Oaktree Specialty Lending Corp - Quarter Report: 2009 March (Form 10-Q)

Large accelerated filer o

Accelerated filer o

Non-accelerated filer þ

Smaller reporting company o

(Do not check if a smaller reporting company)

e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended March 31, 2009


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

For the transition period from: to

Commission File Number: 01-33901

Fifth Street Finance Corp.

(Exact name of registrant as specified in its charter)


Delaware		26-1219283

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

445 Hamilton Ave, Suite 1206
White Plains, NY		10601

(Address of principal executive offices)		(Zip Code)

(914) 286-6800
(Registrant’s telephone number including area code)
n/a
(Former name former address and former fiscal year if changed since last report)

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares outstanding of the issuer’s common stock as of May 1, 2009 was 22,802,821.

FIFTH STREET FINANCE CORP.

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2009

TABLE OF CONTENTS


PART I FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements of Fifth Street Finance Corp. (unaudited):

Consolidated Balance Sheets as of March 31, 2009 and September 30, 2008		3

Consolidated Statements of Operations for the three and six months ended March 31, 2009 and March 31, 2008		4

Consolidated Statements of Changes in Net Assets for the six months ended March 31, 2009 and March 31, 2008		5

Consolidated Statements of Cash Flows for the six months ended March 31, 2009 and March 31, 2008		6

Consolidated Schedule of Investments as of March 31, 2009		7

Consolidated Schedule of Investments as of September 30, 2008		12

Notes to Consolidated Financial Statements		17

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		32

Item 3. Quantitative and Qualitative Disclosures About Market Risk		44

Item 4. Controls and Procedures		44

PART II OTHER INFORMATION		45

Item 1. Legal Proceedings		45

Item 1A. Risk Factors		45

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45

Item 4. Submission of Matters to Vote of Security Holders		46

Item 6. Exhibits		47

Signatures		48

Fifth Street Finance Corp.

Consolidated Balance Sheets

(unaudited)


	March 31,			September 30,
	2009			2008

Assets
Investments at fair value:
Affiliate investments (cost 3/31/09: $84,321,772; cost 9/30/08: $81,820,636)	$	71,103,949		$	71,350,417
Non-control/Non-affiliate investments (cost 3/31/09: $234,014,064; cost 9/30/08: $208,764,349)		219,673,350			202,408,737

Total investments at fair value		290,777,299			273,759,154
Cash and cash equivalents		3,722,068			22,906,376
Interest receivable		2,779,141			2,367,806
Due from portfolio company		43,890			80,763
Prepaid expenses		293,346			34,706

Total Assets	$	297,615,744		$	299,148,805

Liabilities and Stockholders’ Equity
Accounts payable, accrued expenses and other liabilities	$	443,665		$	567,691
Base management fee payable		1,488,079			1,381,212
Incentive fee payable		1,871,827			1,814,013
Due to FSC, Inc.		381,222			574,102
Interest payable		2,814			38,750
Payments received in advance from portfolio companies		75,431			133,737
Offering costs payable		—			303,461
Loans payable		21,000,000			—

Total Liabilities		25,263,038			4,812,966

Commitments and Contingencies (Note 3)
Stockholders’ Equity:
Common stock, $0.01 par value, 49,800,000 shares authorized, 22,802,821 and 22,614,289 shares issued and outstanding at March 31, 2009 and September 30, 2008		228,028			226,143
Additional paid-in-capital		301,789,575			300,524,155
Net unrealized depreciation on investments		(27,558,534	)		(16,825,831	)
Net realized gain (loss) on investments		(12,337,513	)		62,487
Accumulated undistributed net investment income		10,231,150			10,348,885

Total Stockholders’ Equity		272,352,706			294,335,839

Total Liabilities and Stockholders’ Equity	$	297,615,744		$	299,148,805

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Operations

(unaudited)


	Three months ended March 31,						Six months ended March 31,
	2009			2008			2009			2008

Interest income:
Affiliate investments	$	2,649,912		$	1,896,954		$	5,368,398		$	3,357,617
Non-control/Non-affiliate investments		6,605,804			3,392,795			13,477,109			6,144,190
Interest on cash and cash equivalents		10,765			180,432			89,955			393,001

Total interest income		9,266,481			5,470,181			18,935,462			9,894,808

PIK interest income:
Affiliate investments		443,809			336,830			796,846			621,143
Non-control/Non-affiliate investments		1,456,893			622,400			2,920,641			1,066,570

Total PIK interest income		1,900,702			959,230			3,717,487			1,687,713

Fee income:
Affiliate investments		257,258			160,622			704,171			269,676
Non-control/Non-affiliate investments		495,466			264,208			1,112,076			428,878

Total fee income		752,724			424,830			1,816,247			698,554

Dividend and other income:
Other income		—			—			35,396			—

Total dividend and other income		—			—			35,396			—

Total Investment Income		11,919,907			6,854,241			24,504,592			12,281,075

Expenses:
Base management fee		1,488,079			954,404			2,858,754			1,798,926
Incentive fee		1,871,827			1,019,905			3,924,422			1,019,905
Professional fees		416,925			348,171			802,868			554,500
Board of Directors fees		49,000			29,750			88,250			29,750
Organizational costs		—			54,315			—			200,747
Interest expense		128,201			72,982			168,359			187,681
Administrator expense		241,168			140,222			421,598			249,562
Line of credit guarantee expense		—			—			—			83,333
Transaction fees		—			—			—			206,726
General and administrative expenses		237,399			154,873			542,651			196,325

Total expenses		4,432,599			2,774,622			8,806,902			4,527,455

Net Investment Income		7,487,308			4,079,619			15,697,690			7,753,620

Unrealized appreciation (depreciation) on investments:
Affiliate investments		3,121,821			(1,111,855	)		(2,747,604	)		(1,519,886	)
Non-control/Non-affiliate investments		4,627,913			(457,147	)		(7,985,100	)		(525,453	)

