Repurchases of common stock			—				—				(0.02	)
Net asset value at end of period		$	10.07			$	10.43			$	10.84
Per share market value at beginning of period		$	11.14			$	10.93			$	10.05
Per share market value at end of period		$	9.32			$	11.14			$	10.93
Total return(1)			(6.76	)%			11.22	%			26.86	%
Common shares outstanding at beginning of period			54,550				37,879				22,614
Common shares outstanding at end of period			72,376				54,550				37,879
Net assets at beginning of period		$	569,172			$	410,556			$	294,336
Net assets at end of period		$	728,627			$	569,172			$	410,556
Average net assets(2)		$	677,354			$	479,004			$	291,401
Ratio of net investment income to average net assets			9.91	%			8.98	%			10.76	%
Ratio of total expenses to average net assets			8.79	%			5.74	%			6.34	%
Ratio of portfolio turnover to average investments at fair value			7.26	%			2.24	%			0.00	%
Weighted average outstanding debt(3)		$	247,549			$	22,592			$	5,019
Average debt per share		$	3.86			$	0.50			$	0.20

 

 

(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 dividend reinvestment plan. Total return is not annualized during interim periods.

 

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

 

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

 

Note 13.

Preferred Stock

The Company’s restated certificate of incorporation had not authorized any shares of preferred stock. However, on April 4, 2008, the Company’s Board of Directors approved a certificate of amendment to its restated certificate of incorporation reclassifying 200,000 shares of its common stock as shares of non-convertible, non-participating preferred stock, with a par value of $0.01 and a liquidation preference of $500 per share (“Series A Preferred Stock”) and authorizing the issuance of up to 200,000 shares of Series A Preferred Stock. A certificate of amendment was also approved by the holders of a majority of the shares of the Company’s outstanding common stock through a written consent first solicited on April 7, 2008.

On April 20, 2010, at the Company’s 2010 Annual Meeting, the Company’s stockholders approved an amendment to the Company’s restated certificate of incorporation to remove the Company’s authority to issue shares of Series A Preferred Stock.

 

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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 other wise indicated)

 

Note 14.

Interest Rate Swaps

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.

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 swap agreement and realized a loss of $1.3 million, which includes a reclassification of $0.8 million of prior unrealized depreciation.

 

Note 15.

Convertible Senior Notes

On April 12, 2011, the Company issued $152 million 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.

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.

 

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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 other wise indicated)

 

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.

For the year ended September 30, 2011, the Company recorded interest expense of $4.1 million related to the Convertible Notes.

The Company may, to the extent permitted by law, repurchase the Convertible Notes in the open market or by tender offer at any price or by private agreement without giving prior notice to holders. 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 year ended September 30, 2011, the Company repurchased, and surrendered to the Trustee for cancellation, Convertible Notes as follows:

 

Trade Date		Settlement Date				Principal Repurchased				Purchase Price
8/1/2011			8/4/2011			$	2,000			$	1,820
8/3/2011			8/8/2011				5,000				4,525
8/5/2011			8/10/2011				10,000				8,725
Total						$	17,000			$	15,070

During the year ended September 30, 2011, 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 $1.5 million.

As of September 30, 2011, there were $135.0 million Convertible Notes outstanding, which had a fair value of $113.4 million.

 

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Schedule 12-14

Fifth Street Finance Corp.

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

Schedule of Investments in and Advances to Affiliates

 

Portfolio Company/Type of Investment(1)		Amount of Interest, Fees or Dividends Credited in Income(2)				Fair Value at October 1, 2010				Gross Additions(3)				Gross Reductions(4)				Fair Value at September 30, 2011
Control Investments
Lighting by Gregory, LLC
First Lien Term Loan A, 9.75% PIK due 2/28/2013		$	12			$	1,504			$	3,296			$	(2,274	)		$	2,526
First Lien Term Loan B, 14.5% PIK due 2/28/2013			114				2,196				4,824				(7,020	)			—
First Lien Bridge Loan, 8% PIK due 3/31/2012			10				—				38				(38	)			—
97.38% membership interest			—				—				800				(800	)			—
Nicos Polymers & Grinding Inc.
First Lien Term Loan, 8% cash due 12/4/2017			357				—				5,486				(296	)			5,190
First Lien Revolver, 8% cash due 12/4/2017			69				—				1,551				—				1,551
50% membership interest			—				—				7,633				(2,400	)			5,233
Total Control Investments		$	562			$	3,700			$	23,628			$	(12,828	)		$	14,500
Affiliate Investments
O’Currance, Inc.
First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012			1,623				10,806				647				(8,280	)			3,173
First Lien Term Loan B, 12.875% cash 4% PIK due 3/21/2012			258				1,897				103				(1,676	)			324
1.75% Preferred Membership Interest in O’Currance Holding Co., LLC			—				39				27				(66	)			—
3.3% Membership Interest in O’Currance Holding Co., LLC			—				—				—				—				—
MK Network, LLC
First Lien Term Loan A, 13.5% cash due 6/1/2012			73				7,913				8,558				(16,471	)			—
First Lien Term Loan B, 17.5% cash due 6/1/2012			76				3,939				4,824				(8,763	)			—
11,030 Membership Units			—				—				772				(772	)			—
Caregiver Services, Inc.
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013			903				7,112				244				(1,513	)			5,843
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013			2,988				14,180				1,423				(536	)			15,067
1,080,399 shares of Series A Preferred Stock			—				1,336				161				(7	)			1,490
Total Affiliate Investments		$	5,921			$	47,222			$	16,759			$	(38,084	)		$	25,897
Total Control & Affiliate Investments		$	6,483			$	50,922			$	40,387			$	(50,912	)		$	40,397

 

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This schedule should be read in connection with the Company’s Consolidated Financial Statements, including the Consolidated Schedules of Investments and Notes to the Consolidated Financial Statements.

 

 

(1)	The principal amount and ownership detail as shown in the Consolidated Schedules of Investments.

 

(2)	Represents the total amount of interest, fees and dividends credited to income for the portion of the year an investment was included in the Control or Non-Control/Non-Affiliate categories, respectively.

 

(3)

Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on Investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as the movement of an existing portfolio company into this category or out of a different category.

 

(4)

Gross reductions include decreases in the cost basis of investment resulting from principal payments or sales and exchanges of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.

 

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Schedule 12-14

Fifth Street Finance Corp.

Schedule of Investments in and Advances to Affiliates

 

Portfolio Company/Type of Investment(1)		Amount of Interest, Fees or Dividends Credited in Income(2)				Fair Value at October 1, 2009				Gross Additions(3)				Gross Reductions(4)				Fair Value at September 30, 2010
Control Investments
Lighting by Gregory, LLC
First Lien Term Loan A, 9.75% PIK due 2/28/2013		$	83			$	2,420			$	—			$	(916	)		$	1,504
First Lien Term Loan B, 14.5% PIK due 2/28/2013			100				3,271				—				(1,075	)			2,196
First Lien Bridge Loan, 8% Cash due 10/15/2010			—				—				150				(150	)			—
97.38% membership interest			—				—				—				—				—
Total Control Investments		$	183			$	5,691			$	150			$	(2,141	)		$	3,700
Affiliate Investments
O’Currance, Inc.
First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012			1,929				10,187				899				(280	)			10,806
First Lien Term Loan B, 12.875% cash 4% PIK due 3/21/2012			421				2,919				152				(1,174	)			1,897
1.75% Preferred Membership Interest in O’Currance Holding Co., LLC			—				130				—				(91	)			39
3.3% Membership Interest in O’Currance Holding Co., LLC			—				54				—				(54	)			—
CPAC, Inc.
Second Lien Term Loan, 17.5% PIK due 4/13/2012			1,235				4,449				3,625				(8,074	)			—
2,297 shares of Common Stock			—				—				—				—				—
Elephant & Castle, Inc.
Second Lien Term Loan, 15.5% due 4/20/2012			68				7,312				310				(7,622	)			—
7,500 shares of Series A Preferred Stock			—				492				—				(492	)			—
MK Network, LLC
First Lien Term Loan A, 13.5% cash due 6/1/2012			1,460				9,034				510				(1,631	)			7,913
First Lien Term Loan B, 17.5% cash due 6/1/2012			958				5,164				335				(1,560	)			3,939
First Lien Revolver, Prime +1.5% (10% floor), due 6/1/2010			—				—				—				—				—
11,030 Membership Units			—				—				—				—				—
Martini Park, LLC
First Lien Term Loan, 12% cash 2% PIK due 2/20/2013			229				2,068				3,632				(5,700	)			—
5% membership interest			—				—				650				(650	)			—
Caregiver Services, Inc.
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013			1,084				8,225				372				(1,485	)			7,112
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013			2,895				13,508				1,356				(684	)			14,180
1,080,399 shares of Series A Preferred Stock			—				1,207				129				—				1,336
Total Affiliate Investments		$	10,279			$	64,749			$	11,970			$	(29,497	)		$	47,222
Total Control & Affiliate Investments		$	10,462			$	70,440			$	12,120			$	(31,638	)		$	50,922

 

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This schedule should be read in connection with the Company’s Consolidated Financial Statements, including the Consolidated Schedules of Investments and Notes to the Consolidated Financial Statements.

 

 

(1)	The principal amount and ownership detail as shown in the Consolidated Schedules of Investments.

 

(2)	Represents the total amount of interest, fees and dividends credited to income for the portion of the year an investment was included in the Control or Non-Control/Non-Affiliate categories, respectively.

 

(3)

Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on Investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as the movement of an existing portfolio company into this category or out of a different category.

 

(4)

Gross reductions include decreases in the cost basis of investment resulting from principal payments or sales and exchanges of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.

 

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$500,000,000

 

Fifth Street Finance Corp.

Common Stock

Debt Securities

Warrants

 

 

P R O S P E C T U S

 

 

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This prospectus supplement relates to an effective registration statement under the Securities Act of 1933, but is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell and are not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted.

 

[FORM OF PROSPECTUS SUPPLEMENT TO BE USED IN CONJUNCTION WITH FUTURE COMMON STOCK OFFERINGS]

SUBJECT TO COMPLETION, DATED                     , 2012

PRELIMINARY PROSPECTUS SUPPLEMENT

(to Prospectus dated                     , 2012)

Fifth Street Finance Corp.

             Shares

Common Stock

 

 

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

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

On                      and March 31, 2012, the last reported sale price of our common stock on the NASDAQ Global Select Market was $             and $9.76, respectively. We are required to determine the net asset value per share of our common stock on a quarterly basis. Our net asset value per share of our common stock as of March 31, 2012 was $9.87.

Investing in our common stock involves a high degree of risk and should be considered highly speculative. See “Risk Factors” beginning on page 15 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in our common stock.

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

 

		Per Share				Total
Public offering price		$				$
Sales load (underwriting discount)		$				$
Proceeds, before expenses, to us(1)		$				$

 

 

 

(1)

We estimate that we will incur approximately $             (or $             per share of the shares sold in this offering) of expenses relating to this offering, resulting in net proceeds, after sales load (underwriting discount) and expenses, to us of approximately $         million (or $         per share of the shares sold in this offering).

The underwriters expect to deliver the shares on or about                     , 2012.

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

We have granted the underwriters an option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to              additional shares of our common stock.

The date of this prospectus supplement is                     , 2012.

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TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT

 

		Page
ABOUT THIS PROSPECTUS SUPPLEMENT			S-ii
PROSPECTUS SUPPLEMENT SUMMARY			S-1
FEES AND EXPENSES			S-6
USE OF PROCEEDS			S-8
CAPITALIZATION			S-9
UNDERWRITING			S-10
LEGAL MATTERS			S-15
AVAILABLE INFORMATION			S-15

PROSPECTUS

 

[Insert table of contents from base prospectus]

 

S-i

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ABOUT THIS PROSPECTUS SUPPLEMENT

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

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

Forward-Looking Statements

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

 

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USE OF PROCEEDS

The net proceeds from our sale of the              shares of common stock in this offering are estimated to be approximately $             million, or $             million if the underwriters’ option to purchase additional shares is exercised in full, assuming a public offering price of $             per share (based on the last reported sales price of our common stock on the NASDAQ Global Select Market on                     ), and after deducting the underwriting discount and estimated offering expenses. The underwriting discount is $            per share. A $0.50 increase (decrease) in the assumed offering price per share would increase (decrease) net proceeds to us from this offering by $             million, assuming the number of shares offered by us as set forth on the cover page of this prospectus supplement remains the same. Any additional proceeds to us resulting from an increase in the public offering price or the number of shares offered pursuant to this prospectus supplement will be used by us as described below.

We intend to use substantially all of the net proceeds from this offering to make investments in small and mid-sized companies (including investments made through our first SBIC subsidiary and, as discussed elsewhere in this prospectus supplement, our second SBIC subsidiary to the extent that it receives a SBIC license from the SBA) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus and for general corporate purposes, including working capital requirements. We also intend to use $              million of the net proceeds from this offering to repay our outstanding borrowings under our credit facilities and to repurchase the Convertible Notes. As of             , 2012, we had $             million outstanding under the Wells Fargo facility. The Wells Fargo facility has a maturity date of April 25, 2016 and bears interest at a rate of LIBOR (1-month) plus 2.75% per annum with no LIBOR floor. As of             , 2012, we had $             million outstanding under the ING facility. The ING facility has a maturity date of February 29, 2016 and bears interest at a rate of LIBOR (1, 2, 3 or 6-month, at our option) plus 3.25% per annum with no LIBOR floor, or, when the facility is drawn more than 35%, LIBOR plus 3.0% per annum with no LIBOR floor. As of             , 2012 we had $             million outstanding under the Sumitomo facility. The Sumitomo facility has a maturity date of September 16, 2018 and bears interest at a rate of LIBOR (1-month) plus 2.25% per annum with no LIBOR floor. As of                 , 2012, we had $             million Convertible Notes outstanding. The Convertible Notes mature on April 1, 2016, unless previously converted or repurchased in accordance with their terms, and bear interest at a rate of 5.375% per annum. If the repurchase and cancellation of any Convertible Notes provides us with a net gain on extinguishment of debt, such net gain will be 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. We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within              to              months. Pending these uses, we will invest the net proceeds primarily in high quality, short-term debt securities, consistent with our business development company election and our election to be taxed as a RIC, at yields significantly below those we expect to earn on investments in small and mid-sized companies. The management fee payable by us to our investment adviser will not be reduced while our assets are invested in these securities unless such securities constitute cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). Our ability to achieve our investment objective may be limited to the extent that the net proceeds from this offering, pending full investment, are held in lower-yielding interest-bearing deposits or other short-term instruments.

 

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CAPITALIZATION

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

 

•

on an actual basis; and

 

•

on an as adjusted basis to reflect the sale of              shares of common stock in this offering, assuming a public offering price of $             per share (based on the last reported sales price of our common stock on the NASDAQ Global Select Market on             , 2012), after deducting the underwriting discount and estimated offering expenses payable by us.

 

		As of March 31, 2012
		Actual				As Adjusted(1)
						(unaudited)
Cash and cash equivalents		$				$
Long-term debt, including current maturities:
Credit facilities payable		$				$		(2)(3)
Convertible senior notes payable								(4)
SBA debentures payable
Total long-term debt
Net assets:
Common stock, $0.01 par value (150,000,000 shares authorized;                  shares outstanding actual,                  shares outstanding as adjusted)
Additional paid-in-capital
Net unrealized depreciation on investments and interest rate swap
Net realized loss on investments and interest rate swap
Accumulated overdistributed net investment income
Total net assets
Total capitalization		$				$

 

 

(1)

We may change the size of this offering based on demand and market conditions. A $0.50 increase (decrease) in the assumed offering price per share would increase (decrease) net proceeds to us from this offering by $             million, assuming the number of shares offered by us as set forth on the cover page of this prospectus supplement remains the same, after deducting the underwriting discount and estimated expenses payable by us. Any additional proceeds to us resulting from an increase in the public offering price or the number of shares offered pursuant to this prospectus supplement will increase our cash and cash equivalents on an as adjusted basis and will be used as described in “Use of Proceeds.”

 

(2)

As described under “Use of Proceeds,” we may also use a part of the net proceeds from this offering to repay a portion of the borrowings outstanding under our credit facilities. We have not yet determined how much of the net proceeds of this offering will be used for this purpose and, as a result, we have not reflected the consequences of such repayment in this table.

 

(3)	As of             , 2012, we had credit facilities payable in the amount of $             million due to net borrowings under our credit facilities in the amount of $             million subsequent to March 31, 2012. This table has not been adjusted to reflect such net borrowings.

 

(4)	This amount does not reflect the $             million aggregate principal amount of our senior convertible notes that we repurchased subsequent to March 31, 2012.

 

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UNDERWRITING

                     and                      are acting as joint book-running managers of the offering and as representatives of the underwriters named below. Subject to the terms and conditions stated in the underwriting agreement dated                      , 2012, each underwriter named below severally agrees to purchase the number of shares indicated in the following table:

 

Underwriters		Number of Shares
Total

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

Option to Purchase Additional Shares

If the underwriters sell more shares than the total number set forth in the table above, the underwriters have an option to buy up to an additional              shares from us. They may exercise that option for 30 days. If any shares are purchased pursuant to this option, the underwriters will severally purchase shares in approximately the same proportion as set forth in the table above.

Commissions and Discounts

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

 

Paid by Fifth Street		No Exercise				Full Exercise
Per Share		$				$
Total		$				$

Shares sold by the underwriters to the public will initially be offered at the public offering price set forth on the cover of this prospectus supplement. If all the shares are not sold at the public offering price, the representatives may change the offering price and the other selling terms. The offering of the shares by the underwriters is subject to receipt and acceptance and subject to the underwriters’ right to reject any order in whole or in part.

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

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

Lock-up Agreements

We and our officers and directors have agreed with the underwriters, subject to certain exceptions, not to issue, sell, dispose of or hedge any of our common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus supplement continuing through the date      days after the date of this prospectus supplement, except with the prior written consent of each of                      and                     .

The      day restricted period described in the preceding paragraph will be automatically extended if: (1) during the last 17 days of the      day restricted period we issue an earnings release or announce material news or a material event; or (2) prior to the expiration of the      day restricted period, we announce that we will release earnings results during the 15-day period following the last day of the      day restricted period, in which case the restrictions described in the preceding paragraph will continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings release of the announcement of the material news or material event.

 

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Price Stabilizations and Short Positions

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

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

Purchases to cover a short position and stabilizing transactions, as well as other purchases by the underwriters for their own accounts, may have the effect of preventing or retarding a decline in the market price of our stock, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on the NASDAQ Global Select Market, in the over-the-counter market or otherwise.

Additional Underwriter compensation

The underwriters and their respective affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, investment research, principal investment, hedging, financing and brokerage activities. Certain of the underwriters and their respective affiliates have, from time to time, performed, and may in the future perform, various financial advisory and investment banking services for the issuer, for which they received or will receive customary fees and expenses. The underwriters and their respective affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or instruments and may at any time hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments. Certain of the net proceeds from the sale of our common stock, not including underwriting compensation, may be paid to affiliates of                      in connection with the repayment of debt owed under the ING facility. As a result,                      and/or their affiliates may receive more than 5% of the net proceeds of this offering, not including underwriting compensation.

Sales Outside the United States

No action has been taken in any jurisdiction (except in the United States) that would permit a public offering of the common shares, or the possession, circulation or distribution of this prospectus supplement, the accompanying prospectus or any other material relating to us or the common shares in any jurisdiction where action for that purpose is required. Accordingly, the common shares may not be offered or sold, directly or indirectly, and none of this prospectus supplement, the accompanying prospectus or any other offering material or advertisements in connection with the common shares may be distributed or published, in or from any country or jurisdiction except in compliance with any applicable rules and regulations of any such country or jurisdiction.

Each of the underwriters may arrange to sell common shares offered hereby in certain jurisdictions outside the United States, either directly or through affiliates, where they are permitted to do so.

 

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Notice to Prospective Investors in European Economic Area

In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a “Relevant Member State”) an offer to the public of any shares which are the subject of the offering contemplated by this prospectus (the “Shares”) may not be made in that Relevant Member State except that an offer to the public in that Relevant Member State of any Shares may be made at any time under the following exemptions under the Prospectus Directive, if they have been implemented in that Relevant Member State:

(a) to any legal entity which is a qualified investor as defined under the Prospectus Directive;

(b) by the Managers to fewer than 100, or, if the Relevant Member State has implemented the relevant provisions of the 2010 PD Amending Directive, 150, natural or legal persons (other than qualified investors as defined in the Prospectus Directive) subject to obtaining the prior consent of Lead Manager for any such offer; or

(c) in any other circumstances falling within Article 3(2) of the Prospectus Directive,

provided that no such offer of Shares shall result in a requirement for the Issuer or any Manager to publish a prospectus pursuant to Article 3 of the Prospectus Directive or supplement a prospectus pursuant to Article 16 of the Prospectus Directive.

For the purposes of this provision, the expression an “offer to the public” in relation to any Shares in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and any Shares to be offered so as to enable an investor to decide to purchase any Shares, as the same may be varied in that Member State by any measure implementing the Prospectus Directive in that Member State. The expression “Prospectus Directive” means Directive 2003/71/EC (and amendments thereto, including the 2010 PD Amending Directive, to the extent implemented in the Relevant Member State), and includes any relevant implementing measure in each Relevant Member State and the expression “2010 PD Amending Directive” means Directive 2010/73/EU.

The EEA selling restriction is in addition to any other selling restrictions set out in this prospectus.

Notice to Prospective Investors in Australia

This offering memorandum is not a formal disclosure document and has not been, nor will be, lodged with the Australian Securities and Investments Commission. It does not purport to contain all information that an investor or their professional advisers would expect to find in a prospectus or other disclosure document (as defined in the Corporations Act 2001 (Australia)) for the purposes of Part 6D.2 of the Corporations Act 2001 (Australia) or in a product disclosure statement for the purposes of Part 7.9 of the Corporations Act 2001 (Australia), in either case, in relation to the securities.

The securities are not being offered in Australia to “retail clients” as defined in sections 761G and 761GA of the Corporations Act 2001 (Australia). This offering is being made in Australia solely to “wholesale clients” for the purposes of section 761G of the Corporations Act 2001 (Australia) and, as such, no prospectus, product disclosure statement or other disclosure document in relation to the securities has been, or will be, prepared.

This offering memorandum does not constitute an offer in Australia other than to persons who do not require disclosure under Part 6D.2 of the Corporations Act 2001 (Australia) and who are wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Australia). By submitting an application for our securities, you represent and warrant to us that you are a person who does not require disclosure under Part 6D.2 and who is a wholesale client for the purposes of section 761G of the Corporations Act 2001 (Australia). If any recipient of this offering memorandum is not a wholesale client, no offer of, or invitation to apply for, our securities shall be deemed to be made to such recipient and no applications for our securities will be accepted from such recipient. Any offer to a recipient in Australia, and any agreement arising from acceptance of such offer, is personal and may only be accepted by the recipient. In addition, by applying for our securities you undertake to

 

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us that, for a period of 12 months from the date of issue of the securities, you will not transfer any interest in the securities to any person in Australia other than to a person who does not require disclosure under Part 6D.2 and who is a wholesale client.

Notice to Prospective Investors in Hong Kong

The contents of this prospectus have not been reviewed by any regulatory authority in Hong Kong. You are advised to exercise caution in relation to the offer. If you are in any doubt about any of the contents of this prospectus, you should obtain independent professional advice. Please note that (i) our securities may not be offered or sold in Hong Kong, by means of this prospectus or any document other than to “professional investors” within the meaning of Part I of Schedule 1 of the Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) (SFO) and any rules made thereunder, or in other circumstances which do not result in the document being a “prospectus” within the meaning of the Companies Ordinance (Cap.32, Laws of Hong Kong) (CO) or which do not constitute an offer or invitation to the public for the purpose of the CO or the SFO, and (ii) no advertisement, invitation or document relating to our securities may be issued or may be in the possession of any person for the purpose of issue (in each case whether in Hong Kong or elsewhere) which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the securities laws of Hong Kong) other than with respect to the securities which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” within the meaning of the SFO and any rules made thereunder.

Notice to Prospective Investors in Japan

Our securities have not been and will not be registered under the Financial Instruments and Exchange Law of Japan (the Financial Instruments and Exchange Law) and our securities will not be offered or sold, directly or indirectly, in Japan, or to, or for the benefit of, any resident of Japan (which term as used herein means any person resident in Japan, including any corporation or other entity organized under the laws of Japan), or to others for re-offering or resale, directly or indirectly, in Japan, or to a resident of Japan, except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the Financial Instruments and Exchange Law and any other applicable laws, regulations and ministerial guidelines of Japan.

Notice to Prospective Investors in Singapore

This document has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of our securities may not be circulated or distributed, nor may our securities be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 274 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”), (ii) to a relevant person pursuant to Section 275(1), or any person pursuant to Section 275(1A), and in accordance with the conditions specified in Section 275, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

Where our securities are subscribed or purchased under Section 275 by a relevant person which is:

(a) a corporation (which is not an accredited investor (as defined in Section 4A of the SFA)) the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; or

(b) a trust (where the trustee is not an accredited investor) whose sole purpose is to hold investments and each beneficiary of the trust is an individual who is an accredited investor,

securities (as defined in Section 239(1) of the SFA) of that corporation or the beneficiaries’ rights and interest (howsoever described) in that trust shall not be transferred within six months after that corporation or that trust has acquired our securities pursuant to an offer made under Section 275 except:

(1) to an institutional investor or to a relevant person defined in Section 275(2) of the SFA, or to any person arising from an offer referred to in Section 275(1A) or Section 276(4)(i)(B) of the SFA;

 

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(2) where no consideration is or will be given for the transfer;

(3) where the transfer is by operation of law; or

(4) as specified in Section 276(7) of the SFA.

Notice to Prospective Investors in Switzerland

The Prospectus does not constitute an issue prospectus pursuant to Article 652a or Article 1156 of the Swiss Code of Obligations (“CO”) and the shares will not be listed on the SIX Swiss Exchange. Therefore, the Prospectus may not comply with the disclosure standards of the CO and/or the listing rules (including any prospectus schemes) of the SIX Swiss Exchange. Accordingly, the shares may not be offered to the public in or from Switzerland, but only to a selected and limited circle of investors, which do not subscribe to the shares with a view to distribution.

Notice to Prospective Investors in United Kingdom

This prospectus is only being distributed to and is only directed at: (1) persons who are outside the United Kingdom; (2) investment professionals falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”); or (3) high net worth companies, and other persons to whom it may lawfully be communicated, falling within Article 49(2)(a) to (d) of the Order (all such persons falling within (1)-(3) together being referred to as “relevant persons”). The shares are only available to, and any invitation, offer or agreement to subscribe, purchase or otherwise acquire such shares will be engaged in only with, relevant persons. Any person who is not a relevant person should not act or rely on this prospectus or any of its contents.

Electronic Delivery

The underwriters may make prospectuses available in electronic format. A prospectus in electronic format may be made available on the website maintained by any of the underwriters, and underwriters may distribute such prospectuses electronically. The underwriters may agree with us to allocate a limited number of shares for sale to their online brokerage customers. Any such allocation for online distributions will be made by the underwriters on the same basis as other allocations.

The underwriters do not expect sales to discretionary accounts to exceed five percent of the total number of shares offered.

The addresses of the underwriters are:                                                                              

 

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LEGAL MATTERS

The validity of the shares of common stock offered by this prospectus supplement and certain other legal matters will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington D.C. Certain legal matters related to the offering will be passed upon for the underwriters by                      ..

AVAILABLE INFORMATION

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

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

 

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This prospectus supplement relates to an effective registration statement under the Securities Act of 1933, but is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell and are not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted.

 

[FORM OF PROSPECTUS SUPPLEMENT TO BE USED IN CONJUNCTION WITH FUTURE DEBT SECURITIES OFFERINGS]

SUBJECT TO COMPLETION, DATED                     , 2012

PRELIMINARY PROSPECTUS SUPPLEMENT

(to Prospectus dated                     , 2012)

Fifth Street Finance Corp.

$            

    % [conversion/ranking information] Notes due

 

 

We are offering $             in aggregate principal amount of     % [Insert ranking/conversion information] notes due                     , which we refer to as the Notes. [Insert relevant information regarding interest payments, redemption, etc.]

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

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

Investing in the Notes involves a high degree of risk and should be considered highly speculative. See “Risk Factors” beginning on page S-5 of this prospectus supplement and on page 15 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in the Notes.

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

 

		Per Note				Total
Public offering price		$				$
Sales load (underwriting discount)		$				$
Proceeds, before expenses, to us(1)		$				$

 

 

 

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

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

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

We have granted the underwriters an option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to an additional $             total aggregate principal amount of Notes offered hereby.

Delivery of the Notes in book-entry form only through The Depository Trust Company will be made on or about                     , 20     .

The date of this prospectus supplement is                      , 2012.

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PROSPECTUS SUPPLEMENT

 

		Page
ABOUT THIS PROSPECTUS SUPPLEMENT			S-ii
PROSPECTUS SUPPLEMENT SUMMARY			S-1
SPECIFIC TERMS OF THE NOTES AND THE OFFERING			S-4
RISK FACTORS			S-5
USE OF PROCEEDS			S-6
CAPITALIZATION			S-7
MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS			S-8
UNDERWRITING			S-9
LEGAL MATTERS			S-11
AVAILABLE INFORMATION			S-11

PROSPECTUS

 

[Insert table of contents from base prospectus]

 

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ABOUT THIS PROSPECTUS SUPPLEMENT

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

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

Forward-Looking Statements

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

 

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SPECIFIC TERMS OF THE NOTES AND THE OFFERING

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

[Insert material terms of the Notes in tabular form to the extent required to be disclosed by applicable law or regulation.]

 

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RISK FACTORS

[Insert risk factors applicable to the Notes and any additional relevant risk factors not included in the base prospectus to the extent required to be disclosed by applicable law or regulation.]

 

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USE OF PROCEEDS

The net proceeds from our sale of the $             million aggregate principal amount of Notes in this offering are estimated to be approximately $             million, or $             million if the underwriters’ option to purchase additional Notes is exercised in full, assuming a public offering price of 100% of par, and after deducting the underwriting discount and estimated offering expenses. The underwriting discount is $            per share.

We intend to use substantially all of the net proceeds from the Notes to make investments in small and mid-sized companies (including investments made through our first SBIC subsidiary and, as discussed elsewhere in this prospectus supplement, our second SBIC subsidiary to the extent that it receives a SBIC license from the SBA) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus and for general corporate purposes, including working capital requirements. We also intend to use $              million of the net proceeds from this offering to repay our outstanding borrowings under our credit facilities and to repurchase the Convertible Notes. As of             , 2012, we had $             million outstanding under the Wells Fargo facility. The Wells Fargo facility has a maturity date of April 25, 2016 and bears interest at a rate of LIBOR (1-month) plus 2.75% per annum with no LIBOR floor. As of                 , 2012, we had $            million outstanding under the ING facility. The ING facility has a maturity date of February 29, 2016 and bears interest at a rate of LIBOR (1, 2, 3 or 6-month, at our option) plus 3.25% per annum with no LIBOR floor, or, when the facility is drawn more than 35%, LIBOR plus 3.0% per annum with no LIBOR floor. As of                 , 2012 we had $            million outstanding under the Sumitomo facility. The Sumitomo facility has a maturity date of September 16, 2018 and bears interest at a rate of LIBOR (1-month) plus 2.25% per annum with no LIBOR floor. As of                 , 2012, we had $             million Convertible Notes outstanding. The Convertible Notes mature on April 1, 2016, unless previously converted or repurchased in accordance with their terms, and bear interest at a rate of 5.375% per annum. If the repurchase and cancellation of any Convertible Notes provides us with a net gain on extinguishment of debt, such net gain will be 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. We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within              to              months. Pending these uses, we will invest the net proceeds primarily in high quality, short-term debt securities, consistent with our business development company election and our election to be taxed as a RIC, at yields significantly below those we expect to earn on investments in small and mid-sized companies. The management fee payable by us to our investment adviser will not be reduced while our assets are invested in these securities unless such securities constitute cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). Our ability to achieve our investment objective may be limited to the extent that the net proceeds from this offering, pending full investment, are held in lower-yielding interest-bearing deposits or other short-term instruments.

 

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CAPITALIZATION

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

 

•

on an actual basis; and

 

•

on an as adjusted basis to reflect the sale of $             million aggregate principal amount of Notes in this offering, assuming a public offering price of 100% of par, after deducting the underwriting discount and estimated offering expenses payable by us.

 

		As of March 31, 2012
		Actual				As Adjusted(1)
						(unaudited)
Cash and cash equivalents		$				$
Long-term debt, including current maturities:
Credit facilities payable		$				$		(2)(3)
Convertible senior notes payable								(4)
SBA debentures payable
Notes payable
Total long-term debt
Net assets:
Common stock, $0.01 par value (150,000,000 shares authorized;             shares outstanding actual and as adjusted)
Additional paid-in-capital
Net unrealized depreciation on investments and interest rate swap
Net realized loss on investments and interest rate swap
Accumulated overdistributed net investment income
Total net assets
Total capitalization		$				$

 

 

(1)

We may change the size of this offering based on demand and market conditions. Any additional proceeds to us resulting from an increase in the Notes offered pursuant to this prospectus supplement will increase our cash and cash equivalents on an as adjusted basis and will be used as described in “Use of Proceeds.”

 

(2)

As described under “Use of Proceeds,” we may also use a part of the net proceeds from this offering to repay a portion of the borrowings outstanding under our credit facilities. We have not yet determined how much of the net proceeds of this offering will be used for this purpose and, as a result, we have not reflected the consequences of such repayment in this table.

 

(3)	As of             , 2012, we had credit facilities payable in the amount of $             million due to net borrowings under our credit facilities in the amount of $             million subsequent to March 31, 2012. This table has not been adjusted to reflect such net borrowings.

 

(4)	This amount does not reflect the $             million aggregate principal amount of our senior convertible notes that we repurchased subsequent to March 31, 2012.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

[Insert disclosure regarding federal income tax consequences of an investment in the Notes to the extent required to be disclosed by applicable law or regulation.]

 

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UNDERWRITING

                    and                      are acting as joint book-running managers of the offering and as representatives of the underwriters named below. Subject to the terms and conditions stated in the underwriting agreement dated                     , 2012, each underwriter named below severally agrees to purchase the aggregate principal amount of Notes indicated in the following table:

 

Underwriters		Principal Amount
Total

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

Option to Purchase Additional Notes

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

Commissions and Discounts

An underwriting discount of     % per Note will be paid by us. This underwriting discount will also apply to any Notes purchased pursuant to the overallotment option.

The following table shows the total underwriting discounts and commissions that we are to pay to the underwriters in connection with this offering. The information assumes either no exercise or full exercise by the underwriters of their overallotment option.

 

		Per Note		Without Option		With Option
Public offering price
Underwriting discount
Proceeds, before expenses, to us

[The underwriters propose to offer some of the Notes to the public at the public offering price set forth on the cover page of this prospectus supplement and some of the Notes to certain other Financial Industry Regulatory Authority (FINRA) members at the public offering price less a concession not in excess of     % of the aggregate principal amount of the Notes. The underwriters may allow, and the dealers may reallow, a discount not in excess of     % of the aggregate principal amount of the Notes. After the initial offering of the Notes to the public, the public offering price and such concessions may be changed. No such change shall change the amount of proceeds to be received by us as set forth on the cover page of this prospectus supplement.]

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

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

[Listing

The Notes are a new issue of securities with no established trading market. We intend to list the Notes on                     . We expect trading in the Notes on                     to begin within     days after the original issue date. Currently there is no public market for the Notes.

 

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

Price Stabilizations and Short Positions

In connection with the offering, the underwriters may purchase and sell Notes in the open market. These transactions may include overallotment, covering transactions and stabilizing transactions. Overallotment involves sales of securities in excess of the aggregate principal amount of securities to be purchased by the underwriters in the offering, which creates a short position for the underwriters. Covering transactions involve purchases of the securities in the open market after the distribution has been completed in order to cover short positions. Stabilizing transactions consist of certain bids or purchases of securities made for the purpose of preventing or retarding a decline in the market price of the securities while the offering is in progress.

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

Any of these activities may cause the price of the Notes to be higher than the price that otherwise would exist in the open market in the absence of such transactions. These transactions may be effected in the over-the-counter market or otherwise and, if commenced, may be discontinued at any time without any notice relating thereto.

Additional Underwriter compensation

The underwriters and their respective affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, investment research, principal investment, hedging, financing and brokerage activities. Certain of the underwriters and their respective affiliates have, from time to time, performed, and may in the future perform, various financial advisory and investment banking services for the issuer, for which they received or will receive customary fees and expenses. The underwriters and their respective affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or instruments and may at any time hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments. Certain of the net proceeds from the sale of the Notes, not including underwriting compensation, may be paid to affiliates of                     in connection with the repayment of debt owed under the [ING facility]. As a result,                     and/or their affiliates may receive more than 5% of the net proceeds of this offering, not including underwriting compensation.

If any of the underwriters or their affiliates has a lending relationship with us, certain of those underwriters or their affiliates routinely hedge or may hedge their credit exposure to us consistent with their customary risk management policies. Typically, these underwriters and their affiliates would hedge such exposure by entering into transactions which consist of either the purchase of credit default swaps or the creation of short positions in our securities, including potentially the Notes. Any such credit default swaps or short positions could adversely affect future trading prices of the Notes.

[Describe any other specific transactions and compensation related thereto to the extent required to be disclosed by applicable law or regulation.]