Total unrealized appreciation (depreciation) on investments		7,749,734			(1,569,002	)		(10,732,704	)		(2,045,339	)

Realized loss on investments:
Affiliate investments		(4,000,000	)		—			(4,000,000	)		—
Non-control/Non-affiliate investments		(8,400,000	)		—			(8,400,000	)		—

Total realized loss on investments		(12,400,000	)		—			(12,400,000	)		—

Net increase (decrease) in net assets resulting from operations	$	2,837,042		$	2,510,617		$	(7,435,014	)	$	5,708,281

Earnings (loss) per common share — basic and diluted (1)	$	0.12		$	0.20		$	(0.34	)	$	0.46
Net investment income per common share — basic and diluted (1)	$	0.33		$	0.33		$	0.69		$	0.62
Weighted average common shares — basic and diluted		22,752,668			12,480,972			22,656,383			12,480,972


(1)		The earnings and net investment income per share calculations for the six months ended March 31, 2008 are based on the assumption that if the number of shares issued at the time of the merger of Fifth Street Mezzanine Partners III L.P. with and into Fifth Street Finance Corp. on January 2, 2008 (12,480,972 shares of common stock) had been issued at the beginning of the six-month period, on October 1, 2007, Fifth Street Finance Corp’s earnings and net investment income per share would have been $0.46 and $0.62 per share, respectively.

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(unaudited)


	Six months ended March 31,
	2009			2008

Operations:
Net investment income	$	15,697,690		$	7,753,620
Net unrealized depreciation on investments		(10,732,704	)		(2,045,339	)
Net realized loss on investments		(12,400,000	)		—

Net increase (decrease) in net assets from operations		(7,435,014	)		5,708,281

Stockholder transactions:
Distributions to stockholders from net investment income		(15,815,427	)		—

Net decrease in net assets from stockholder transactions		(15,815,427	)		—

Capital share transactions:
Fractional shares paid to partners from conversion		—			(358	)
Issuance of common stock under dividend reinvestment plan		1,729,790			—
Repurchases of common stock		(462,482	)		—
Capital contributions from partners		—			66,497,000
Capital withdrawals by partners		—			(2,810,369	)

Net increase in net assets from capital share transactions		1,267,308			63,686,273

Total increase (decrease) in net assets		(21,983,133	)		69,394,554
Net assets at beginning of period		294,335,839			106,815,695

Net assets at end of period	$	272,352,706		$	176,210,249

Net asset value per common share	$	11.94		$	14.12

Common shares outstanding at end of period		22,802,821			12,480,972

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Cash Flows

(unaudited)


	Six months ended March 31,
	2009			2008
Cash flows from operating activities:
Net increase (decrease) in net assets resulting from operations	$	(7,435,014	)	$	5,708,281
Change in unrealized depreciation on investments		10,732,704			2,045,339
Net realized loss on investments		12,400,000			—
PIK interest income, net of cash received		(3,553,912	)		(1,672,075	)
Recognition of fee income		(1,816,247	)		(698,554	)
Accretion of original issue discount on investments		(400,738	)		(400,849	)
Other income		(35,396	)		—
Change in operating assets and liabilities:
Fee income received		2,227,846			3,047,617
Increase in interest receivable		(411,335	)		(695,588	)
Decrease in due from portfolio company		36,873			77,737
Decrease in prepaid management fees		—			252,586
Increase in prepaid expenses		(258,640	)		(83,426	)
Decrease in accounts payable, accrued expenses and other liabilities		(124,025	)		(313,555	)
Increase in base management fee payable		106,867			954,404
Increase in incentive fee payable		57,814			1,019,905
Increase (decrease) in due to FSC, Inc.		(192,880	)		147,720
Increase (decrease) in interest payable		(35,936	)		62,359
Increase (decrease) in payments received in advance from portfolio companies		(58,306	)		125,877
Purchase of investments		(47,850,000	)		(102,291,785	)
Principal payments received on investments (scheduled amortization)		2,892,201			252,500
Principal payments received on investments (payoffs)		8,350,000			—

Net cash used by operating activities		(25,368,124	)		(92,461,507	)

Cash flows from financing activities:
Dividends paid in cash		(14,085,637	)		—
Repurchases of common stock		(462,482	)		—
Capital contributions		—			66,497,000
Capital withdrawals		—			(2,810,369	)
Borrowings		22,000,000			43,645,667
Repayments of borrowings		(1,000,000	)		(29,250,000	)
Offering costs paid		(268,065	)		(821,444	)
Redemption of partnership interests for cash		—			(358	)

Net cash provided by financing activities		6,183,816			77,260,496

Net decrease in cash and cash equivalents		(19,184,308	)		(15,201,011	)
Cash and cash equivalents, beginning of period		22,906,376			17,654,056

Cash and cash equivalents, end of period	$	3,722,068		$	2,453,045

Supplemental information:
Cash paid for interest	$	141,795		$	125,322
Non-cash financing activities:
Issuance of shares of common stock under dividend reinvestment plan	$	1,729,790		$	—
Redemption of partnership interests	$	—		$	(173,699,632	)
Issuance of shares of common stock in exchange for partnership interests	$	—		$	173,699,632

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2009

(unaudited)


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost			Fair Value
Control Investments (3)
Affiliate Investments (4)

O’Currance, Inc.	Data Processing &
	Outsourced Services
First Lien Term Loan A, 16.875% due 3/21/2012		$	10,314,991	$	10,126,682		$	10,137,999
First Lien Term Loan B, 16.875% due 3/21/2012			3,207,341		3,156,378			3,159,906
1.75% Preferred Membership Interest in O’Currance Holding Co., LLC					130,413			71,164
3.3% Membership Interest in O’Currance Holding Co., LLC					250,000			—
					13,663,473			13,369,069