[Insert principal business addresses of underwriters.]

[Insert applicable legends for jurisdictions in which offers and sales may be made.]

 

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LEGAL MATTERS

Certain legal matters in connection with the offering will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington D.C. Certain legal matters related to the offering will be passed upon for the underwriters by                 .

AVAILABLE INFORMATION

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

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

 

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This prospectus supplement relates to an effective registration statement under the Securities Act of 1933, but is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell and are not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted.

 

[FORM OF PROSPECTUS SUPPLEMENT TO BE USED IN CONJUNCTION WITH FUTURE

WARRANT OFFERINGS]

SUBJECT TO COMPLETION, DATED                 , 2012

PRELIMINARY PROSPECTUS SUPPLEMENT

(to Prospectus dated                 , 2012)

Fifth Street Finance Corp.

Warrants to Purchase up to             [type of security]

 

 

We are offering for sale warrants to purchase up to                     [type of security]. Each warrant entitles the holder to purchase                     [type of security].

The exercise price will be $         per warrant. The warrants will be exercisable beginning on                     , 20     , and will expire on                     , 20     , or earlier upon redemption.

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

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

On             and March 31, 2012, the last reported sale price of our common stock on the NASDAQ Global Select Market was $             and $9.76, respectively. We are required to determine the net asset value per share of our common stock on a quarterly basis. Our net asset value per share of our common stock as of March 31, 2012 was $9.87.

Investing in our warrants involves a high degree of risk and should be considered highly speculative. See “Risk Factors” beginning on page S-5 of this prospectus supplement and on page 15 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in our warrants.

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

 

		Per Warrant				Total
Public offering price		$				$
Sales load (underwriting discount)		$				$
Proceeds, before expenses, to us(1)		$				$

 

 

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

The underwriters expect to deliver the warrants on or about                     , 2012.

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

We have granted the underwriters an option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to                 additional warrants.

The date of this prospectus supplement is                     , 2012.

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TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT

 

		Page
ABOUT THIS PROSPECTUS SUPPLEMENT			S-ii
PROSPECTUS SUPPLEMENT SUMMARY			S-1
SPECIFIC TERMS OF OUR WARRANTS AND THE OFFERING			S-4
RISK FACTORS			S-5
FEES AND EXPENSES			S-6
USE OF PROCEEDS			S-8
DESCRIPTION OF OUR WARRANTS			S-9
CAPITALIZATION			S-10
MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS			S-11
UNDERWRITING			S-12
LEGAL MATTERS			S-14
AVAILABLE INFORMATION			S-14

PROSPECTUS

 

[Insert table of contents from base prospectus]

 

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ABOUT THIS PROSPECTUS SUPPLEMENT

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

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

Forward-Looking Statements

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

 

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SPECIFIC TERMS OF OUR WARRANTS AND THE OFFERING

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

[Insert material terms of our warrants in tabular form to the extent required to be disclosed by applicable law or regulation.]

 

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RISK FACTORS

[If you exercise your warrants, you may be unable to sell any [type of security] you purchase at a profit.

The public trading market price of our [type of security] may decline after you elect to exercise your warrants. If that occurs, you will have committed to buy [type of security] at a price above the prevailing market price and you will have an immediate unrealized loss. Moreover, we cannot assure you that following the exercise of warrants you will be able to sell your [type of security] at a price equal to or greater than the exercise price.

The exercise price is not necessarily an indication of our value.

The exercise price of the warrants does not necessarily bear any relationship to any established criteria for valuation of business development companies. You should not consider the exercise price an indication of our value or any assurance of future value. After the date of this prospectus supplement, our [type of security] may trade at prices above or below the subscription price.]

[Insert any additional relevant risk factors not included in the base prospectus to the extent required to be disclosed by applicable law or regulation.]

 

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FEES AND EXPENSES

[Include this section if warrants are for the purchase of common stock.]

The following table is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this prospectus supplement contains a reference to fees or expenses paid by “you,” “us” or “Fifth Street,” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in us.

 

Stockholder Transaction Expenses:
Sales load (as a percentage of offering price)				%(1)
Offering expenses (as a percentage of offering price)				%(2)
Dividend reinvestment plan fees			—	%(3)
Debt securities offering expenses borne by holders of common stock			—	%(4)
Total stockholder transaction expenses (as a percentage of offering price)				%
Annual Expenses (as a percentage of net assets attributable to common stock):
Management fees				%(5)
Interest payments on borrowed funds (including other costs of servicing debt securities)				%(6)
Other expenses				%(7)
Total annual expenses				%(8)

 

 

(1)	Represents the underwriting discount with respect to the warrants sold by us in this offering.

 

(2)

The expenses of this offering payable by us are estimated to be approximately $            . The offering expenses, as a percentage of the offering price of warrants to be sold in this offering, is based on $            , the sales price of our warrants. If the underwriters exercise their option to purchase additional warrants in full, the offering expenses borne by our common stockholders (as a percentage of the offering price) will be approximately             %.

 

(3)	The expenses of administering our dividend reinvestment plan are included in “other expenses.”

 

(4)	The expenses of any offering of our debt securities are included in “other expenses.”

 

(5)

Our “management fees” are made up of our base management fee and the incentive fees payable under our investment advisory agreement. The base management fee portion of our “management fees” reflected in the table above is     %, which is calculated based on our net assets as of             of $                 million (rather than our gross assets). Our base management fee under the investment advisory agreement is calculated at an annual rate of 2% of our gross assets, which includes borrowings for investment purposes of $         million and excludes cash and cash equivalents of $             million. The incentive fee portion of our “management fees” is     %, which is calculated based on our net assets as of             . This calculation assumes that annual incentive fees earned by our investment adviser remain consistent with the incentive fees earned by our investment adviser during the year ended             . The incentive fee consists of two parts. The first part, which is payable quarterly in arrears, will equal 20% of the excess, if any, of our “Pre-Incentive Fee Net Investment Income” that exceeds a 2% quarterly (8% annualized) hurdle rate, subject to a “catch up” provision measured at the end of each fiscal quarter. The first part of the incentive fee will be computed and paid on income that may include interest that is accrued but not yet received in cash. The operation of the first part of the incentive fee for each quarter is as follows:

 

•

no incentive fee is payable to the investment adviser in any fiscal quarter in which our Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”).

 

•

100% of our 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. We refer to this portion of our 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 our investment adviser with an

 

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incentive fee of 20% on all of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when our Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and

 

•

20% of the amount of our 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 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 fees. The second part of the incentive fee is payable, in arrears, at the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date).

 

(6)

“Interest payments on borrowed funds (including other costs of servicing debt securities)” represent our estimated annual interest payments and other costs of servicing our borrowed funds and relate to borrowings under the Wells Fargo facility, the ING facility, the Sumitomo facility and our SBA-guaranteed debentures, as well as our unsecured senior convertible notes (the “Convertible Notes”). Although we expect our borrowings to fluctuate throughout the year, this item is based on estimated average borrowings of approximately $             for the next twelve months. The amount of leverage that we employ at any particular time will depend on, among other things, our board of directors’ assessment of market and other factors at the time of any proposed borrowing.

 

(7)	“Other Expenses” are based on estimated amounts for the current fiscal year. We estimate we will incur approximately $             of expenses of offering our debt securities within the next 12 months, which is         % of the aggregate proceeds of this offering.

 

(8)	“Total annual expenses” are presented as a percentage of net assets attributable to common stockholders because our common stockholders bear all of our fees and expenses.

Example

The following example demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in our common stock. In calculating the following expense amounts, we have assumed that our annual operating expenses, including interest expenses, offering expenses and all other costs related to servicing our borrowings, would remain at the levels set forth in the table above, and that you would pay a sales load of     % (the underwriting discount to be paid by us with respect to the warrants sold by us in this offering).

 

1 Year

3 Years

5 Years

10 Years

You would pay the following expenses on a $1,000 investment, assuming a 5% annual return

$

$

$

$

The example and the expenses in the tables above should not be considered a representation of our future expenses, and actual expenses may be greater or less than those shown. While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. The income portion of our incentive fee under the investment advisory agreement, which, assuming a 5% annual return, would either not be payable or have an insignificant impact on the expense amounts shown above, is not included in the example. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses, and returns to our investors, would be higher. In addition, while the example assumes reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a number of shares of our common stock, determined by dividing the total dollar amount of the cash distribution payable to a participant by either (i) the greater of (a) the current net asset value per share of our common stock and (b) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our Board of Directors in the event that we use newly issued shares to satisfy the share requirements of the divided reinvestment plan or (ii) the average purchase price, excluding any brokerage charges or other charges, of all shares of common stock purchased by the administrator of the dividend reinvestment plan in the event that shares are purchased in the open market to satisfy the share requirements of the dividend reinvestment plan, which may be at, above or below net asset value.

 

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USE OF PROCEEDS

The net proceeds from our sale of             warrants in this offering are estimated to be approximately $             million, or $             million if the underwriters’ option to purchase additional warrants is exercised in full, assuming a public offering price of $             per warrant, and after deducting the underwriting discount and estimated offering expenses. The underwriting discount is $             per warrant. A $0.50 increase (decrease) in the assumed offering price per warrant would increase (decrease) net proceeds to us from this offering by $             million, assuming the number of warrant offered by us as set forth on the cover page of this prospectus supplement remains the same. Any additional proceeds to us resulting from an increase in the public offering price or the number of warrants offered pursuant to this prospectus supplement will be used by us as described below.

We intend to use substantially all of the net proceeds from this offering to make investments in small and mid-sized companies (including investments made through our first SBIC subsidiary and, as discussed elsewhere in this prospectus supplement, our second SBIC subsidiary to the extent that it receives a SBIC license from the SBA) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus and for general corporate purposes, including working capital requirements. We also intend to use $             million of the net proceeds from this offering to repay our outstanding borrowings under our credit facilities and to repurchase the Convertible Notes. As of             , 2012, we had $             million outstanding under the Wells Fargo facility. The Wells Fargo facility has a maturity date of April 25, 2016 and bears interest at a rate of LIBOR (1-month) plus 2.75% per annum with no LIBOR floor. As of             , 2012, we had $             million outstanding under the ING facility. The ING facility has a maturity date of February 29, 2016 and bears interest at a rate of LIBOR (1, 2, 3 or 6-month, at our option) plus 3.25% per annum with no LIBOR floor, or, when the facility is drawn more than 35%, LIBOR plus 3.0% per annum with no LIBOR floor. As of             , 2012 we had $ million outstanding under the Sumitomo facility. The Sumitomo facility has a maturity date of September 16, 2018 and bears interest at a rate of LIBOR (1-month) plus 2.25% per annum with no LIBOR floor. As of                 , 2012, we had $             million Convertible Notes outstanding. The Convertible Notes mature on April 1, 2016, unless previously converted or repurchased in accordance with their terms, and bear interest at a rate of 5.375% per annum. If the repurchase and cancellation of any Convertible Notes provides us with a net gain on extinguishment of debt, such net gain will be 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. We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within              to              months. Pending these uses, we will invest the net proceeds primarily in high quality, short-term debt securities, consistent with our business development company election and our election to be taxed as a RIC, at yields significantly below those we expect to earn on investments in small and mid-sized companies. The management fee payable by us to our investment adviser will not be reduced while our assets are invested in these securities unless such securities constitute cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). Our ability to achieve our investment objective may be limited to the extent that the net proceeds from this offering, pending full investment, are held in lower-yielding interest-bearing deposits or other short-term instruments.

 

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DESCRIPTION OF OUR WARRANTS

This prospectus supplement sets forth certain terms of our warrants that we are offering pursuant to this prospectus supplement and the accompanying prospectus. This section outlines the specific legal and financial terms of our warrants. You should read this section together with the more general description of our warrants in the accompanying prospectus under the heading “Description of Our Warrants” before investing in our warrants. This summary is not necessarily complete and is subject to and entirely qualified by reference to [insert relevant documents].

[Insert material terms of our warrants to the extent required to be disclosed by applicable law or regulation.]

 

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CAPITALIZATION

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

 

•

on an actual basis; and

 

•

on an as adjusted basis to reflect the sale of             warrants in this offering, assuming a public offering price of $             per warrant, after deducting the underwriting discount and estimated offering expenses payable by us.

 

		As of March 31, 2012
		Actual				As Adjusted(1)
						(unaudited)
Cash and cash equivalents		$				$
Long-term debt, including current maturities:
Credit facilities payable		$				$		(2)(3)
Convertible senior notes payable								(4)
SBA debentures payable
Total long-term debt
Net assets:
Common stock, $0.01 par value (150,000,000 shares authorized;                 shares outstanding actual,                 shares outstanding as adjusted)
Additional paid-in-capital
Net unrealized depreciation on investments and interest rate swap
Net realized loss on investments and interest rate swap
Accumulated overdistributed net investment income
Total net assets
Total capitalization		$				$

 

(1)

We may change the size of this offering based on demand and market conditions. A $0.50 increase (decrease) in the assumed offering price per warrant would increase (decrease) net proceeds to us from this offering by $                 million, assuming the number of warrants offered by us as set forth on the cover page of this prospectus supplement remains the same, after deducting the underwriting discount and estimated expenses payable by us. Any additional proceeds to us resulting from an increase in the public offering price or the number of warrants offered pursuant to this prospectus supplement will increase our cash and cash equivalents on an as adjusted basis and will be used as described in “Use of Proceeds.”

 

(2)

As described under “Use of Proceeds,” we may also use a part of the net proceeds from this offering to repay a portion of the borrowings outstanding under our credit facilities. We have not yet determined how much of the net proceeds of this offering will be used for this purpose and, as a result, we have not reflected the consequences of such repayment in this table.

 

(3)	As of                 , 2012, we had credit facilities payable in the amount of $             million due to net borrowings under our credit facilities in the amount of $             million subsequent to March 31, 2012. This table has not been adjusted to reflect such net borrowings.

 

(4)	This amount does not reflect the $             million aggregate principal amount of our senior convertible notes that we repurchased subsequent to March 31, 2012.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

[Insert disclosure regarding federal income tax consequences of an investment in the warrants to the extent required to be disclosed by applicable law or regulation.]

 

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UNDERWRITING

                    and             are acting as joint book-running managers of the offering and as representatives of the underwriters named below. Subject to the terms and conditions stated in the underwriting agreement dated             , 2012, each underwriter named below severally agrees to purchase the number of warrants indicated in the following table:

 

Underwriters		Number of Warrants
Total

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

Option to Purchase Additional Warrants

If the underwriters sell more warrants than the total number set forth in the table above, the underwriters have an option to buy up to an additional          warrants from us. They may exercise that option for 30 days. If any warrants are purchased pursuant to this option, the underwriters will severally purchase warrants in approximately the same proportion as set forth in the table above.

Commissions and Discounts

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

 

Paid by Fifth Street		No Exercise				Full Exercise
Per Warrant		$				$
Total		$				$

Warrants sold by the underwriters to the public will initially be offered at the public offering price set forth on the cover of this prospectus supplement. If all the warrants are not sold at the public offering price, the representatives may change the offering price and the other selling terms. The offering of the warrants by the underwriters is subject to receipt and acceptance and subject to the underwriters’ right to reject any order in whole or in part.

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

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

[No Sales of Similar Securities

We have agreed, with exceptions, not to sell or transfer any warrants or [type of security] for      days after the date of this prospectus supplement without first obtaining the written consent of [            ].]

[NASDAQ Global Select Market Listing

[Our [type of security] is listed on the NASDAQ Global Select Market under the symbol “             .”]

[Our warrants are a new issue of securities with no established trading market. We intend to list our warrants on                 . We expect trading in our warrants on                 to begin within      days after the original issue date. Currently there is no public market for our warrants.

 

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

Price Stabilizations and Short Positions

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

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

Purchases to cover a short position and stabilizing transactions, as well as other purchases by the underwriters for their own accounts, may have the effect of preventing or retarding a decline in the market price of our warrants, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of our warrants. As a result, the price of the warrants may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on the NASDAQ Global Select Market, in the over-the-counter market or otherwise.

Additional Underwriter compensation

The underwriters and their respective affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, investment research, principal investment, hedging, financing and brokerage activities. Certain of the underwriters and their respective affiliates have, from time to time, performed, and may in the future perform, various financial advisory and investment banking services for the issuer, for which they received or will receive customary fees and expenses. The underwriters and their respective affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or instruments and may at any time hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments. Certain of the net proceeds from the sale of our warrants, not including underwriting compensation, may be paid to affiliates of             in connection with the repayment of debt owed under the ING facility. As a result,                 and/or their affiliates may receive more than 5% of the net proceeds of this offering, not including underwriting compensation.

[Describe any other specific transactions and compensation related thereto to the extent required to be disclosed by applicable law or regulation.]

[Insert principal business addresses of underwriters.]

[Insert applicable legends for jurisdictions in which offers and sales may be made.]

 

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LEGAL MATTERS

Certain legal matters in connection with the offering will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington D.C. Certain legal matters related to the offering will be passed upon for the underwriters by                     .

AVAILABLE INFORMATION

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

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

 

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PART C

Other Information

 

Item 25.

Financial Statements And Exhibits

(1) Financial Statements

The following financial statements of Fifth Street Finance Corp. (the “Registrant” or the “Company”) are included in Part A of this Registration Statement:

 

		Page
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Assets and Liabilities as of March 31, 2012 and September 30, 2011			F-2
Consolidated Statements of Operations for the three and six months ended March 31, 2012 and March  31, 2011			F-3
Consolidated Statements of Changes in Net Assets for the six months ended March 31, 2012 and March  31, 2011			F-4
Consolidated Statements of Cash Flows for the six months ended March 31, 2012 and March 31, 2011			F-5
Consolidated Schedules of Investments as of March 31, 2012 and September 30, 2011			F-6
Notes to Consolidated Financial Statements			F-22

 

AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms			F-60
Consolidated Statement of Assets and Liabilities as of September 30, 2011 and 2010			F-62
Consolidated Statements of Operations for the Years Ended September 30, 2011, 2010 and 2009			F-63
Consolidated Statements of Changes in Net Assets for the Years Ended September  30, 2011, 2010 and 2009			F-64
Consolidated Statements of Cash Flows for the Years Ended September 30, 2011, 2010 and 2009			F-65
Consolidated Schedules of Investments as of September 30, 2011 and 2010			F-66
Notes to Consolidated Financial Statements			F-80

(2) Exhibits

 

(a)(1)

Restated Certificate of Incorporation of the Registrant (Incorporated by reference to Exhibit 3.1 filed with Fifth Street Finance Corp.’s Form 8-A (File No. 001-33901) filed on January 2, 2008).

 

(a)(2)

Certificate of Amendment to the Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit(a)(2) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-146743) filed on June 6, 2008).

 

(a)(3)

Certificate of Correction to the Certificate of Amendment to the Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit(a)(3) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-146743) filed on June 6, 2008).

 

(a)(4)

Certificate of Amendment to Registrant’s Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 filed with Fifth Street Finance Corp.’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 5, 2010).

 

(b)	Amended and Restated Bylaws of the Registrant (Incorporated by reference to Exhibit 3.2 filed with Fifth Street Finance Corp.’s Form 8-A (File No. 001-33901) filed on January 2, 2008).

 

(d)(1)

Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 filed with Fifth Street Finance Corp.’s Form 8-A (File No. 001-33901) filed on January 2, 2008).

 

(d)(2)

Indenture, dated April 12, 2011, between Registrant and Deutsche Bank Trust Company Americas, as trustee (Incorporated by reference to Exhibit 4.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on April 12, 2011).

 

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(d)(3)

Form of 5.375% Convertible Senior Notes due 2016 (Incorporated by reference to Exhibit 4.2 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on April 12, 2011).

 

(d)(4)

Indenture, dated April 30, 2012, between Registrant and Deutsche Bank Trust Company Americas, as trustee.*

 

(d)(5)

Form of Warrant Agreement and Warrant Certificate.**

 

(d)(6)

Statement of Eligibility of Trustee on Form T-1.*

 

(e)	Amended and Restated Dividend Reinvestment Plan (Incorporated by reference to Exhibit(10.1) filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on October 28, 2010).

 

(g)	Second Amended and Restated Investment Advisory Agreement by and between Registrant and Fifth Street Management LLC (Incorporated by reference to Exhibit 10.5 filed with Fifth Street Finance Corp.’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 4, 2011).

 

(h)(1)

Form of Underwriting Agreement for equity securities.**

 

(h)(2)

Form of Underwriting Agreement for debt securities.**

 

(j)	Custody Agreement (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 10-Q (File No. 001-33901) filed on January 31, 2011).

 

(k)(1)

Amended and Restated Administration Agreement by and between Registrant and FSC, Inc. (Incorporated by reference to Exhibit 10.6 filed with Fifth Street Finance Corp.’s Quarterly Report on Form 10-Q (File No. 001-33901) filed on May 4, 2011).

 

(k)(2)

Form of License Agreement by and between Registrant and Fifth Street Capital LLC (Incorporated by reference to Exhibit(k)(2) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-146743) filed on May 8, 2008).

 

(k)(3)

Amended and Restated Loan and Servicing Agreement among Fifth Street Funding, LLC, Registrant, Wells Fargo Securities, LLC, and Wells Fargo Bank, N.A., dated as of November 5, 2010 (Incorporated by reference to Exhibit 10.6 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 001-33901) filed on December 2, 2010).

 

(k)(4)

Amendment No. 1 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of February 25, 2011. (Incorporated by reference to Exhibit(k)(4) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).

 

(k)(5)

Purchase and Sale Agreement by and between Registrant and Fifth Street Funding, LLC, dated as of November 16, 2009 (Incorporated by reference to Exhibit 10.7 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 001-33901) filed on December 9, 2009).

 

(k)(6)

Pledge Agreement by and between Registrant and Wells Fargo Bank, N.A., dated as of November 16, 2009 (Incorporated by reference to Exhibit 10.8 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 001-33901) filed on December 9, 2009).

 

(k)(7)

Omnibus Amendment No. 1 relating to Registrant’s credit facility with Wells Fargo Bank, N.A., dated as of May 26, 2010 (Incorporated by reference to Exhibit(k)(6) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-166012) filed on June 4, 2010).

 

(k)(8)

Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, ING Capital LLC, Royal Bank of Canada, UBS Loan Finance, LLC, Morgan Stanley Bank, N.A., Key Equipment Finance Inc., Deutsche Bank Trust Company Americas and Patriot National Bank, dated as of February 22, 2011. (Incorporated by reference to Exhibit(k)(8) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).

 

(k)(9)

Guarantee, Pledge and Security Agreement among Registrant, FSFC Holdings, Inc., and ING Capital LLC, dated as of May 27, 2010 (Incorporated by reference to Exhibit(k)(8) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-166012) filed on June 4, 2010).

 

(k)(10)

Amendment and Reaffirmation Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC and ING Capital LLC, dated as of February 22, 2011. (Incorporated by reference to Exhibit(k)(10) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-166012) filed on March 30, 2011).

 

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(k)(11)

Amendment No. 1 to Amended and Restated Senior Secured Revolving Credit Agreement and Amendment No. 2 to the Guarantee, Pledge and Security Agreement, among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Royal Bank of Canada, UBS Loan Finance LLC, Morgan Stanley Bank, N.A., Key Equipment Finance, Inc., Deutsche Bank Trust Company Americas and Patriot National Bank, dated as of July 8, 2011. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on July 14, 2011).

 

(k)(12)

Amendment No. 2 to Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Key Equipment Finance, Inc. and UBS Loan Finance LLC, dated as of November 29, 2011. (Incorporated by reference to Exhibit 10.15 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).

 

(k)(13)

Amendment No. 3 to Amended and Restated Senior Secured Revolving Credit Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of February 29, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on March 2, 2012).

 

(k)(14)

Incremental Assumption Agreement among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC and Royal Bank of Canada, dated as of July 8, 2011. (Incorporated by reference to Exhibit 10.2 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on July 14, 2011).

 

(k)(15)

Waiver Letter among Registrant, FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, Royal Bank of Canada and Key Equipment Finance, Inc., dated as of August 3, 2011. (Incorporated by reference to Exhibit 10.17 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).

 

(k)(16)

Loan and Servicing Agreement among Registrant, Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of September 16, 2011. (Incorporated by reference to Exhibit 10.18 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).

 

(k)(17)

Purchase and Sale Agreement by and between Registrant and Fifth Street Funding II, LLC, dated as of September 16, 2011. (Incorporated by reference to Exhibit 10.19 filed with Fifth Street Finance Corp.’s Annual Report on Form 10-K (File No. 814-00755) filed on November 29, 2011).

 

(k)(18)

Amendment No. 1 and Waiver to the Loan and Servicing Agreement among Registrant, Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of March 16, 2012. (Incorporated by reference to Exhibit 10.2 filed with Fifth Street Finance Corp.’s Form 10-Q (File No. 001-33901) filed on May 8, 2012).

 

(k)(19)

Amendment No. 3 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of November 30, 2011. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on December 5, 2011).

 

(k)(20)

Amendment No. 1 to the Purchase and Sale Agreement by and between Registrant and Fifth Street Funding, LLC, dated as of November 30, 2011. (Incorporated by reference to Exhibit 10.2 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on December 5, 2011).

 

(k)(21)

Amendment No. 4 to the Amended and Restated Loan and Servicing Agreement among Registrant, Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of April 23, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on April 25, 2012).

 

(l)	Opinion and Consent of Sutherland Asbill & Brennan LLP.*

 

(n)(1)

Consent of Grant Thornton LLP.*

 

(n)(2)

Consent of PricewaterhouseCoopers LLP.*

 

(n)(3)

Report of PricewaterhouseCoopers LLP. (Incorporated by reference to Exhibit(n)(3) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-178391) filed on December 9, 2011).

 

(r)(1)

Code of Ethics of the Registrant (Incorporated by reference to Exhibit(r) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-146743) filed on May 8, 2008).

 

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(r)(2)

Code of Ethics of Fifth Street Management LLC (Incorporated by reference to Exhibit(r)(2) filed with Fifth Street Finance Corp.’s Registration Statement on Form N-2 (File No. 333-159720) filed on June 4, 2009).

 

99.1	Statement of Computation of Ratios of Earnings to Fixed Charges*

 

*	Filed herewith.

 

**	To be filed by post-effective amendment, if applicable.

 

Item 26.

Marketing Arrangements

The information contained under the heading “Plan of Distribution” on this Registration Statement is incorporated herein by reference and any information concerning any underwriters will be contained in the accompanying prospectus supplement, if any.

 

Item 27.

Other Expenses Of Issuance And Distribution

 

SEC registration fee		$	57,300
NASDAQ Global Select Market listing fee		$	130,000
FINRA filing fee		$	50,500
Accounting fees and expenses		$	75,000
Legal fees and expenses		$	200,000
Printing and engraving		$	150,000
Total		$	662,800

The amounts set forth above, except for the SEC and FINRA fees, are in each case estimated. All of the expenses set forth above shall be borne by the Registrant.

 

Item 28.

Persons Controlled By Or Under Common Control

The following list sets forth each of the Registrant’s subsidiaries, the state or country under whose laws the subsidiary is organized, and the percentage of voting securities or membership interests owned by the Registrant in such subsidiary:

 

•

FSFC Holdings, Inc. — a Delaware corporation (100%)

 

•

Fifth Street Fund of Funds LLC — a Delaware limited liability company (100%)

 

•

Fifth Street Funding, LLC — a Delaware limited liability company (100%)

 

•

Fifth Street Funding II, LLC — a Delaware limited liability company (100%)

 

•

Fifth Street Mezzanine Partners IV, L.P. — a Delaware limited partnership (100%)

 

•

FSMP IV GP, LLC — a Delaware limited liability company (100%)

 

•

Fifth Street Mezzanine Partners V, L.P. — a Delaware limited partnership (100%)

 

•

FSMP V GP, LLC — a Delaware limited liability company (100%)

Each of our subsidiaries is consolidated for financial reporting purposes.

In addition, the Registrant may be deemed to control Lighting by Gregory, LLC and Coll Materials Group LLC, two of the Registrant’s portfolio companies.

 

Item 29.

Number Of Holders Of Securities

The following table sets forth the number of record holders of the Registrant’s capital stock at June 30, 2012.

 

Title of Class		Number of Record Holders
Common stock, $0.01 par value			73

 

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Item 30.

Indemnification

Section 145 of the Delaware General Corporation Law empowers a Delaware corporation to indemnify its officers and directors and specific other persons to the extent and under the circumstances set forth therein.

Section 102(b)(7) of the Delaware General Corporation Law allows a Delaware corporation to eliminate the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liabilities arising (a) from any breach of the director’s duty of loyalty to the corporation or its stockholders; (b) from acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (c) under Section 174 of the Delaware General Corporation Law; or (d) from any transaction from which the director derived an improper personal benefit.

Subject to the Investment Company Act of 1940, as amended (the “1940 Act”) or any valid rule, regulation or order of the SEC thereunder, our Restated Certificate of Incorporation provides that we will indemnify any person who was or is a party or is threatened to be made a party to any threatened action, suit or proceeding whether civil, criminal, administrative or investigative, by reason of the fact that he is or was a director or officer of the Registrant, or is or was serving at the request of the Registrant as a director or officer of another corporation, partnership, limited liability company, joint venture, trust or other enterprise, in accordance with provisions corresponding to Section 145 of the Delaware General Corporation Law. The 1940 Act provides that a company may not indemnify any director or officer against liability to it or its security holders to which he or she might otherwise be subject by reason of his or her willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her office unless a determination is made by final decision of a court, by vote of a majority of a quorum of directors who are disinterested, non-party directors or by independent legal counsel that the liability for which indemnification is sought did not arise out of the foregoing conduct. In addition, our Restated Certificate of Incorporation provides that the indemnification described therein is not exclusive and shall not exclude any other rights to which the person seeking to be indemnified may be entitled under statute, any bylaw, agreement, vote of stockholders or directors who are not interested persons, or otherwise, both as to action in his official capacity and to his action in another capacity while holding such office.

The above discussion of Section 145 of the Delaware General Corporation Law and the Registrant’s Restated Certificate of Incorporation is not intended to be exhaustive and is respectively qualified in its entirety by such statute and the Registrant’s Restated Certificate of Incorporation.

The Registrant has obtained primary and excess insurance policies insuring our directors and officers against some liabilities they may incur in their capacity as directors and officers. Under such policies, the insurer, on the Registrant’s behalf, may also pay amounts for which the Registrant has granted indemnification to the directors or officers.

The Registrant may agree to indemnify any underwriters in connection with an offering pursuant to this Registration Statement against specific liabilities, including liabilities under the Securities Act of 1933, as amended (the “Securities Act”).

 

Item 31.

Business And Other Connections Of Investment Adviser

A description of any other business, profession, vocation, or employment of a substantial nature in which our investment adviser, and each executive officer of our investment adviser, is or has been during the past two fiscal years, engaged in for his or her own account or in the capacity of director, officer, employee, partner or trustee, is set forth in Part A of this Registration Statement in the sections entitled “Business — The Investment Adviser,” “Management — Board of Directors and Executive Officers — Directors,” “— Executive Officers” and “Investment Advisory Agreement.” Additional information regarding our investment adviser and its officers is set forth in its Form ADV, as filed with the Securities and Exchange Commission (SEC File No. 801-68676), and is incorporated herein by reference.

 

Item 32.

Location Of Accounts And Records

All accounts, books and other documents required to be maintained by Section 31(a) of the Investment Company Act of 1940, and the rules thereunder are maintained at the offices of:

(1) the Registrant, Fifth Street Finance Corp., 10 Bank Street, 12th Floor, White Plains, NY 10606;

 

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(2) the Transfer Agent, American Stock Transfer & Trust Company, 6201 15th Avenue, Brooklyn, NY 11219;

(3) the Custodian, U.S. Bank National Association, 214 N Tryon Street, 27th Floor, Charlotte, NC 28202;

(4) the investment adviser, Fifth Street Management LLC, 2 Greenwich Office Park, 2nd Floor, Greenwich, CT 06831; and

(5) the administrator, FSC, Inc., 10 Bank Street, 12th Floor, White Plains, NY 10606.

 

Item 33.

Management Services

Not Applicable.

 

Item 34.

Undertakings

1. We hereby undertake to suspend any offering of shares until the prospectus is amended if (1) subsequent to the effective date of this Registration Statement, our net asset value declines more than ten percent from our net asset value as of the effective date of this Registration Statement or (2) our net asset value increases to an amount greater than our net proceeds (if applicable) as stated in the prospectus.

2. We hereby undertake:

a. to file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement:

(1) to include any prospectus required by Section 10(a)(3) of the Securities Act;

(2) to reflect in the prospectus or prospectus supplement any facts or events after the effective date of this Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in this Registration Statement; and

(3) to include any material information with respect to the plan of distribution not previously disclosed in this Registration Statement or any material change to such information in this Registration Statement.

b. for the purpose of determining any liability under the Securities Act, that each such post-effective amendment to this Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of those securities at that time shall be deemed to be the initial bona fide offering thereof.

c. to remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering.

d. for the purpose of determining liability under the Securities Act to any purchaser, that if we are subject to Rule 430C under the Securities Act, each prospectus filed pursuant to Rule 497(b), (c), (d) or (e) under the Securities Act as part of this Registration Statement relating to an offering shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness, provided, however, that no statement made in a registration statement or prospectus or prospectus supplement that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supercede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use.

e. for the purpose of determining liability of the Registrant under the Securities Act to any purchaser in the initial distribution of securities, regardless of the underwriting method used to sell such securities to the

 

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purchaser, that if the securities are offered or sold to such purchaser by means of any of the following communications, we will be a seller to the purchaser and will be considered to offer or sell such securities to the purchaser:

(1) any preliminary prospectus or prospectus or prospectus supplement of us relating to the offering required to be filed pursuant to Rule 497 under the Securities Act;

(2) the portion of any advertisement pursuant to Rule 482 under the Securities Act relating to the offering containing material information about us or our securities provided by or on behalf of us; and

(3) any other communication that is an offer in the offering made by us to the purchaser.

f. to file a post-effective amendment to the registration statement, and to suspend any offers or sales pursuant to the registration statement until such post-effective amendment has been declared effective under the 1933 Act, in the event our shares of common stock are trading below our net asset value per share and either (i) we receive, or have been advised by our independent registered accounting firm that we will receive, an audit report reflecting substantial doubt regarding our ability to continue as a going concern or (ii) we have concluded that a fundamental change has occurred in our financial position or results of operations.

g. Insofar as indemnification for liability arising under the Securities Act may be permitted to our directors, officers and controlling persons, that we have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by us of expenses incurred or paid by a director, officer or controlling person of us in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, we undertake, unless in the opinion of our counsel the matter has been settled by controlling precedent, to submit to a court of appropriate jurisdiction the question whether such indemnification by us is against public policy as expressed in the Securities Act and we will be governed by the final adjudication of such issue.

3. We hereby undertake that:

a. For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by us pursuant to Rule 424(b) (1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective.

b. For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

4. We hereby undertake to not seek to sell shares under a prospectus supplement to the registration statement, or a post-effective amendment to the registration statement, of which the prospectus forms a part (the “current registration statement”) if the cumulative dilution to our net asset value (“NAV”) per share arising from offerings from the effective date of the current registration statement through and including any follow-on offering would exceed 15% based on the anticipated pricing of such follow-on offering. This limit would be measured separately for each offering pursuant to the current registration statement by calculating the percentage dilution or accretion to aggregate NAV from that offering and then summing the anticipated percentage dilution from each subsequent offering. If we file a new post-effective amendment, the threshold would reset.

 

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SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Pre-Effective Amendment No. 1 to the Registration Statement on Form N-2 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of White Plains, State of New York, on July 27, 2012.

 

Pursuant to the requirements of the Securities Act of 1933, this Pre-Effective Amendment No. 1 to the Registration Statement on Form N-2 has been signed below by the following persons in the capacities and on the dates indicated:

 

Signature		Title		Date
/s/    LEONARD M. TANNENBAUM Leonard M. Tannenbaum		Chief Executive Officer and Director (Principal Executive Officer)		July 27, 2012
/s/    ALEXANDER C. FRANK Alexander C. Frank		Chief Financial Officer (Principal Financial and Accounting Officer)		July 27, 2012
/s/    BERNARD D. BERMAN Bernard D. Berman		President, Chief Compliance Officer, Secretary and Director		July 27, 2012
* Brian S. Dunn		Director		July 27, 2012
* Richard P. Dutkiewicz		Director		July 27, 2012
* Byron J. Haney		Director		July 27, 2012
* Frank C. Meyer		Director		July 27, 2012
* Douglas F. Ray		Director		July 27, 2012

 

 

 

*	Signed by Bernard D. Berman pursuant to a power of attorney signed by each individual on March 21, 2012.

 

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Exhibit (d)(4)

EXECUTION VERSION

FIFTH STREET FINANCE CORP.

Issuer

and

DEUTSCHE BANK TRUST COMPANY AMERICAS

Trustee

Indenture

Dated as of April 30, 2012

Providing for the Issuance

Of

Debt Securities

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Exhibit (d)(4)

EXECUTION VERSION

FIFTH STREET FINANCE CORP.

Reconciliation and tie between Trust Indenture Act of 1939

and Indenture, dated as of April 30, 2012

 

Trust Indenture Act Section						Indenture Section
§ 310		(a)(1)				607
		(a)(2)				607
		(b)				609
§ 312		(c)				701
§ 314		(a)				704
		(a)(4)				1005
		(c)(1)				102
		(c)(2)				102
		(e)				102
§ 315		(b)				601
§ 316		(a) (last sentence)				101 (“Outstanding”)
		(a)(1)(A)				502,512
		(a)(1)(B)				513
		(b)				508
§ 317		(a)(1)				503
		(a)(2)				504
§ 318		(a)				111
		(c)				111

 

NOTE: This reconciliation and tie shall not, for any purpose, be deemed to be a part of the Indenture.

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TABLE OF CONTENTS

 

				Page
ARTICLE ONE
DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION
SECTION 101.		Definitions.			1
SECTION 102.		Compliance Certificates and Opinions.			10
SECTION 103.		Form of Documents Delivered to Trustee.			11
SECTION 104.		Acts of Holders.			11
SECTION 105.		Notices, Etc., to Trustee and Company.			13
SECTION 106.		Notice to Holders; Waiver.			13
SECTION 107.		Conflict with TIA.			14
SECTION 108.		Effect of Headings and Table of Contents.			14
SECTION 109.		Successors and Assigns.			14
SECTION 110.		Separability Clause.			14
SECTION 111.		Benefits of Indenture.			14
SECTION 112.		Governing Law.			14
SECTION 113.		Legal Holidays.			14
SECTION 114.		Submission to Jurisdiction.			15
ARTICLE TWO
SECURITIES FORMS
SECTION 201.		Forms of Securities.			15
SECTION 202.		Form of Trustee’s Certificate of Authentication.			15
SECTION 203.		Securities Issuable in Global Form.			16
ARTICLE THREE
THE SECURITIES
SECTION 301.		Amount Unlimited; Issuable in Series.			17
SECTION 302.		Denominations.			21
SECTION 303.		Execution, Authentication, Delivery and Dating.			21
SECTION 304.		Temporary Securities.			22
SECTION 305.		Registration, Registration of Transfer and Exchange.			23
SECTION 306.		Mutilated, Destroyed, Lost and Stolen Securities.			25
SECTION 307.		Payment of Interest; Interest Rights Preserved; Optional Interest Reset.			26
SECTION 308.		Optional Extension of Maturity.			28
SECTION 309.		Persons Deemed Owners.			29
SECTION 310.		Cancellation.			29
SECTION 311.		Computation of Interest.			30
SECTION 312.		Currency and Manner of Payments in Respect of Securities.			30
SECTION 313.		Appointment and Resignation of Successor Exchange Rate Agent.			33
SECTION 314.		CUSIP Numbers.			34

 

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ARTICLE FOUR
SATISFACTION AND DISCHARGE
SECTION 401.		Satisfaction and Discharge of Indenture.			34
SECTION 402.		Application of Trust Funds.			35
ARTICLE FIVE
REMEDIES
SECTION 501.		Events of Default.			36
SECTION 502.		Acceleration of Maturity; Rescission and Annulment.			37
SECTION 503.		Collection of Indebtedness and Suits for Enforcement by Trustee.			38
SECTION 504.		Trustee May File Proofs of Claim.			39
SECTION 505.		Trustee May Enforce Claims Without Possession of Securities.			40
SECTION 506.		Application of Money Collected.			40
SECTION 507.		Limitation on Suits.			41
SECTION 508.		Unconditional Right of Holders to Receive Principal, Premium and Interest.			41
SECTION 509.		Restoration of Rights and Remedies.			41
SECTION 510.		Rights and Remedies Cumulative.			42
SECTION 511.		Delay or Omission Not Waiver.			42
SECTION 512.		Control by Holders of Securities.			42
SECTION 513.		Waiver of Past Defaults.			42
SECTION 514.		Waiver of Stay or Extension Laws.			43
ARTICLE SIX
THE TRUSTEE
SECTION 601.		Notice of Defaults.			43
SECTION 602.		Certain Rights of Trustee.			43
SECTION 603.		Not Responsible for Recitals or Issuance of Securities.			45
SECTION 604.		May Hold Securities.			46
SECTION 605.		Money Held in Trust.			46
SECTION 606.		Compensation and Reimbursement and Indemnification of Trustee.			46
SECTION 607.		Corporate Trustee Required; Eligibility.			47
SECTION 608.		Disqualification; Conflicting Interests.			47
SECTION 609.		Resignation and Removal; Appointment of Successor.			47
SECTION 610.		Acceptance of Appointment by Successor.			49
SECTION 611.		Merger, Conversion, Consolidation or Succession to Business.			50
SECTION 612.		Appointment of Authenticating Agent.			50
ARTICLE SEVEN
HOLDERS’ LISTS AND REPORTS BY TRUSTEE AND COMPANY
SECTION 701.		Company to Furnish Trustee Names and Addresses of Holders.			52
SECTION 702.		Preservation of Information; Communications to Holders.			52
SECTION 703.		Reports by Trustee.			53

 

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SECTION 704.		Reports by Company.			53
SECTION 705.		Calculation of Original Issue Discount.			53
ARTICLE EIGHT
CONSOLIDATION, MERGER, CONVEYANCE OR TRANSFER
SECTION 801.		Company May Consolidate, Etc., Only on Certain Terms.			54
SECTION 802.		Successor Person Substituted.			54
ARTICLE NINE
SUPPLEMENTAL INDENTURES
SECTION 901.		Supplemental Indentures Without Consent of Holders.			54
SECTION 902.		Supplemental Indentures with Consent of Holders.			56
SECTION 903.		Execution of Supplemental Indentures.			57
SECTION 904.		Effect of Supplemental Indentures.			57
SECTION 905.		Conformity with Trust Indenture Act.			57
SECTION 906.		Reference in Securities to Supplemental Indentures.			57
ARTICLE TEN
COVENANTS
SECTION 1001.		Payment of Principal, Premium, if any, and Interest.			58
SECTION 1002.		Maintenance of Office or Agency.			58
SECTION 1003.		Money for Securities Payments to Be Held in Trust.			59
SECTION 1004.		Additional Amounts.			60
SECTION 1005.		Statement as to Compliance.			60
SECTION 1006.		Waiver of Certain Covenants.			61
ARTICLE ELEVEN
REDEMPTION OF SECURITIES
SECTION 1101.		Applicability of Article.			61
SECTION 1102.		Election to Redeem; Notice to Trustee.			61
SECTION 1103.		Selection by Trustee of Securities to Be Redeemed.			62
SECTION 1104.		Notice of Redemption.			62
SECTION 1105.		Deposit of Redemption Price.			63
SECTION 1106.		Securities Payable on Redemption Date.			63
SECTION 1107.		Securities Redeemed in Part.			64
ARTICLE TWELVE
SINKING FUNDS
SECTION 1201.		Applicability of Article.			64
SECTION 1202.		Satisfaction of Sinking Fund Payments with Securities.			65
SECTION 1203.		Redemption of Securities for Sinking Fund.			65

 

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ARTICLE THIRTEEN
REPAYMENT AT THE OPTION OF HOLDERS
SECTION 1301.		Applicability of Article.			65
SECTION 1302.		Repayment of Securities.			66
SECTION 1303.		Exercise of Option.			66
SECTION 1304.		When Securities Presented for Repayment Become Due and Payable.			66
SECTION 1305.		Securities Repaid in Part.			67
ARTICLE FOURTEEN
DEFEASANCE AND COVENANT DEFEASANCE
SECTION 1401.		Applicability of Article; Company’s Option to Effect Defeasance or Covenant Defeasance.			67
SECTION 1402.		Defeasance and Discharge.			67
SECTION 1403.		Covenant Defeasance.			68
SECTION 1404.		Conditions to Defeasance or Covenant Defeasance.			68
SECTION 1405.		Deposited Money and Government Obligations to Be Held in Trust; Other Miscellaneous Provisions.			70
ARTICLE FIFTEEN
MEETINGS OF HOLDERS OF SECURITIES
SECTION 1501.		Purposes for Which Meetings May Be Called.			71
SECTION 1502.		Call, Notice and Place of Meetings.			71
SECTION 1503.		Persons Entitled to Vote at Meetings.			71
SECTION 1504.		Quorum; Action.			72
SECTION 1505.		Determination of Voting Rights; Conduct and Adjournment of Meetings.			73
SECTION 1506.		Counting Votes and Recording Action of Meetings.			73
ARTICLE SIXTEEN
SUBORDINATION OF SECURITIES
SECTION 1601.		Agreement to Subordinate.			74
SECTION 1602.		Distribution on Dissolution, Liquidation and Reorganization; Subrogation of Subordinated Securities.			74
SECTION 1603.		No Payment on Subordinated Securities in Event of Default on Designated Senior Indebtedness.			76
SECTION 1604.		Payments on Subordinated Securities Permitted.			76
SECTION 1605.		Authorization of Holders to Trustee to Effect Subordination.			77
SECTION 1606.		Notices to Trustee.			77
SECTION 1607.		Trustee as Holder of Designated Senior Indebtedness.			77
SECTION 1608.		Modifications of Terms of Designated Senior Indebtedness.			78
SECTION 1609.		Reliance on Judicial Order or Certificate of Liquidating Agent.			78

 

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INDENTURE, dated as of April 30, 2012, between FIFTH STREET FINANCE CORP., a Delaware corporation (hereinafter called the “Company”), having its principal office at 10 Bank Street, 12^th Floor, White Plains, New York 10606, and Deutsche Bank Trust Company Americas, as Trustee (hereinafter called the “Trustee”), having its Corporate Trust Office at 60 Wall Street, MS NYC 60-2710, New York, New York 10005.

RECITALS OF THE COMPANY

The Company deems it necessary to issue from time to time for its lawful purposes debt securities (hereinafter called the “Securities”) evidencing its secured or unsecured indebtedness, which may or may not be convertible into or exchangeable for any securities of any Person (including the Company), and has duly authorized the execution and delivery of this Indenture to provide for the issuance from time to time of the Securities, to be issued in one or more series, unlimited as to principal amount, to bear such rates of interest, to mature at such times and to have such other provisions as shall be fixed as hereinafter provided.

This Indenture (as defined herein) is subject to the provisions of the Trust Indenture Act of 1939, as amended, that are required to be part of this Indenture and shall, to the extent applicable, be governed by such provisions.

All things necessary to make this Indenture a valid and legally binding agreement of the Company, in accordance with its terms, have been done.

NOW, THEREFORE, THIS INDENTURE WITNESSETH:

For and in consideration of the premises and the purchase of the Securities by the Holders (as defined herein) thereof, it is mutually covenanted and agreed, for the equal and proportionate benefit of all Holders of the Securities, or of a series thereof, as follows:

ARTICLE ONE

DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION

 

SECTION 101.		Definitions.

For all purposes of this Indenture, except as otherwise expressly provided or unless the context otherwise requires:

(1) the terms defined in this Article have the meanings assigned to them in this Article, and include the plural as well as the singular and, pursuant to Section 301, any such item may, with respect to any particular series of Securities, be amended or modified or specified as being inapplicable;

(2) all other terms used herein which are defined in the Trust Indenture Act (as defined herein), either directly or by reference therein, have the meanings assigned to them therein, and the terms “cash transaction” and “self-liquidating paper”, as used in Section 311 of the Trust Indenture Act, shall have the meanings assigned to them in the rules of the Commission (as defined herein) adopted under the Trust Indenture Act;

 

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(3) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles in the United States of America; and

(4) the words “herein”, “hereof” and “hereunder” and other words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other subdivision.

Certain terms, used principally in Article Three, Article Five, Article Six and Article Ten, are defined in those Articles.

“Act”, when used with respect to any Holder of a Security, has the meaning specified in Section 104.

“Additional Amounts” means any additional amounts which are required by a Security or by or pursuant to a Board Resolution, under circumstances specified therein, to be paid by the Company in respect of certain taxes imposed on certain Holders and which are owing to such Holders.

“Affiliate” of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, “control” when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms “controlling” and “controlled” have meanings correlative to the foregoing.

“Authenticating Agent” means any authenticating agent appointed by the Trustee pursuant to Section 612 to act on behalf of the Trustee to authenticate Securities of one or more series.

“Authorized Newspaper” means a newspaper, in the English language or in an official language of the country of publication, customarily published on each Business Day, whether or not published on Saturdays, Sundays or holidays, and of general circulation in each place in connection with which the term is used or in the financial community of each such place. Where successive publications are required to be made in Authorized Newspapers, the successive publications may be made in the same or in different newspapers in the same city meeting the foregoing requirements and in each case on any Business Day.

“Board of Directors” means the board of directors of the Company, the executive committee or any committee of that board duly authorized to act hereunder.

“Board Resolution” means a copy of a resolution certified by the Secretary or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors and to be in full force and effect on the date of such certification, and delivered to the Trustee.

“Business Day”, when used with respect to any Place of Payment or any other particular location referred to in this Indenture or in the Securities, means, unless otherwise specified with respect to any Securities pursuant to Section 301, each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banking institutions in that Place of Payment or particular location are authorized or obligated by law or executive order to close.

 

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“Commission” means the Securities and Exchange Commission, as from time to time constituted, created under the Securities Exchange Act of 1934, or, if at any time after execution of this instrument such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body performing such duties on such date.

“Company” means the Person named as the “Company” in the first paragraph of this Indenture until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter “Company” shall mean such successor corporation.

“Company Request” and “Company Order” mean, respectively, a written request or order signed in the name of the Company by the Chief Executive Officer, President or a Vice President of the Company, and by the Chief Financial Officer, Chief Operating Officer, Secretary or an Assistant Secretary of the Company, and delivered to the Trustee.

“Conversion Date” has the meaning specified in Section 312(d).

“Conversion Event” means the cessation of use of (i) a Foreign Currency both by the government of the country which issued such currency and for the settlement of transactions by a central bank or other public institutions of or within the international banking community, (ii) the Euro within Economic and Monetary Union of the European Union or (iii) any currency unit (or composite currency) other than the Euro for the purposes for which it was established.

“Corporate Trust Office” means the office of the Trustee at which, at any particular time, its corporate trust business shall be principally administered, which office at the date hereof is located at 60 Wall Street, MS NYC 60-2710, New York, New York 10005.

“corporation” includes corporations, associations, companies and business trusts.

“Currency” means any currency or currencies, composite currency or currency unit or currency units issued by the government of one or more countries or by any reorganized confederation or association of such governments.

“Default” means any event which is, or after notice or passage of time or both would be, an Event of Default.

“Defaulted Interest” has the meaning specified in Section 307.

“Depository” means the clearing agency registered under the Exchange Act that is designated to act as the Depository for global Securities. DTC shall be the initial Depository, until a successor shall have been appointed and become such pursuant to the applicable provisions of this Indenture, and thereafter, “Depository” shall mean or include such successor.

“Designated Senior Indebtedness” means the principal of (and premium, if any) and unpaid interest on (a) indebtedness of the Company (including indebtedness of others guaranteed by the Company), whether outstanding on the date hereof or thereafter created, incurred,

 

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assumed or guaranteed, for money borrowed, that has been designated by the Company as “Designated Senior Indebtedness” for purposes of this Indenture by a Company Order delivered to the Trustee, (b) Designated Senior Securities, and (c) renewals, extensions, modifications and refinancings of any such indebtedness.

“Designated Senior Security” or “Designated Senior Securities” means any Security or Securities designated pursuant to Section 301 as a Designated Senior Security.

“Dollar” or “ $” means a dollar or other equivalent unit in such coin or currency of the United States of America as at the time shall be legal tender for the payment of public and private debts.

“DTC” means The Depository Trust Company.

“Euro” means the euro or other equivalent unit in such official coin or currency of the European Union.

“Election Date” has the meaning specified in Section 312(h).

“Event of Default” has the meaning specified in Article Five.

“Exchange Rate Agent”, with respect to Securities of or within any series, means, unless otherwise specified with respect to any Securities pursuant to Section 301, a bank that is a member of the New York Clearing House Association, designated pursuant to Section 301 or Section 313.

“Exchange Rate Officer’s Certificate” means a certificate setting forth (i) the applicable Market Exchange Rate or the applicable bid quotation and (ii) the Dollar or Foreign Currency amounts of principal (and premium, if any) and interest, if any (on an aggregate basis and on the basis of a Security having the lowest denomination principal amount determined in accordance with Section 302 in the relevant Currency), payable with respect to a Security of any series on the basis of such Market Exchange Rate or the applicable bid quotation signed by the Chief Financial Officer or any Vice President of the Company.

“Foreign Currency” means any Currency, including, without limitation, the Euro issued by the government of one or more countries other than the United States of America or by any recognized confederation or association of such governments.

“Government Obligations” means securities which are (i) direct obligations of the United States of America or the government which issued the Foreign Currency in which the Securities of a particular series are payable, for the payment of which its full faith and credit is pledged or (ii) obligations of a Person controlled or supervised by and acting as an agency or instrumentality of the United States of America or such government which issued the Foreign Currency in which the Securities of such series are payable, the timely payment of which is unconditionally guaranteed as a full faith and credit obligation by the United States of America or such other government, which, in either case, are not callable or redeemable at the option of the issuer thereof, and shall also include a depository receipt issued by a bank or trust company as custodian with respect to any such Government Obligation or a specific payment of interest on or

 

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principal of any such Government Obligation held by such custodian for the account of the holder of a depository receipt; provided that (except as required by law) such custodian is not authorized to make any deduction from the amount payable to the holder of such depository receipt from any amount received by the custodian in respect of the Government Obligation or the specific payment of interest on or principal of the Government Obligation evidenced by such depository receipt.

“Holder” means the Person in whose name a Security is registered in the Security Register.

“Indenture” means this instrument as originally executed or as it may from time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof, and shall include the terms of particular series of Securities established as contemplated by Section 301; provided, however, that, if at any time more than one Person is acting as Trustee under this instrument, “Indenture” shall mean, with respect to any one or more series of Securities for which such Person is Trustee, this instrument as originally executed or as it may from time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof and shall include the terms of the or those particular series of Securities for which such Person is Trustee established as contemplated by Section 301, exclusive, however, of any provisions or terms which relate solely to other series of Securities for which such Person is not Trustee, regardless of when such terms or provisions were adopted, and exclusive of any provisions or terms adopted by means of one or more indentures supplemental hereto executed and delivered after such Person had become such Trustee but to which such Person, as such Trustee, was not a party.

“Indexed Security” means a Security as to which all or certain interest payments and/or the principal amount payable at Maturity are determined by reference to prices, changes in prices, or differences between prices, of securities, Currencies, intangibles, goods, articles or commodities or by such other objective price, economic or other measures as are specified in or pursuant to Section 301 hereof.

“Interest”, when used with respect to an Original Issue Discount Security which by its terms bears interest only after Maturity, means interest payable after Maturity, and, when used with respect to a Security which provides for the payment of Additional Amounts pursuant to Section 1004, includes such Additional Amounts.

“Interest Payment Date”, when used with respect to any Security, means the Stated Maturity of an installment of interest on such Security.

“Market Exchange Rate” means, unless otherwise specified with respect to any Securities pursuant to Section 301, (i) for any conversion involving a currency unit on the one hand and Dollars or any Foreign Currency on the other, the exchange rate between the relevant currency unit and Dollars or such Foreign Currency calculated by the method specified pursuant to Section 301 for the Securities of the relevant series, (ii) for any conversion of Dollars into any Foreign Currency, the noon buying rate for such Foreign Currency for cable transfers quoted in New York City as certified for customs purposes by the Federal Reserve Bank of New York and

 

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(iii) for any conversion of one Foreign Currency into Dollars or another Foreign Currency, the spot rate at noon local time in the relevant market at which, in accordance with normal banking procedures, the Dollars or Foreign Currency into which conversion is being made could be purchased with the Foreign Currency from which conversion is being made from major banks located in either New York City, London or any other principal market for Dollars or such purchased Foreign Currency, in each case determined by the Exchange Rate Agent. Unless otherwise specified with respect to any Securities pursuant to Section 301, in the event of the unavailability of any of the exchange rates provided for in the foregoing clauses (i), (ii) and (iii), the Exchange Rate Agent shall use, in its sole discretion and without liability on its part, such quotation of the Federal Reserve Bank of New York as of the most recent available date, or quotations from one or more major banks in New York City, London or other principal market for such currency or currency unit in question, or such other quotations as the Exchange Rate Agent shall deem appropriate. Unless otherwise specified by the Exchange Rate Agent, if there is more than one market for dealing in any currency or currency unit by reason of foreign exchange regulations or otherwise, the market to be used in respect of such currency or currency unit shall be that upon which a nonresident issuer of securities designated in such currency or currency unit would purchase such currency or currency unit in order to make payments in respect of such securities.

“Maturity”, when used with respect to any Security, means the date on which the principal of such Security or an installment of principal becomes due and payable as therein or herein provided, whether at the Stated Maturity or by declaration of acceleration, notice of redemption, notice of option to elect repayment, notice of exchange or conversion or otherwise.

“Notice of Default” has the meaning provided in Section 501.

“Officers’ Certificate” means a certificate signed by the Chief Executive Officer, President or a Vice President of the Company, and by the Chief Financial Officer, Chief Operating Officer, Secretary or an Assistant Secretary of the Company, and delivered to the Trustee.

“Opinion of Counsel” means a written opinion of counsel, who may be counsel for the Company or who may be an employee of or other counsel for the Company and who shall be reasonably satisfactory to the Trustee.

“Original Issue Discount Security” means any Security which provides for an amount less than the principal amount thereof to be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 502.

“Outstanding”, when used with respect to Securities or any series of Securities, means, as of the date of determination, all Securities or all Securities of such series, as the case may be, theretofore authenticated and delivered under this Indenture, except:

(i) Securities theretofore cancelled by the Trustee or delivered to the Trustee for cancellation;

(ii) Securities, or portions thereof, for whose payment or redemption or repayment at the option of the Holder money in the necessary amount has been

 

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theretofore deposited with the Trustee or any Paying Agent (other than the Company) in trust or set aside and segregated in trust by the Company (if the Company shall act as its own Paying Agent) for the Holders of such Securities, provided that, if such Securities are to be redeemed, notice of such redemption has been duly given pursuant to this Indenture or provision therefor satisfactory to the Trustee has been made;

(iii) Securities, except to the extent provided in Sections 1402 and 1403, with respect to which the Company has effected defeasance and/or covenant defeasance as provided in Article Fourteen;

(iv) Securities that have been changed into any other securities of the Company or any other Person in accordance with this Indenture if the terms of such Securities provide for convertibility or exchangeability pursuant to Section 301; and

(v) Securities which have been paid pursuant to Section 306 or in exchange for or in lieu of which other Securities have been authenticated and delivered pursuant to this Indenture, other than any such Securities in respect of which there shall have been presented to the Trustee proof satisfactory to it that such Securities are held by a protected purchaser in whose hands such Securities are valid obligations of the Company;

provided, however, that in determining whether the Holders of the requisite principal amount of the Outstanding Securities have given any request, demand, authorization, direction, notice, consent or waiver hereunder or are present at a meeting of Holders for quorum purposes, and for the purpose of making the calculations required by TIA Section 313, (i) the principal amount of an Original Issue Discount Security that may be counted in making such determination or calculation and that shall be deemed to be Outstanding for such purpose shall be equal to the amount of principal thereof that would be (or shall have been declared to be) due and payable, at the time of such determination, upon a declaration of acceleration of the Maturity thereof pursuant to Section 502, (ii) the principal amount of any Security denominated in a Foreign Currency that may be counted in making such determination or calculation and that shall be deemed Outstanding for such purpose shall be equal to the Dollar equivalent, determined as of the date such Security is originally issued by the Company as set forth in an Exchange Rate Officer’s Certificate delivered to the Trustee, of the principal amount (or, in the case of an Original Issue Discount Security or Indexed Security, the Dollar equivalent as of such date of original issuance of the amount determined as provided in clause (i) above or (iii) below, respectively) of such Security, (iii) the principal amount of any Indexed Security that may be counted in making such determination or calculation and that shall be deemed outstanding for such purpose shall be equal to the principal face amount of such Indexed Security at original issuance, unless otherwise provided with respect to such Security pursuant to Section 301, and (iv) Securities owned by the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in making such calculation or in relying upon any such request, demand, authorization, direction, notice, consent or waiver or upon any such determination as to the presence of a quorum, only Securities which a Responsible Officer of the Trustee actually knows to be so owned shall be so disregarded. Securities so owned which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Trustee the pledgee’s right so to act with respect to such Securities and that the pledgee is not the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor.

 

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“Paying Agent” means any Person authorized by the Company to pay the principal of (or premium, if any) or interest, if any, on any Securities on behalf of the Company.

“Person” means any individual, corporation, partnership, joint venture, association, joint-stock company, limited liability company, trust, unincorporated organization or government or any agency or political subdivision thereof, or any other entity.

“Place of Payment”, when used with respect to the Securities of or within any series, means the place or places where the principal of (and premium, if any) and interest, if any, on such Securities are payable as specified and as contemplated by Sections 301 and 1002.

“Predecessor Security” of any particular Security means every previous Security evidencing all or a portion of the same debt as that evidenced by such particular Security; and, for the purposes of this definition, any Security authenticated and delivered under Section 306 in exchange for or in lieu of a mutilated, destroyed, lost or stolen Security shall be deemed to evidence the same debt as the mutilated, destroyed, lost or stolen Security.

“Redemption Date”, when used with respect to any Security to be redeemed, in whole or in part, means the date fixed for such redemption by or pursuant to this Indenture.

“Redemption Price”, when used with respect to any Security to be redeemed, means the price at which it is to be redeemed pursuant to this Indenture.

“Registered Security” means any Security which is registered in the Security Register.

“Regular Record Date” for the interest payable on any Interest Payment Date on the Registered Securities of or within any series means the date specified for that purpose as contemplated by Section 301, whether or not a Business Day.

“Repayment Date” means, when used with respect to any Security to be repaid at the option of the Holder, means the date fixed for such repayment by or pursuant to this Indenture.

“Repayment Price” means, when used with respect to any Security to be repaid at the option of the Holder, means the price at which it is to be repaid by or pursuant to this Indenture.

“Responsible Officer”, when used with respect to the Trustee, means any officer of the Trustee assigned by the Trustee to administer its corporate trust matters and who shall have direct responsibility for the administration of this Indenture.

“Security” or “Securities” has the meaning stated in the first recital of this Indenture and, more particularly, means any Security or Securities authenticated and delivered under this Indenture; provided, however, that, if at any time there is more than one Person acting as Trustee under this Indenture, “Securities” with respect to the Indenture as to which such Person is Trustee shall have the meaning stated in the first recital of this Indenture and shall more particularly mean Securities authenticated and delivered under this Indenture, exclusive, however, of Securities of any series as to which such Person is not Trustee.

 

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“Security Register” and “Security Registrar” have the respective meanings specified in Section 305.

“Senior Indebtedness” means the principal of (and premium, if any) and unpaid interest on (a) indebtedness of the Company (including indebtedness of others guaranteed by the Company) that does not constitute Designated Senior Indebtedness or Subordinated Indebtedness, whether outstanding on the date hereof or thereafter created, incurred, assumed or guaranteed, for money borrowed, (b) Securities that are not designated as Designated Senior Securities or Subordinated Securities, and (c) renewals, extensions, modifications and refinancings of any such indebtedness.

“Special Record Date” for the payment of any Defaulted Interest on the Registered Securities of or within any series means a date fixed by the Trustee pursuant to Section 307.

“Stated Maturity”, when used with respect to any Security or any installment of principal thereof or interest thereon, means the date specified in such Security as the fixed date on which the principal of such Security or such installment of principal or interest is due and payable, as such date may be extended pursuant to the provisions of Section 308.

“Subordinated Indebtedness” means the principal of (and premium, if any) and unpaid interest on (a) indebtedness of the Company (including indebtedness of others guaranteed by the Company), whether outstanding on the date hereof or thereafter created, incurred, assumed or guaranteed, for money borrowed, which in the instrument creating or evidencing the same or pursuant to which the same is outstanding it is provided that such indebtedness ranks junior in right of payment to the Company’s Designated Senior Indebtedness, equally and pari passu in right of payment with all other Subordinated Indebtedness, (b) Subordinated Securities, and (c) renewals, extensions, modifications and refinancings of any such indebtedness.

“Subordinated Security” or “Subordinated Securities” means any Security or Securities designated pursuant to Section 301 as a Subordinated Security.

“Subsidiary” means (1) any corporation a majority of the outstanding voting stock of which is owned, directly or indirectly, by the Company or by one or more other Subsidiaries of the Company, (2) any other Person (other than a corporation) in which such Person, one or more Subsidiaries of such Person, or such Person and one or more Subsidiaries of such Person, directly or indirectly, at the date of determination thereof has a majority ownership interest, or (3) a partnership in which such Person or a Subsidiary of such Person is, at the time, a general partner and in which such Person, directly or indirectly, at the date of determination thereof has a majority ownership interest. For the purposes of this definition, “voting stock” means stock having voting power for the election of directors, whether at all times or only so long as no senior class of stock has such voting power by reason of any contingency.

“Trust Indenture Act” or “TIA” means the Trust Indenture Act of 1939, as amended, as in force at the date as of which this Indenture was executed, except as provided in Section 905.

 

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“Trustee” means the Person named as the “Trustee” in the first paragraph of this Indenture until a successor Trustee shall have become such pursuant to the applicable provisions of this Indenture, and thereafter “Trustee” shall mean or include each Person who is then a Trustee hereunder; provided, however, that if at any time there is more than one such Person, “Trustee” as used with respect to the Securities of any series shall mean only the Trustee with respect to Securities of that series.

“United States” means, unless otherwise specified with respect to any Securities pursuant to Section 301, the United States of America (including the states and the District of Columbia), its territories, its possessions and other areas subject to its jurisdiction.

“United States person” means, unless otherwise specified with respect to any Securities pursuant to Section 301, any individual who is a citizen or resident of the United States, a corporation, partnership or other entity created or organized in or under the laws of the United States, any state thereof or the District of Columbia (other than a partnership that is not treated as a United States person under any applicable Treasury regulations), any estate the income of which is subject to United States federal income taxation regardless of its source, or any trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust. Notwithstanding the preceding sentence, to the extent provided in the Treasury regulations, certain trusts in existence on August 20, 1996, and treated as United States persons prior to such date that elect to continue to be treated as United States persons, will also be United States persons.

“Valuation Date” has the meaning specified in Section 312(c).

“Yield to Maturity” means the yield to maturity, computed at the time of issuance of a Security (or, if applicable, at the most recent redetermination of interest on such Security) and as set forth in such Security in accordance with generally accepted United States bond yield computation principles.

 

SECTION 102.		Compliance Certificates and Opinions.

Upon any application or request by the Company to the Trustee to take any action under any provision of this Indenture, the Company shall furnish to the Trustee an Officers’ Certificate stating that all conditions precedent, if any, provided for in this Indenture relating to the proposed action have been complied with and an Opinion of Counsel stating that in the opinion of such counsel all such conditions precedent, if any, have been complied with, except that in the case of any such application or request as to which the furnishing of such documents is specifically required by any provision of this Indenture relating to such particular application or request, no additional certificate or opinion need be furnished.

Every certificate or opinion with respect to compliance with a condition or covenant provided for in this Indenture (other than pursuant to Section 1005) shall include:

(1) a statement that each individual signing such certificate or opinion has read such condition or covenant and the definitions herein relating thereto;

 

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(2) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such certificate or opinion are based;

(3) a statement that, in the opinion of each such individual, he or she has made such examination or investigation as is necessary to enable such individual to express an informed opinion as to whether or not such condition or covenant has been complied with; and

(4) a statement as to whether, in the opinion of each such individual, such condition or covenant has been complied with.

 

SECTION 103.		Form of Documents Delivered to Trustee.

In any case where several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion as to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents.

Any certificate or opinion of an officer of the Company may be based, insofar as it relates to legal matters, upon an Opinion of Counsel, or a certificate or representations by counsel, unless such officer knows, or in the exercise of reasonable care should know, that the opinion, certificate or representations with respect to the matters upon which his certificate or opinion is based are erroneous. Any such Opinion of Counsel or certificate or representations may be based, insofar as it relates to factual matters, upon a certificate or opinion of, or representations by, an officer or officers of the Company stating that the information as to such factual matters is in the possession of the Company, unless such counsel knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations as to such matters are erroneous.

Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument.

 

SECTION 104.		Acts of Holders.

(a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be given or taken by Holders of the Outstanding Securities of all series or one or more series, as the case may be, may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by agents duly appointed in writing. Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be given or taken by Holders of Securities of such series may, alternatively, be embodied in and evidenced by the record of Holders of Securities of such series voting in favor thereof, either in person or by proxies duly appointed in writing, at any meeting of Holders of Securities of such series duly called and held in accordance with the provisions of Article Fifteen, or a combination of such instruments and any such record. Except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments or record or both are delivered to the Trustee and, where it is hereby expressly

 

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required, to the Company. Such instrument or instruments and any such record (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the “Act” of the Holders signing such instrument or instruments or so voting at any such meeting. Proof of execution of any such instrument or of a writing appointing any such agent, or of the holding by any Person of a Security, shall be sufficient for any purpose of this Indenture and conclusive in favor of the Trustee and the Company and any agent of the Trustee or the Company, if made in the manner provided in this Section. The record of any meeting of Holders of Securities shall be proved in the manner provided in Section 1506.

(b) The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him or her the execution thereof. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. The fact and date of the execution of any such instrument or writing or the authority of the Person executing the same may also be proved in any other reasonable manner in which the Trustee deems sufficient.

(c) The ownership of Registered Securities shall be proved by the Security Register.

(d) If the Company shall solicit from the Holders of Registered Securities any request, demand, authorization, direction, notice, consent, waiver or other Act, the Company may, at its option, in or pursuant to a Board Resolution, fix in advance a record date for the determination of Holders entitled to give such request, demand, authorization, direction, notice, consent, waiver or other Act, but the Company shall have no obligation to do so. Such record date shall be the record date specified in or pursuant to such Board Resolution, which shall be a date not earlier than the date 30 days prior to the first solicitation of Holders generally in connection therewith and not later than the date such solicitation is completed. If such a record date is fixed, such request, demand, authorization, direction, notice, consent, waiver or other Act may be given before or after such record date, but only the Holders of record at the close of business on such record date shall be deemed to be Holders for the purposes of determining whether Holders of the requisite proportion of Outstanding Securities have authorized or agreed or consented to such request, demand, authorization, direction, notice, consent, waiver or other Act, and for that purpose the Outstanding Securities shall be computed as of such record date; provided that no such authorization, agreement or consent by the Holders on such record date shall be deemed effective unless it shall become effective pursuant to the provisions of this Indenture not later than eleven months after the record date.

(e) Any request, demand, authorization, direction, notice, consent, waiver or other Act of the Holder of any Security shall bind every future Holder of the same Security and the Holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee, any Security Registrar, any Paying Agent, any Authenticating Agent or the Company in reliance thereon, whether or not notation of such action is made upon such Security.

 

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SECTION 105.		Notices, Etc., to Trustee and Company.

Any request, demand, authorization, direction, notice, consent, waiver or Act of Holders or other document provided or permitted by this Indenture to be made upon, given or furnished to, or filed with,

(1) the Trustee by any Holder or by the Company shall be sufficient for every purpose hereunder if made, given, furnished, filed or mailed, first-class postage prepaid in writing to or with the Trustee at its Corporate Trust Office, Attention: Corporates Team Deal – Manager Fifth Street Finance Corp., or

(2) the Company by the Trustee or by any Holder shall be sufficient for every purpose hereunder (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, to the Company addressed to it at the address of its principal office specified in the first paragraph of this Indenture, to the attention of its Secretary or at any other address previously furnished in writing to the Trustee by the Company.

 

SECTION 106.		Notice to Holders; Waiver.

Where this Indenture provides for notice of any event to Holders of Registered Securities by the Company or the Trustee, such notice shall be sufficiently given (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, to each such Holder affected by such event, at his address as it appears in the Security Register, not later than the latest date, and not earlier than the earliest date, prescribed for the giving of such notice. In any case where notice to Holders of Registered Securities is given by mail, neither the failure to mail such notice, nor any defect in any notice so mailed, to any particular Holder shall affect the sufficiency of such notice with respect to other Holders of Registered Securities. Any notice mailed to a Holder in the manner herein prescribed shall be conclusively deemed to have been received by such Holder, whether or not such Holder actually receives such notice.

If by reason of the suspension of or irregularities in regular mail service or by reason of any other cause it shall be impracticable to give such notice by mail, then such notification to Holders of Registered Securities as shall be made with the approval of the Trustee shall constitute a sufficient notification to such Holders for every purpose hereunder.

Any request, demand, authorization, direction, notice, consent or waiver required or permitted under this Indenture shall be in the English language, except that any published notice may be in an official language of the country of publication.

Where this Indenture provides for notice in any manner, such notice may be waived in writing by the Person entitled to receive such notice, either before or after the event, and such waiver shall be the equivalent of such notice. Waivers of notice by Holders shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver.

 

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SECTION 107.		Conflict with TIA.

If any provision of this Indenture limits, qualifies or conflicts with a provision of the TIA that is required under the TIA to be a part of and govern this Indenture, the provision of the TIA shall control. If any provision of this Indenture modifies or excludes any provision of the TIA that may be so modified or excluded, the provision of the TIA shall be deemed to apply to this Indenture as so modified or only to the extent not so excluded, as the case may be.

 

SECTION 108.		Effect of Headings and Table of Contents.

The Article and Section headings herein and the Table of Contents are for convenience only and shall not affect the construction hereof.

 

SECTION 109.		Successors and Assigns.

All covenants and agreements in this Indenture by the Company shall bind its successors and assigns, whether so expressed or not.

 

SECTION 110.		Separability Clause.

In case any provision in this Indenture or in any Security shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby.