CPAC, Inc. (9)	Household Products
	& Specialty
	Chemicals
Second Lien Term Loan, 17.5% due 4/13/2012			11,029,737		9,532,903			1,953,743
Charge-off of principal balance of impaired loan (12)					(4,000,000	)		—
2,297 shares of Common Stock					2,297,000			—
					7,829,903			1,953,743

Elephant & Castle, Inc.	Restaurants
Second Lien Term Loan, 15.5% due 4/20/2012			7,918,718		7,348,154			7,236,024
7,500 shares of Series A Preferred Stock					750,000			112,371
					8,098,154			7,348,395

MK Network, LLC	Healthcare
	technology
First Lien Term Loan A, 13.5% due 6/1/2012			9,500,000		9,167,631			8,989,316
First Lien Term Loan B, 17.5% due 6/1/2012			5,371,615		5,082,632			4,983,899
First Lien Revolver, Prime + 1.5% (10% floor), due 6/1/2010 – undrawn revolver of $2,000,000 (10)			—		—			—
11,030 Membership Units (6)					771,575			128,536
					15,021,838			14,101,751

Rose Tarlow, Inc. (9)	Home Furnishing
	Retail
First Lien Term Loan, 12% due 1/25/2014			10,062,630		9,873,347			7,895,226
First Lien Revolver, LIBOR+4% (9% floor) due 1/25/2014 – undrawn revolver of $1,450,000 (10)			1,550,000		1,537,514			1,356,869
6.9% Membership interest in RTMH Acquisition Company					1,275,000			—
0.1% Membership interest in RTMH Acquisition Company					25,000			—
					12,710,861			9,252,095

Martini Park, LLC (9)	Restaurants
First Lien Term Loan, 14% due 2/20/2013			4,216,400		3,416,351			2,227,670
5% Membership interest					650,000			—
					4,066,351			2,227,670


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost		Fair Value
Caregiver Services, Inc.	Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (12% floor) due 2/25/2013			9,285,298		8,729,047		8,753,034
Second Lien Term Loan B, 16.5% due 2/25/2013			14,023,011		13,121,747		13,157,806
1,080,399 shares of Series A Preferred Stock					1,080,398		940,386
					22,931,192		22,851,226

Total Affiliate Investments					84,321,772		71,103,949


Non-Control/Non-Affiliate Investments (7)

Best Vinyl Acquisition Corporation (9)	Building Products
Second Lien Term Loan, 12% due 3/30/2013			7,000,000		6,748,330		6,704,802
25,641 shares of Series A Preferred Stock					253,846		253,846
25,641 shares of Common Stock					2,564		61,302
					7,004,740		7,019,950

Traffic Control & Safety Corporation	Construction and
	Engineering
Second Lien Term Loan, 15% due 6/29/2014			19,024,152		18,808,539		18,442,807
24,750 shares of Series B Preferred Stock					247,500		77,712
25,000 shares of Common Stock					2,500		—
					19,058,539		18,520,519

Nicos Polymers & Grinding Inc. (9)	Environmental &
	Facilities Services
First Lien Term Loan A, LIBOR+5% (10% floor), due 7/17/2012			3,123,222		3,102,965		2,846,470
First Lien Term Loan B, 13.5% due 7/17/2012			5,882,276		5,713,750		5,241,479
3.32% Interest in Crownbrook Acquisition I LLC					168,086		—
					8,984,801		8,087,949

TBA Global, LLC (9)	Media: Advertising
Second Lien Term Loan A, LIBOR+5% (10% floor), due 8/3/2010			2,557,692		2,546,024		2,262,985
Second Lien Term Loan B, 14.5% due 8/3/2012			10,580,959		10,135,404		9,012,582
53,994 Senior Preferred Shares					215,975		—
191,977 Shares A Shares					191,977		—
					13,089,380		11,275,567

Fitness Edge, LLC	Leisure Facilities
First Lien Term Loan A, LIBOR+5.25% (10% floor), due 8/8/2012			2,000,000		1,987,007		1,918,194
First Lien Term Loan B, 15% due 8/8/2012			5,421,480		5,289,688		5,131,270
1,000 Common Units					42,908		57,939
					7,319,603		7,107,403

Filet of Chicken (9)	Food Distributors
Second Lien Term Loan, 14.5% due 7/31/2012			12,484,699		12,008,090		11,887,135
					12,008,090		11,887,135


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost			Fair Value
Boot Barn (9)	Footwear and Apparel
Second Lien Term Loan, 14.5% due 10/3/2013			21,838,888		21,639,131			21,361,618
24,706 shares of Series A Preferred Stock					247,060			73,559
1,308 shares of Common Stock					131			—
					21,886,322			21,435,177

American Hardwoods Industries Holdings, LLC (9)	Lumber Products
Second Lien Term Loan, 15% due 10/15/2012			10,073,644		10,107,688			916,400
Charge-off of principal balance of impaired loan (12)					(8,400,000	)		—
24,375 Membership Units					250,000			—
					1,957,688			916,400

Premier Trailer Leasing, Inc.	Trailer Leasing
	Services
Second Lien Term Loan, 16.5% due 10/23/2012			17,563,450		17,064,270			12,418,047
285 shares of Common Stock					1,140			—
					17,065,410			12,418,047

Pacific Press Technologies, Inc.
Second Lien Term Loan, 14.75% due 1/10/2013	Capital Goods		9,677,913		9,456,575			9,783,839
33,463 shares of Common Stock					344,513			516,828

					9,801,088			10,300,667

Goldco, LLC
Second Lien Term Loan, 17.5% due 1/31/2013	Restaurants		7,862,908		7,750,407			7,803,323
					7,750,407			7,803,323

Lighting by Gregory, LLC	Housewares &
	Specialties
First Lien Term Loan A, 9.75% due 2/28/2013			4,250,003		4,185,363			2,627,336
First Lien Term Loan B, 14.5% due 2/28/2013			7,051,533		6,913,440			4,338,443
1.1% Membership interest					110,000			—
					11,208,803			6,965,779