 

SECTION 111.		Benefits of Indenture.

Nothing in this Indenture or in the Securities, express or implied, shall give to any Person, other than the parties hereto, any Security Registrar, any Paying Agent, any Authenticating Agent and their successors hereunder and the Holders any benefit or any legal or equitable right, remedy or claim under this Indenture.

 

SECTION 112.		Governing Law.

This Indenture and the Securities shall be governed by and construed in accordance with the law of the State of New York without regard to principles of conflicts of laws. This Indenture is subject to the provisions of the Trust Indenture Act that are required to be part of this Indenture and shall, to the extent applicable, be governed by such provisions.

 

SECTION 113.		Legal Holidays.

In any case where any Interest Payment Date, Redemption Date, Repayment Date, sinking fund payment date, Stated Maturity or Maturity of any Security shall not be a Business Day at any Place of Payment, then (notwithstanding any other provision of this Indenture or any Security other than a provision in the Securities of any series which specifically states that such provision shall apply in lieu of this Section), payment of principal (or premium, if any) or interest, if any, need not be made at such Place of Payment on such date, but may be made on the next succeeding Business Day at such Place of Payment with the same force and effect as if made on the Interest Payment Date, Redemption Date, Repayment Date or sinking fund payment

 

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date, or at the Stated Maturity or Maturity; provided that no interest shall accrue on the amount so payable for the period from and after such Interest Payment Date, Redemption Date, Repayment Date, sinking fund payment date, Stated Maturity or Maturity, as the case may be.

 

SECTION 114.		Submission to Jurisdiction.

The Company hereby irrevocably submits to the non-exclusive jurisdiction of any New York state or federal court sitting in The City of New York in any action or proceeding arising out of or relating to the Indenture and the Securities of any series, and the Company hereby irrevocably agrees that all claims in respect of such action or proceeding may be heard and determined in such New York state or federal court. The Company hereby irrevocably waives, to the fullest extent it may effectively do so, the defense of an inconvenient forum to the maintenance of such action or proceeding.

ARTICLE TWO

SECURITIES FORMS

 

SECTION 201.		Forms of Securities.

The Registered Securities of each series, the temporary global Securities of each series, if any, and the permanent global Securities of each series, if any, shall be in substantially the forms as shall be established in one or more indentures supplemental hereto or approved from time to time by or pursuant to a Board Resolution in accordance with Section 301, shall have such appropriate insertions, omissions, substitutions and other variations as are required or permitted by this Indenture or any indenture supplemental hereto, and may have such letters, numbers or other marks of identification or designation and such legends or endorsements placed thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Indenture, or as may be required to comply with any law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which the Securities may be listed, or to conform to usage.

The definitive Securities shall be printed, lithographed or engraved or produced by any combination of these methods on a steel engraved border or steel engraved borders or may be produced in any other manner, all as determined by the officers executing such Securities, as evidenced by their execution of such Securities.

 

SECTION 202.		Form of Trustee’s Certificate of Authentication.

Subject to Section 611, the Trustee’s certificate of authentication shall be in substantially the following form:

This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture.

 

 

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SECTION 203.		Securities Issuable in Global Form.

If Securities of or within a series are issuable in global form, as specified as contemplated by Section 301, then, notwithstanding clause (8) of Section 301 and the provisions of Section 302, any such Security shall represent such of the Outstanding Securities of such series as shall be specified therein and may provide that it shall represent the aggregate amount of Outstanding Securities of such series from time to time endorsed thereon and that the aggregate amount of Outstanding Securities of such series represented thereby may from time to time be increased or decreased to reflect exchanges. Any endorsement of a Security in global form to reflect the amount, or any increase or decrease in the amount, of Outstanding Securities represented thereby shall be made by the Trustee or the Security Registrar in such manner and upon instructions given by such Person or Persons as shall be specified therein or in the Company Order to be delivered to the Trustee pursuant to Section 303 or 304. Subject to the provisions of Section 303 and, if applicable, Section 304, the Trustee or the Security Registrar shall deliver and redeliver any Security in permanent global form in the manner and upon instructions given by the Person or Persons specified therein or in the applicable Company Order. If a Company Order pursuant to Section 303 or 304 has been, or simultaneously is, delivered, any instructions by the Company with respect to endorsement, delivery or redelivery of a Security in global form shall be in writing but need not comply with Section 102 and need not be accompanied by an Opinion of Counsel.

The provisions of the last sentence of Section 303 shall apply to any Security represented by a Security in global form if such Security was never issued and sold by the Company and the Company delivers to the Trustee or the Security Registrar the Security in global form together with written instructions (which need not comply with Section 102 and need not be accompanied by an Opinion of Counsel) with regard to the reduction in the principal amount of Securities represented thereby, together with the written statement contemplated by the last sentence of Section 303.

Notwithstanding the provisions of Section 307, unless otherwise specified as contemplated by Section 301, payment of principal of (and premium, if any) and interest, if any, on any Security in permanent global form shall be made to the Person or Persons specified therein.

Notwithstanding the provisions of Section 309 and except as provided in the preceding paragraph, the Company, the Trustee and any agent of the Company and the Trustee shall treat as the Holder of such principal amount of Outstanding Securities represented by a permanent global Security, the Holder of such permanent global Security.

 

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Unless otherwise specified as contemplated by Section 301 for the Securities evidenced thereby, every global Security authenticated and delivered hereunder shall bear a legend in substantially the following form:

THIS SECURITY IS A GLOBAL SECURITY WITHIN THE MEANING OF THE INDENTURE HEREINAFTER REFERRED TO AND IS REGISTERED IN THE NAME OF A DEPOSITORY OR A NOMINEE THEREOF. THIS SECURITY MAY NOT BE EXCHANGED IN WHOLE OR IN PART FOR A SECURITY REGISTERED, AND NO TRANSFER OF THIS SECURITY IN WHOLE OR IN PART MAY BE REGISTERED, IN THE NAME OF ANY PERSON OTHER THAN SUCH DEPOSITORY OR A NOMINEE THEREOF, EXCEPT IN THE LIMITED CIRCUMSTANCES DESCRIBED IN THE INDENTURE.

ARTICLE THREE

THE SECURITIES

 

SECTION 301.		Amount Unlimited; Issuable in Series.

The aggregate principal amount of Securities which may be authenticated and delivered under this Indenture is unlimited.

The Securities may be issued in one or more series as Registered Securities and may (but do not have to) be designated as Designated Senior Securities or Subordinated Securities. Designated Senior Securities are unsubordinated, shall rank equally and pari passu with all of the Company’s other Designated Senior Indebtedness and the Company’s Senior Indebtedness and senior to all of the Company’s Subordinated Indebtedness. Subordinated Securities shall rank junior to the Company’s Designated Senior Indebtedness and equally and pari passu with all of the Company’s other Subordinated Indebtedness. There shall be established in one or more Board Resolutions or pursuant to authority granted by one or more Board Resolutions and, subject to Section 303, set forth, or determined in the manner provided, in an Officers’ Certificate, or established in one or more indentures supplemental hereto, prior to the issuance of Securities of any series, any or all of the following, as applicable (each of which (except for the matters set forth in clauses (1), (2) and (15) below), if so provided, may be determined from time to time by the Company with respect to unissued Securities of the series when issued from time to time):

(1) the title of the Securities of the series including CUSIP numbers (which shall distinguish the Securities of such series from all other series of Securities);

(2) any limit upon the aggregate principal amount of the Securities of the series that may be authenticated and delivered under this Indenture (except for Securities authenticated and delivered upon registration of transfer of, or in exchange for, or in lieu of, other Securities of the series pursuant to Section 304, 305, 306, 906, 1107 or 1305, and except for any Securities which, pursuant to Section 303, are deemed never to have been authenticated and delivered hereunder);

 

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(3) the date or dates, or the method by which such date or dates will be determined or extended, on which the principal of the Securities of the series shall be payable;

(4) the rate or rates at which the Securities of the series shall bear interest, if any, or the method by which such rate or rates shall be determined, the date or dates from which such interest shall accrue or the method by which such date or dates shall be determined, the Interest Payment Dates on which such interest will be payable and the Regular Record Date, if any, for the interest payable on any Registered Security on any Interest Payment Date, or the method by which such date shall be determined, the basis upon which such interest shall be calculated if other than that of a 360-day year of twelve 30-day months;

(5) the place or places, if any, other than or in addition to the Borough of Manhattan, The City of New York, where the principal of (and premium, if any) and interest, if any, on Securities of the series shall be payable, any Registered Securities of the series may be surrendered for registration of transfer, Securities of the series may be surrendered for exchange, where Securities of that series that are convertible or exchangeable may be surrendered for conversion or exchange, as applicable, and where notices or demands to or upon the Company in respect of the Securities of the series and this Indenture may be served;

(6) the period or periods within which, or the date or dates on which, the price or prices at which, the Currency or Currencies in which, and other terms and conditions upon which Securities of the series may be redeemed, in whole or in part, at the option of the Company, if the Company is to have the option;

(7) the obligation, if any, of the Company to redeem, repay or purchase Securities of the series pursuant to any sinking fund or analogous provision or at the option of a Holder thereof, and the period or periods within which or the date or dates on which, the price or prices at which, the Currency or Currencies in which, and other terms and conditions upon which Securities of the series shall be redeemed, repaid or purchased, in whole or in part, pursuant to such obligation;

(8) if other than denominations of $1,000 and any integral multiple thereof, the denomination or denominations in which any Registered Securities of the series shall be issuable;

(9) if other than the Trustee, the identity of each Security Registrar and/or Paying Agent;

(10) if other than the principal amount thereof, the portion of the principal amount of Securities of the series that shall be payable upon declaration of acceleration of the Maturity thereof pursuant to Section 502, upon redemption of the Securities of the series which are redeemable before their Stated Maturity, upon surrender for repayment at the option of the Holder, or which the Trustee shall be entitled to claim pursuant to Section 504 or the method by which such portion shall be determined;

(11) if other than Dollars, the Currency or Currencies in which payment of the principal of (or premium, if any) or interest, if any, on the Securities of the series shall be made or in which the Securities of the series shall be denominated and the particular provisions applicable thereto in accordance with, in addition to or in lieu of any of the provisions of Section 312;

 

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(12) whether the amount of payments of principal of (or premium, if any) or interest, if any, on the Securities of the series may be determined with reference to an index, formula or other method (which index, formula or method may be based, without limitation, on one or more Currencies, commodities, equity indices or other indices), and the manner in which such amounts shall be determined;

(13) whether the principal of (or premium, if any) or interest, if any, on the Securities of the series are to be payable, at the election of the Company or a Holder thereof, in one or more Currencies other than that in which such Securities are denominated or stated to be payable, the period or periods within which (including the Election Date), and the terms and conditions upon which, such election may be made, and the time and manner of determining the exchange rate between the Currency or Currencies in which such Securities are denominated or stated to be payable and the Currency or Currencies in which such Securities are to be paid, in each case in accordance with, in addition to or in lieu of any of the provisions of Section 312;

(14) provisions, if any, granting special rights to the Holders of Securities of the series upon the occurrence of such events as may be specified;

(15) any deletions from, modifications of or additions to the Events of Default or covenants (including any deletions from, modifications of or additions to any of the provisions of Section 1006) of the Company with respect to Securities of the series, whether or not such Events of Default or covenants are consistent with the Events of Default or covenants set forth herein;

(16) whether any Securities of the series are to be issuable initially in temporary global form and whether any Securities of the series are to be issuable in permanent global form and, if so, whether beneficial owners of interests in any such permanent global Security may exchange such interests for Securities of such series in certificated form and of like tenor of any authorized form and denomination and the circumstances under which any such exchanges may occur, if other than in the manner provided in Section 305, and the circumstances under which and the place or places where such exchanges may be made and if Securities of the series are to be issuable as a global Security, the identity of the depository for such series;

(17) the date as of which any temporary global Security representing Outstanding Securities of the series shall be dated if other than the date of original issuance of the first Security of the series to be issued;

(18) the Person to whom any interest on any Registered Security of the series shall be payable, if other than the Person in whose name such Security (or one or more Predecessor Securities) is registered at the close of business on the Regular Record Date for such interest, and the extent to which, or the manner in which, any interest payable on a temporary global Security on an Interest Payment Date will be paid; and the extent to which, or the manner in which, any interest payable on a permanent global Security on an Interest Payment Date will be paid if other than in the manner provided in Section 307;

 

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(19) the applicability, if any, of Sections 1402 and/or 1403 to the Securities of the series and any provisions in modification of, in addition to or in lieu of any of the provisions of Article Fourteen;

(20) if the Securities of such series are to be issuable in definitive form (whether upon original issue or upon exchange of a temporary Security of such series) only upon receipt of certain certificates or other documents or satisfaction of other conditions, then the form and/or terms of such certificates, documents or conditions;

(21) whether, under what circumstances and the Currency in which, the Company will pay Additional Amounts as contemplated by Section 1004 on the Securities of the series to any Holder who is not a United States person (including any modification to the definition of such term) in respect of any tax, assessment or governmental charge and, if so, whether the Company will have the option to redeem such Securities rather than pay such Additional Amounts (and the terms of any such option);

(22) the designation of the initial Exchange Rate Agent, if any;

(23) if the Securities of the series are to be issued upon the exercise of warrants, the time, manner and place for such Securities to be authenticated and delivered;

(24) if the Securities of the series are to be convertible into or exchangeable for any securities of any Person (including the Company), the terms and conditions upon which such Securities will be so convertible or exchangeable;

(25) if the Securities of the series are to be secured, the terms and conditions upon which such Securities will be so secured;

(26) the appointment of any calculation agent, foreign currency exchange agent or other additional agents; and

(27) any other terms of the series (which terms shall not be inconsistent with the provisions of this Indenture or the requirements of the Trust Indenture Act).

All Securities of any one series shall be substantially identical except as to denomination and except as may otherwise be provided in or pursuant to the Board Resolution referred to above (subject to Section 303) and set forth in the Officers’ Certificate referred to above or in any such indenture supplemental hereto. All Securities of any one series need not be issued at the same time and, unless otherwise provided, a series may be reopened, without the consent of the Holders, for issuances of additional Securities of such series.

If any of the terms of the Securities of any series are established by action taken pursuant to one or more Board Resolutions, a copy of an appropriate record of such action(s) shall be certified by the Secretary or an Assistant Secretary of the Company and delivered to the Trustee at or prior to the delivery of the Officers’ Certificate setting forth the terms of the Securities of such series.

 

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SECTION 302.		Denominations.

The Securities of each series shall be issuable in such denominations as shall be specified as contemplated by Section 301. With respect to Securities of any series denominated in Dollars, in the absence of any such provisions with respect to the Securities of any series, the Registered Securities of such series, other than Registered Securities issued in global form (which may be of any denomination) shall be issuable in denominations of $1,000 and any integral multiple thereof.

 

SECTION 303.		Execution, Authentication, Delivery and Dating.

The Securities shall be executed on behalf of the Company by its Chief Executive Officer, its President its Chief Operating Officer, its Chief Financial Officer or any of its Vice Presidents and attested by its Secretary or any of its Assistant Secretaries. The signature of any of these officers on the Securities may be manual or facsimile signatures of the present or any future such authorized officer and may be imprinted or otherwise reproduced on the Securities.

Securities bearing the manual or facsimile signatures of individuals who were at any time the proper officers of the Company shall bind the Company, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and delivery of such Securities or did not hold such offices at the date of such Securities.

At any time and from time to time after the execution and delivery of this Indenture, the Company may deliver Securities of any series executed by the Company, to the Trustee for authentication, together with a Company Order and an Officers’ Certificate and Opinion of Counsel in accordance with Section 102 for the authentication and delivery of such Securities, and the Trustee in accordance with the Company Order shall authenticate and deliver such Securities. If all the Securities of any series are not to be issued at one time and if the Board Resolution or supplemental indenture establishing such series shall so permit, such Company Order may set forth procedures acceptable to the Trustee for the issuance of such Securities and determining the terms of particular Securities of such series, such as interest rate, maturity date, date of issuance and date from which interest shall accrue. In authenticating such Securities, and accepting the additional responsibilities under this Indenture in relation to such Securities, the Trustee shall be entitled to receive, and shall be fully protected in relying upon,

(i) an Opinion of Counsel stating,

(a) that the form or forms of such Securities have been established in conformity with the provisions of this Indenture;

(b) that the terms of such Securities have been established in conformity with the provisions of this Indenture; and

(c) that such Securities, when completed by appropriate insertions and executed and delivered by the Company to the Trustee for authentication in accordance with this Indenture, authenticated and delivered by the Trustee in accordance with this Indenture and issued by the Company in the manner and subject to any conditions specified in such Opinion of Counsel, will constitute

 

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legal, valid and binding obligations of the Company, enforceable in accordance with their terms, subject to applicable bankruptcy, insolvency, reorganization and other similar laws of general applicability relating to or affecting the enforcement of creditors’ rights, to general equitable principles and to such other qualifications as such counsel shall conclude do not materially affect the rights of Holders of such Securities; and

(ii) an Officers’ Certificate stating, to the best of the knowledge of the signers of such certificate, that no Event of Default with respect to any of the Securities shall have occurred and be continuing.

Notwithstanding the provisions of Section 301 and of this Section 303, if all the Securities of any series are not to be issued at one time, it shall not be necessary to deliver an Officers’ Certificate otherwise required pursuant to Section 301 or the Company Order, Opinion of Counsel or Officers’ Certificate otherwise required pursuant to the preceding paragraph at the time of issuance of each Security of such series, but such order, opinion and certificates, with appropriate modifications to cover such future issuances, shall be delivered at or before the time of issuance of the first Security of such series.

If such form or terms have been so established, the Trustee shall not be required to authenticate such Securities if the issue of such Securities pursuant to this Indenture will affect the Trustee’s own rights, duties, obligations or immunities under the Securities and this Indenture or otherwise in a manner which is not reasonably acceptable to the Trustee. Notwithstanding the generality of the foregoing, the Trustee will not be required to authenticate Securities denominated in a Foreign Currency if the Trustee reasonably believes that it would be unable to perform its duties with respect to such Securities.

Each Registered Security shall be dated the date of its authentication.

No Security shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Security a certificate of authentication substantially in the form provided for herein duly executed by the Trustee or an Authenticating Agent by manual signature of an authorized signatory, and such certificate upon any Security shall be conclusive evidence, and the only evidence, that such Security has been duly authenticated and delivered hereunder and is entitled to the benefits of this Indenture. Notwithstanding the foregoing, if any Security shall have been authenticated and delivered hereunder but never issued and sold by the Company, and the Company shall deliver such Security to the Trustee for cancellation as provided in Section 310 together with a written statement (which need not comply with Section 102 and need not be accompanied by an Opinion of Counsel) stating that such Security has never been issued and sold by the Company, for all purposes of this Indenture such Security shall be deemed never to have been authenticated and delivered hereunder and shall never be entitled to the benefits of this Indenture.

 

SECTION 304.		Temporary Securities.

Pending the preparation of definitive Securities of any series, the Company may execute, and upon Company Order the Trustee shall authenticate and deliver, temporary Securities which

 

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are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Securities in lieu of which they are issued, in registered form and with such appropriate insertions, omissions, substitutions and other variations as the officers executing such Securities may determine, as conclusively evidenced by their execution of such Securities. In the case of Securities of any series, such temporary Securities may be in global form.

Except in the case of temporary Securities in global form (which shall be exchanged as provided in or pursuant to a Board Resolution), if temporary Securities of any series are issued, the Company will cause definitive Securities of that series to be prepared without unreasonable delay. After the preparation of definitive Securities of such series, the temporary Securities of such series shall be exchangeable for definitive Securities of such series upon surrender of the temporary Securities of such series at the office or agency of the Company in a Place of Payment for that series, without charge to the Holder. Upon surrender for cancellation of any one or more temporary Securities of any series, the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a like principal amount and like tenor of definitive Securities of the same series of authorized denominations. Until so exchanged, the temporary Securities of any series shall in all respects be entitled to the same benefits under this Indenture as definitive Securities of such series.

 

SECTION 305.		Registration, Registration of Transfer and Exchange.

The Company shall cause to be kept at the Corporate Trust Office of the Trustee or in any office or agency of the Company in a Place of Payment a register for each series of Securities (the registers maintained in such office or in any such office or agency of the Company in a Place of Payment being herein sometimes referred to collectively as the “Security Register”) in which, subject to such reasonable regulations as it may prescribe, the Company shall provide for the registration of Registered Securities and of transfers of Registered Securities. The Security Register shall be in written form or any other form capable of being converted into written form within a reasonable time. The Trustee, at its Corporate Trust Office, is hereby initially appointed “Security Registrar” for the purpose of registering Registered Securities and transfers of Registered Securities on such Security Register as herein provided, and for facilitating exchanges of temporary global Securities for permanent global Securities or definitive Securities, or both, or of permanent global Securities for definitive Securities, or both, as herein provided. In the event that the Trustee shall cease to be Security Registrar, it shall have the right to examine the Security Register at all reasonable times.

Upon surrender for registration of transfer of any Registered Security of any series at any office or agency of the Company in a Place of Payment for that series, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Registered Securities of the same series, of any authorized denominations and of a like aggregate principal amount, bearing a number not contemporaneously outstanding and containing identical terms and provisions.

At the option of the Holder, Registered Securities of any series may be exchanged for other Registered Securities of the same series, of any authorized denomination or denominations and of a like aggregate principal amount, containing identical terms and provisions, upon

 

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surrender of the Registered Securities to be exchanged at any such office or agency. Whenever any Registered Securities are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Registered Securities which the Holder making the exchange is entitled to receive.

Whenever any Securities are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Securities which the Holder making the exchange is entitled to receive.

Notwithstanding the foregoing, except as otherwise specified as contemplated by Section 301, any permanent global Security shall be exchangeable only as provided in this paragraph. If any beneficial owner of an interest in a permanent global Security is entitled to exchange such interest for Securities of such series and of like tenor and principal amount of another authorized form and denomination, as specified as contemplated by Section 301 and provided that any applicable notice provided in the permanent global Security shall have been given, then without unnecessary delay but in any event not later than the earliest date on which such interest may be so exchanged, the Company shall deliver to the Trustee definitive Securities in aggregate principal amount equal to the principal amount of such beneficial owner’s interest in such permanent global Security, executed by the Company. On or after the earliest date on which such interests may be so exchanged, such permanent global Security shall be surrendered by the depository specified as contemplated by Section 3.01 or such other depositary as shall be specified in the Company Order with respect thereto to the Trustee, as the Company’s agent for such purpose, or to the Security Registrar, to be exchanged, in whole or from time to time in part, for definitive Securities of the same series without charge and the Trustee shall authenticate and deliver, in exchange for each portion of such permanent global Security, an equal aggregate principal amount of definitive Securities of the same series of authorized denominations and of like tenor as the portion of such permanent global Security to be exchanged; provided, however, that no such exchanges may occur during a period beginning at the opening of business 15 days before any selection of Securities to be redeemed and ending on the relevant Redemption Date if the Security for which exchange is requested may be among those selected for redemption. If a Registered Security is issued in exchange for any portion of a permanent global Security after the close of business at the office or agency where such exchange occurs on (i) any Regular Record Date and before the opening of business at such office or agency on the relevant Interest Payment Date, or (ii) any Special Record Date and before the opening of business at such office or agency on the related proposed date for payment of Defaulted Interest or interest, as the case may be, will not be payable on such Interest Payment Date or proposed date for payment, as the case may be, in respect of such Registered Security, but will be payable on such Interest Payment Date or proposed date for payment, as the case may be, only to the Person to whom interest in respect of such portion of such permanent global Security is payable in accordance with the provisions of this Indenture.

All Securities issued upon any registration of transfer or exchange of Securities shall be valid obligations of the Company, evidencing the same debt and entitled to the same benefits under this Indenture, as the Securities surrendered upon such registration of transfer or exchange.

 

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Every Registered Security presented or surrendered for registration of transfer or for exchange shall (if so required by the Company or the Security Registrar or any transfer agent) be duly endorsed, or be accompanied by a written instrument of transfer in form satisfactory to the Company and the Security Registrar, duly executed by the Holder thereof or his attorney or any transfer agent duly authorized in writing.

No service charge shall be made for any registration of transfer or exchange of Securities, but the Company or the Trustee may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Securities, other than exchanges pursuant to Section 304, 906, 1107 or 1305 not involving any transfer.

The Company shall not be required (i) to issue, register the transfer of or exchange any Security if such Security may be among those selected for redemption during a period beginning at the opening of business 15 days before selection of the Securities to be redeemed under Section 1103 and ending at the close of business on the day of the mailing of the relevant notice of redemption, or (ii) to register the transfer of or exchange any Registered Security so selected for redemption in whole or in part, except, in the case of any Registered Security to be redeemed in part, the portion thereof not to be redeemed or (iii) to issue, register the transfer of or exchange any Security which has been surrendered for repayment at the option of the Holder, except the portion, if any, of such Security not to be so repaid.

 

SECTION 306.		Mutilated, Destroyed, Lost and Stolen Securities.

If any mutilated Security is surrendered to the Trustee or the Company, together with, in proper cases, such security or indemnity as may be required by the Company or the Trustee to save each of them or any agent of either of them harmless, the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a new Security of the same series and principal amount, containing identical terms and provisions and bearing a number not contemporaneously outstanding.

If there shall be delivered to the Company and to the Trustee (i) evidence to their satisfaction of the destruction, loss or theft of any Security, and (ii) such security or indemnity as may be required by them to save each of them and any agent of either of them harmless, then, in the absence of notice to the Company or the Trustee that such Security has been acquired by a protected purchaser, the Company shall, subject to the following paragraph, execute and upon its request the Trustee shall authenticate and deliver, in lieu of any such destroyed, lost or stolen Security, a new Security of the same series and principal amount, containing identical terms and provisions and bearing a number not contemporaneously outstanding.

Notwithstanding the provisions of the previous two paragraphs, in case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, the Company in its discretion may, instead of issuing a new Security, pay such Security.

Upon the issuance of any new Security under this Section, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses (including the fees and expenses of the Trustee) connected therewith.

 

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Every new Security of any series issued pursuant to this Section in lieu of any destroyed, lost or stolen Security shall constitute an original additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Security shall be at any time enforceable by anyone, and shall be entitled to all the benefits of this Indenture equally and proportionately with any and all other Securities of that series duly issued hereunder.

The provisions of this Section are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities.

 

SECTION 307.		Payment of Interest; Interest Rights Preserved; Optional Interest Reset.

(a) Except as otherwise specified with respect to a series of Securities in accordance with the provisions of Section 301, interest, if any, on any Registered Security that is payable, and is punctually paid or duly provided for, on any Interest Payment Date shall be paid to the Person in whose name that Security (or one or more Predecessor Securities) is registered at the close of business on the Regular Record Date for such interest at the office or agency of the Company maintained for such purpose pursuant to Section 1002; provided, however, that each installment of interest, if any, on any Registered Security may at the Company’s option be paid by (i) mailing a check for such interest, payable to or upon the written order of the Person entitled thereto pursuant to Section 309, to the address of such Person as it appears on the Security Register or (ii) transfer to an account maintained by the payee located in the United States.

Except as otherwise specified with respect to a series of Securities in accordance with the provisions of Section 301, any interest on any Registered Security of any series that is payable, but is not punctually paid or duly provided for, on any Interest Payment Date (herein called “Defaulted Interest”) shall forthwith cease to be payable to the registered Holder thereof on the relevant Regular Record Date by virtue of having been such Holder, and such Defaulted Interest may be paid by the Company, at its election in each case, as provided in clause (1) or (2) below:

(1) The Company may elect to make payment of any Defaulted Interest to the Persons in whose names the Registered Securities of such series (or their respective Predecessor Securities) are registered at the close of business on a Special Record Date for the payment of such Defaulted Interest, which shall be fixed in the following manner. The Company shall notify the Trustee in writing of the amount of Defaulted Interest proposed to be paid on each Registered Security of such series and the date of the proposed payment (which shall not be less than 20 days after such notice is received by the Trustee), and at the same time the Company shall deposit with the Trustee an amount of money in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)) equal to the aggregate amount proposed to be paid in respect of such Defaulted Interest or shall make arrangements satisfactory to the Trustee for such deposit on or prior to the date of the proposed payment, such money when deposited to be held in trust for the benefit of the Persons entitled to such Defaulted Interest as in this clause provided. Thereupon the Trustee shall fix a Special Record Date for the payment of such Defaulted Interest which shall be not more than 15 days

 

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and not less than 10 days prior to the date of the proposed payment and not less than 10 days after the receipt by the Trustee of the notice of the proposed payment. The Trustee shall promptly notify the Company of such Special Record Date and, in the name and at the expense of the Company, shall cause notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor to be mailed, first-class postage prepaid, to each Holder of Registered Securities of such series at his address as it appears in the Security Register not less than 10 days prior to such Special Record Date. Notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor having been mailed as aforesaid, such Defaulted Interest shall be paid to the Persons in whose names the Registered Securities of such series (or their respective Predecessor Securities) are registered at the close of business on such Special Record Date and shall no longer be payable pursuant to the following clause (2).

(2) The Company may make payment of any Defaulted Interest on the Registered Securities of any series in any other lawful manner not inconsistent with the requirements of any securities exchange on which such Securities may be listed, and upon such notice as may be required by such exchange, if, after notice given by the Company to the Trustee of the proposed payment pursuant to this clause, such manner of payment shall be deemed practicable by the Trustee.

(b) The provisions of this Section 307(b) may be made applicable to any series of Securities pursuant to Section 301 (with such modifications, additions or substitutions as may be specified pursuant to such Section 301). The interest rate (or the spread or spread multiplier used to calculate such interest rate, if applicable) on any Security of such series may be reset by the Company on the date or dates specified on the face of such Security (each an “Optional Reset Date”). The Company may exercise such option with respect to such Security by notifying the Trustee of such exercise at least 45 but not more than 60 days prior to an Optional Reset Date for such Security. Not later than 40 days prior to each Optional Reset Date, the Trustee shall transmit, in the manner provided for in Section 106, to the Holder of any such Security a notice (the “Reset Notice”) indicating whether the Company has elected to reset the interest rate (or the spread or spread multiplier used to calculate such interest rate, if applicable), and if so (i) such new interest rate (or such new spread or spread multiplier, if applicable) and (ii) the provisions, if any, for redemption during the period from such Optional Reset Date to the next Optional Reset Date or if there is no such next Optional Reset Date, to the Stated Maturity of such Security (each such period a “Subsequent Interest Period”), including the date or dates on which or the period or periods during which and the price or prices at which such redemption may occur during the Subsequent Interest Period.

Notwithstanding the foregoing, not later than 20 days prior to the Optional Reset Date, the Company may, at its option, revoke the interest rate (or the spread or spread multiplier used to calculate such interest rate, if applicable) provided for in the Reset Notice and establish a higher interest rate (or a spread or spread multiplier providing for a higher interest rate, if applicable) for the Subsequent Interest Period by causing the Trustee to transmit, in the manner provided for in Section 106, notice of such higher interest rate (or such higher spread or spread multiplier providing for a higher interest rate, if applicable) to the Holder of such Security. Such notice shall be irrevocable. All Securities with respect to which the interest rate (or the spread or spread multiplier used to calculate such interest rate, if applicable) is reset on an Optional Reset Date, and with respect to which the Holders of such Securities have not tendered such Securities

 

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for repayment (or have validly revoked any such tender) pursuant to the next succeeding paragraph, will bear such higher interest rate (or such higher spread or spread multiplier providing for a higher interest rate, if applicable).

The Holder of any such Security will have the option to elect repayment by the Company of the principal of such Security on each Optional Reset Date at a price equal to the principal amount thereof plus interest accrued to such Optional Reset Date. In order to obtain repayment on an Optional Reset Date, the Holder must follow the procedures set forth in Article Thirteen for repayment at the option of Holders except that the period for delivery or notification to the Trustee shall be at least 25 but not more than 35 days prior to such Optional Reset Date and except that, if the Holder has tendered any Security for repayment pursuant to the Reset Notice, the Holder may, by written notice to the Trustee, revoke such tender or repayment until the close of business on the tenth day before such Optional Reset Date.

Subject to the foregoing provisions of this Section and Section 305, each Security delivered under this Indenture upon registration of transfer of or in exchange for or in lieu of any other Security shall carry the rights to interest accrued and unpaid, and to accrue, which were carried by such other Security.

 

SECTION 308.		Optional Extension of Maturity.

The provisions of this Section 308 may be made applicable to any series of Securities pursuant to Section 301 (with such modifications, additions or substitutions as may be specified pursuant to such Section 301). The Stated Maturity of any Security of such series may be extended at the option of the Company for the period or periods specified on the face of such Security (each an “Extension Period”) up to but not beyond the date (the “Final Maturity”) set forth on the face of such Security. The Company may exercise such option with respect to any Security by notifying the Trustee of such exercise at least 45 but not more than 60 days prior to the Stated Maturity of such Security in effect prior to the exercise of such option (the “Original Stated Maturity”). If the Company exercises such option, the Trustee shall transmit, in the manner provided for in Section 106, to the Holder of such Security not later than 40 days prior to the Original Stated Maturity a notice (the “Extension Notice”), prepared by the Company, indicating (i) the election of the Company to extend the Stated Maturity, (ii) the new Stated Maturity, (iii) the interest rate (or spread, spread multiplier or other formula to calculate such interest rate, if applicable), if any, applicable to the Extension Period and (iv) the provisions, if any, for redemption during such Extension Period. Upon the Trustee’s transmittal of the Extension Notice, the Stated Maturity of such Security shall be extended automatically and, except as modified by the Extension Notice and as described in the next paragraph, such Security will have the same terms as prior to the transmittal of such Extension Notice.

Notwithstanding the foregoing, not later than 20 days before the Original Stated Maturity of such Security, the Company may, at its option, revoke the interest rate (or spread, spread multiplier or other formula to calculate such interest rate, if applicable) provided for in the Extension Notice and establish a higher interest rate (or spread, spread multiplier or other formula to calculate such higher interest rate, if applicable) for the Extension Period by causing the Trustee to transmit, in the manner provided for in Section 106, notice of such higher interest rate (or spread, spread multiplier or other formula to calculate such interest rate, if applicable) to the Holder of such Security. Such notice shall be irrevocable. All Securities with respect to which the Stated Maturity is extended will bear such higher interest rate.

 

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If the Company extends the Stated Maturity of any Security, the Holder will have the option to elect repayment of such Security by the Company on the Original Stated Maturity at a price equal to the principal amount thereof, plus interest accrued to such date. In order to obtain repayment on the Original Stated Maturity once the Company has extended the Stated Maturity thereof, the Holder must follow the procedures set forth in Article Thirteen for repayment at the option of Holders, except that the period for delivery or notification to the Trustee shall be at least 25 but not more than 35 days prior to the Original Stated Maturity and except that, if the Holder has tendered any Security for repayment pursuant to an Extension Notice, the Holder may by written notice to the Trustee revoke such tender for repayment until the close of business on the tenth day before the Original Stated Maturity.

 

SECTION 309.		Persons Deemed Owners.

Prior to due presentment of a Registered Security for registration of transfer, the Company, the Trustee and any agent of the Company or the Trustee shall treat the Person in whose name such Registered Security is registered as the owner of such Registered Security for the purpose of receiving payment of principal of (and premium, if any) and (subject to Sections 305 and 307) interest, if any, on such Registered Security and for all other purposes whatsoever, whether or not such Registered Security be overdue, and neither the Company, the Trustee nor any agent of the Company or the Trustee shall be affected by notice to the contrary.

None of the Company, the Trustee, any Paying Agent or the Security Registrar will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests of a Security in global form or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests.

Notwithstanding the foregoing, with respect to any global temporary or permanent Security, nothing herein shall prevent the Company, the Trustee, or any agent of the Company or the Trustee, from giving effect to any written certification, proxy or other authorization furnished by any depositary, as a Holder, with respect to such global Security or impair, as between such depositary and owners of beneficial interests in such global Security, the operation of customary practices governing the exercise of the rights of such depositary (or its nominee) as Holder of such global Security.

 

SECTION 310.		Cancellation.

All Securities surrendered for payment, redemption, repayment at the option of the Holder, registration of transfer or exchange or for credit against any sinking fund payment shall, if surrendered to any Person other than the Trustee, be delivered to the Trustee, and any such Securities surrendered directly to the Trustee for any such purpose shall be promptly cancelled by the Trustee. The Company may at any time deliver to the Trustee for cancellation any Securities previously authenticated and delivered hereunder which the Company may have acquired in any manner whatsoever, and may deliver to the Trustee (or to any other Person for delivery to the Trustee) for cancellation any Securities previously authenticated hereunder which

 

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the Company has not issued and sold, and all Securities so delivered shall be promptly cancelled by the Trustee. If the Company shall so acquire any of the Securities, however, such acquisition shall not operate as a redemption or satisfaction of the indebtedness represented by such Securities unless and until the same are surrendered to the Trustee for cancellation. No Securities shall be authenticated in lieu of or in exchange for any Securities cancelled as provided in this Section, except as expressly permitted by this Indenture. Cancelled Securities held by the Trustee shall be destroyed by the Trustee in accordance with its customary procedures, unless by a Company Order the Company directs the Trustee to deliver a certificate of such destruction to the Company or to return them to the Company.

 

SECTION 311.		Computation of Interest.

Except as otherwise specified as contemplated by Section 301 with respect to Securities of any series, interest, if any, on the Securities of each series shall be computed on the basis of a 360-day year consisting of twelve 30-day months.

 

SECTION 312.		Currency and Manner of Payments in Respect of Securities.

(a) Unless otherwise specified with respect to any Securities pursuant to Section 301, with respect to Registered Securities of any series not permitting the election provided for in paragraph (b) below or the Holders of which have not made the election provided for in paragraph (b) below, payment of the principal of (and premium, if any, on) and interest, if any, on any Registered Security of such series will be made in the Currency in which such Registered Security is payable. The provisions of this Section 312 may be modified or superseded with respect to any Securities pursuant to Section 301.

(b) It may be provided pursuant to Section 301 with respect to Registered Securities of any series that Holders shall have the option, subject to paragraphs (d) and (e) below, to receive payments of principal of (or premium, if any, on) or interest, if any, on such Registered Securities in any of the Currencies which may be designated for such election by delivering to the Trustee for such series of Registered Securities a written election with signature guarantees and in the applicable form established pursuant to Section 301, not later than the close of business on the Election Date immediately preceding the applicable payment date. If a Holder so elects to receive such payments in any such Currency, such election will remain in effect for such Holder or any transferee of such Holder until changed by such Holder or such transferee by written notice to the Trustee for such series of Registered Securities (but any such change must be made not later than the close of business on the Election Date immediately preceding the next payment date to be effective for the payment to be made on such payment date and no such change of election may be made with respect to payments to be made on any Registered Security of such series with respect to which an Event of Default has occurred or with respect to which the Company has deposited funds pursuant to Article Four or Fourteen or with respect to which a notice of redemption has been given by the Company or a notice of option to elect repayment has been sent by such Holder or such transferee). Any Holder of any such Registered Security who shall not have delivered any such election to the Trustee of such series of Registered Securities not later than the close of business on the applicable Election Date will be paid the amount due on the applicable payment date in the relevant Currency as provided in Section 312(a). The Trustee for each such series of Registered Securities shall notify the Exchange Rate Agent as soon as practicable after the Election Date of the aggregate principal amount of Registered Securities for which Holders have made such written election.

 

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(c) Unless otherwise specified pursuant to Section 301, if the election referred to in paragraph (b) above has been provided for pursuant to Section 301, then, not later than the fourth Business Day after the Election Date for each payment date for Registered Securities of any series, the Exchange Rate Agent will deliver to the Company a written notice specifying the Currency in which Registered Securities of such series are payable, the respective aggregate amounts of principal of (and premium, if any, on) and interest, if any, on the Registered Securities to be paid on such payment date, specifying the amounts in such Currency so payable in respect of the Registered Securities as to which the Holders of Registered Securities denominated in any Currency shall have elected to be paid in another Currency as provided in paragraph (b) above. If the election referred to in paragraph (b) above has been provided for pursuant to Section 301 and if at least one Holder has made such election, then, unless otherwise specified pursuant to Section 301, on the second Business Day preceding such payment date the Company will deliver to the Trustee for such series of Registered Securities an Exchange Rate Officer’s Certificate in respect of the Dollar or Foreign Currency or Currencies payments to be made on such payment date. Unless otherwise specified pursuant to Section 301, the Dollar or Foreign Currency or Currencies amount receivable by Holders of Registered Securities who have elected payment in a Currency as provided in paragraph (b) above shall be determined by the Company on the basis of the applicable Market Exchange Rate in effect on the second Business Day (the “Valuation Date”) immediately preceding each payment date, and such determination shall be conclusive and binding for all purposes, absent manifest error.

(d) If a Conversion Event occurs with respect to a Foreign Currency in which any of the Securities are denominated or payable other than pursuant to an election provided for pursuant to paragraph (b) above, then with respect to each date for the payment of principal of (and premium, if any) and interest, if any, on the applicable Securities denominated or payable in such Foreign Currency occurring after the last date on which such Foreign Currency was used (the “Conversion Date”), the Dollar shall be the currency of payment for use on each such payment date. Unless otherwise specified pursuant to Section 301, the Dollar amount to be paid by the Company to the Trustee of each such series of Securities and by such Trustee or any Paying Agent to the Holders of such Securities with respect to such payment date shall be, in the case of a Foreign Currency other than a currency unit, the Dollar Equivalent of the Foreign Currency or, in the case of a currency unit, the Dollar Equivalent of the Currency Unit, in each case as determined by the Exchange Rate Agent in the manner provided in paragraph (f) or (g) below.

(e) Unless otherwise specified pursuant to Section 301, if the Holder of a Registered Security denominated in any Currency shall have elected to be paid in another Currency as provided in paragraph (b) above, and a Conversion Event occurs with respect to such elected Currency, such Holder shall receive payment in the Currency in which payment would have been made in the absence of such election; and if a Conversion Event occurs with respect to the Currency in which payment would have been made in the absence of such election, such Holder shall receive payment in Dollars as provided in paragraph (d) of this Section 312.

 

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(f) The “Dollar Equivalent of the Foreign Currency” shall be determined by the Exchange Rate Agent and shall be obtained for each subsequent payment date by converting the specified Foreign Currency into Dollars at the Market Exchange Rate on the Conversion Date.

(g) The “Dollar Equivalent of the Currency Unit” shall be determined by the Exchange Rate Agent and subject to the provisions of paragraph (h) below shall be the sum of each amount obtained by converting the Specified Amount of each Component Currency into Dollars at the Market Exchange Rate for such Component Currency on the Valuation Date with respect to each payment.

(h) For purposes of this Section 312, the following terms shall have the following meanings:

A “Component Currency” shall mean any currency which, on the Conversion Date, was a component currency of the relevant currency unit.

A “Specified Amount” of a Component Currency shall mean the number of units of such Component Currency or fractions thereof which were represented in the relevant currency unit on the Conversion Date. If after the Conversion Date the official unit of any Component Currency is altered by way of combination or subdivision, the Specified Amount of such Component Currency shall be divided or multiplied in the same proportion. If after the Conversion Date two or more Component Currencies are consolidated into a single currency, the respective Specified Amounts of such Component Currencies shall be replaced by an amount in such single currency equal to the sum of the respective Specified Amounts of such consolidated Component Currencies expressed in such single currency, and such amount shall thereafter be a Specified Amount and such single currency shall thereafter be a Component Currency. If after the Conversion Date any Component Currency shall be divided into two or more currencies, the Specified Amount of such Component Currency shall be replaced by amounts of such two or more currencies, having an aggregate Dollar Equivalent value at the Market Exchange Rate on the date of such replacement equal to the Dollar Equivalent of the Specified Amount of such former Component Currency at the Market Exchange Rate immediately before such division, and such amounts shall thereafter be Specified Amounts and such currencies shall thereafter be Component Currencies. If, after the Conversion Date of the relevant currency unit, a Conversion Event (other than any event referred to above in this definition of “Specified Amount”) occurs with respect to any Component Currency of such currency unit and is continuing on the applicable Valuation Date, the Specified Amount of such Component Currency shall, for purposes of calculating the Dollar Equivalent of the Currency Unit, be converted into Dollars at the Market Exchange Rate in effect on the Conversion Date of such Component Currency.

An “Election Date” shall mean the Regular Record Date for the applicable series of Registered Securities or at least 16 days prior to Maturity, as the case may be, or such other prior date for any series of Registered Securities as specified pursuant to clause 13 of Section 301 by which the written election referred to in Section 312(b) may be made.

 

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All decisions and determinations of the Exchange Rate Agent regarding the Dollar Equivalent of the Foreign Currency, the Dollar Equivalent of the Currency Unit, the Market Exchange Rate and changes in the Specified Amounts as specified above shall be in its sole discretion and shall, in the absence of manifest error, be conclusive for all purposes and irrevocably binding upon the Company, the Trustee for the appropriate series of Securities and all Holders of such Securities denominated or payable in the relevant Currency. The Exchange Rate Agent shall promptly give written notice to the Company and the Trustee for the appropriate series of Securities of any such decision or determination.

In the event that the Company determines in good faith that a Conversion Event has occurred with respect to a Foreign Currency, the Company will immediately give written notice thereof to the Trustee of the appropriate series of Securities and to the Exchange Rate Agent (and such Trustee will promptly thereafter give notice in the manner provided in Section 106 to the affected Holders) specifying the Conversion Date. In the event the Company so determines that a Conversion Event has occurred with respect to any other currency unit in which Securities are denominated or payable, the Company will immediately give written notice thereof to the Trustee of the appropriate series of Securities and to the Exchange Rate Agent (and such Trustee will promptly thereafter give notice in the manner provided in Section 106 to the affected Holders) specifying the Conversion Date and the Specified Amount of each Component Currency on the Conversion Date. In the event the Company determines in good faith that any subsequent change in any Component Currency as set forth in the definition of Specified Amount above has occurred, the Company will similarly give written notice to the Trustee of the appropriate series of Securities and to the Exchange Rate Agent.

The Trustee of the appropriate series of Securities shall be fully justified and protected in relying and acting upon information received by it from the Company and the Exchange Rate Agent and shall not otherwise have any duty or obligation to determine the accuracy or validity of such information independent of the Company or the Exchange Rate Agent.

 

SECTION 313.		Appointment and Resignation of Successor Exchange Rate Agent.

(a) Unless otherwise specified pursuant to Section 301, if and so long as the Securities of any series (i) are denominated in a Foreign Currency or (ii) may be payable in a Foreign Currency, or so long as it is required under any other provision of this Indenture, then the Company will maintain with respect to each such series of Securities, or as so required, at least one Exchange Rate Agent. The Company will cause the Exchange Rate Agent to make the necessary foreign exchange determinations at the time and in the manner specified pursuant to Section 301 for the purpose of determining the applicable rate of exchange and, if applicable, for the purpose of converting the issued Foreign Currency into the applicable payment Currency for the payment of principal (and premium, if any) and interest, if any, pursuant to Section 312.

(b) No resignation of the Exchange Rate Agent and no appointment of a successor Exchange Rate Agent pursuant to this Section shall become effective until the acceptance of appointment by the successor Exchange Rate Agent as evidenced by a written instrument delivered to the Company and the Trustee of the appropriate series of Securities accepting such appointment executed by the successor Exchange Rate Agent.

 

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(c) If the Exchange Rate Agent shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of the Exchange Rate Agent for any cause, with respect to the Securities of one or more series, the Company, by or pursuant to a Board Resolution, shall promptly appoint a successor Exchange Rate Agent or Exchange Rate Agents with respect to the Securities of that or those series (it being understood that any such successor Exchange Rate Agent may be appointed with respect to the Securities of one or more or all of such series and that, unless otherwise specified pursuant to Section 301, at any time there shall only be one Exchange Rate Agent with respect to the Securities of any particular series that are originally issued by the Company on the same date and that are initially denominated and/or payable in the same Currency).

 

SECTION 314.		CUSIP Numbers.

The Company in issuing the Securities may use “CUSIP” numbers (if then generally in use), and, if so, the Trustee shall indicate the respective “CUSIP” numbers of the Securities in notices of redemption as a convenience to Holders; provided that any such notice may state that no representation is made as to the correctness of such numbers either as printed on the Securities or as contained in any notice of redemption and that reliance may be placed only on the other identification numbers printed on the Securities, and any such redemption shall not be affected by any defect in or omission of such numbers. The Company shall advise the Trustee as promptly as practicable in writing of any change in the CUSIP numbers.

ARTICLE FOUR

SATISFACTION AND DISCHARGE

 

SECTION 401.		Satisfaction and Discharge of Indenture.

Except as set forth below, this Indenture shall upon Company Request cease to be of further effect with respect to any series of Securities specified in such Company Request (except as to any surviving rights of registration of transfer or exchange of Securities of such series expressly provided for herein or pursuant hereto, any surviving rights of tender for repayment at the option of the Holders and any right to receive Additional Amounts, as provided in Section 1004), and the Trustee, upon receipt of a Company Order, and at the expense of the Company, shall execute proper instruments acknowledging satisfaction and discharge of this Indenture as to such series when

(1) either

(A) all Securities of such series theretofore authenticated and delivered (other than (i) Securities of such series which have been destroyed, lost or stolen and which have been replaced or paid as provided in Section 306 and (ii) Securities of such series for whose payment money has theretofore been deposited in trust with the Trustee or any Paying Agent or segregated and held in trust by the Company and thereafter repaid to the Company or discharged from such trust, as provided in Section 1003) have been delivered to the Trustee for cancellation; or

(B) all Securities of such series

 

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(i) have become due and payable, or

(ii) will become due and payable at their Stated Maturity within one year, or

(iii) if redeemable at the option of the Company, are to be called for redemption within one year under arrangements satisfactory to the Trustee for the giving of notice of redemption by the Trustee in the name, and at the expense, of the Company,

and the Company, in the case of (i), (ii) or (iii) above, has irrevocably deposited or caused to be deposited with the Trustee as trust funds in trust for such purpose, solely for the benefit of the Holders, an amount in the Currency in which the Securities of such series are payable, sufficient to pay and discharge the entire indebtedness on such Securities not theretofore delivered to the Trustee for cancellation, for principal (and premium, if any) and interest, if any, to the date of such deposit (in the case of Securities which have become due and payable) or to the Stated Maturity or Redemption Date, as the case may be;

(2) the Company has irrevocably paid or caused to be irrevocably paid all other sums payable hereunder by the Company; and

(3) the Company has delivered to the Trustee an Officers’ Certificate and an Opinion of Counsel, each stating that all conditions precedent herein provided for relating to the satisfaction and discharge of this Indenture as to such series have been complied with.

Notwithstanding the satisfaction and discharge of this Indenture, the obligations of the Company to the Trustee and any predecessor Trustee under Section 606, the obligations of the Company to any Authenticating Agent under Section 612 and, if money shall have been deposited with the Trustee pursuant to subclause (B) of clause (1) of this Section, the obligations of the Trustee under Section 402 and the last paragraph of Section 1003 shall survive any termination of this Indenture.

 

SECTION 402.		Application of Trust Funds.

Subject to the provisions of the last paragraph of Section 1003, all money deposited with the Trustee pursuant to Section 401 shall be held in trust and applied by it, in accordance with the provisions of the Securities and this Indenture, to the payment, either directly or through any Paying Agent (including the Company acting as its own Paying Agent) as the Trustee may determine, to the Persons entitled thereto, of the principal (and premium, if any) and interest, if any, for whose payment such money has been deposited with or received by the Trustee, but such money need not be segregated from other funds except to the extent required by law.

 

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ARTICLE FIVE

REMEDIES

 

SECTION 501.		Events of Default.

“Event of Default”, wherever used herein with respect to any particular series of Securities, means any one of the following events (whatever the reason for such Event of Default and whether or not it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body), unless it is either inapplicable to a particular series or is specifically deleted or modified in or pursuant to the supplemental indenture or a Board Resolution establishing such series of Securities or is in the form of Security for such series:

(1) default in the payment of any interest upon any Security of that series when such interest becomes due and payable, and continuance of such default for a period of 30 days; or

(2) default in the payment of the principal of (or premium, if any, on) any Security of that series when it becomes due and payable at its Maturity; or

(3) default in the deposit of any sinking fund payment, when and as due by the terms of any Security of that series, and continuance of such default for a period of 2 Business Days; or

(4) default in the performance, or breach, of any covenant or agreement of the Company in this Indenture with respect to any Security of that series (other than a covenant or agreement a default in whose performance or whose breach is elsewhere in this Section specifically dealt with or which has expressly been included in this Indenture solely for the benefit of a series of Securities other than that series), and continuance of such default or breach for a period of 60 days after there has been given, by registered or certified mail, to the Company by the Trustee or to the Company and the Trustee by the Holders of at least 25% in principal amount of the Outstanding Securities of that series a written notice specifying such default or breach and requiring it to be remedied and stating that such notice is a “Notice of Default” hereunder;

(5) the Company, pursuant to or within the meaning of any Bankruptcy Law:

(A) commences a voluntary case or proceeding under any Bankruptcy Law,

(B) consents to the commencement of any bankruptcy or insolvency case or proceeding against it, or files a petition or answer or consent seeking reorganization or relief against it,

(C) consents to the entry of a decree or order for relief against it in an involuntary case or proceeding,

(D) consents to the filing of such petition or to the appointment of or taking possession by a Custodian of the Company or for all or substantially all of its property, or

 

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(E) makes an assignment for the benefit of creditors, or admits in writing of its inability to pay its debts generally as they become due or takes any corporate action in furtherance of any such action; or

(6) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that:

(A) is for relief against the Company in an involuntary case or proceeding, or

(B) adjudges the Company bankrupt or insolvent, or approves as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Company, or

(C) appoints a Custodian of the Company or for all or substantially all of its property, or

(D) orders the winding up or liquidation of the Company,

and the continuance of any such decree or order for relief or any such other decree or order unstayed and in effect for a period of 90 consecutive days; or

(7) if, pursuant to Sections 18(a)(1)(c)(ii) and 61 of the Investment Company Act of 1940, as amended, on the last business day of each of twenty-four consecutive calendar months any class of Securities shall have an asset coverage of less than 100 per centum;

(8) any other Event of Default provided with respect to Securities of that series.

The term “Bankruptcy Law” means title 11, U.S. Code or any applicable federal or state bankruptcy, insolvency, reorganization or other similar law. The term “Custodian” means any custodian, receiver, trustee, assignee, liquidator, sequestrator or other similar official under any Bankruptcy Law.

 

SECTION 502.		Acceleration of Maturity; Rescission and Annulment.

If an Event of Default with respect to Securities of any series at the time Outstanding occurs and is continuing, then and in every such case the Trustee or the Holders of not less than 25% in principal amount of the Outstanding Securities of that series may (and the Trustee shall at the request of such Holders) declare the principal (or, if any Securities are Original Issue Discount Securities or Indexed Securities, such portion of the principal as may be specified in the terms thereof) of all the Securities of that series to be due and payable immediately, by a notice in writing to the Company (and to the Trustee if given by the Holders), and upon any such declaration such principal or specified portion thereof shall become immediately due and payable.

Any application by the Trustee for written instructions from the requisite amount of Holders (as determined pursuant to this Indenture) may, at the option of the Trustee, set forth in writing any action proposed to be taken or omitted by the Trustee under this Indenture and the date on and/or after which such action shall be taken or such omission shall be effective. The

 

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Trustee shall not be liable for any action taken by, or omission of, the Trustee in accordance with a proposal included in such application on or after the date specified in such application unless prior to taking any such action (or the effective date in the case of an omission), the Trustee shall have received written instructions from the requisite amount of Holders (as determined pursuant to this Indenture) in response to such application specifying the action to be taken or omitted.

At any time after such a declaration of acceleration with respect to Securities of any series has been made and before a judgment or decree for payment of the money due has been obtained by the Trustee as hereinafter provided in this Article, the Holders of a majority in principal amount of the Outstanding Securities of that series, by written notice to the Company and the Trustee, may rescind and annul such declaration and its consequences if:

(1) the Company has paid or deposited with the Trustee a sum sufficient to pay in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)):

(A) all overdue installments of interest, if any, on all Outstanding Securities of that series,

(B) the principal of (and premium, if any, on) all Outstanding Securities of that series which have become due otherwise than by such declaration of acceleration and interest thereon at the rate or rates borne by or provided for in such Securities,

(C) to the extent that payment of such interest is lawful, interest upon overdue installments of interest at the rate or rates borne by or provided for in such Securities, and

(D) all sums paid or advanced by the Trustee hereunder and the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel; and

(2) all Events of Default with respect to Securities of that series, other than the nonpayment of the principal of (or premium, if any) or interest on Securities of that series which have become due solely by such declaration of acceleration, have been cured or waived as provided in Section 513.

No such rescission shall affect any subsequent default or impair any right consequent thereon.

 

SECTION 503.		Collection of Indebtedness and Suits for Enforcement by Trustee.

The Company covenants that if:

(1) default is made in the payment of any installment of interest on any Security of any series when such interest becomes due and payable and such default continues for a period of 30 days, or

 

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(2) default is made in the payment of the principal of (or premium, if any, on) any Security of any series at its Maturity,

then the Company will, upon demand of the Trustee, pay to the Trustee, for the benefit of the Holders of Securities of such series, the whole amount then due and payable on such Securities for principal (and premium, if any) and interest, if any, with interest upon any overdue principal (and premium, if any) and, to the extent that payment of such interest shall be legally enforceable, upon any overdue installments of interest, if any, at the rate or rates borne by or provided for in such Securities, and, in addition thereto, such further amount as shall be sufficient to cover the costs and expenses of collection, including the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel.

If the Company fails to pay such amounts forthwith upon such demand, the Trustee, in its own name and as trustee of an express trust, may institute a judicial proceeding for the collection of the sums so due and unpaid, and may prosecute such proceeding to judgment or final decree, and may enforce the same against the Company or any other obligor upon Securities of such series and collect the moneys adjudged or decreed to be payable in the manner provided by law out of the property of the Company or any other obligor upon such Securities of such series, wherever situated.

If an Event of Default with respect to Securities of any series occurs and is continuing, the Trustee may in its discretion proceed to protect and enforce its rights and the rights of the Holders of Securities of such series by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any such rights, whether for the specific enforcement of any covenant or agreement in this Indenture or in aid of the exercise of any power granted herein, or to enforce any other proper remedy.

 

SECTION 504.		Trustee May File Proofs of Claim.

In case of the pendency of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to the Company or any other obligor upon the Securities or the property of the Company or of such other obligor or their creditors, the Trustee (irrespective of whether the principal of the Securities of any series shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand on the Company for the payment of any overdue principal, premium or interest) shall be entitled and empowered, by intervention in such proceeding or otherwise:

(i) to file and prove a claim for the whole amount of principal (or in the case of Original Issue Discount Securities or Indexed Securities, such portion of the principal as may be provided for in the terms thereof) (and premium, if any) and interest, if any, owing and unpaid in respect of the Securities and to file such other papers or documents as may be necessary or advisable in order to have the claims of the Trustee (including any claim for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel) and of the Holders allowed in such judicial proceeding, and

(ii) to collect and receive any moneys or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator (or other similar official) in any such judicial proceeding

 

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is hereby authorized by each Holder of Securities of such series to make such payments to the Trustee, and in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due to it for the reasonable compensation, expenses, disbursements and advances of the Trustee and any predecessor Trustee, their agents and counsel, and any other amounts due the Trustee or any predecessor Trustee under Section 606.

Subject to Article Eight and Section 902 and unless otherwise provided as contemplated by Section 301, nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder of a Security any plan of reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Holder thereof, or to authorize the Trustee to vote in respect of the claim of any Holder of a Security in any such proceeding.

 

SECTION 505.		Trustee May Enforce Claims Without Possession of Securities.

All rights of action and claims under this Indenture or any of the Securities may be prosecuted and enforced by the Trustee without the possession of any of the Securities or the production thereof in any proceeding relating thereto, and any such proceeding instituted by the Trustee shall be brought in its own name and as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Holders of the Securities in respect of which such judgment has been recovered.

 

SECTION 506.		Application of Money Collected.

Any money collected by the Trustee pursuant to this Article shall be applied in the following order, at the date or dates fixed by the Trustee and, in case of the distribution of such money on account of principal (or premium, if any) or interest, if any, upon presentation of the Securities and the notation thereon of the payment if only partially paid and upon surrender thereof if fully paid:

FIRST: To the payment of all amounts due the Trustee and any predecessor Trustee under Section 606 and any other agent hereunder;

SECOND: To the payment of the amounts then due and unpaid upon the Securities for principal (and premium, if any) and interest, if any, in respect of which or for the benefit of which such money has been collected, ratably, without preference or priority of any kind, according to the aggregate amounts due and payable on such Securities for principal (and premium, if any) and interest, if any, respectively; and

THIRD: To the payment of the remainder, if any, to the Company or any other Person or Persons entitled thereto.

 

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SECTION 507.		Limitation on Suits.

No Holder of any Security of any series shall have any right to institute any proceeding, judicial or otherwise, with respect to this Indenture, or for the appointment of a receiver or trustee, or for any other remedy hereunder, unless:

(1) such Holder has previously given written notice to the Trustee of a continuing Event of Default with respect to the Securities of that series;

(2) the Holders of not less than 25% in principal amount of the Outstanding Securities of that series shall have made written request to the Trustee to institute proceedings in respect of such Event of Default in its own name as Trustee hereunder;

(3) such Holder or Holders have offered to the Trustee reasonable indemnity, security or both against the costs, expenses and liabilities to be incurred in compliance with such request;

(4) the Trustee for 60 days after its receipt of such notice, request and offer of indemnity and/or security has failed to institute any such proceeding; and

(5) no direction inconsistent with such written request has been given to the Trustee during such 60-day period by the Holders of a majority in principal amount of the Outstanding Securities of that series;

it being understood and intended that no one or more of such Holders shall have any right in any manner whatever by virtue of, or by availing of, any provision of this Indenture to affect, disturb or prejudice the rights of any other of such Holders, or to obtain or to seek to obtain priority or preference over any other of such Holders or to enforce any right under this Indenture, except in the manner herein provided and for the equal and ratable benefit of all such Holders.

 

SECTION 508.		Unconditional Right of Holders to Receive Principal, Premium and Interest.

Notwithstanding any other provision in this Indenture, the Holder of any Security shall have the right which is absolute and unconditional to receive payment of the principal of (and premium, if any) and (subject to Sections 305 and 307) interest, if any, on such Security on the Stated Maturity or Maturities expressed in such Security (or, in the case of redemption, on the Redemption Date or, in the case of repayment at the option of the Holders on the Repayment Date) and to institute suit for the enforcement of any such payment, and such rights shall not be impaired without the consent of such Holder.

 

SECTION 509.		Restoration of Rights and Remedies.

If the Trustee or any Holder of a Security has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding has been discontinued or abandoned for any reason, or has been determined adversely to the Trustee or to such Holder, then and in every such case the Company, the Trustee and the Holders of Securities shall, subject to any determination in such proceeding, be restored severally and respectively to their former positions hereunder and thereafter all rights and remedies of the Trustee and the Holders shall continue as though no such proceeding had been instituted.

 

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SECTION 510.		Rights and Remedies Cumulative.

Except as otherwise provided with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities in the last paragraph of Section 306, no right or remedy herein conferred upon or reserved to the Trustee or to the Holders of Securities is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy.

 

SECTION 511.		Delay or Omission Not Waiver.

No delay or omission of the Trustee or of any Holder of any Security to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the Holders may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders of Securities, as the case may be.

 

SECTION 512.		Control by Holders of Securities.

The Holders of a majority in principal amount of the Outstanding Securities of any series shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred on the Trustee with respect to the Securities of such series, provided that

(1) such direction shall not be in conflict with any rule of law or with this Indenture,

(2) the Trustee may take any other action deemed proper by the Trustee which is not inconsistent with such direction,

(3) the Trustee need not take any action which might involve it in personal liability or be unjustly prejudicial to the Holders of Securities of such series not consenting, and

(4) the Holders shall have provided the Trustee with security, indemnity or both reasonably satisfactory to the Trustee.

 

SECTION 513.		Waiver of Past Defaults.

Subject to Section 502, the Holders of not less than a majority in principal amount of the Outstanding Securities of any series may on behalf of the Holders of all the Securities of such series waive any past default hereunder with respect to Securities of such series and its consequences, except a default

 

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(1) in the payment of the principal of (or premium, if any) or interest, if any, on any Security of such series, or

(2) in respect of a covenant or provision hereof which under Article Nine cannot be modified or amended without the consent of the Holder of each Outstanding Security of such series affected.

Upon any such waiver, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been cured, for every purpose of this Indenture; but no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon.

 

SECTION 514.		Waiver of Stay or Extension Laws.

The Company covenants (to the extent that it may lawfully do so) that it will not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay or extension law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such law, and covenants that it will not hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law had been enacted.

ARTICLE SIX

THE TRUSTEE

 

SECTION 601.		Notice of Defaults.

Within 90 days after the occurrence of any Default hereunder with respect to the Securities of any series, the Trustee shall transmit in the manner and to the extent provided in TIA Section 313(c), notice of such Default hereunder known to the Trustee, unless such Default shall have been cured or waived; provided, however, that, except in the case of a Default in the payment of the principal of (or premium, if any) or interest, if any, on any Security of such series, or in the payment of any sinking or purchase fund installment with respect to the Securities of such series, the Trustee shall be protected in withholding such notice if and so long as the board of directors, the executive committee or a trust committee of directors and/or Responsible Officers of the Trustee in good faith determines that the withholding of such notice is in the interest of the Holders of the Securities of such series; and provided further that in the case of any Default or breach of the character specified in Section 501 (4) with respect to the Securities of such series, no such notice to Holders shall be given until at least 60 days after the occurrence thereof.

 

SECTION 602.		Certain Rights of Trustee.

(1) The Trustee may rely and shall be protected in acting or refraining from acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, coupon or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties.

 

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(2) Any request or direction of the Company mentioned herein shall be sufficiently evidenced by a Company Request or Company Order (other than delivery of any Security, to the Trustee for authentication and delivery pursuant to Section 303 which shall be sufficiently evidenced as provided therein) and any resolution of the Board of Directors may be sufficiently evidenced by a Board Resolution.

(3) Whenever in the administration of this Indenture the Trustee shall deem it desirable that a matter be proved or established prior to taking, suffering or omitting any action hereunder, the Trustee (unless other evidence be herein specifically prescribed) may require and, in the absence of bad faith on its part, rely upon a Board Resolution, an Opinion of Counsel or an Officers’ Certificate.

(4) The Trustee may consult with counsel and the written advice of such counsel or any Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in reliance thereon.

(5) The Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request or direction of any of the Holders of Securities of any series pursuant to this Indenture, unless such Holders shall have offered to the Trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction.

(6) The Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, coupon or other paper or document, but the Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall be entitled upon reasonable notice and at reasonable times during normal business hours to examine the books, records and premises of the Company, personally or by agent or attorney.

(7) The Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed with due care by it hereunder.

(8) The Trustee shall not be deemed to have notice of any Default or Event of Default unless a Responsible Officer of the Trustee has actual knowledge thereof or unless written notice of any event which is in fact such a default is received by the Trustee at the Corporate Trust Office of the Trustee, and such notice references the Securities and this Indenture.

(9) The rights, privileges, protections, immunities and benefits given to the Trustee, including, without limitation, its right to be indemnified, are extended to, and shall be enforceable by, the Trustee in each of its capacities hereunder.

 

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(10) The permissive rights of the Trustee enumerated herein shall not be construed as duties and the Trustee shall not be answerable for other than its own negligent action, its own negligent failure to act or its own willful misconduct with respect to such permissive rights.

(11) In no event shall the Trustee be liable for special, indirect, punitive or consequential loss or damage of any kind (including, but not limited to, loss of profit) irrespective of whether the Trustee has been advised of the likelihood of such loss or damage and regardless of the form of action.

(12) The Trustee shall not be responsible or liable for any failure or delay in the performance of its obligations under this Indenture arising out of or caused, directly or indirectly, by circumstances beyond its reasonable control, including without limitation, acts of God; earthquakes; fire; flood; terrorism; wars and other military disturbances; sabotage; epidemics; riots; interruptions; loss or malfunctions of utilities, computer (hardware or software) or communications services; accidents; labor disputes; acts of civil or military authorities and governmental action.

The Trustee shall not be required to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it.

The parties hereto acknowledge that in order to help the United States government fight the funding of terrorism and money laundering activities, pursuant to Federal regulations that became effective on October 1, 2003 (Section 326 of the USA PATRIOT Act) all financial institutions are required to obtain, verify, record and update information that identifies each person establishing a relationship or opening an account. The parties to this Agreement agree that they will provide to the Trustee such information as it may request, from time to time, in order for the Trustee to satisfy the requirements of the USA PATRIOT Act, including but not limited to the name, address, tax identification number and other information that will allow it to identify the individual or entity who is establishing the relationship or opening the account and may also ask for formation documents such as articles of incorporation or other identifying documents to be provided.

 

SECTION 603.		Not Responsible for Recitals or Issuance of Securities.

The recitals contained herein and in the Securities, except the Trustee’s certificate of authentication, shall be taken as the statements of the Company, and neither the Trustee nor any Authenticating Agent assumes any responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of the Securities, except that the Trustee represents that it is duly authorized to execute and deliver this Indenture, authenticate the Securities and perform its obligations hereunder and that the statements made by it in a Statement of Eligibility on Form T-1 supplied to the Company are true and accurate, subject to the qualifications set forth therein. Neither the Trustee nor any Authenticating Agent shall be accountable for the use or application by the Company of Securities or the proceeds thereof.

 

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SECTION 604.		May Hold Securities.

The Trustee, any Paying Agent, Security Registrar, Authenticating Agent or any other agent of the Company, in its individual or any other capacity, may become the owner or pledgee of Securities and, subject to TIA Sections 310(b) and 311, may otherwise deal with the Company with the same rights it would have if it were not Trustee, Paying Agent, Security Registrar, Authenticating Agent or such other agent.

 

SECTION 605.		Money Held in Trust.

Money held by the Trustee in trust hereunder need not be segregated from other funds except to the extent required by law. The Trustee shall be under no liability for interest on any money received by it hereunder except as otherwise agreed with the Company.

 

SECTION 606.		Compensation and Reimbursement and Indemnification of Trustee.

The Company agrees:

(1) To pay to the Trustee or any predecessor Trustee from time to time such compensation for all services rendered by it hereunder as has been agreed upon from time to time in writing (which compensation shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust).

(2) Except as otherwise expressly provided herein, to reimburse each of the Trustee and any predecessor Trustee upon its request for all reasonable expenses, disbursements and advances incurred or made by the Trustee or any predecessor Trustee in accordance with any provision of this Indenture (including the reasonable compensation and the expenses and disbursements of its agents and counsel), except any such expense, disbursement or advance as may be attributable to its negligence or willful misconduct.

(3) To indemnify each of the Trustee or any predecessor Trustee and their respective officers, directors, employees, representatives and agents, for, and to hold it harmless against, any loss, liability or expense incurred without negligence or willful misconduct on its own part, arising out of or in connection with the acceptance or administration of the trust or trusts hereunder, including the costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder.

As security for the performance of the obligations of the Company under this Section, the Trustee shall have a claim prior to the Securities upon all property and funds held or collected by the Trustee as such, except funds held in trust for the payment of principal of (or premium, if any) or interest, if any, on particular Securities.

When the Trustee incurs expenses or renders services after an Event of Default specified in Section 501 occurs, the expenses and compensation for such services are intended to constitute expenses of administration under Title 11, U.S. Code, or any similar Federal, State or analogous foreign law for the relief of debtors.

 

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The provisions of this Section 606 shall survive the resignation or removal of the Trustee and the satisfaction, termination or discharge of this Indenture.

 

SECTION 607.		Corporate Trustee Required; Eligibility.

There shall at all times be a Trustee hereunder which shall be eligible to act as Trustee under TIA Section 310(a)(1) and shall have a combined capital and surplus of at least $50,000,000. If such corporation publishes reports of condition at least annually, pursuant to law or to the requirements of Federal, State, Territorial or District of Columbia supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such corporation shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, it shall resign immediately in the manner and with the effect hereinafter specified in this Article.

 

SECTION 608.		Disqualification; Conflicting Interests.

If the Trustee has or shall acquire a conflicting interest within the meaning of the Trust Indenture Act, the Trustee shall either eliminate such interest or resign, to the extent and in the manner provided by, and subject to the provisions of, the Trust Indenture Act and this Indenture.

 

SECTION 609.		Resignation and Removal; Appointment of Successor.

(a) No resignation or removal of the Trustee and no appointment of a successor Trustee pursuant to this Article shall become effective until the acceptance of appointment by the successor Trustee in accordance with the applicable requirements of Section 610.

(b) The Trustee may resign at any time with respect to the Securities of one or more series by giving written notice thereof to the Company.

(c) The Trustee may be removed at any time with respect to the Securities of any series by (i) the Company, by an Officers’ Certificate delivered to the Trustee, provided that contemporaneously therewith (x) the Company immediately appoints a successor Trustee with respect to the Securities of such series meeting the requirements of Section 607 hereof and (y) the terms of Section 610 hereof are complied with in respect of such appointment (the Trustee being removed hereby agreeing to execute the instrument contemplated by Section 610(b) hereof, if applicable, under such circumstances) and provided further that no Default with respect to such Securities shall have occurred and then be continuing at such time, or (ii) Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Trustee and to the Company.

(d) If at any time:

(1) the Trustee shall fail to comply with the provisions of TIA Section 310(b) after written request therefor by the Company or by any Holder of a Security who has been a bona fide Holder of a Security for at least six months, or

 

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(2) the Trustee shall cease to be eligible under Section 607 and shall fail to resign after written request therefor by the Company or by any Holder of a Security who has been a bona fide Holder of a Security for at least six months, or

(3) the Trustee shall become incapable of acting or shall be adjudged a bankrupt or insolvent or a receiver of the Trustee or of its property shall be appointed or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then, in any such case, (i) the Company by or pursuant to a Board Resolution may remove the Trustee and appoint a successor Trustee with respect to all Securities, or (ii) subject to TIA Section 315(e), any Holder of a Security who has been a bona fide Holder of a Security for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee with respect to all Securities and the appointment of a successor Trustee or Trustees.

(e) If an instrument of acceptance by a successor Trustee shall not have been delivered to the Trustee within 30 days after the giving of a notice of resignation or the delivery of an Act of removal, the Trustee resigning or being removed may petition any court of competent jurisdiction for the appointment of a successor Trustee.