Rail Acquisition Corp.	Manufacturing -
	Mechanical Products
First Lien Term Loan, 17% due 4/1/2013			15,859,602		15,579,195			15,523,110
					15,579,195			15,523,110

Western Emulsions, Inc.	Emulsions
	Manufacturing
Second Lien Term Loan, 15% due 6/30/2014			9,784,219		9,610,219			9,788,669
					9,610,219			9,788,669

Storytellers Theaters Corporation	Entertainment -
	Theaters
First Lien Term Loan, 15% due 7/16/2014			7,229,530		7,109,538			7,141,829
First Lien Revolver, LIBOR+3.5% (10% floor), due 7/16/2014 – undrawn revolver of $2,000,000 (11)			—		(17,499	)		(17,499	)
1,692 shares of Common Stock					169			—
20,000 shares of Preferred Stock					200,000			133,454
					7,292,208			7,257,784


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost			Fair Value
HealthDrive Corporation	Healthcare
	facilities
First Lien Term Loan A, 10% due 7/17/2013			7,900,000		7,831,578			7,181,345
First Lien Term Loan B, 13% due 7/17/2013			10,025,021		9,855,021			9,043,744
First Lien Revolver, 12% due 7/17/2013 – undrawn revolver of $1,000,000			1,000,000		983,000			963,944
					18,669,599			17,189,033

idX Corporation	Merchandise Display
Second Lien Term Loan, 14.5% due 7/1/2014			13,181,664		12,954,164			12,889,165
					12,954,164			12,889,165

Cenegenics, LLC	Healthcare services
First Lien Term Loan, 17% due 10/27/2013			10,857,610		10,524,700			10,770,966
116,237 Common Units (6)					151,108			418,707
					10,675,808			11,189,673

IZI Medical Products, Inc.	Healthcare
	technology
First Lien Term Loan A, 12% due 3/31/2014			5,600,000		5,488,000			5,488,000
First Lien Term Loan B, 16% due 3/31/2014			17,000,000		16,206,245			16,206,245
First Lien Revolver, 10% due 3/31/2014 – undrawn revolver of $2,500,000 (11)			—		(50,000	)		(50,000	)
453,755 Preferred units of IZI Holdings, LLC					453,755			453,755
					22,098,000			22,098,000


Total Non-Control/Non-Affiliate Investments					234,014,064			219,673,350


*Total Portfolio Investments*				$	318,335,836		$	290,777,299


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

(2)		See Note 3 for summary geographic location.

(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. As of March 31, 2009, the Company did not have a controlling interest in any of its investments.

(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

CPAC, Inc.

November 21, 2008

—

+ 1.0% on Term Loan

Per waiver agreement

+ 3.0% on Revolver

Rose Tarlow, Inc.

January 1, 2009

+ 0.5% on Term Loan

+ 2.5% on Term Loan

Tier pricing per waiver agreement

Martini Park, LLC

October 1, 2008

- 6.0% on Term Loan

+ 6.0% on Term Loan

Per waiver agreement

Best Vinyl Acquisition Corporation

April 1, 2008

+ 0.5% on Term Loan

—

Per loan amendment

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 A & B

Per waiver agreement

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

American Hardwoods Industries Holdings, LLC

April 1, 2008

+ 6.75% on Term Loan

- 3.0% 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)		All or a portion of the loan is considered permanently impaired and, accordingly, the charge-off of the principal balance has been recorded as a realized loss for financial reporting purposes.

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Schedule of Investments

September 30, 2008


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost			Fair Value
Control Investments (3)
Affiliate Investments (4)

O’Currance, Inc.	Data Processing &
	Outsourced Services
First Lien Term Loan A, 16.875% due 3/21/2012		$	10,108,838	$	9,888,488		$	9,888,488
First Lien Term Loan B, 16.875% due 3/21/2012			3,640,702		3,581,245			3,581,245
1.75% Preferred Membership Interest in O’Currance Holding Co., LLC					130,413			130,413
3.3% Membership Interest in O’Currance Holding Co., LLC					250,000			97,156
					13,850,146			13,697,302

CPAC, Inc.	Household Products &
	Specialty Chemicals
Second Lien Term Loan, 17.5% due 4/13/2012			10,613,769		9,556,805			3,626,497
2,297 shares of Common Stock					2,297,000			—
					11,853,805			3,626,497

Elephant & Castle, Inc.	Restaurants
Second Lien Term Loan, 15.5% due 4/20/2012			7,809,513		7,145,198			7,145,198
7,500 shares of Series A Preferred Stock					750,000			196,386

					7,895,198			7,341,584

MK Network, LLC	Healthcare technology
First Lien Term Loan A, 13.5% due 6/1/2012			9,500,000		9,115,152			9,115,152
First Lien Revolver, Prime + 1.5% (10% floor), due 6/1/2010 – undrawn revolver of $2,000,000 (10)			—		(11,113	)		(11,113	)
6,114 Membership Units (6)					584,795			760,441
					9,688,834			9,864,480

Rose Tarlow, Inc.	Home Furnishing
	Retail
First Lien Term Loan, 12% due 1/25/2014			10,000,000		9,796,648			9,796,648
First Lien Revolver, LIBOR+4% (9% floor) due 1/25/2014 – undrawn revolver of $2,650,000			350,000		323,333			323,333
6.9% Membership interest in RTMH Acquisition Company					1,275,000			591,939
0.1% Membership interest in RTMH Acquisition Company					25,000			11,607
					11,419,981			10,723,527


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost		Fair Value
Martini Park, LLC	Restaurants
First Lien Term Loan, 14% due 2/20/2013			4,049,822		3,188,351		2,719,236
5% Membership interest					650,000		—
					3,838,351		2,719,236