(f) If the Trustee shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of Trustee for any cause with respect to the Securities of one or more series, the Company, by or pursuant to a Board Resolution, shall promptly appoint a successor Trustee or Trustees with respect to the Securities of that or those series (it being understood that any such successor Trustee may be appointed with respect to the Securities of one or more or all of such series and that at any time there shall be only one Trustee with respect to the Securities of any particular series). If, within one year after such resignation, removal or incapability, or the occurrence of such vacancy, a successor Trustee with respect to the Securities of any series shall be appointed by Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Company and the retiring Trustee, the successor Trustee so appointed shall, forthwith upon its acceptance of such appointment, become the successor Trustee with respect to the Securities of such series and to that extent supersede the successor Trustee appointed by the Company. If no successor Trustee with respect to the Securities of any series shall have been so appointed by the Company or the Holders of Securities and accepted appointment in the manner hereinafter provided, any Holder of a Security who has been a bona fide Holder of a Security of such series for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor Trustee with respect to Securities of such series.

(g) The Company shall give notice of each resignation and each removal of the Trustee with respect to the Securities of any series and each appointment of a successor Trustee with respect to the Securities of any series in the manner provided for notices to the Holders of Securities in Section 106. Each notice shall include the name of the successor Trustee with respect to the Securities of such series and the address of its Corporate Trust Office.

 

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SECTION 610.		Acceptance of Appointment by Successor.

(a) In case of the appointment hereunder of a successor Trustee with respect to all Securities, every such successor Trustee shall execute, acknowledge and deliver to the Company and to the retiring Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Trustee shall become effective and such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; but, on request of the Company or the successor Trustee, such retiring Trustee shall, upon payment of its charges, execute and deliver an instrument transferring to such successor Trustee all the rights, powers and trusts of the retiring Trustee, and shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder, subject nevertheless to its claim, if any, provided for in Section 606.

(b) In case of the appointment hereunder of a successor Trustee with respect to the Securities of one or more (but not all) series, the Company, the retiring Trustee and each successor Trustee with respect to the Securities of one or more series shall execute and deliver an indenture supplemental hereto wherein each successor Trustee shall accept such appointment and which (1) shall contain such provisions as shall be necessary or desirable to transfer and confirm to, and to vest in, each successor Trustee all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates, (2) if the retiring Trustee is not retiring with respect to all Securities, shall contain such provisions as shall be deemed necessary or desirable to confirm that all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series as to which the retiring Trustee is not retiring shall continue to be vested in the retiring Trustee, and (3) shall add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee, it being understood that nothing herein or in such supplemental indenture shall constitute such Trustees co-trustees of the same trust and that each such Trustee shall be trustee of a trust or trusts hereunder separate and apart from any trust or trusts hereunder administered by any other such Trustee; and upon the execution and delivery of such supplemental indenture the resignation or removal of the retiring Trustee shall become effective to the extent provided therein and each such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates; but, on request of the Company or any successor Trustee, such retiring Trustee shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder with respect to the Securities of that or those series to which the appointment of such successor Trustee relates. Whenever there is a successor Trustee with respect to one or more (but less than all) series of securities issued pursuant to this Indenture, the terms “Indenture” and “Securities” shall have the meanings specified in the provisos to the respective definition of those terms in Section 101 which contemplate such situation.

(c) Upon request of any such successor Trustee, the Company shall execute any and all instruments for more fully and certainly vesting in and confirming to such successor Trustee all such rights, powers and trusts referred to in paragraph (a) or (b) of this Section, as the case may be.

(d) No successor Trustee shall accept its appointment unless at the time of such acceptance such successor Trustee shall be qualified and eligible under this Article.

 

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SECTION 611.		Merger, Conversion, Consolidation or Succession to Business.

Any corporation into which the Trustee may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any corporation succeeding to all or substantially all of the corporate trust business of the Trustee, shall be the successor of the Trustee hereunder, provided such corporation shall be otherwise qualified and eligible under this Article, without the execution or filing of any paper or any further act on the part of any of the parties hereto. In case any Securities shall have been authenticated, but not delivered, by the Trustee then in office, any successor by merger, conversion or consolidation to such authenticating Trustee may adopt such authentication and deliver the Securities so authenticated with the same effect as if such successor Trustee had itself authenticated such Securities. In case any Securities shall not have been authenticated by such predecessor Trustee, any such successor Trustee may authenticate and deliver such Securities, in either its own name or that of its predecessor Trustee, with the full force and effect which this Indenture provides for the certificate of authentication of the Trustee; provided, however, that the right to adopt the certificate of authentication of any predecessor Trustee or to authenticate Securities in the name of any predecessor Trustee shall apply only to its successor or successors by merger, conversion or consolidation.

 

SECTION 612.		Appointment of Authenticating Agent.

At any time when any of the Securities remain Outstanding, the Trustee may appoint an Authenticating Agent or Agents (which may be an Affiliate or Affiliates of the Company) with respect to one or more series of Securities which shall be authorized to act on behalf of the Trustee to authenticate Securities of such series issued upon original issue or upon exchange, registration of transfer or partial redemption thereof, and Securities so authenticated shall be entitled to the benefits of this Indenture and shall be valid and obligatory for all purposes as if authenticated by the Trustee hereunder. Any such appointment shall be evidenced by an instrument in writing signed by a Responsible Officer of the Trustee, a copy of which instrument shall be promptly furnished to the Company. Wherever reference is made in this Indenture to the authentication and delivery of Securities by the Trustee or the Trustee’s certificate of authentication, such reference shall be deemed to include authentication and delivery on behalf of the Trustee by an Authenticating Agent and a certificate of authentication executed on behalf of the Trustee by an Authenticating Agent. Each Authenticating Agent shall be acceptable to the Company and, except as may otherwise be provided pursuant to Section 301, shall at all times be a bank or trust company or corporation organized and doing business and in good standing under the laws of the United States of America or of any State or the District of Columbia, authorized under such laws to act as Authenticating Agent, eligible to serve as trustee hereunder pursuant to Section 607. If such Authenticating Agent publishes reports of condition at least annually, pursuant to law or the requirements of the aforesaid supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such Authenticating Agent shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. In case at any time an Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, such Authenticating Agent shall resign immediately in the manner and with the effect specified in this Section.

 

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Any corporation into which an Authenticating Agent may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which such Authenticating Agent shall be a party, or any corporation succeeding to the corporate agency or corporate trust business of an Authenticating Agent, shall continue to be an Authenticating Agent, provided such corporation shall be otherwise eligible under this Section, without the execution or filing of any paper or further act on the part of the Trustee or the Authenticating Agent.

An Authenticating Agent for any series of Securities may at any time resign by giving written notice of resignation to the Trustee for such series and to the Company. The Trustee for any series of Securities may at any time terminate the agency of an Authenticating Agent by giving written notice of termination to such Authenticating Agent and to the Company. Upon receiving such a notice of resignation or upon such a termination, or in case at any time such Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, the Trustee for such series may appoint a successor Authenticating Agent which shall be acceptable to the Company and shall promptly give written notice of such appointment to all Holders of Securities of the series with respect to which such Authenticating Agent will serve in the manner set forth in Section 106. Any successor Authenticating Agent upon acceptance of its appointment hereunder shall become vested with all the rights, powers and duties of its predecessor hereunder, with like effect as if originally named as an Authenticating Agent herein. No successor Authenticating Agent shall be appointed unless eligible under the provisions of this Section.

The Company agrees to pay to each Authenticating Agent from time to time reasonable compensation including reimbursement of its reasonable expenses for its services under this Section.

If an appointment with respect to one or more series is made pursuant to this Section, the Securities of such series may have endorsed thereon, in addition to or in lieu of the Trustee’s certificate of authentication, an alternate certificate of authentication substantially in the following form:

This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture.

 

 

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If all of the Securities of a series may not be originally issued at one time, and the Trustee does not have an office capable of authenticating Securities upon original issuance located in a Place of Payment where the Company wishes to have Securities of such series authenticated upon original issuance, the Trustee, if so requested by the Company in writing (which writing need not comply with Section 102 and need not be accompanied by an Opinion of Counsel), shall appoint in accordance with this Section an Authenticating Agent (which, if so requested by the Company, shall be an Affiliate of the Company) having an office in a Place of Payment designated by the Company with respect to such series of Securities, provided that the terms and conditions of such appointment are acceptable to the Trustee.

ARTICLE SEVEN

HOLDERS’ LISTS AND REPORTS BY TRUSTEE AND COMPANY

 

SECTION 701.		Company to Furnish Trustee Names and Addresses of Holders.

The Company will furnish or cause to be furnished to the Trustee:

(a) Semi-annually, not later than March 15 and September 15 in each year, a list, in such form as the Trustee may reasonably require, of the names and addresses of the Holders of Securities of each series as of the preceding March 1 or September 1, as the case may be; and

(b) At such other times as the Trustee may request in writing, within thirty (30) calendar days after receipt by the Company of any such request, a list of similar form and content as of a date not more than fifteen (15) calendar days prior to the time such list is furnished;

Excluding from any such list names and addresses received by the Trustee in its capacity as Security Registrar.

 

SECTION 702.		Preservation of Information; Communications to Holders.

(a) The Trustee shall preserve, in as current a form as is reasonably practicable, the names and addresses of Holders contained in the most recent list furnished to the Trustee as provided in Section 701 and the names and addresses of Holders received by the Trustee in its capacity as Security Registrar. The Trustee may destroy any list furnished to it as provided in Section 701 upon receipt of a new list so furnished.

(b) The rights of Holders to communicate with other Holders with respect to their rights under this Indenture or under the Securities, and the corresponding rights and duties of the Trustee, shall be as provided by the Trust Indenture Act.

(c) Every Holder of Securities, by receiving and holding the same, agrees with the Company and the Trustee that neither the Company nor the Trustee nor any Authenticating Agent nor any Paying Agent nor any Security Registrar nor any agent of any of them shall be held accountable by reason of the disclosure of any information as to the names and addresses of the Holders of Securities in accordance with TIA Section 312, regardless of the source from which such information was derived, and that the Trustee shall not be held accountable by reason of mailing any material pursuant to a request made under TIA Section 312(b).

 

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SECTION 703.		Reports by Trustee.

Within 60 days after May 15 of each year commencing with the first May 15 after the first issuance of Securities pursuant to this Indenture, the Trustee shall transmit by mail to all Holders of Securities in the manner and to the extent provided in TIA Section 313(c) a brief report dated as of such May 15 which meets the requirements of TIA Section 313(a).

A copy of each such report shall, at the time of such transmission to Holders, be filed by the Trustee with each stock exchange, if any, upon which the Securities are listed, with the Commission and with the Company. The Company will promptly notify the Trustee of the listing of the Securities on any stock exchange.

 

SECTION 704.		Reports by Company.

The Company will:

(1) file with the Trustee, within 15 days after the Company is required to file the same with the Commission, copies of the annual reports and of the information, documents, and other reports (or copies of such portions of any of the foregoing as the Commission may from time to time by rules and regulations prescribe) which the Company may be required to file with the Commission pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934; or, if the Company is not required to file information, documents or reports pursuant to either of such Sections, then it will file with the Trustee and the Commission, in accordance with rules and regulations prescribed from time to time by the Commission, such of the supplementary and periodic information, documents and reports which may be required pursuant to Section 13 of the Securities Exchange Act of 1934 in respect of a security listed and registered on a national securities exchange as may be prescribed from time to time in such rules and regulations; and

(2) file with the Trustee and the Commission, in accordance with rules and regulations prescribed from time to time by the Commission, such additional information, documents and reports with respect to compliance by the Company with the conditions and covenants of this Indenture as may be required from time to time by such rules and regulations.

The Trustee shall transmit by mail to the Holders of Securities, within 30 days after the filing thereof with the Trustee, in the manner and to the extent provided in TIA Section 313(c), such summaries of any information, documents and reports required to be filed by the Company pursuant to subparagraphs (1) and (2) of this Section as may be required by rules and regulations prescribed from time to time by the Commission. In no event shall the Trustee be obligated to determine whether or not any report, information or document shall have been filed with the Commission.

 

SECTION 705.		Calculation of Original Issue Discount.

The Company shall file with the Trustee promptly at the end of each calendar year a written notice specifying the amount of original issue discount (including daily rates and accrual periods), if any, accrued on Outstanding Securities as of the end of such year.

 

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ARTICLE EIGHT

CONSOLIDATION, MERGER, CONVEYANCE OR TRANSFER

 

SECTION 801.		Company May Consolidate, Etc., Only on Certain Terms.

The Company shall not consolidate with or merge with or into any other corporation or convey or transfer its properties and assets substantially as an entirety to any Person, unless:

(1) either the Company shall be the continuing corporation, or the corporation (if other than the Company) formed by such consolidation or into which the Company is merged or the Person which acquires by conveyance or transfer the properties and assets of the Company substantially as an entirety shall expressly assume, by an indenture supplemental hereto, executed and delivered to the Trustee, in form satisfactory to the Trustee, the due and punctual payment of the principal of (and premium, if any) and interest, if any, on all the Securities and the performance of every covenant of this Indenture on the part of the Company to be performed or observed;

(2) immediately after giving effect to such transaction, no Default or Event of Default shall have happened and be continuing; and

(3) the Company and the successor Person have delivered to the Trustee an Officers’ Certificate and an Opinion of Counsel each stating that such consolidation, merger, conveyance or transfer and such supplemental indenture comply with this Article and that all conditions precedent herein provided for relating to such transaction have been complied with.

 

SECTION 802.		Successor Person Substituted.

Upon any consolidation or merger, or any conveyance or transfer of the properties and assets of the Company substantially as an entirety in accordance with Section 801, the successor corporation formed by such consolidation or into which the Company is merged or the successor Person to which such conveyance or transfer is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under this Indenture with the same effect as if such successor had been named as the Company herein; and in the event of any such conveyance or transfer, the Company shall be discharged from all obligations and covenants under this Indenture and the Securities and may be dissolved and liquidated.

ARTICLE NINE

SUPPLEMENTAL INDENTURES

 

SECTION 901.		Supplemental Indentures Without Consent of Holders.

Without the consent of any Holders of Securities, the Company, when authorized by or pursuant to a Board Resolution, and the Trustee, at any time and from time to time, may enter into one or more indentures supplemental hereto, in form reasonably satisfactory to the Trustee, for any of the following purposes:

(1) to evidence the succession of another Person to the Company and the assumption by any such successor of the covenants of the Company herein and in the Securities contained; or

 

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(2) to add to the covenants of the Company for the benefit of the Holders of all or any series of Securities (and if such covenants are to be for the benefit of less than all series of Securities, stating that such covenants are expressly being included solely for the benefit of such series) or to surrender any right or power herein conferred upon the Company; or

(3) to add any additional Events of Default for the benefit of the Holders of all or any series of Securities (and if such Events of Default are to be for the benefit of less than all series of Securities, stating that such Events of Default are expressly being included solely for the benefit of such series); provided, however, that in respect of any such additional Events of Default such supplemental indenture may provide for a particular period of grace after default (which period may be shorter or longer than that allowed in the case of other defaults) or may provide for an immediate enforcement upon such default or may limit the remedies available to the Trustee upon such default or may limit the right of the Holders of a majority in aggregate principal amount of that or those series of Securities to which such additional Events of Default apply to waive such default; or

(4) to change or eliminate any of the provisions of this Indenture; provided that any such change or elimination shall become effective only when there is no Security Outstanding of any series created prior to the execution of such supplemental indenture which is entitled to the benefit of such provision; or

(5) to secure the Securities; or

(6) to establish the form or terms of Securities of any series as permitted by Sections 201 and 301, including the provisions and procedures relating to Securities convertible into or exchangeable for any securities of any Person (including the Company); or

(7) to evidence and provide for the acceptance of appointment hereunder by a successor Trustee with respect to the Securities of one or more series and to add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee; or

(8) to cure any ambiguity, to correct or supplement any provision herein which may be inconsistent with any other provision herein, or to make any other provisions with respect to matters or questions arising under this Indenture; provided that such action shall not adversely affect the interests of the Holders of Securities of any series in any material respect; or

(9) to supplement any of the provisions of this Indenture to such extent as shall be necessary to permit or facilitate the defeasance and discharge of any series of Securities pursuant to Sections 401, 1402 and 1403; provided that any such action shall not adversely affect the interests of the Holders of Securities of such series or any other series of Securities in any material respect.

 

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SECTION 902.		Supplemental Indentures with Consent of Holders.

With the consent of the Holders of not less than a majority in aggregate principal amount of all Outstanding Securities affected by such supplemental indenture, by Act of said Holders delivered to the Company and the Trustee, the Company, when authorized by or pursuant to a Board Resolution, and the Trustee may enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture which affects such series of Securities or of modifying in any manner the rights of the Holders of such series of Securities under this Indenture; provided, however, that no such supplemental indenture shall, without the consent of the Holder of each Outstanding Security affected thereby:

(1) change the Stated Maturity of the principal of (or premium, if any) or any installment of principal of or interest on, any Security, subject to the provisions of Section 308; or the terms of any sinking fund with respect to any Security; or reduce the principal amount thereof or the rate of interest (or change the manner of calculating the rate of interest, thereon, or any premium payable upon the redemption thereof, or change any obligation of the Company to pay Additional Amounts pursuant to Section 1004 (except as contemplated by Section 801(1) and permitted by Section 901(1)), or reduce the portion of the principal of an Original Issue Discount Security or Indexed Security that would be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 502, or upon the redemption thereof or the amount thereof provable in bankruptcy pursuant to Section 504, or adversely affect any right of repayment at the option of the Holder of any Security, or change any Place of Payment where, or the Currency in which, any Security or any premium or interest thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity thereof (or, in the case of redemption or repayment at the option of the Holder, on or after the Redemption Date or the Repayment Date, as the case may be), or adversely affect any right to convert or exchange any Security as may be provided pursuant to Section 301 herein, or

(2) reduce the percentage in principal amount of the Outstanding Securities of any series, the consent of whose Holders is required for any such supplemental indenture, or the consent of whose Holders is required for any waiver with respect to such series (of compliance with certain provisions of this Indenture or certain defaults hereunder and their consequences) provided for in this Indenture, or reduce the requirements of Section 1504 for quorum or voting, or

(3) modify any of the provisions of this Section, Section 513 or Section 1006, except to increase any such percentage or to provide that certain other provisions of this Indenture cannot be modified or waived without the consent of the Holder of each Outstanding Security affected thereby; provided, however, that this clause shall not be deemed to require the consent of any Holder of a Security with respect to changes in the references to “the Trustee” and concomitant changes in this Section, or the deletion of this proviso, in accordance with the requirements of Sections 610(b) and 901(8).

It shall not be necessary for any Act of Holders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such Act shall approve the substance thereof.

 

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A supplemental indenture which changes or eliminates any covenant or other provision of this Indenture which has expressly been included solely for the benefit of one or more particular series of Securities, or which modifies the rights of the Holders of Securities of such series with respect to such covenant or other provision, shall be deemed not to affect the rights under this Indenture of the Holders of Securities of any other series.

The Company may, but shall not be obligated to, fix a record date for the purpose of determining the Persons entitled to consent to any indenture supplemental hereto. If a record date is fixed, the Holders on such record date, or their duly designated proxies, and only such Persons, shall be entitled to consent to such supplemental indenture, whether or not such Holders remain Holders after such record date; provided, that unless such consent shall have become effective by virtue of the requisite percentage having been obtained prior to the date which is 90 days after such record date, any such consent previously given shall automatically and without further action by any Holder be cancelled and of no further effect.

 

SECTION 903.		Execution of Supplemental Indentures.

In executing, or accepting the additional trusts created by, any supplemental indenture permitted by this Article or the modification thereby of the trusts created by this Indenture, the Trustee shall be entitled to receive, and shall be fully protected in relying upon, in addition to the documents required by Section 102 of this Indenture, an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture. The Trustee may, but shall not be obligated to, enter into any such supplemental indenture which affects the Trustee’s own rights, duties or immunities under this Indenture or otherwise.

 

SECTION 904.		Effect of Supplemental Indentures.

Upon the execution of any supplemental indenture under this Article, this Indenture shall be modified in accordance therewith, and such supplemental indenture shall form a part of this Indenture for all purposes; and every Holder of Securities theretofore or thereafter authenticated and delivered hereunder shall be bound thereby.

 

SECTION 905.		Conformity with Trust Indenture Act.

Every supplemental indenture executed pursuant to this Article shall conform to the requirements of the Trust Indenture Act as then in effect.

 

SECTION 906.		Reference in Securities to Supplemental Indentures.

Securities of any series authenticated and delivered after the execution of any supplemental indenture pursuant to this Article may, and shall, if required by the Trustee, bear a notation in form approved by the Trustee as to any matter provided for in such supplemental indenture. If the Company shall so determine, new Securities of any series so modified as to conform, in the opinion of the Trustee and the Company, to any such supplemental indenture may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities of such series.

 

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ARTICLE TEN

COVENANTS

 

SECTION 1001.		Payment of Principal, Premium, if any, and Interest.

The Company covenants and agrees for the benefit of the Holders of each series of Securities that it will duly and punctually pay the principal of (and premium, if any, on) and interest, if any, on the Securities of that series in accordance with the terms of such series of Securities and this Indenture. Unless otherwise specified with respect to Securities of any series pursuant to Section 301, at the option of the Company, all payments of principal may be paid by check to the registered Holder of the Registered Security or other person entitled thereto against surrender of such Security.

 

SECTION 1002.		Maintenance of Office or Agency.

The Company shall maintain in each Place of Payment for any series of Securities an office or agency where Securities of that series may be presented or surrendered for payment, where Securities of that series may be surrendered for registration of transfer or exchange, where Securities of that series that are convertible or exchangeable may be surrendered for conversion or exchange, as applicable, and where notices and demands to or upon the Company in respect of the Securities of that series and this Indenture may be served. The Company will give prompt written notice to the Trustee of the location, and any change in the location, of each such office or agency. If at any time the Company shall fail to maintain any such required office or agency in respect of any series of Securities or shall fail to furnish the Trustee with the address thereof, such presentations, surrenders, notices and demands may be made or served at the Corporate Trust Office of the Trustee, and the Company hereby appoints the Trustee at its Corporate Trust Office as its agent to receive such respective presentations, surrenders, notices and demands.

The Company may also from time to time designate one or more other offices or agencies where the Securities of one or more series may be presented or surrendered for any or all of such purposes, and may from time to time rescind such designations; provided, however, that no such designation or rescission shall in any manner relieve the Company of its obligation to maintain an office or agency in accordance with the requirements set forth above for Securities of any series for such purposes. The Company will give prompt written notice to the Trustee of any such designation or rescission and of any change in the location of any such other office or agency. Unless otherwise specified with respect to any Securities pursuant to Section 301 with respect to a series of Securities, the Company hereby designates as a Place of Payment for each series of Securities the office or agency of the Company in the Borough of Manhattan, The City of New York, and initially appoints the Trustee at its Corporate Trust Office as Paying Agent in the Borough of Manhattan, The City of New York and as its agent to receive all such presentations, surrenders, notices and demands.

Unless otherwise specified with respect to any Securities pursuant to Section 301, if and so long as the Securities of any series (i) are denominated in a currency other than Dollars or (ii) may be payable in a currency other than Dollars, or so long as it is required under any other provision of the Indenture, then the Company will maintain with respect to each such series of Securities, or as so required, at least one Exchange Rate Agent.

 

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SECTION 1003.		Money for Securities Payments to Be Held in Trust.

If the Company shall at any time act as its own Paying Agent with respect to any series of any Securities, it will, on or before each due date of the principal of (or premium, if any) or interest, if any, on any of the Securities of that series, segregate and hold in trust for the benefit of the Persons entitled thereto a sum in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)), sufficient to pay the principal (and premium, if any) and interest, if any, on Securities of such series so becoming due until such sums shall be paid to such Persons or otherwise disposed of as herein provided, and will promptly notify the Trustee of its action or failure so to act.

Whenever the Company shall have one or more Paying Agents for any series of Securities, it will, on or before each due date of the principal of (or premium, if any) or interest, if any, on any Securities of that series, deposit with a Paying Agent a sum (in the Currency or Currencies described in the preceding paragraph) sufficient to pay the principal (or premium, if any) or interest, if any, so becoming due, such sum of money to be held in trust for the benefit of the Persons entitled to such principal, premium or interest and (unless such Paying Agent is the Trustee) the Company will promptly notify the Trustee of its action or failure so to act.

The Company may at any time, for the purpose of obtaining the satisfaction and discharge of this Indenture or for any other purpose, pay, or by Company Order direct any Paying Agent to pay, to the Trustee all sums of money held in trust by the Company or such Paying Agent, such sums to be held by the Trustee upon the same trusts as those upon which such sums were held by the Company or such Paying Agent; and, upon such payment by any Paying Agent to the Trustee, such Paying Agent shall be released from all further liability with respect to such sums.

Except as otherwise provided in the Securities of any series, any money deposited with the Trustee or any Paying Agent, or then held by the Company, in trust for the payment of the principal of (or premium, if any) or interest, if any, on any Security of any series and remaining unclaimed for two years after such principal, premium or interest has become due and payable shall be paid to the Company upon Company Request, or (if then held by the Company) shall be discharged from such trust; and the Holder of such Security shall thereafter, as an unsecured general creditor, look only to the Company for payment thereof, and all liability of the Trustee or such Paying Agent with respect to such money held in trust, and all liability of the Company as trustee thereof, shall thereupon cease; provided, however, that the Trustee or such Paying Agent, before being required to make any such repayment, may at the expense of the Company cause to be published once, in an Authorized Newspaper, notice that such money remains unclaimed and that, after a date specified therein, which shall not be less than 30 days from the date of such publication, any unclaimed balance of such money then remaining will be repaid to the Company.

 

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SECTION 1004.		Additional Amounts.

If the Securities of a series provide for the payment of Additional Amounts, the Company will pay to the Holder of any Security of such series such Additional Amounts as may be specified as contemplated by Section 301. Whenever in this Indenture there is mentioned, in any context, the payment of the principal of (or premium, if any) or interest, if any, on any Security of any series or the net proceeds received on the sale or exchange of any Security of any series, such mention shall be deemed to include mention of the payment of Additional Amounts provided for by the terms of such series established pursuant to Section 301 to the extent that, in such context, Additional Amounts are, were or would be payable in respect thereof pursuant to such terms and express mention of the payment of Additional Amounts (if applicable) in any provisions hereof shall not be construed as excluding Additional Amounts in those provisions hereof where such express mention is not made.

Except as otherwise specified as contemplated by Section 301, if the Securities of a series provide for the payment of Additional Amounts, at least 10 days prior to the first Interest Payment Date with respect to that series of Securities (or if the Securities of that series will not bear interest prior to Maturity, the first day on which a payment of principal premium is made), and at least 10 days prior to each date of payment of principal, premium or interest if there has been any change with respect to the matters set forth in the below-mentioned Officers’ Certificate, the Company will furnish the Trustee and the Company’s principal Paying Agent or Paying Agents, if other than the Trustee, with an Officers’ Certificate instructing the Trustee and such Paying Agent or Paying Agents whether such payment of principal, premium or interest on the Securities of that series shall be made to Holders of Securities of that series who are not United States persons without withholding for or on account of any tax, assessment or other governmental charge described in the Securities of that series. If any such withholding shall be required, then such Officers’ Certificate shall specify by country the amount, if any, required to be withheld on such payments to such Holders of Securities of that series and the Company will pay to the Trustee or such Paying Agent the Additional Amounts required by the terms of such Securities. In the event that the Trustee or any Paying Agent, as the case may be, shall not so receive the above-mentioned certificate, then the Trustee or such Paying Agent shall be entitled (i) to assume that no such withholding or deduction is required with respect to any payment of principal or interest with respect to any Securities of a series until it shall have received a certificate advising otherwise and (ii) to make all payments of principal and interest with respect to the Securities of a series without withholding or deductions until otherwise advised. The Company covenants to indemnify the Trustee and any Paying Agent for, and to hold them harmless against, any loss, liability or expense reasonably incurred without negligence or bad faith on their part arising out of or in connection with actions taken or omitted by any of them in reliance on any Officers’ Certificate furnished pursuant to this Section or in reliance on the Company’s not furnishing such an Officers’ Certificate.

 

SECTION 1005.		Statement as to Compliance.

(1) The Company will deliver to the Trustee, within 120 days after the end of each fiscal year ending after the date hereof so long as any Security is Outstanding hereunder, a brief certificate from the principal executive officer, principal financial officer or principal accounting officer of the Company as to his or her knowledge of the Company’s compliance with all

 

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conditions and covenants under this Indenture. For purposes of this Section 1005, such compliance shall be determined without regard to any period of grace or requirement of notice under this Indenture.

(2) The Company will, so long as any series of Securities are Outstanding, deliver to the Trustee, as promptly as practicable upon any officer listed in (a) above becoming aware of any Default, Event of Default or default in the performance of any covenant, agreement or condition contained in this Indenture, an Officers’ Certificate specifying such Default, Event of Default, default or event of default and what action the Company is taking or proposes to take with respect thereto and the status thereof.

 

SECTION 1006.		Waiver of Certain Covenants.

As specified pursuant to Section 301(15), for Securities of any series, the Company may omit in any particular instance to comply with any covenant or condition set forth in any covenants of the Company added to Article Ten pursuant to Section 301(14) or Section 301 (15) in connection with the Securities of a series, if before or after the time for such compliance the Holders of at least a majority in aggregate principal amount of all Outstanding Securities of such series, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such covenant or condition, but no such waiver shall extend to or affect such covenant or condition except to the extent so expressly waived, and, until such waiver shall become effective, the obligations of the Company and the duties of the Trustee in respect of any such covenant or condition shall remain in full force and effect.

ARTICLE ELEVEN

REDEMPTION OF SECURITIES

 

SECTION 1101.		Applicability of Article.

Securities of any series which are redeemable before their Stated Maturity shall be redeemable in accordance with their terms and (except as otherwise specified as contemplated by Section 301 for Securities of any series) in accordance with this Article.

 

SECTION 1102.		Election to Redeem; Notice to Trustee.

The election of the Company to redeem any Securities shall be evidenced by or pursuant to a Board Resolution. In case of any redemption at the election of the Company of less than all of the Securities of any series, the Company shall, at least 60 days prior to the Redemption Date fixed by the Company (unless a shorter notice shall be satisfactory to the Trustee), notify the Trustee in writing of such Redemption Date and of the principal amount of Securities of such series to be redeemed, and, if applicable, of the tenor of the Securities to be redeemed, and shall deliver to the Trustee such documentation and records as shall enable the Trustee to select the Securities to be redeemed pursuant to Section 1103. In the case of any redemption of Securities of any series prior to the expiration of any restriction on such redemption provided in the terms of such Securities or elsewhere in this Indenture, the Company shall furnish the Trustee with an Officers’ Certificate evidencing compliance with such restriction.

 

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SECTION 1103.		Selection by Trustee of Securities to Be Redeemed.

If less than all the Securities of any series issued on the same day with the same terms are to be redeemed, the particular Securities to be redeemed shall be selected not more than 60 days prior to the Redemption Date by the Trustee, from the Outstanding Securities of such series issued on such date with the same terms not previously called for redemption, by such method as the Trustee shall deem fair and appropriate and otherwise in accordance with the procedures of the Depository; provided that such method complies with the rules of any national securities exchange or quotation system on which the Securities are listed, and may provide for the selection for redemption of portions (equal to the minimum authorized denomination for Securities of that series or any integral multiple thereof) of the principal amount of Securities of such series of a denomination larger than the minimum authorized denomination for Securities of that series; provided, however, that no such partial redemption shall reduce the portion of the principal amount of a Security not redeemed to less than the minimum authorized denomination for Securities of such series.

The Trustee shall promptly notify the Company and the Security Registrar (if other than itself) in writing of the Securities selected for redemption and, in the case of any Securities selected for partial redemption, the principal amount thereof to be redeemed.

For all purposes of this Indenture, unless the context otherwise requires, all provisions relating to the redemption of Securities shall relate, in the case of any Security redeemed or to be redeemed only in part, to the portion of the principal amount of such Security which has been or is to be redeemed.

 

SECTION 1104.		Notice of Redemption.

Notice of redemption shall be given in the manner provided in Section 106, not less than 30 days nor more than 60 days prior to the Redemption Date, unless a shorter period is specified by the terms of such series established pursuant to Section 301, to each Holder of Securities to be redeemed, but failure to give such notice in the manner herein provided to the Holder of any Security designated for redemption as a whole or in part, or any defect in the notice to any such Holder, shall not affect the validity of the proceedings for the redemption of any other such Security or portion thereof.

Any notice that is mailed to the Holders of Registered Securities in the manner herein provided shall be conclusively presumed to have been duly given, whether or not the Holder receives the notice.

All notices of redemption shall state:

(1) the Redemption Date,

(2) the Redemption Price and accrued interest, if any, to the Redemption Date payable as provided in Section 1106,

 

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(3) if less than all Outstanding Securities of any series are to be redeemed, the identification (and, in the case of partial redemption, the principal amount) of the particular Security or Securities to be redeemed,

(4) in case any Security is to be redeemed in part only, the notice which relates to such Security shall state that on and after the Redemption Date, upon surrender of such Security, the Holder will receive, without a charge, a new Security or Securities of authorized denominations for the principal amount thereof remaining unredeemed,

(5) that on the Redemption Date, the Redemption Price and accrued interest, if any, to the Redemption Date payable as provided in Section 1106 will become due and payable upon each such Security, or the portion thereof, to be redeemed and, if applicable, that interest thereon shall cease to accrue on and after said date,

(6) the Place or Places of Payment where such Securities, are to be surrendered for payment of the Redemption Price and accrued interest, if any,

(7) that the redemption is for a sinking fund, if such is the case, and

(8) the CUSIP number of such Security, if any.

A notice of redemption published as contemplated by Section 106 need not identify particular Registered Securities to be redeemed. Notice of redemption of Securities to be redeemed shall be given by the Company or, at the Company’s request, by the Trustee in the name and at the expense of the Company.

 

SECTION 1105.		Deposit of Redemption Price.

On or prior to 10:00 am, New York City time, on any Redemption Date, the Company shall deposit with the Trustee or with a Paying Agent (or, if the Company is acting as its own Paying Agent, which it may not do in the case of a sinking fund payment under Article Twelve, segregate and hold in trust as provided in Section 1003) an amount of money in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)) sufficient to pay on the Redemption Date the Redemption Price of, and (unless otherwise specified pursuant to Section 301) accrued interest on, all the Securities or portions thereof which are to be redeemed on that date.

 

SECTION 1106.		Securities Payable on Redemption Date.

Notice of redemption having been given as aforesaid, the Securities so to be redeemed shall, on the Redemption Date, become due and payable at the Redemption Price therein specified in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)) (together with accrued interest, if any, to the Redemption Date), and from and after such date (unless the Company shall default in the payment of the Redemption Price and accrued interest, if any) such Securities shall if the same were interest-bearing cease to bear interest. Upon surrender of any such Security for redemption

 

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in accordance with said notice, such Security shall be paid by the Company at the Redemption Price, together with accrued interest, if any, to the Redemption Date; provided, however, that unless otherwise specified as contemplated by Section 301, installments of interest on Registered Securities whose Stated Maturity is on or prior to the Redemption Date shall be payable to the Holders of such Securities, or one or more Predecessor Securities, registered as such at the close of business on the relevant Record Dates according to their terms and the provisions of Section 307.

If any Security called for redemption shall not be so paid upon surrender thereof for redemption, the Redemption Price shall, until paid, bear interest from the Redemption Date at the rate of interest set forth in such Security or, in the case of an Original Issue Discount Security, at the Yield to Maturity of such Security.

 

SECTION 1107.		Securities Redeemed in Part.

Any Registered Security which is to be redeemed only in part (pursuant to the provisions of this Article or of Article Twelve) shall be surrendered at a Place of Payment therefor (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or such Holder’s attorney duly authorized in writing) and the Company shall execute and the Trustee shall authenticate and deliver to the Holder of such Security without service charge a new Security or Securities of the same series and of like tenor, of any authorized denomination as requested by such Holder in aggregate principal amount equal to and in exchange for the unredeemed portion of the principal of the Security so surrendered. If a temporary global Security or permanent global Security is so surrendered, such new Security so issued shall be a new temporary global Security or permanent global Security, respectively. However, if less than all the Securities of any series with differing issue dates, interest rates and stated maturities are to be redeemed, the Company in its sole discretion shall select the particular Securities to be redeemed and shall notify the Trustee in writing thereof at least 45 days prior to the relevant redemption date.

ARTICLE TWELVE

SINKING FUNDS

 

SECTION 1201.		Applicability of Article.

The provisions of this Article shall be applicable to any sinking fund for the retirement of Securities of a series except as otherwise specified as contemplated by Section 301 for Securities of such series.

The minimum amount of any sinking fund payment provided for by the terms of Securities of any series is herein referred to as a “mandatory sinking fund payment”, and any payment in excess of such minimum amount provided for by the terms of such Securities of any series is herein referred to as an “optional sinking fund payment”. If provided for by the terms of any Securities of any series, the cash amount of any mandatory sinking fund payment may be subject to reduction as provided in Section 1202. Each sinking fund payment shall be applied to the redemption of Securities of any series as provided for by the terms of Securities of such series.

 

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SECTION 1202.		Satisfaction of Sinking Fund Payments with Securities.

The Company may, in satisfaction of all or any part of any mandatory sinking fund payment with respect to the Securities of a series, (1) deliver Outstanding Securities of such series (other than any previously called for redemption) and (2) apply as a credit Securities of such series which have been redeemed either at the election of the Company pursuant to the terms of such Securities or through the application of permitted optional sinking fund payments pursuant to the terms of such Securities, as provided for by the terms of such Securities; provided that such Securities so delivered or applied as a credit have not been previously so credited. Such Securities shall be received and credited for such purpose by the Trustee at the applicable Redemption Price specified in such Securities for redemption through operation of the sinking fund and the amount of such mandatory sinking fund payment shall be reduced accordingly.

 

SECTION 1203.		Redemption of Securities for Sinking Fund.

Not less than 60 days prior to each sinking fund payment date for Securities of any series, the Company will deliver to the Trustee an Officers’ Certificate specifying the amount of the next ensuing mandatory sinking fund payment for that series pursuant to the terms of that series, the portion thereof, if any, which is to be satisfied by payment of cash in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)) and the portion thereof, if any, which is to be satisfied by delivering and crediting Securities of that series pursuant to Section 1202, and the optional amount, if any, to be added in cash to the next ensuing mandatory sinking fund payment, and will also deliver to the Trustee any Securities to be so delivered and credited. If such Officers’ Certificate shall specify an optional amount to be added in cash to the next ensuing mandatory sinking fund payment, the Company shall thereupon be obligated to pay the amount therein specified. Not less than 30 days before each such sinking fund payment date the Trustee shall select the Securities to be redeemed upon such sinking fund payment date in the manner specified in Section 1103 and cause notice of the redemption thereof to be given in the name of and at the expense of the Company in the manner provided in Section 1104. Such notice having been duly given, the redemption of such Securities shall be made upon the terms and in the manner stated in Sections 1106 and 1107.

ARTICLE THIRTEEN

REPAYMENT AT THE OPTION OF HOLDERS

 

SECTION 1301.		Applicability of Article.

Repayment of Securities of any series before their Stated Maturity at the option of Holders thereof shall be made in accordance with the terms of such Securities and (except as otherwise specified by the terms of such series established pursuant to Section 301) in accordance with this Article.

 

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SECTION 1302.		Repayment of Securities.

Securities of any series subject to repayment in whole or in part at the option of the Holders thereof will, unless otherwise provided in the terms of such Securities, be repaid at the Repayment Price thereof, together with interest, if any, thereon accrued to the Repayment Date specified in or pursuant to the terms of such Securities. The Company covenants that on or before 10:00 am, New York City time, on the Repayment Date it will deposit with the Trustee or with a Paying Agent (or, if the Company is acting as its own Paying Agent, segregate and hold in trust as provided in Section 1003) an amount of money in the Currency in which the Securities of such series are payable (except as otherwise specified pursuant to Section 301 for the Securities of such series and except, if applicable, as provided in Sections 312(b), 312(d) and 312(e)) sufficient to pay the Repayment Price of, and (unless otherwise specified pursuant to Section 301) accrued interest on, all the Securities or portions thereof, as the case may be, to be repaid on such date.

 

SECTION 1303.		Exercise of Option.

Securities of any series subject to repayment at the option of the Holders thereof will contain an “Option to Elect Repayment” form on the reverse of such Securities. To be repaid at the option of the Holder, any Security so providing for such repayment, with the “Option to Elect Repayment” form on the reverse of such Security duly completed by the Holder (or by the Holder’s attorney duly authorized in writing), must be received by the Company at the Place of Payment therefor specified in the terms of such Security (or at such other place or places of which the Company shall from time to time notify the Holders of such Securities) not earlier than 45 days nor later than 30 days prior to the Repayment Date. If less than the entire Repayment Price of such Security is to be repaid in accordance with the terms of such Security, the portion of the Repayment Price of such Security to be repaid, in increments of the minimum denomination for Securities of such series, and the denomination or denominations of the Security or Securities to be issued to the Holder for the portion of such Security surrendered that is not to be repaid, must be specified. Any Security providing for repayment at the option of the Holder thereof may not be repaid in part if, following such repayment, the unpaid principal amount of such Security would be less than the minimum authorized denomination of Securities of the series of which such Security to be repaid is a part. Except as otherwise may be provided by the terms of any Security providing for repayment at the option of the Holder thereof, exercise of the repayment option by the Holder shall be irrevocable unless waived by the Company.

 

SECTION 1304.		When Securities Presented for Repayment Become Due and Payable.

If Securities of any series providing for repayment at the option of the Holders thereof shall have been surrendered as provided in this Article and as provided by or pursuant to the terms of such Securities, such Securities or the portions thereof, as the case may be, to be repaid shall become due and payable and shall be paid by the Company on the Repayment Date therein specified, and on and after such Repayment Date (unless the Company shall default in the payment of such Securities on such Repayment Date) such Securities shall, if the same were interest-bearing, cease to bear interest. Upon surrender of any such Security for repayment in accordance with such provisions, the Repayment Price of such Security so to be repaid shall be

 

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paid by the Company, together with accrued interest, if any, to the Repayment Date; provided, however, that installments of interest on Registered Securities, whose Stated Maturity is prior to (or, if specified pursuant to Section 301, on) the Repayment Date shall be payable (but without interest thereon, unless the Company shall default in the payment thereof) to the Holders of such Securities, or one or more Predecessor Securities, registered as such at the close of business on the relevant Record Dates according to their terms and the provisions of Section 307.

If any Security surrendered for repayment shall not be so repaid upon surrender thereof, the Repayment Price shall, until paid, bear interest from the Repayment Date at the rate of interest set forth in such Security or, in the case of an Original Issue Discount Security, at the Yield to Maturity of such Security.

 

SECTION 1305.		Securities Repaid in Part.

Upon surrender of any Registered Security which is to be repaid in part only, the Company shall execute and the Trustee shall authenticate and deliver to the Holder of such Security, without service charge and at the expense of the Company, a new Registered Security or Securities of the same series, and of like tenor, of any authorized denomination specified by the Holder, in an aggregate principal amount equal to and in exchange for the portion of the principal of such Security so surrendered which is not to be repaid. If a temporary global Security or permanent global Security is so surrendered, such new Security so issued shall be a new temporary global Security or a new permanent global Security, respectively.

ARTICLE FOURTEEN

DEFEASANCE AND COVENANT DEFEASANCE

 

SECTION 1401.		Applicability of Article; Company’s Option to Effect Defeasance or Covenant Defeasance.

If pursuant to Section 301 provision is made for either or both of (a) defeasance of the Securities of or within a series under Section 1402 or (b) covenant defeasance of the Securities of or within a series under Section 1403, then the provisions of such Section or Sections, as the case may be, together with the other provisions of this Article (with such modifications thereto as may be specified pursuant to Section 301 with respect to any Securities), shall be applicable to such Securities, and the Company may at its option by Board Resolution, at any time, with respect to such Securities, elect to have either Section 1402 (if applicable) or Section 1403 (if applicable) be applied to such Outstanding Securities upon compliance with the conditions set forth below in this Article.

 

SECTION 1402.		Defeasance and Discharge.

Upon the Company’s exercise of the above option applicable to this Section with respect to any Securities of or within a series, the Company shall be deemed to have been discharged from its obligations with respect to such Outstanding Securities on and after the date the conditions set forth in Section 1404 are satisfied (hereinafter, “defeasance”). For this purpose, such defeasance means that the Company shall be deemed to have paid and discharged the entire

 

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indebtedness represented by such Outstanding Securities, which shall thereafter be deemed to be “Outstanding” only for the purposes of Section 1405 and the other Sections of this Indenture referred to in clauses (A) and (B) of this Section, and to have satisfied all its other obligations under such Securities and this Indenture insofar as such Securities are concerned (and the Trustee, at the expense of the Company, shall execute proper instruments acknowledging the same), except for the following which shall survive until otherwise terminated or discharged hereunder: (A) the rights of Holders of such Outstanding Securities to receive, solely from the trust fund described in Section 1404 and as more fully set forth in such Section, payments in respect of the principal of (and premium, if any, on) and interest, if any, on such Securities when such payments are due, (B) the Company’s obligations with respect to such Securities under Sections 305, 306, 1002 and 1003 and with respect to the payment of Additional Amounts, if any, on such Securities as contemplated by Section 1004, (C) the rights, powers, trusts, duties and immunities of the Trustee hereunder and (D) this Article. Subject to compliance with this Article Fourteen, the Company may exercise its option under this Section notwithstanding the prior exercise of its option under Section 1403 with respect to such Securities. Following a defeasance, payment of such Securities may not be accelerated because of an Event of Default.

 

SECTION 1403.		Covenant Defeasance.

Upon the Company’s exercise of the above option applicable to this Section with respect to any Securities of or within a series, if specified pursuant to Section 301, the Company shall be released from its obligations under any covenant, with respect to such Outstanding Securities on and after the date the conditions set forth in Section 1404 are satisfied (hereinafter, “covenant defeasance”), and such Securities shall thereafter be deemed to be not “Outstanding” for the purposes of any direction, waiver, consent or declaration or Act of Holders (and the consequences of any thereof) in connection with such covenant, but shall continue to be deemed “Outstanding” for all other purposes hereunder. For this purpose, such covenant defeasance means that, with respect to such Outstanding Securities, the Company may omit to comply with and shall have no liability in respect of any term, condition or limitation set forth in any such Section or such other covenant, whether directly or indirectly, by reason of any reference elsewhere herein to any such Section or such other covenant or by reason of reference in any such Section or such other covenant to any other provision herein or in any other document and such omission to comply shall not constitute a Default or an Event of Default under Section 501(4) or 501(8) or otherwise, as the case may be, but, except as specified above, the remainder of this Indenture and such Securities shall be unaffected thereby. Following a covenant defeasance, payment of such Securities may not be accelerated because of an Event of Default solely by reference to such Sections specified above in this Section 1403.

 

SECTION 1404.		Conditions to Defeasance or Covenant Defeasance.

The following shall be the conditions to application of either Section 1402 or Section 1403 to any Outstanding Securities of or within a series:

(a) The Company shall have irrevocably deposited or caused to be irrevocably deposited with the Trustee (or another trustee satisfying the requirements of Section 607 who shall agree to comply with the provisions of this Article Fourteen applicable to it) as trust funds in trust for the purpose of making the following payments, specifically pledged as security for

 

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the benefit of, and dedicated solely to, the Holders of such Securities, (1) an amount (in such Currency in which such Securities are then specified as payable at Stated Maturity), or (2) Government Obligations applicable to such Securities (determined on the basis of the Currency in which such Securities are then specified as payable at Stated Maturity) which through the scheduled payment of principal and interest in respect thereof in accordance with their terms will provide, not later than one day before the due date of any payment of principal of (and premium, if any, on) and interest, if any, on such Securities, money in an amount, or (3) a combination thereof in an amount, sufficient, in the opinion of a nationally recognized firm of independent public accountants expressed in a written certification thereof delivered to the Trustee, to pay and discharge, and which shall be applied by the Trustee (or other qualifying trustee) to pay and discharge, (i) the principal of (and premium, if any, on) and interest, if any, on such Outstanding Securities on the Stated Maturity of such principal or installment of principal or interest and (ii) any mandatory sinking fund payments or analogous payments applicable to such Outstanding Securities on the day on which such payments are due and payable in accordance with the terms of this Indenture and of such Securities.

(b) Such defeasance or covenant defeasance shall not result in a breach or violation of, or constitute a default under, this Indenture or any other material agreement or instrument to which the Company is a party or by which it is bound.

(c) No Default or Event of Default with respect to such Securities shall have occurred and be continuing on the date of such deposit or, insofar as Sections 501(5) and 501(6) are concerned, at any time during the period ending on the 91st day after the date of such deposit (it being understood that this condition shall not be deemed satisfied until the expiration of such period).

(d) In the case of an election under Section 1402, the Company shall have delivered to the Trustee an Opinion of Counsel stating that (i) the Company has received from, or there has been published by, the Internal Revenue Service a ruling, or (ii) since the date of execution of this Indenture, there has been a change in the applicable Federal income tax law, in either case to the effect that, and based thereon such opinion shall confirm that, the Holders of such Outstanding Securities will not recognize income, gain or loss for Federal income tax purposes as a result of such defeasance and will be subject to Federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such defeasance had not occurred.

(e) In the case of an election under Section 1403, the Company shall have delivered to the Trustee an Opinion of Counsel to the effect that the Holders of such Outstanding Securities will not recognize income, gain or loss for Federal income tax purposes as a result of such covenant defeasance and will be subject to Federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such covenant defeasance had not occurred.

(f) The Company shall have delivered to the Trustee an Officers’ Certificate and an Opinion of Counsel, each stating that all conditions precedent to either the defeasance under Section 1402 or the covenant defeasance under Section 1403 (as the case may be) have been complied with and an Opinion of Counsel to the effect that as a result of a deposit pursuant to

 

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subsection (a) above and the related exercise of the Company’s option under Section 1402 or Section 1403 (as the case may be), registration is not required under the Investment Company Act of 1940, as amended, by the Company, with respect to the trust funds representing such deposit or by the trustee for such trust funds.

(g) Notwithstanding any other provisions of this Section, such defeasance or covenant defeasance shall be effected in compliance with any additional or substitute terms, conditions or limitations which may be imposed on the Company in connection therewith pursuant to Section 301.

 

SECTION 1405.		Deposited Money and Government Obligations to Be Held in Trust; Other Miscellaneous Provisions.

Subject to the provisions of the last paragraph of Section 1003, all money and Government Obligations (or other property as may be provided pursuant to Section 301) (including the proceeds thereof) deposited with the Trustee (or other qualifying trustee, collectively for purposes of this Section 1405, the “Trustee”) pursuant to Section 1404 in respect of any Outstanding Securities of any series shall be held in trust and applied by the Trustee, in accordance with the provisions of such Securities and this Indenture, to the payment, either directly or through any Paying Agent (including the Company acting as its own Paying Agent) as the Trustee may determine, to the Holders of such Securities of all sums due and to become due thereon in respect of principal (and premium, if any) and interest, if any, but such money need not be segregated from other funds except to the extent required by law.

Unless otherwise specified with respect to any Security pursuant to Section 301, if, after a deposit referred to in Section 1404(a) has been made, (a) the Holder of a Security in respect of which such deposit was made is entitled to, and does, elect pursuant to Section 312(b) or the terms of such Security to receive payment in a Currency other than that in which the deposit pursuant to Section 1404(a) has been made in respect of such Security, or (b) a Conversion Event occurs as contemplated in Section 312(d) or 312(e) or by the terms of any Security in respect of which the deposit pursuant to Section 1404(a) has been made, the indebtedness represented by such Security shall be deemed to have been, and will be, fully discharged and satisfied through the payment of the principal of (and premium, if any, on) and interest, if any, on such Security as the same becomes due out of the proceeds yielded by converting (from time to time as specified below in the case of any such election) the amount or other property deposited in respect of such Security into the Currency in which such Security becomes payable as a result of such election or Conversion Event based on the applicable Market Exchange Rate for such Currency in effect on the second Business Day prior to each payment date, except, with respect to a Conversion Event, such conversion shall be based on the applicable Market Exchange Rule for such Currency in effect (as nearly as feasible) at the time of the Conversion Event.

The Company shall pay and indemnify the Trustee against any tax, fee or other charge imposed on or assessed against the money or Government Obligations deposited pursuant to Section 1404 or the principal and interest received in respect thereof other than any such tax, fee or other charge which by law is for the account of the Holders of such Outstanding Securities.

 

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Anything in this Article to the contrary notwithstanding, the Trustee shall deliver or pay to the Company from time to time upon Company Request any money or Government Obligations (or other property and any proceeds therefrom) held by it as provided in Section 1404 which, in the opinion of a nationally recognized firm of independent public accountants expressed in a written certification thereof delivered to the Trustee, are in excess of the amount thereof which would then be required to be deposited to effect a defeasance or covenant defeasance, as applicable, in accordance with this Article.

ARTICLE FIFTEEN

MEETINGS OF HOLDERS OF SECURITIES

 

SECTION 1501.		Purposes for Which Meetings May Be Called.

A meeting of Holders of any series of Securities may be called at any time and from time to time pursuant to this Article to make, give or take any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be made, given or taken by Holders of Securities of such series.

 

SECTION 1502.		Call, Notice and Place of Meetings.

(a) The Trustee may at any time call a meeting of Holders of Securities of any series for any purpose specified in Section 1501, to be held at such time and at such place in the Borough of Manhattan, The City of New York as the Trustee shall determine. Notice of every meeting of Holders of Securities of any series, setting forth the time and the place of such meeting and in general terms the action proposed to be taken at such meeting, shall be given, in the manner provided in Section 106, not less than 21 nor more than 180 days prior to the date fixed for the meeting.

(b) In case at any time the Company, pursuant to a Board Resolution, or the Holders of at least 10% in principal amount of the Outstanding Securities of any series shall have requested the Trustee to call a meeting of the Holders of Securities of such series for any purpose specified in Section 1501, by written request setting forth in reasonable detail the action proposed to be taken at the meeting, and the Trustee shall not have made the first publication or mailing of the notice of such meeting within 21 days after receipt of such request or shall not thereafter proceed to cause the meeting to be held as provided herein, then the Company or the Holders of Securities of such series in the amount above specified, as the case may be, may determine the time and the place in the Borough of Manhattan, The City of New York for such meeting and may call such meeting for such purposes by giving notice thereof as provided in subsection (a) of this Section.

 

SECTION 1503.		Persons Entitled to Vote at Meetings.

To be entitled to vote at any meeting of Holders of Securities of any series, a Person shall be (1) a Holder of one or more Outstanding Securities of such series, or (2) a Person appointed by an instrument in writing as proxy for a Holder or Holders of one or more Outstanding Securities of such series by such Holder or Holders. The only Persons who shall be entitled to be

 

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present or to speak at any meeting of Holders of Securities of any series shall be the Persons entitled to vote at such meeting and their counsel, any representatives of the Trustee and its counsel and any representatives of the Company and its counsel.

 

SECTION 1504.		Quorum; Action.

The Persons entitled to vote a majority in principal amount of the Outstanding Securities of a series shall constitute a quorum for a meeting of Holders of Securities of such series; provided, however, that if any action is to be taken at such meeting with respect to a consent, waiver, request, demand, notice, authorization, direction or other action which this Indenture expressly provides may be made, given or taken by the Holders of not less than a specified percentage in principal amount of the Outstanding Securities of a series, the Persons entitled to vote such specified percentage in principal amount of the Outstanding Securities of such series shall constitute a quorum. In the absence of a quorum within 30 minutes of the time appointed for any such meeting, the meeting shall, if convened at the request of Holders of Securities of such series, be dissolved. In any other case the meeting may be adjourned for a period of not less than 10 days as determined by the chairman of the meeting prior to the adjournment of such meeting. In the absence of a quorum at any such adjourned meeting, such adjourned meeting may be further adjourned for a period of not less than 10 days as determined by the chairman of the meeting prior to the adjournment of such adjourned meeting. Notice of the reconvening of any adjourned meeting shall be given as provided in Section 1502(a), except that such notice need be given only once not less than five days prior to the date on which the meeting is scheduled to be reconvened. Notice of the reconvening of any adjourned meeting shall state expressly the percentage, as provided above, of the principal amount of the Outstanding Securities of such series which shall constitute a quorum.

Except as limited by the proviso to Section 902, any resolution presented to a meeting or adjourned meeting duly reconvened at which a quorum is present as aforesaid may be adopted by the affirmative vote of the Holders of a majority in principal amount of the Outstanding Securities of that series; provided, however, that, except as limited by the proviso to Section 902, any resolution with respect to any consent, waiver, request, demand, notice, authorization, direction or other action which this Indenture expressly provides may be made, given or taken by the Holders of a specified percentage, which is less than a majority, in principal amount of the Outstanding Securities of a series may be adopted at a meeting or an adjourned meeting duly reconvened and at which a quorum is present as aforesaid by the affirmative vote of the Holders of such specified percentage in principal amount of the Outstanding Securities of that series.

Any resolution passed or decision taken at any meeting of Holders of Securities of any series duly held in accordance with this Section shall be binding on all the Holders of Securities of such series, whether or not present or represented at the meeting.

Notwithstanding the foregoing provisions of this Section 1504, if any action is to be taken at a meeting of Holders of Securities of any series with respect to any consent, waiver, request, demand, notice, authorization, direction or other action that this Indenture expressly provides may be made, given or taken by the Holders of a specified percentage in principal amount of all Outstanding Securities affected thereby, or of the Holders of such series and one or more additional series:

(i) there shall be no minimum quorum requirement for such meeting; and

 

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(ii) the principal amount of the Outstanding Securities of such series that vote in favor of such consent, waiver, request, demand, notice, authorization, direction or other action shall be taken into account in determining whether such request, demand, authorization, direction, notice, consent, waiver or other action has been made, given or taken under this Indenture.

 

SECTION 1505.		Determination of Voting Rights; Conduct and Adjournment of Meetings.

(a) Notwithstanding any other provisions of this Indenture, the Trustee may make such reasonable regulations as it may deem advisable for any meeting of Holders of Securities of a series in regard to proof of the holding of Securities of such series and of the appointment of proxies and in regard to the appointment and duties of inspectors of votes, the submission and examination of proxies, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it shall deem appropriate. Except as otherwise permitted or required by any such regulations, the holding of Securities shall be proved in the manner specified in Section 104 and the appointment of any proxy shall be proved in the manner specified in Section 104. Such regulations may provide that written instruments appointing proxies, regular on their face, may be presumed valid and genuine without the proof specified in Section 104 or other proof.

(b) The Trustee shall, by an instrument in writing appoint a temporary chairman of the meeting, unless the meeting shall have been called by the Company or by Holders of Securities as provided in Section 1502(b), in which case the Company or the Holders of Securities of the series calling the meeting, as the case may be, shall in like manner appoint a temporary chairman. A permanent chairman and a permanent secretary of the meeting shall be elected by vote of the Persons entitled to vote a majority in principal amount of the Outstanding Securities of such series represented at the meeting.

(c) At any meeting of Holders, each Holder of a Security of such series or proxy shall be entitled to one vote for each $1,000 principal amount of the Outstanding Securities of such series held or represented by such Holder; provided, however, that no vote shall be cast or counted at any meeting in respect of any Security challenged as not Outstanding and ruled by the chairman of the meeting to be not Outstanding. The chairman of the meeting shall have no right to vote, except as a Holder of a Security of such series or proxy.

(d) Any meeting of Holders of Securities of any series duly called pursuant to Section 1502 at which a quorum is present may be adjourned from time to time by Persons entitled to vote a majority in principal amount of the Outstanding Securities of such series represented at the meeting, and the meeting may be held as so adjourned without further notice.

 

SECTION 1506.		Counting Votes and Recording Action of Meetings.

The vote upon any resolution submitted to any meeting of Holders of Securities of any series shall be by written ballots on which shall be subscribed the signatures of the Holders of Securities of such series or of their representatives by proxy and the principal amounts and serial

 

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numbers of the Outstanding Securities of such series held or represented by them. The permanent chairman of the meeting shall appoint two inspectors of votes who shall count all votes cast at the meeting for or against any resolution and who shall make and file with the secretary of the meeting their verified written reports in duplicate of all votes cast at the meeting. A record, at least in duplicate, of the proceedings of each meeting of Holders of Securities of any Series shall be prepared by the secretary of the meeting and there shall be attached to said record the original reports of the inspectors of votes on any vote by ballot taken thereat and affidavits by one or more persons having knowledge of the fact, setting forth a copy of the notice of the meeting and showing that said notice was given as provided in Section 1502 and, if applicable, Section 1504. Each copy shall be signed and verified by the affidavits of the permanent chairman and secretary of the meeting and one such copy shall be delivered to the Company and another to the Trustee to be preserved by the Trustee, the latter to have attached thereto the ballots voted at the meeting. Any record so signed and verified shall be conclusive evidence of the matters therein stated.

ARTICLE SIXTEEN

SUBORDINATION OF SECURITIES

 

SECTION 1601.		Agreement to Subordinate.

The Company, for itself, its successors and assigns, covenants and agrees, and each Holder of Subordinated Securities by his acceptance thereof, likewise covenants and agrees, that the payment of the principal of (and premium, if any) and interest, if any, on each and all of the Subordinated Securities is hereby expressly subordinated, to the extent and in the manner hereinafter set forth, in right of payment to the prior payment in full of all Designated Senior Indebtedness.

 

SECTION 1602.		Distribution on Dissolution, Liquidation and Reorganization; Subrogation of Subordinated Securities.

Upon any distribution of assets of the Company upon any dissolution, winding up, liquidation or reorganization of the Company, whether in bankruptcy, insolvency, reorganization or receivership proceedings or upon an assignment for the benefit of creditors or any other marshalling of the assets and liabilities of the Company or otherwise (subject to the power of a court of competent jurisdiction to make other equitable provision reflecting the rights conferred in this Indenture upon the Designated Senior Indebtedness and the holders thereof with respect to the Securities and the holders thereof by a lawful plan of reorganization under applicable bankruptcy law):

(a) the holders of all Designated Senior Indebtedness shall be entitled to receive payment in full of the principal thereof (and premium, if any) and interest due thereon before the Holders of the Subordinated Securities are entitled to receive any payment upon the principal (or premium, if any) or interest, if any, on indebtedness evidenced by the Subordinated Securities; and

 

74

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(b) any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities, to which the Holders of the Securities or the Trustee would be entitled except for the provisions of this Article Sixteen shall be paid by the liquidating trustee or agent or other person making such payment or distribution, whether a trustee in bankruptcy, a receiver or liquidating trustee or otherwise, directly to the holders of Designated Senior Indebtedness or their representative or representatives or to the trustee or trustees under any indenture under which any instruments evidencing any of such Designated Senior Indebtedness may have been issued, ratably according to the aggregate amounts remaining unpaid on account of the principal of (and premium, if any) and interest on the Designated Senior Indebtedness held or represented by each, to the extent necessary to make payment in full of all Designated Senior Indebtedness remaining unpaid, after giving effect to any concurrent payment or distribution to the holders of such Designated Senior Indebtedness; and

(c) in the event that, notwithstanding the foregoing, any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities, shall be received by the Trustee or the Holders of the Subordinated Securities before all Designated Senior Indebtedness is paid in full, such payment or distribution shall be paid over, upon written notice to the Trustee, to the holder of such Designated Senior Indebtedness or their representative or representatives or to the trustee or trustees under any indenture under which any instrument evidencing any of such Designated Senior Indebtedness may have been issued, ratably as aforesaid, for application to payment of all Designated Senior Indebtedness remaining unpaid until all such Designated Senior Indebtedness shall have been paid in full, after giving effect to any concurrent payment or distribution to the holders of such Designated Senior Indebtedness.

Subject to the payment in full of all Designated Senior Indebtedness, the Holders of the Subordinated Securities shall be subrogated to the rights of the holders of Designated Senior Indebtedness to receive payments or distributions of cash, property or securities of the Company applicable to Designated Senior Indebtedness until the principal of (and premium, if any, on) and interest, if any, on the Subordinated Securities shall be paid in full and no such payments or distributions to the Holders of the Subordinated Securities of cash, property or securities otherwise distributable to the holders of Designated Senior Indebtedness shall, as between the Company, its creditors other than the holders of Designated Senior Indebtedness, and the Holders of the Subordinated Securities be deemed to be a payment by the Company to or on account of the Subordinated Securities. It is understood that the provisions of this Article Sixteen are and are intended solely for the purpose of defining the relative rights of the Holders of the Subordinated Securities, on the one hand, and the holders of the Designated Senior Indebtedness, on the other hand. Nothing contained in this Article Sixteen or elsewhere in this Indenture or in the Subordinated Securities is intended to or shall impair, as between the Company, its creditors other than the holders of Designated Senior Indebtedness, and the Holders of the Subordinated Securities, the obligation of the Company, which is unconditional and absolute, to pay to the Holders of the Subordinated Securities the principal of (and premium, if any) and interest, if any, on the Subordinated Securities as and when the same shall become due and payable in accordance with their terms, or to affect the relative rights of the Holders of the Subordinated Securities and creditors of the Company other than the holders of Designated Senior Indebtedness, nor shall anything herein or in the Subordinated Securities prevent the Trustee or the Holder of any Subordinated Security from exercising all remedies otherwise permitted by applicable law upon default under this Indenture, subject to the rights, if any, under this Article Sixteen of the holders of Designated Senior Indebtedness in respect of cash, property or

 

75

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securities of the Company received upon the exercise of any such remedy. Upon any payment or distribution of assets of the Company referred to in this Article Sixteen, the Trustee, subject to the provisions of Section 601, shall be entitled to rely upon a certificate of the liquidating trustee or agent or other person making any distribution to the Trustee for the purpose of ascertaining the Persons entitled to participate in such distribution, the holders of Designated Senior Indebtedness and other indebtedness of the Company, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Article Sixteen.

If the Trustee or any Holder of Subordinated Securities does not file a proper claim or proof of debt in the form required in any proceeding referred to above prior to 30 days before the expiration of the time to file such claim in such proceeding, then the holder of any Designated Senior Indebtedness is hereby authorized, and has the right, to file an appropriate claim or claims for or on behalf of such Holder of Subordinated Securities.

With respect to the holders of Designated Senior Indebtedness, the Trustee undertakes to perform or to observe only such of its covenants or obligations as are specifically set forth in this Article and no implied covenants or obligations with respect to holders of Designated Senior Indebtedness shall be read into this Indenture against the Trustee. The Trustee does not owe any fiduciary duties to the holders of Designated Senior Indebtedness other than Securities issued under this Indenture.

 

SECTION 1603.		No Payment on Subordinated Securities in Event of Default on Designated Senior Indebtedness.

No payment by the Company on account of principal (or premium, if any), sinking funds or interest, if any, on the Subordinated Securities shall be made unless full payment of amounts then due for principal (premium, if any), sinking funds and interest on Designated Senior Indebtedness has been made or duly provided for in money or money’s worth.

 

SECTION 1604.		Payments on Subordinated Securities Permitted.

Nothing contained in this Indenture or in any of the Subordinated Securities shall (a) affect the obligation of the Company to make, or prevent the Company from making, at any time except as provided in Sections 1602 and 1603, payments of principal of (or premium, if any) or interest, if any, on the Subordinated Securities, (b) without limiting clause (c) of this sentence, prevent the application by the Trustee of any moneys deposited with it hereunder to the payment of or on account of the principal of (or premium, if any) or interest, if any, on the Subordinated Securities, unless the Trustee shall have received at its Corporate Trust Office written notice of any event prohibiting the making of such payment more than three Business Days prior to the date fixed for such payment or (c) prevent the application by the Trustee of any moneys or the proceeds of Government Obligations deposited with or pursuant to Section 1404(a) to the payment of or on account of the principal of (or premium, if any, on) or interest, if any, on the Subordinated Securities if all the conditions specified in Section 1404 to the application of Section 1402 or Section 1403, as applicable, have been satisfied prior to the date the Trustee shall have received at its Corporate Trust Office written notice of any event prohibiting the making of such payment.

 

76

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SECTION 1605.		Authorization of Holders to Trustee to Effect Subordination.

Each Holder of Subordinated Securities by his acceptance thereof authorizes and directs the Trustee on his behalf to take such action as may be necessary or appropriate to effectuate the subordination as provided in this Article Sixteen and appoints the Trustee his attorney-in-fact for any and all such purposes.

 

SECTION 1606.		Notices to Trustee.

Notwithstanding the provisions of this Article or any other provisions of this Indenture, neither the Trustee nor any Paying Agent (other than the Company) shall be charged with knowledge of the existence of any Designated Senior Indebtedness or of any event which would prohibit the making of any payment of moneys to or by the Trustee or such Paying Agent, unless and until the Trustee or such Paying Agent shall have received (in the case of the Trustee, at its Corporate Trust Office) written notice thereof from the Company or from the holder of any Designated Senior Indebtedness or from the trustee for any such holder, together with proof satisfactory to the Trustee of such holding of Designated Senior Indebtedness or of the authority of such trustee; PROVIDED, HOWEVER, that if at least three Business Days prior to the date upon which by the terms hereof any such moneys may become payable for any purpose (including, without limitation, the payment of either the principal (or premium, if any) or interest, if any, on any Subordinated Security) the Trustee shall not have received with respect to such moneys the notice provided for in this Section 1606, then, anything herein contained to the contrary notwithstanding, the Trustee shall have full power and authority to receive such moneys and to apply the same to the purpose for which they were received, and shall not be affected by any notice to the contrary, which may be received by it within three Business Days prior to such date. The Trustee shall be entitled to rely on the delivery to it of a written notice by a Person representing himself to be a holder of Designated Senior Indebtedness (or a trustee on behalf of such holder) to establish that such a notice has been given by a holder of Designated Senior Indebtedness or a trustee on behalf of any such holder. In the event that the Trustee determines in good faith that further evidence is required with respect to the right of any Person as a holder of Designated Senior Indebtedness to participate in any payment or distribution pursuant to this Article Sixteen, the Trustee may request such Person to furnish evidence to the reasonable satisfaction of the Trustee as to the amount of Designated Senior Indebtedness held by such Person, the extent to which such Person is entitled to participate in such payment or distribution and any other facts pertinent to the rights of such Person under this Article Sixteen and, if such evidence is not furnished, the Trustee may defer any payment to such Person pending judicial determination as to the right of such Person to receive such payment.

 

SECTION 1607.		Trustee as Holder of Designated Senior Indebtedness.

The Trustee in its individual capacity shall be entitled to all the rights set forth in this Article Sixteen in respect of any Designated Senior Indebtedness at any time held by it to the same extent as any other holder of Designated Senior Indebtedness and nothing in this Indenture shall be construed to deprive the Trustee of any of its rights as such holder.

Nothing in this Article Sixteen shall apply to claims of, or payments to, the Trustee under or pursuant to Section 606.

 

77

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SECTION 1608.		Modifications of Terms of Designated Senior Indebtedness.

Any renewal or extension of the time of payment of any Designated Senior Indebtedness or the exercise by the holders of Designated Senior Indebtedness of any of their rights under any instrument creating or evidencing Designated Senior Indebtedness, including, without limitation, the waiver of default thereunder, may be made or done all without notice to or assent from the Holders of the Subordinated Securities or the Trustee.

No compromise, alteration, amendment, modification, extension, renewal or other change of, or waiver, consent or other action in respect of, any liability or obligation under or in respect of, or of any of the terms, covenants or conditions of any indenture or other instrument under which any Designated Senior Indebtedness is outstanding or of such Designated Senior Indebtedness, whether or not any of the foregoing are in accordance with the provisions of any applicable document, shall in any way alter or affect any of the provisions of this Article Sixteen or of the Subordinated Securities relating to the subordination thereof.

 

SECTION 1609.		Reliance on Judicial Order or Certificate of Liquidating Agent.

Upon any payment or distribution of assets of the Company referred to in this Article Sixteen, the Trustee and the Holders of the Securities shall be entitled to rely upon any order or decree entered by any court of competent jurisdiction in which such insolvency, bankruptcy, receivership, liquidation, reorganization, dissolution, winding up or similar case or proceeding is pending, or a certificate of the trustee in bankruptcy, liquidating trustee, custodian, receiver, assignee for the benefit of creditors, agent or other person making such payment or distribution, delivered to the Trustee or to the Holders of Subordinated Securities, for the purpose of ascertaining the persons entitled to participate in such payment or distribution, the holders of Designated Senior Indebtedness and other indebtedness of the Company, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Article Sixteen.

* * * * *

This Indenture may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same Indenture.

 

78

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IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed, as of the day and year first above written.

 

 

[Signature Page to Indenture]

Exhibit (d)(6)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM T-1

 

 

STATEMENT OF ELIGIBILITY

UNDER THE TRUST INDENTURE ACT OF 1939 OF A

CORPORATION DESIGNATED TO ACT AS TRUSTEE

 

CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE PURSUANT TO SECTION 305(b)(2)

 

 

DEUTSCHE BANK TRUST COMPANY AMERICAS

(formerly BANKERS TRUST COMPANY)

(Exact name of trustee as specified in its charter)

 

 

 

NEW YORK		13-4941247
(Jurisdiction of Incorporation or		(I.R.S. Employer
organization if not a U.S. national bank)		Identification no.)
60 WALL STREET
NEW YORK, NEW YORK		10005
(Address of principal executive offices)		(Zip Code)

Deutsche Bank Trust Company Americas

Attention: Lynne Malina

Legal Department

60 Wall Street, 37th Floor

New York, New York 10005

(212) 250 – 0677

(Name, address and telephone number of agent for service)

 

 

Fifth Street Finance Corp.

(Exact name of obligor as specified in its charter)

 

 

 

Delaware		26-1219283
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
10 Bank Street, 12th Floor, White Plains, NY		10606
(Address of principal executive offices)		(Zip Code)

 

 

Debt Securities

(Title of the Indenture securities)

 

 

 

---

Item 1. General Information.

Furnish the following information as to the trustee.

 

(a)

Name and address of each examining or supervising authority to which it is subject.

 

Name		Address
Federal Reserve Bank (2nd District)		New York, NY
Federal Deposit Insurance Corporation		Washington, D.C.
New York State Banking Department		Albany, NY

 

(b)

Whether it is authorized to exercise corporate trust powers.

Yes.

Item 2. Affiliations with Obligor.

If the obligor is an affiliate of the Trustee, describe each such affiliation.

None.

 

Item 3. -15.

Not Applicable

 

Item 16.

List of Exhibits.