Caregiver Services, Inc.	Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (12% floor) due 2/25/2013			10,000,000		9,381,973		9,381,973
Second Lien Term Loan B, 16.5% due 2/25/2013			13,809,891		12,811,950		12,811,951
1,080,399 shares of Series A Preferred Stock					1,080,398		1,183,867
					23,274,321		23,377,791

Total Affiliate Investments					81,820,636		71,350,417


Non-Control/Non-Affiliate Investments (7)

Best Vinyl Acquisition Corporation (9)	Building Products
Second Lien Term Loan, 12% due 3/30/2013			7,000,000		6,716,712		6,716,712
25,641 shares of Series A Preferred Stock					253,846		253,846
25,641 shares of Common Stock					2,564		4,753
					6,973,122		6,975,311

Traffic Control & Safety Corporation	Construction and
	Engineering
Second Lien Term Loan, 15% due 6/29/2014			18,741,969		18,503,268		18,503,268
24,750 shares of Series B Preferred Stock					247,500		179,899
25,000 shares of Common Stock					2,500		—
					18,753,268		18,683,167

Nicos Polymers & Grinding Inc. (9)	Environmental &
	Facilities Services
First Lien Term Loan A, LIBOR+5% (10% floor), due 7/17/2012			3,216,511		3,192,408		3,192,408
First Lien Term Loan B, 13.5% due 7/17/2012			5,786,547		5,594,313		5,594,313
3.32% Interest in Crownbrook Acquisition I LLC					168,086		72,756
					8,954,807		8,859,477

TBA Global, LLC (9)	Media: Advertising
Second Lien Term Loan A, LIBOR+5% (10% floor), due 8/3/2010			2,531,982		2,516,148		2,516,148
Second Lien Term Loan B, 14.5% due 8/3/2012			10,369,491		9,857,130		9,857,130
53,944 Senior Preferred Shares					215,975		143,418
191,977 Shares A Shares					191,977		—
					12,781,230		12,516,696

Fitness Edge, LLC	Leisure Facilities
First Lien Term Loan A, LIBOR+5.25% (10% floor), due 8/8/2012			2,250,000		2,233,636		2,233,636
First Lien Term Loan B, 15% due 8/8/2012			5,353,461		5,206,261		5,206,261
1,000 Common Units					42,908		55,033
					7,482,805		7,494,930


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost		Fair Value
Filet of Chicken (9)	Food Distributors
Second Lien Term Loan, 14.5% due 7/31/2012			12,516,185		11,994,788		11,994,788
					11,994,788		11,994,788

Boot Barn	Footwear and Apparel
Second Lien Term Loan, 14.5% due 10/3/2013			18,095,935		17,788,078		17,788,078
24,706 shares of Series A Preferred Stock					247,060		146,435
1,308 shares of Common Stock					131		—
					18,035,269		17,934,513

American Hardwoods Industries Holdings, LLC	Lumber Products
Second Lien Term Loan, 15% due 10/15/2012			10,334,704		10,094,129		4,384,489
24,375 Membership Units					250,000		—
					10,344,129		4,384,489

Premier Trailer Leasing, Inc.	Trailer Leasing
	Services
Second Lien Term Loan, 16.5% due 10/23/2012			17,277,619		16,985,473		16,985,473
285 shares of Common Stock					1,140		—
					16,986,613		16,985,473

Pacific Press Technologies, Inc.
Second Lien Term Loan, 14.75% due 1/10/2013	Capital Goods		9,544,447		9,294,486		9,294,486
33,463 shares of Common Stock					344,513		481,210
					9,638,999		9,775,696

Goldco, LLC
Second Lien Term Loan, 17.5% due 1/31/2013	Restaurants		7,705,762		7,578,261		7,578,261
					7,578,261		7,578,261

Lighting by Gregory, LLC	Housewares &
	Specialties
First Lien Term Loan A, 9.75% due 2/28/2013			4,500,002		4,420,441		4,420,441
First Lien Term Loan B, 14.5% due 2/28/2013			7,010,207		6,888,876		6,888,876
1.1% Membership interest					110,000		98,459
					11,419,317		11,407,776

Rail Acquisition Corp.	Manufacturing -
	Mechanical Products
First Lien Term Loan, 17% due 4/1/2013			15,800,700		15,494,737		15,494,737
					15,494,737		15,494,737


Portfolio Company /Type of Investment (1)(2)(5)	Industry	Principal (8)		Cost			Fair Value
Western Emulsions, Inc.	Emulsions
	Manufacturing
Second Lien Term Loan, 15% due 6/30/2014			9,661,464		9,523,464			9,523,464
					9,523,464			9,523,464

Storytellers Theaters Corporation	Entertainment -
	Theaters
First Lien Term Loan, 15% due 7/16/2014			11,824,414		11,598,248			11,598,248
First Lien Revolver, LIBOR+3.5% (10% floor), due 7/16/2014 – undrawn revolver of $2,000,000 (10)			—		(17,566	)		(17,566	)
1,692 shares of Common Stock					169			—
20,000 shares of Preferred Stock					200,000			196,588
					11,780,851			11,777,270

HealthDrive Corporation	Healthcare facilities
First Lien Term Loan A, 10% due 7/17/2013			8,000,000		7,923,357			7,923,357
First Lien Term Loan B, 13% due 7/17/2013			10,008,333		9,818,333			9,818,333
First Lien Revolver, 12% due 7/17/2013 – undrawn revolver of $1,500,000			500,000		481,000			481,000
					18,222,690			18,222,690

idX Corporation	Merchandise Display
Second Lien Term Loan, 14.5% due 7/1/2014			13,049,166		12,799,999			12,799,999
					12,799,999			12,799,999

Total Non-Control/Non-Affiliate Investments					208,764,349			202,408,737

*Total Portfolio Investments*				$	290,584,985		$	273,759,154


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

(2)		See Note 3 for summary geographic location.

(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. As of September 30, 2008, the Company did not have a controlling interest in any of its investments.

(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)		Rates have been adjusted on the term loans, as follows:


Portfolio Company	Effective date	Cash interest	PIK interest	Reason
Best Vinyl Acquisition Corporation	April 1, 2008	+ 0.5% on Term Loan	—	Per loan amendment
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 A & B	Per waiver agreement
Filet of Chicken	August 1, 2008	+ 1.0% on Term Loan	+ 1.0% on Term Loan	Per loan amendment


(10)		Amounts represent unearned income related to undrawn commitments.

See notes to Consolidated Financial Statements.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2009 (unaudited)

Note 1. Organization

Fifth Street Mezzanine Partners III, L.P. (“Fifth Street” or “Partnership”), a Delaware limited partnership, was organized on February 15, 2007 to primarily invest in debt securities of small and/or 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., 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”). The merger involved the exchange of shares between companies under common control. In accordance with the guidance on exchanges of shares between entities under common control contained in Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”), the Company’s results of operations and cash flows for the six months ended March 31, 2008 are presented as if the merger had occurred as of October 1, 2007. Accordingly, no adjustments were made to the carrying value of assets and liabilities (or the cost basis of investments) as a result of the merger. Fifth Street Finance Corp. is managed by the Investment Adviser. Prior to January 2, 2008, references to the Company are to the Partnership. On and as of 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 Taxable Subsidiaries which hold certain portfolio investments of the Company. The Taxable Subsidiaries are consolidated with the Company, in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and the portfolio investments held by the Taxable Subsidiaries are included in the Company’s consolidated financial statements. All significant intercompany balances have been eliminated. The purpose of the Taxable Subsidiaries is to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for 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, is reflected in the Company’s Consolidated Statement of Operations.

On June 17, 2008, Fifth Street Finance Corp. completed an initial public offering of 10,000,000 shares of its common stock at the offering price of $14.12 per share. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “FSC.”

Note 2. Significant Accounting Policies

Basis of Presentation and Liquidity:

Interim consolidated financial statements of the Company are prepared in accordance with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Regulation S-X. 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 results of operations for the current period are not necessarily indicative of results that ultimately may be achieved for any other interim period or for the year ending September 30, 2009. The interim unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended September 30, 2008.

Although the Company expects to fund the growth of the Company’s 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 in order to satisfy the requirements applicable to regulated investment companies, or “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 under its $50 million secured revolving credit facility, which matures on December 29, 2009. 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, we may realize significantly less than their recorded value. As of March 31, 2009, the Company had $3.7 million in cash, portfolio investments (at fair value) of $290.8 million, $2.8 million of interest receivable, $21.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million. At April 30, 2009, we had $1.8 million in cash, $2.2 million of interest receivable, $5.7 million of dividends payable, $17.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million.

Use of estimates:

The preparation of financial statements in conformity with GAAP and Article 6 of Regulation S-X under the Securities Exchange Act of 1934 requires management to make certain estimates and assumptions affecting amounts reported in the financial statements. 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 estimate inherent in the preparation of the Company’s consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation.

The consolidated financial statements include portfolio investments at fair value of $290.8 million and $273.8 million at March 31, 2009 and September 30, 2008, respectively. The portfolio investments represent 106.8% and 93.0% of stockholders’ equity at March 31, 2009 and September 30, 2008, 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 illiquidity of these 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 the investments’ recorded value.

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; and, “Affiliate Investments” are defined as investments in companies in which the Company owns between 5% and 25% of the voting securities. Under the 1940 Act, “Non-Control/ Non-Affiliate Investments” are defined as investments that are neither Control Investments nor Affiliate Investments.

Recently Issued Accounting Pronouncements

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133, which requires additional disclosures for derivative instruments and hedging activities. SFAS 161 was effective for the Company beginning January 1, 2009. The Company does not have any derivative instruments nor has it engaged in any hedging activities. As a result, the adoption of SFAS 161 had no impact on the Company’s consolidated financial statements.

On April 9, 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1 Interim Disclosures about Fair Value of Financial Instruments. This FSP shall be effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has not elected to early adopt this pronouncement.

On April 9, 2009, the FASB issued FSP FAS 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This FSP shall be effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has not elected to early adopt this pronouncement.

Investments:

a) Valuation:

As described below, effective October 1, 2008, the Company adopted Statement of Financial Standards No. 157—Fair Value Measurements, or SFAS 157. In accordance with that standard, the Company changed its presentation for all periods presented to net unearned fees against the associated debt investments. Prior to the adoption of SFAS 157 on October 1, 2008, the Company reported unearned fees as a single line item on the Consolidated Balance Sheets and Consolidated Schedule of Investments. This change in presentation had no impact on the overall net cost or fair value of the Company’s investment portfolio and had no impact on the Company’s financial position or results of operations.

At March 31, 2009 and September 30, 2008, $270.4 million and $251.5 million, respectively, of the Company’s portfolio debt investments at fair value were at fixed rates, which represented approximately 94% and 93%, respectively, of the Company’s total portfolio of debt investments at fair value. At March 31, 2009 and September 30, 2008, the Company had equity investments designed to provide the Company with an opportunity for an enhanced internal rate of return. These instruments generally do not produce a current return, but are held for potential investment appreciation and capital gains.

During the three and six months ended March 31, 2009, the Company recorded realized losses on investments of $12.4 million. During the three and six months ended March 31, 2008, the Company recorded no realized gains or losses on investments. During the three months ended March 31, 2009 and 2008, the Company recorded unrealized appreciation (depreciation) of $7.7 million and ($1.6 million), respectively. During the six months ended March 31, 2009 and 2008, the Company recorded unrealized depreciation of $10.7 million and $2.0 million, respectively.