 

		Exhibit 1 -		Restated Organization Certificate of Bankers Trust Company dated August 6, 1998, Certificate of Amendment of the Organization Certificate of Bankers Trust Company dated September 25, 1998, Certificate of Amendment of the Organization Certificate of Bankers Trust Company dated December 16, 1998, and Certificate of Amendment of the Organization Certificate of Bankers Trust Company dated February 27, 2002 - Incorporated herein by reference to Exhibit 1 filed with Form T-1 Statement, Registration No. 333-157637-01.
		Exhibit 2 -		Certificate of Authority to commence business - Incorporated herein by reference to Exhibit 2 filed with Form T-1 Statement, Registration No. 333-157637-01.
		Exhibit 3 -		Authorization of the Trustee to exercise corporate trust powers - Incorporated herein by reference to Exhibit 3 filed with Form T-1 Statement, Registration No. 333-157637-01.
		Exhibit 4 -		Existing By-Laws of Deutsche Bank Trust Company Americas, as amended on April 15, 2002 business - Incorporated herein by reference to Exhibit 4 filed with Form T-1 Statement, Registration No. 333-157637-01.

---

		Exhibit 5 -		Not applicable.
		Exhibit 6 -		Consent of Bankers Trust Company required by Section 321(b) of the Act. - business - Incorporated herein by reference to Exhibit 6 filed with Form T-1 Statement, Registration No. 333-157637-01.
		Exhibit 7 -		The latest report of condition of Deutsche Bank Trust Company Americas dated as of December 31, 2011. Copy attached.
		Exhibit 8 -		Not Applicable.
		Exhibit 9 -		Not Applicable.

---

SIGNATURE

Pursuant to the requirements of the Trust Indenture Act of 1939, as amended, the trustee, Deutsche Bank Trust Company Americas, a corporation organized and existing under the laws of the State of New York, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in The City of New York, and State of New York, on this 23^rd day of July, 2012.

 

---

 

DeUtSCHE( BANK TRUST COMPANY AMERICAS W[ Q31

I. The & B.n-ê ._ aci

rWYORK I i5 I

.,

NY

10006

Z)p Code

FDIC c&tte O623

Consolidated Report of Condition for Insured Commercial and State-Chartered Savings Banks for Deceniber 31, 2011

Al sd1e11ues we to be reportI b thcu Ct dobers. 1k1S othweise mdcateO, repat me amount QitSz1dU1g Ct the buSt1S day cd the quatt.

Schedule RC—Balance Sheet

Dcilr kwst ri Thcn-ith CFt, t

1. Cafr id bsN 0.r from dnxa4tEry reCAi.Oxfl (Tn Sdie24e Rc-A):

a. b1r6e t-bn,n9 bea. w.i aJIT’cy and r (1)

b. tn-bng bea. (2) —             - Lb

2. jrt

a. Indd-1o-natIs*y is1beftm) Sdindide- b.rnn A)

Av+jie ijit (n SiIe -8 odijm 0)—1.t lb

3. aI frr Id ItiI1 pui txd an4 In rd: 0I

a. FaI tunth d 6i dcw,—            1 149, 24

Pt,

b. SjIt XId .r t. to r

4. Lr and fIneian rv (horn Sd.ie AC-C)

a. loans and leases held by sale

b.loans and leases net of unearned income

Ln a Irn r d unearnnd ÜEUTI6 — BT3 1 )X 4b

C LESS: *Iowanc fri bei w,i Ieae I—-            CO9 4.c

wd Im ri & urirarrind hm,ir aid Daeic (an 4b pre 4c) 17.456. 4d

5. trading assets from schedule RC-D

. 6premises and fixed ass ets included capitalized issues

7other real estate owned f

8. invest ment in unconsol idated subsidiaries and associated companies

9. direct and indirect investments in real estate ventures

10. intangible nb assets

a. goodwill

b 11other intangib le assets from schedule RC-M

11other intangible assets from schedule RC-F

12. Total ass ets (sum of items 1 through 11

1) includes cash I tems in proc ess of collection and unposted debits

(2) includes time ce rtificates of de posit not held for trading

(3) includes all securities resale agreements in domestic and foreign offices, regardless of maturity

---

 

DuTSo4r RANK TRtJSr cOMPANy AMERICAS

—

L The & P9e RC-la

DlCCtfeo.jm: I 15a I

Schedule RC—Continued

UAUTIES

11 Dt:

. in dcrc • (itn lDs ct a*inm A and C frcni iekiIe RC-E. mIt I)             ha

(1)	(1)_ -. 6631 15,. L1L&1

(2)	1r1-br 6636 6,457,)X 13.a.2

b In fgn -. Ee and *q id1anei. and I

( SctkiIe -E, ,t U)

(1)	irit-bewHig

(2)	1rtt-tt*ç .—- LJ 4.

14.	FUW unc pLIt±Ind and irtr .c un rert’. .

a. Fai fur. puid n &rnl,1 fi. 2i :4a

SjiL. éd jid l rri’ I

15.	Trac Ii.it, ‘rjin tie

16.	O1 -nry rrJu, ,rj’,- i-j,j

LrctI:1 :r-. i-: -’-’-, :t

11.	dnd 1d IL $4A.9t

19.	Sulnnd r1 and dtw (4) 3X 0 j

2	Oth IabI (fran Sdindte -G)—29fl 1 62cD

2	.557.OOO .

22.

Nc çabe

(1)	Irjd nonir*L-Oirç dnand tlrr. and

(2)	axt alIt ndal I’kre Li B* in Sdi . ii 16. WW ,uwnd muie

(3)	h,xiid I ix63 r,rtha -’ n dcarLc md ri c. ci rrntty.

(4)	Irid Ihrtnd-I We c,rnd k dAd ndalnd axpIi.

CiLir kTuun n Tho.ith

---

 

8ANK TRUST COMPAI4Y AMeRICAS

EQUiTY CAPITAL

Bk

21 pi 1R d rilnd urpL,

24.	Ca,r.,un ,.t             -.-.- —

25.	Surthit (id’ all ia,iu6 beatnd tt prdwnd itodi)

26 a. Rr eeii,

b. kairryjlat adw ,ne (5)

C. Odin eIibV ci arp,rieth (6)

27.	& T be* equity cetM (a,i IberO 23 deoi4 26.c) -.

b b1aohrç (nvulty) e hi caoculdatnd ii.mt

26 TM quiity c6M (0,n tw 27.a w,d 27.b) -

29Toti

h-._ ,.,i Pe PC-2

I 16

To be reported with the March Report oW Corididori °’ MM I DO

2. 8aiIiJiical eqa-01a1 d

(5)	ftd.iche ndi urwljnd hri lfla (i) on avaiode-foraie jnt, aco.mj r ern (i)

o lw curulwe fori wrrwty trandallon acflLeZlrw’b and mrn01n po,1on liat6lty atJuthi101t

(6)	Ixd4ie timairsy stork id .rrnnd Emoy Stock Omrwhp Pi ihe.

Lepd Title i1 Bm*

FOE CelIftAte iejm: l623

3838

3229

•.IIIIWI I1.

023

2.l27, 24

595,0 25

5,626. 26a

l7, 26.ti

0 26c

6394100 27.a

211,X0 27.b

6575.000 26

5l.l.000 29

Mixxlida

To be reported with the March Report at Condition.

1. toke ii the bor at the flqll the m.rnbw at he dnwt beow t bnd ci he rrcdi a. rte leehi oW auditing worh polarmed 1 tile tei* b rdei1 ohend

A333

3tO

3660

Gl66

3320

t — hem1e1 3.12 02 bul* b mdi goiriely 2C66 3.12nQ nth12 by a c01tiId patC 3Jton9 ibm

e1661 rut.,ma a ,yt on the beik

2- l,emm381 1.12 at 02 tarn pont rOlanQ onpoI mn2on it aoe i po’maay acd a.aTtPg 0112 by a ontjbm p.ti aatmg 1.0 odib 1.6mb a .egot on 1*

te.3.i mmnayrm (itt on 62 balI oayaia2h

3— 01 lank managm9mro 6Ofl 21 the I3.0 of tile 8II*3

1621la mrOd 0mw lOweiti b by a ceof Id pdk a.u38n Ito.

PCI byrihe

8724 NIA M.1

4	— D.s’ 02wti010.i t0 ban x1lI.d 01 a611

021w* xaylad a.,*n candalI a cwOId p6ic .abIg (101 (may be ,eg.666 by otlee diamonthQ atalleltyl

S — mamniorl1.n & tie ball pwfemml by 6621 2166011 e4bm8 (not, be m1nkad by lay Ct tdi19 a.Jlon’ay)

6	• di 02 tan&’o 6680CM 0’0m38 by 21100111.1102

7	— Coepthaon di the 66*0 Iita.l I ero by 21101011 andlOs

I — Othe 3.12 pmma (21oba13. 1. Idmk)

(1. 010 2166,111 auat

Exhibit (l)

July 27, 2012

Fifth Street Finance Corp.

10 Bank Street, 12^th Floor

White Plains, NY 10606

Ladies and Gentlemen:

We have acted as counsel to Fifth Street Finance Corp., a Delaware corporation (the “Company”), in connection with the offering by the Company pursuant to Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), of up to $500,000,000 in aggregate of (i) shares (the “Shares”) of the Company’s common stock, par value $0.01 per share (the “Common Stock”), including Shares to be issuable upon exercise of the Warrants (as such term is defined below), (ii) debt securities, including debt securities to be issuable upon exercise of the Warrants (such debt securities are collectively referred to herein as the “Debt Securities”) and (iii) warrants to purchase Common Stock or Debt Securities (the “Warrants,” and together with the Shares and Debt Securities, the “Securities”). That offering will be made pursuant to a registration statement on Form N-2 (No. 333-180267) filed under the Securities Act (the “Registration Statement”).

The Debt Securities are to be issued under an indenture (the “Indenture”) entered into by and between the Company and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”). The Warrants will be issued under warrant agreements (the “Warrant Agreements”) to be entered into by and between the Company and the purchasers thereof or a warrant agent to be identified in the applicable agreement.

As counsel to the Company, we have participated in the preparation of the Registration Statement and have examined the originals or copies of such records, documents or other instruments as we in our judgment deem necessary or appropriate for us to render the opinions set forth in this opinion letter including, without limitation, the following:

 

(i)

The Restated Certificate of Incorporation of the Company, certified as of the date of this opinion letter by an officer of the Company (the “Certificate of Incorporation”);

 

(ii)

The Amended and Restated Bylaws of the Company, certified as of the date of this opinion letter by an officer of the Company (the “Bylaws”);

 

(iii)

The Indenture filed as an exhibit to the Registration Statement;

 

(iv)

A Certificate of Good Standing with respect to the Company issued by the Delaware Secretary of State as of a recent date (the “Certificate of Good Standing”); and

 

(v)

The resolutions of the board of directors of the Company (the “Board”) relating to, among other things, (a) the authorization and approval of the preparation and filing of the Registration Statement, (b) the authorization, issuance, offer and sale of the Securities pursuant to the Registration Statement and (c) the authorization, execution and delivery of the Indenture and Warrant Agreements, certified as of the date of this opinion letter by an officer of the Company (collectively, the “Resolutions”).

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Fifth Street Finance Corp.

Page 2

As to certain matters of fact relevant to the opinions in this opinion letter, we have relied on a certificate of an officer of the Company. We have also relied on certificates of public officials. We have not independently established the facts, or in the case of certificates of public officials, the other statements, so relied upon.

For purposes of our opinions in this opinion letter, we have assumed that: (a) each document that we have reviewed is accurate and complete, is either an authentic original or a copy that conforms to an authentic original, and the signatures on it are genuine; (b) each governmental or officer’s certificate has been properly issued and that it is accurate, complete and authentic (and we have assumed that such certificates remain accurate on the date of this letter); (c) all natural persons have sufficient legal capacity; (d) the accuracy and completeness of all corporate records made available to us by the Company; (e) the Warrant Agreements will be governed by the laws of the State of New York; and (f) the Indenture and the Warrant Agreements will be valid and legally binding obligations of the parties thereto (other than the Company).

This opinion letter is limited to the effect of the General Corporation Law of the State of Delaware (the “DGCL”) and, as to the Debt Securities and Warrants constituting valid and legally binding obligations of the Company, the laws of the State of New York, in each case, as in effect on the date of this opinion letter, and we express no opinion as to the applicability or effect of any other laws of such jurisdictions or the laws of any other jurisdictions. Without limiting the preceding sentence, we express no opinion as to any state securities or broker dealer laws or regulations thereunder relating to the offer, issuance and sale of the Securities. This opinion letter has been prepared, and should be interpreted, in accordance with customary practice followed in the preparation of opinion letters by lawyers who regularly give, and such customary practice followed by lawyers who on behalf of their clients regularly advise opinion recipients regarding, opinion letters of this kind.

The opinions expressed below are subject are subject to (i) bankruptcy, insolvency, reorganization, receivership, moratorium, fraudulent conveyance, and other similar laws affecting the rights and remedies of creditors generally; (ii) general principles of equity (including without limitation the availability of specific performance or injunctive relief and the application of concepts of materiality, reasonableness, good faith and fair dealing), regardless of whether considered in a proceeding at law or in equity; and (iii) federal and state securities laws or public policy which may limit rights to indemnification and contribution.

On the basis of and subject to the foregoing and subject to the limitations and qualifications set forth in this opinion letter, we are of the opinion that:

 

1.

Assuming that (i) the issuance, offer and sale of the Shares from time to time and the final terms and conditions of such issuance, offer and sale, including those relating to the price and amount of the Shares to be issued, offered and sold, have been duly authorized and determined or otherwise established by proper action of the Board in accordance with the DGCL, the Company’s Certificate of Incorporation and Bylaws, and the Resolutions, (ii) the Shares have been delivered to, and the agreed consideration has been fully paid at the time of such delivery by, the purchasers thereof, (iii) upon issuance of the Shares, the total number of shares of Common Stock issued and outstanding does not exceed the total number of shares of Common Stock that the Company is then authorized to issue under the Certificate of Incorporation, (iv) the Certificate of Good Standing remains accurate, and (v) in the case of Shares issuable upon the exercise of the Warrants, the assumptions stated in paragraph numbered (3) below are true and correct, the Shares will be duly authorized, validly issued, fully paid and nonassessable.

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Fifth Street Finance Corp.

Page 3

 

2.

Assuming that (i) the Indenture relating to the Debt Securities has been duly authorized, executed and delivered by each of the Company and the Trustee in accordance with the terms of the Indenture, (ii) the issuance, offer and sale of the Debt Securities from time to time and the final terms and conditions of the Debt Securities to be so issued, offered and sold, including those relating to price and amount of Debt Securities to be issued, offered and sold, (a) have been duly authorized and determined or otherwise established by proper action of the Board in accordance with the Certificate of Incorporation and Bylaws, (b) are consistent with the terms thereof in the Indenture, (c) do not violate any applicable law, (d) do not violate or result in a default under or breach of any agreement, instrument or other document binding upon the Company, and (e) comply with all requirements or restrictions imposed by any court or governmental body having jurisdiction over the Company, (iii) the Debt Securities have been (a) duly executed and delivered by the Company and duly authenticated by the Trustee in accordance with the Indenture and (b) delivered to, and the agreed consideration therefor has been fully paid at the time of such delivery by, the purchasers thereof, and (iv) in the case of Debt Securities issuable upon the exercise of the Warrants, the assumptions stated in paragraph numbered (3) below are true and correct, the Debt Securities will constitute valid and legally binding obligations of the Company.

 

3.

Assuming that (i) the Warrant Agreements relating to the Warrants have been duly authorized, executed and delivered by the parties thereto, and that no terms included therein would affect the validity of the opinion expressed in this paragraph numbered (3), (ii) the issuance, offer and sale of Warrants from time to time and the final terms and conditions of the Warrants to be so issued, offered and sold, including those relating to price and amount of Warrants to be issued, offered and sold, (a) have been duly authorized and determined or otherwise established by proper action of the Board in accordance with the Certificate of Incorporation and Bylaws, (b) are consistent with the terms thereof in the applicable Warrant Agreement, (c) do not violate any applicable law, (d) do not violate or result in a default under or breach of any agreement, instrument or other document binding upon the Company, and (e) comply with all requirements or restrictions imposed by any court or governmental body having jurisdiction over the Company and (iii) the Warrants have been (a) duly executed and delivered by the Company and duly countersigned in accordance with the applicable Warrant Agreement, and (b) delivered to, and the agreed consideration therefor has been fully paid at the time of such delivery by, the purchasers thereof as contemplated by the Registration Statement, the Warrants will constitute valid and legally binding obligations of the Company.

The opinions expressed in this opinion letter (a) are strictly limited to the matters stated in this opinion letter, and without limiting the foregoing, no other opinions are to be implied and (b) are only as of the date of this opinion letter, and we are under no obligation, and do not undertake, to advise the addressee of this opinion letter or any other person or entity either of any change of law or fact that occurs, or of any fact that comes to our attention, after the date of this opinion letter, even though such change or such fact may affect the legal analysis or a legal conclusion in this opinion letter.

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Fifth Street Finance Corp.

Page 4

We hereby consent to the filing of this opinion as an exhibit to the Registration Statement and to the reference to our firm in the “Legal Matters” section in the Registration Statement. We do not admit by giving this consent that we are in the category of persons whose consent is required under Section 7 of the Securities Act.

 

Exhibit (n)(1)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our report dated December 9, 2009, with respect to the consolidated financial statements of Fifth Street Finance Corp. contained in the Registration Statement and Prospectus. We consent to the use of the aforementioned report in the Registration Statement and Prospectus, and to the use of our name as it appears under the caption “Independent Registered Public Accounting Firm.”

/s/    GRANT THORNTON LLP

New York, New York

July 25, 2012

Exhibit (n)(2)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the use in this Registration Statement on Form N-2 of Fifth Street Finance Corp. of our report dated November 29, 2011 relating to the consolidated financial statements, which appears in such Registration Statement. We also consent to the reference to us under the heading “Independent Registered Public Accounting Firm” in such Registration Statement.

/s/    PricewaterhouseCoopers LLP

New York, New York

July 25, 2012

Exhibit 99.1

Fifth Street Finance Corp.

Computation of Ratios of Earnings to Fixed Charges

 

		Six Months Ended March 31, 2012				Year Ended September 30, 2011				Year Ended September 30, 2010				Year Ended September  30, 2009				Year Ended September  30, 2008				For The Period February 15, 2007 through September 30, 2007
Earnings:
Net increase in net assets resulting from operations		$	30,240,007			$	30,206,514			$	22,416,350			$	6,193,797			$	3,257,936			$	1,082,326
Income tax expense, including excise tax			—				114,928				61,743				9,523				—				—
Total earnings before taxes		$	30,240,007			$	30,321,442			$	22,478,093			$	6,203,320			$	3,257,936			$	1,082,326
Fixed Charges:
Interest expense		$	11,325,857			$	15,136,573			$	1,929,389			$	636,901			$	917,043			$	522,316
Total fixed charges		$	11,325,857			$	15,136,573			$	1,929,389			$	636,901			$	917,043			$	522,316
Earnings available to cover fixed charges		$	41,565,864			$	45,458,015			$	24,407,482			$	6,840,221			$	4,174,979			$	1,604,642
Ratio of earnings to fixed charges			3.67				3.00				12.65				10.74				4.55				3.07

[Letterhead of Sutherland Asbill & Brennan LLP]

July 27, 2012

VIA EDGAR

Mr. Kevin Rupert

Mr. Dominic Minore

Division of Investment Management

U.S. Securities & Exchange Commission

100 F Street, N.E.

Washington, DC 20549

 

Re:

Fifth Street Finance Corp.

Registration Statement on Form N-2

File No.:  333-180267

Dear Messrs. Rupert and Minore:

On behalf of Fifth Street Finance Corp. (the “Company”), set forth below are the Company’s responses to the comments provided by the staff of the Division of Investment Management (the “Staff”) of the Securities and Exchange Commission (the “Commission”) to the Company in a letter dated April 3, 2012 and orally on April 19, 2012, May 15, 2012 and June 25, 2012, relating to the registration statement on Form N-2 (File No. 333-180267) (the “Registration Statement”). The Staff’s comments are set forth below in italics and are followed by the Company’s responses.

Prospectus Cover Page

 

1.

In the sixth paragraph, provide the net asset value per share and the last reported sale price per share of the common stock of the Company as of a recent date.

The Company has revised the fifth paragraph of the prospectus cover page to disclose the net asset value per share of its common stock as of March 31, 2012 and the last reported sale price of its common stock as of a recent date. However, consistent with Section 55(b) of the Investment Company Act of 1940, the Company determines the value of its investments “as of the date of the most recent financial statements filed by [the Company] with the Commission pursuant to section 13 of the Securities Exchange Act of 1934” (i.e., on a quarterly basis in connection with filing its annual reports on Form 10-K and quarterly reports on Form 10-Q with the Commission). Because market quotations are not generally readily available for the Company’s investments, it must undertake the multi-step valuation process described in the Registration Statement each quarter in

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 2

 

connection with determining the value of its investments. In light of the foregoing and the fact that the value of the Company’s investments is a significant component in the determination of the Company’s net asset value, the Company does not expect to recalculate the net asset value per share of its common stock until at or around the time that it files its quarterly report on Form 10-Q for the quarter ended June 30, 2012 with the Commission (which is required to be filed by the Company with the SEC on or before August 9, 2012).

 

2.

In the third paragraph, disclose that the Company’s portfolio investments are, or would be, rated below investment grade by rating agencies.

The Company has revised the disclosure accordingly.

Prospectus Summary

 

3.

We refer to the disclosure in the paragraph under the heading “Recent Developments.” Please discuss the importance of early repayments and explain why the Company expects repayments to revert to historical norms.

The Company has removed this disclosure.

Fees and Expenses

 

4.

The following comments should be addressed in the fee table and Example that is included in the current prospectus, as well as in any prospectus supplement used with any offering from this shelf registration statement that triggers the need to include a fee table and Example. Any such fee table and Example should also be updated in accordance with current staff positions with the most current information available to the Company.

The Company will address the following comments in the fee table and the Example in the prospectus. In addition, the Company will include an updated fee table and expense table in any prospectus supplement reflecting the specific terms of each securities offering, as needed.

 

a.

We note the absence of the Acquired Fund Fees & Expenses line item from the Company’s fee table. Please confirm to us in your response letter that the Company will not in the upcoming year make investments at the level that triggers the need for the additional line item of Acquired Fund Fees & Expenses. If no such additional line item is required, please indicate in your response letter that any Acquired Fund Fees & Expenses is nonetheless included in “Other Expenses” or that the Company does not intend to invest in any “Acquired

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 3

 

Funds.” If the Company anticipates leveraging through the offering of debt securities during the next twelve months, then provide the additional disclosure, as applicable.

Although the Company has made investments in “Acquired Funds” (as such term is defined in the SEC’s Form N-2), the Company confirms that such investments fall within the exception to the “Acquired Fund Fees and Expenses” disclosure set forth in Form N-2, which states that “ [i]n the event the fees and expenses incurred indirectly by the Registrant as a result of investment in shares of one or more Acquired Funds do not exceed 0.01 percent (one basis point) of average net assets of the Registrant, the Registrant may include these fees and expenses under the subcaption “Other Expenses” in lieu of this disclosure requirement.” As a result, the Company has included the fees and expenses incurred indirectly by the Company as a result of its investments in “Acquired Funds” in the line item entitled “Other Expenses” in the “Fees and Expenses” table. Although the Company does not currently expect to incur Acquired Fund Fees and Expenses exceeding 0.01 percent of the Company’s average net assets, it will include such fees and expenses in a separate line item of the fee table if it exceeds such threshold.

 

b.

Under the “Stockholder transaction expenses” section of the fee table, provide a “debt securities offering expenses borne by holders of common stock” line item presentation. Expand the disclosure accompanying the Example to clarify that such amount is included in the Example tabular presentation.

The Company has revised the disclosure accordingly. Regarding the inclusion of such disclosure in a prospectus supplement for an offering of common stock, and given that the expenses of an offering of debt securities are not relevant to a common stock offering transaction, the Company believes it is appropriate to include such expenses in the Annual Expenses section of the fee table rather than the Stockholder Transaction Expenses section. In a footnote to the fee table of any prospectus supplement, the Company will disclose its expectation of such expenses over the next twelve months as a percentage of the aggregate offering price. The Company has also added disclosure to footnote 2 of the fee table to clarify that expenses for any security offering, including a debt securities offering, will be borne by common stockholders.

 

c.

The cost of servicing debt securities line item should include all of the costs of servicing debt services as a percentage of net assets attributable to common shares. Accordingly, before the “Total Annual Expenses” line item, add a “Cost of Servicing Debt Securities” line item, and provide a footnote explanation of what is included therein.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 4

 

Given that interest payments on borrowed funds are a component of the total cost of servicing debt securities, the Company has revised the disclosure to include the other costs of servicing debt securities in the “Interest Payments on Borrowed Funds” line item of the fee table. This is similar to the approach taken by THL Credit, Inc.

 

d.

Also disclose in a footnote the assumptions used when determining the amount included in the “Cost of Servicing Debt Securities” line item. Moreover, in a separately captioned section of the prospectus, describe the likely terms, including material covenants, of the debt securities that the Company is expected to issue.

The Company has revised the disclosure accordingly. The Company has included the likely terms of debt securities that it expects to issue in the section entitled “Description of Our Debt Securities.” The Company will provide information regarding the terms and material covenants in the associated prospectus supplement in a separately captioned item.

 

e.

State that the Example includes interest expenses, offering expenses and other costs of servicing amounts borrowed.

The Company has revised the disclosure accordingly.

 

f.

Revise the “Interest payments on borrowed funds” and corresponding footnote disclosure to reflect the Company’s borrowing plans for the next twelve months.

The Company has revised the disclosure accordingly.

 

g.

In a footnote to the fee table, disclose that the Company does not expect to issue preferred shares during the next twelve months.

The Company advises the Staff that it is not authorized to issue preferred shares under its charter. If the charter is amended to authorize such issuance in the future, the Company will disclose its expectation of issuing preferred shares in a footnote to the fee table.

 

h.

In the third sentence of footnote (5), insert the phrase “is calculated at an annual rate of 2% and” after the word “agreement.”

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 5

 

The Company has revised the disclosure accordingly.

Risk Factors

 

5.

Please consider adding a risk factor in light of the recent enactment of the Jumpstart Our Business Startups (JOBS) Act. In particular, consider whether the types of portfolio companies in which the Company will seek to invest will consider raising capital through a direct offering of their securities in light of the relaxed requirements under the JOBS Act relating to offerings.

The Company advises the Staff on a supplemental basis that it does not believe that risk factor disclosure regarding the JOBS Act is necessary or appropriate at the present time. Specifically, the JOBS Act eliminates or relaxes legal requirements in connection with issuing equity securities in a private offering or becoming a public company via an initial public offering, but does not create investor demand to invest in private or newly-public companies. There is presently no indication that such investor demand will increase in a manner that would cause the JOBS Act to have a meaningful impact on capital formation. In addition, the Company also believes that the types of companies in which it invests will continue to prefer debt financing rather than equity financing, which would dilute ownership interests.

Use of Proceeds

 

6.

The use of proceeds section should state with the degree of specificity required by the instructions to Item 7 of Form N-2.

The Company has revised the disclosure accordingly. In each prospectus supplement in connection with a takedown from the Registration Statement, the Company undertakes to specify, if material, the estimated dollar amount of offering proceeds that the Company anticipates using to pay down each of its credit facilities and its convertible senior notes.

 

7.

The disclosure contained in the third and fourth paragraphs on page 62 indicate the amount of the Convertible Notes of the Company that were repurchased by the Company during the last quarter of 2011 at a discount. It further discloses that $124.5 million Convertible Notes of the Company remain outstanding as of December 31, 2011, with a fair value of $112.4 million. The disclosure on page 48, under “Gain on Extinguishment of Convertible Senior Notes,” indicates that the repurchase and subsequent cancellation of the Convertible Notes resulted in a gain that was included in the amount used to determine the incentive fee payable

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 6

 

to the Company’s Investment Adviser. Disclose whether the proceeds from an offering of this registration statement may be used to make further repurchases and cancellations of the Company’s outstanding debt at a discount that could generate a gain used to determine the incentive fee payable to the Company’s Investment Adviser. In addition, disclose in plain English why it is appropriate for the Company to recognize an income incentive fee on this type of gain, and disclose that it may happen again. Further, disclose (i) whether the board of directors specifically approved the payment of these incentive fees, (ii) the economic reasons that allowed the Company to repurchase its convertible notes at a price below par value, (iii) whether the payment of such an incentive fee was contemplated and intended by the parties to the investment advisory agreement, and (iv) whether such a net gain was on the list of permissible types of income that generate an income incentive fee under the investment advisory agreement. Finally, include the estimated amount of any such incentive fees in the “Management fees” line item of the fee table.

The Company has revised the disclosure accordingly and undertakes to include the estimated amount of any incentive fees resulting from such a gain in the “Management fees” line item of the fee table.

Price Range of Common Stock and Distributions

 

8.

Complete the tabular presentation of the “Year ending September 30, 2012 Second Quarter” information through the entire period ending March 31, 2012.

The Company has revised the disclosure accordingly.

 

9.

Revise the tabular presentation to include columns disclosing the premium or discount of common stock price to NAV rather than common stock price as a percentage of NAV.

The Company has revised the disclosure accordingly.

Ratio of Earnings to Fixed Charges

 

10.

Update the information to provide the Earnings to Fixed Charges ratio for the six months ended March 31, 2012. In this regard, disclose management’s assessment of any material trends in the Company’s Earnings to Fixed Charges ratio.

The Company has revised the disclosure accordingly.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 7

 

Portfolio Asset Quality

 

11.

Consider using a term other than investment “rating” to describe the Company’s portfolio rating process. The term “rating” may be confused with an investment grade rating issued by a national credit rating agency.

The Company has revised the disclosure accordingly.

Other Sources of Liquidity

 

12.

Clarify whether the dollar amounts included under the “Debenture Amount” column are in thousands of dollars.

The Company has revised the disclosure accordingly.

Description of Our Debt Securities

 

13.

Expand the disclosure, as necessary, to ensure that the material provisions of the indenture have been discussed in this section of the prospectus and also include a statement to that effect in the third paragraph.

The Company has reviewed the disclosure in light of the material provisions of the form of indenture filed as Exhibit (d)(4) to the Registration Statement, and is comfortable that the disclosure is adequate. The disclosure has been revised to include a statement to that effect in the third paragraph.

 

14.

Disclose that any person from whom the Company borrows will not, in their capacity as either a lender or debt holder, have either a veto power or a vote in approving or changing any of the Company’s investment or operational policies. If this statement cannot be made, explain why such a veto power or vote is consistent with the board’s fiduciary duties, including under Section 36 of the Investment Company Act of 1940 or otherwise, to the Company and its stockholders.

The Company has revised the disclosure in accordance with the Staff’s comment with respect to the holders of the debt securities being registered. See page 116 of the Registration Statement. However, the Company advises the Staff that it must obtain the consent of the lenders under its credit facility led by ING Capital LLC (the “ING Facility”) before changing its investment policies. In this regard, the Company was required to furnish ING Capital with its investment policies (which are reflected in the Registration Statement) at the time that it entered into the ING Facility. In connection therewith, the Company also agreed to obtain the consent from ING Capital, as agent, or from two-thirds of the lenders thereunder prior to changing its investment policies. Such consent is not required for amendments necessary to comply with applicable law.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 8

 

These investment policies apply to the Company’s entire investment portfolio and, like the disclosure of the same in the Registration Statement, are broadly worded to cover a myriad of investing activities. To date, the Company has not had an issue investing within the parameters of its investment policies.

The Company believes that it is important to highlight that it is standard market practice for lenders to require business development companies (“BDCs”) and other investment funds to provide assurance to the lenders that they will not deviate from their contemplated investment activities (i.e., the lenders are willing to lend money to the BDCs and other investment funds based on their then current understanding of the BDCs’ and other investment funds’ lending and investment policies). Such assurance is typically set forth in an agreement by the BDC or investment fund to obtain the consent of the lenders before the BDC or investment fund changes its investment policies.

The Company believes that its board of directors satisfied its fiduciary duties in exercising its business judgment in determining that the Company’s entry into the ING Facility was an appropriate in allowing the Company to access the capital necessary to expand and diversify the Company’s investment platform. In doing so, the board of directors also ensured that the investment policies would provide the Company with adequate flexibility to pursue its investment objective. Moreover, the Company believes that ING Capital would likely consent to any reasonable request by the Company to change to the investment policies that it previously furnished to ING Capital in connection with ING Facility should such a need arise.

 

15.

In the third paragraph, clarify that although you are urged to read the indenture, the prospectus and the prospectus supplement nonetheless, describe the material terms of the debt securities being offered and the debt holders’ rights. Please ensure that the prospectus and applicable prospectus supplement are revised to include all such material terms and related rights.

The Company has revised the disclosure accordingly and confirms that the applicable prospectus supplement will include all such material terms and related rights.

Business Development Company Provisions

 

16.

Delete the phrase “we will generally agree that” from the first sentence.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 9

 

The Company has removed this disclosure.

Full Defeasance

 

17.

Expand the first bullet paragraph to indicate whether there exists a risk that the amount on deposit could ultimately result in a shortfall in the amount needed to repay “interest, principal, and any other payments on the debt securities” in full.

The Company refers the Staff to the first two sentences of the last paragraph of the “Full Defeasance” sub-section, which discusses the risk of a shortfall in the amount needed to repay the debt securities.

Plan of Distribution

 

18.

Expand the disclosure to indicate the extent to which the Company’s common shareholders will indirectly bear all of the various expenses incurred in connection with all of the distribution activities described therein.

The Company has revised the disclosure accordingly.

 

19.

Please confirm to the staff in your response letter that the Company will submit any underwritten offering to FINRA for its prior approval of the underwriting terms.

The Company confirms that it will submit any underwritten offering pursuant to the Registration Statement to FINRA for its prior approval of the underwriting terms.

 

20.

In your response letter, undertake to include in any prospectus supplement, as applicable, under a section captioned “Additional Underwriter Compensation,” a description of the terms of any agreement that the Company will have entered into with the underwriters, and specify the nature of the services that the underwriter has provided or will provide thereunder. Further, undertake to disclose whether any such fee payable thereunder is a one-time fee or whether it is payable annually. Also undertake to file all such agreements as exhibits in a post-effective amendment to the registration statement.

The Company hereby undertakes to include in any prospectus supplement a section entitled “Additional Underwriter Compensation” if, pursuant to any agreement, the underwriter will receive any material compensation in addition to the underwriting discounts and commissions disclosed under the section captioned “Underwriting.” If not previously filed, the Company further

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 10

 

undertakes to file any such material agreement as an exhibit-only filing in a post-effective amendment to the Registration Statement which will become effective immediately.

Accounting Comments

 

21.

In your response letter, discuss the Company’s plans to update all applicable financial statements and other material information, as well as its auditor’s consent, for each takedown of securities offered from this shelf registration statement.

Auditors’ consents as of a recent date are filed as Exhibits (n)(1) and (n)(2) to the Registration Statement. The Company will provide current financial statements and financial information filed with the SEC in a prospectus supplement in connection with each offering pursuant to the Registration Statement. The Company undertakes to file an auditor's consent for each takedown from a shelf registration statement where a prospectus supplement includes new audited financial statements of the Company and will comply with any formal determination made by the Staff to require an auditor's consent for each takedown from a shelf registration statement where a prospectus supplement only includes new unaudited financial statements of the Company.

Part C

Item 25. Financial Statements and Exhibits

 

22.

It appears that the Company should file in a pre-effective amendment, as an exhibit to the registration statement, the trust indenture that will be used with its proposed debt offerings. The Statement of Eligibility of Trustee on Form T-1 should be filed in a similar fashion or, in the alternative, include the following undertaking under Item 34 of Part C if the Company intends to rely on section 305(b)(2) of the Trust Indenture Act of 1939 for determining the eligibility of the trustee under indentures for securities to be issued, offered or sold on a delayed basis by or on behalf of the registrant.

The undersigned registrant hereby undertakes to file an application for the purpose of determining the eligibility of the trustee to act under subsection (a) of section 310 of the Trust Indenture Act (“Act”) in accordance with the rules and regulations prescribed by the Commission under section 305(b)(2) of the Act.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 11

 

The Company has filed a form of trust indenture and the Statement of Eligibility of Trustee on Form T-1 as exhibits to the Registration Statement.

 

23.

Please file as an exhibit the legality opinion regarding the shares and warrants and the binding obligations of the debt securities being registered, and related consent of counsel, with your next pre-effective amendment. In this regard, it appears that since the terms of the actual offerings from this registration statement have not yet been authorized by the Company’s board of directors, it may be necessary for the Company to undertake to file an unqualified legality of share opinion, and related consent of counsel, in a post-effective amendment with each takedown from this shelf registration statement.

The legality opinion, and related consent of counsel, has been included as an exhibit to the Registration Statement. The Company hereby undertakes to file an unqualified legality opinion, and related consent of counsel, in a post-effective amendment with each takedown from the Registration Statement.

Item 34. Undertakings

 

24.

Include an undertaking in Part C of the registration statement to file for staff review a post-effective amendment under section 8(c) of the Securities Act of 1933 in respect of any one or more offerings of the Company’s common shares (including warrants to purchase its common shares) below NAV that will result in greater than 15% dilution in the aggregate to existing shareholder net asset value. We may have further comments.

The Company has added the requested undertaking.

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Mr. Kevin Rupert

Mr. Dominic Minore

July 27, 2012

Page 12

 

*                *                 *                

If you have any questions or additional comments concerning the foregoing, please contact the undersigned at (202) 383-0805, or Steven B. Boehm at (202) 383-0176.