The composition of the Company’s investments as of March 31, 2009 and September 30, 2008 at cost and fair value was as follows:


	March 31, 2009				September 30, 2008
	Cost		Fair Value		Cost		Fair Value
Investments in debt securities	$	308,223,218	$	287,477,740	$	281,264,010	$	269,154,948
Investments in equity securities		10,112,618		3,299,559		9,320,975		4,604,206

Total	$	318,335,836	$	290,777,299	$	290,584,985	$	273,759,154

Fair Value Measurements

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Standards No. 157—Fair Value Measurements, or SFAS 157, which was effective for fiscal years beginning after November 15, 2007, with early adoption permitted. SFAS 157 defines fair value as the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. 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, valuation techniques are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the investments or market and the investments’ complexity.

Assets and liabilities recorded at fair value in the Company’s Consolidated Balance Sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by SFAS 157 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.

The following table presents the financial instruments carried at fair value as of March 31, 2009, by caption on the Company’s Consolidated Balance Sheet for each of the three levels of hierarchy established by SFAS 157.


			Internal models
	Quoted market		with significant		Internal models with significant		Total fair value
	prices in active		observable market		unobservable market		reported in
	markets (Level 1)		parameters (Level 2)		parameters (Level 3)		Consolidated Balance Sheet
Affiliate investments		—		—	$	71,103,949	$	71,103,949
Non-Control/Non-Affiliate investments		—		—		219,673,350		219,673,350
Control investments		—		—		—		—

Total investments at fair value		—		—	$	290,777,299	$	290,777,299

The following table provides a roll-forward in the changes in fair value from September 30, 2008 to March 31, 2009, for all investments for which the Company determines fair value using unobservable (Level 3) factors. 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 table below includes changes in fair value due in part to observable factors that are part of the valuation methodology.


	Affiliate			Non-Control/Non-Affiliate			Control
	investments			investments			investments		Total
Fair value as of September 30, 2008	$	71,350,417		$	202,408,737			—	$	273,759,154
Total realized losses		(4,000,000	)		(8,400,000	)		—		(12,400,000	)
Change in unrealized depreciation		(2,747,604	)		(7,985,100	)		—		(10,732,704	)
Purchases, issuances, settlements and other, net		6,501,136			33,649,713			—		40,150,849
Transfers in (out) of Level 3		—			—			—		—

Fair value as of March 31, 2009	$	71,103,949		$	219,673,350			—	$	290,777,299

Concurrent with its adoption of SFAS 157, 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). Prior to October 1, 2008, the Company estimated the fair value of its Level 3 debt investments by first estimating the enterprise value of the portfolio company which issued the debt investment. To estimate the enterprise value of a portfolio company, the Company analyzed various factors, including the portfolio companies historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (Earning Before Interest, Taxes, Depreciation and Amortization), cash flow, net income, revenues or, in limited instances, book value.

In estimating a multiple to use for valuation purposes, the Company looked to private merger and acquisition statistics, discounted public trading multiples or industry practices. In some cases, the best valuation methodology may have been a discounted cash flow analysis based on future projections. If a portfolio company was distressed, a liquidation analysis may have provided the best indication of enterprise value.

If there was adequate enterprise value to support the repayment of the Company’s debt, the fair value of the Level 3 loan or debt security normally corresponded to cost plus the amortized original issue discount unless the borrower’s condition or other factors lead to a determination of fair value at a different amount.

Beginning on October 1, 2008, the Company also introduced a bond-yield model to value these investments based on the present value of expected cash flows. The primary 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. During the three months ended March 31, 2009 and 2008, the Company recorded net unrealized appreciation (depreciation) of $7.7 million and ($1.6 million), respectively, on its investments. For the three months ended March 31, 2009, the Company’s net unrealized appreciation (depreciation) consisted of $12.4 million of reclassifications to realized losses, offset by unrealized depreciation of (3.6 million) resulting from declines in EBITDA or market multiples of its portfolio companies requiring closer monitoring or performing below expectations; and approximately ($1.1 million) resulted from the adoption of SFAS 157.

The table below summarizes the changes in the Company’s investment portfolio from September 30, 2008 to March 31, 2009.


	Debt			Equity			Total

Fair value at September 30, 2008	$	269,154,948		$	4,604,206		$	273,759,154
New investments		47,058,356			791,644			47,850,000
Redemptions/ repayments		(11,242,202	)		—			(11,242,202	)
Net accrual of PIK interest income		3,553,912			—			3,553,912
Accretion of original issue discount		400,738			—			400,738
Recognition of unearned income		(411,599	)		—			(411,599	)
Net unrealized depreciation		(8,636,413	)		(2,096,291	)		(10,732,704	)
Net changes from unrealized to realized		(12,400,000	)		—			(12,400,000	)

Fair value at March 31, 2009	$	287,477,740		$	3,299,559		$	290,777,299

Realized gain or loss on the sale of investments is the difference between the proceeds received from dispositions of portfolio investments and their stated cost. Realized losses may also be recorded in connection with the Company’s determination that certain investments are permanently impaired.

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.

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

The Company has investments in debt securities which contain a payment in kind or “PIK” interest provision. 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. For the three months ended March 31, 2009 and 2008, the Company recorded PIK income of $1,900,702 and $959,230, respectively. For the six months ended March 31, 2009 and 2008, the Company recorded PIK income of $3,717,487 and $1,687,713, respectively.

The Company capitalizes upfront loan origination fees received in connection with investments. The unearned fee income from such fees is accreted into fee income based on the effective interest method over the life of the investment. 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 fee income over the life of the loan.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS 159 also requires entities to display the fair value of the selected assets and liabilities on the face of the balance sheet. SFAS 159 does not eliminate disclosure requirements of other accounting standards, including fair value measurement disclosures in SFAS 157. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption was permitted as of the beginning of the previous fiscal year provided that the entity made that choice in the first 120 days of that fiscal year and also elected to apply the provisions of SFAS 157. While SFAS 159 became effective for the Company’s 2009 fiscal year, the Company did not elect the fair value measurement option for any of its financial assets or liabilities.

In October 2008, the FASB issued Staff Position No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active (“FSP 157-3”). FSP 157-3 provides an illustrative example of how to determine the fair value of a financial asset in an inactive market. The FSP does not change the fair value measurement principles set forth in SFAS 157. Since adopting SFAS 157 in the quarter ending December 31, 2008, the Company’s practices for determining the fair value of its investment portfolio have been, and continue to be, consistent with the guidance provided in the example in FSP 157-3. Therefore, the Company’s adoption of FSP 157-3 did not affect its practices for determining the fair value of its investment portfolio and does not have a material effect on its financial position or results of operations.

Consolidation:

The Company has certain wholly owned Taxable Subsidiaries which hold certain portfolio investments of the Company. The Taxable Subsidiaries are consolidated with the Company for GAAP reporting purposes, and the portfolio investments held by the Taxable Subsidiaries are included in the Company’s consolidated financial statements. All significant intercompany balances have been eliminated. The purpose of the Taxable Subsidiaries is to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for 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 its ownership of certain portfolio investments. This income tax expense, if any, is reflected in the Company’s Consolidated Statement of Operations.

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.

Income Taxes:

Prior to the merger of the Partnership with and into the Company, the Partnership was treated as a partnership for federal and state income tax purposes. The Partnership generally did not record a provision for income taxes because the partners report their shares of the partnership income or loss on their income tax returns. Accordingly, the taxable income was passed through to the partners and the Partnership was not subject to an entity level tax as of December 31, 2007.

As a partnership, Fifth Street Mezzanine Partners III, LP filed a calendar year tax return for a short year initial period from February 15, 2007 through December 31, 2007. Upon the merger, Fifth Street Finance Corp., the surviving C-Corporation, made an election to be treated as a Regulated Investment Company (“RIC”) under the Code and adopted a September 30 tax year end. Accordingly, the first RIC tax return will be filed for the tax year beginning January 1, 2008 and ending September 30, 2008. The Company has filed for a tax extension and has until June 15, 2009 to file its tax return.

As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed to its stockholders as a dividend. The Company anticipates distributing 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. 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 (i.e., calendar year 2009). The Company anticipates timely distribution of its taxable income within the tax rules, however, the Company may incur a U.S. Federal excise tax for the calendar year 2009.

The Company uses the asset and liability method to account for our 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 carryforwards that we 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 we expect 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 $3.6 million. However, this amount has been fully offset by a valuation allowance of $3.6 million, since it is more likely than not, that these deferred tax assets will not be realized.

Listed below is a reconciliation of “net increase (decrease) in net assets resulting from operations” to taxable income for the three and six months ended March 31, 2009.


	Three months ended			Six months ended
	March 31, 2009(1)			March 31, 2009(1)

Net increase (decrease) in net assets resulting from operations	$	2,837,000		$	(7,435,000	)
Net change in unrealized (appreciation) depreciation from investments		(7,749,000	)		10,733,000
Book/tax difference due to deferred loan origination fees, net		493,000			412,000
Book/tax difference due to organizational and deferred offering costs		(22,000	)		(44,000	)
Book/tax difference due to interest income on certain loans		(40,000	)		262,000
Other nondeductible expenses		—			18,000

Taxable/Tax Distributable Income	$	(4,481,000	)	$	3,946,000


(1)		The Company’s taxable income for 2009 is an estimate and will not be finally determined until the Company files its tax return for the fiscal year ended September 30, 2009. Therefore, the final taxable income may be different than the estimate.

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; and (4) recognition of interest income on certain loans.

As of March 31, 2009, there is no material difference between the book and tax basis of the Company’s assets.

The Company adopted Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes at inception on February 15, 2007. FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the consolidated financial statements. FIN 48 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. Adoption of FIN 48 was applied to all open taxable years as of the effective date. The adoption of FIN 48 did not have an effect on the financial position or results of operations of the Company as there was no liability for unrecognized tax benefits and no change to the beginning capital of the Company. Management’s determinations regarding FIN 48 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof.

Dividends Paid:

Distributions to stockholders are recorded on the declaration date. The Company is required to distribute annually to its stockholders at least 90% of its net ordinary 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 each quarter and is based on management’s estimate of the Company’s annual taxable income. Based on that, a dividend is declared and paid each quarter. The Company maintains an “opt out” dividend reimbursement plan for its stockholders.

To date, the Company’s Board of Directors declared the following distributions:


Dividend Type	Date Declared	Record Date	Payment Date	Amount
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

For income tax purposes, the Company estimates that these distributions will be composed entirely of ordinary income, and will be reflected as such on the Form 1099-DIV for the calendar year 2009. To date, the Company’s operations have resulted in no long-term capital gains or losses. The Company anticipates declaring further distributions to its stockholders to meet the distribution requirements pursuant to Subchapter M of the Code.

Guarantees and Indemnification Agreements:

The Company follows FASB Interpretation Number 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 elaborates on the disclosure requirements of a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires a guarantor to recognize, at the inception of a guarantee, for those guarantees that are covered by FIN 45, the fair value of the obligation undertaken in issuing certain guarantees. The Interpretation has had no impact on the Company’s consolidated financial statements.

Reclassifications:

Certain prior period amounts have been reclassified to conform to the current presentation.

Note 3. Portfolio Investments

At March 31, 2009, 106.8% of stockholders’ equity or $290.8 million was invested in 26 long-term portfolio investments and 1.4% of stockholders’ equity or $3.7 million was invested in cash and cash equivalents. In comparison, at September 30, 2008, 93.0% of stockholders’ equity or $273.8 million was invested in 24 long-term portfolio investments and 7.8% of stockholders’ equity or $22.9 million was invested in cash and cash equivalents. As of March 31, 2009, all of the Company’s debt investments were secured by first or second priority liens on the assets of the portfolio companies. Moreover, the Company held equity investments in its portfolio companies consisting of common stock, preferred stock or limited liability company interests.

The Company’s off-balance sheet arrangements consisted of $11.0 million and $24.7 million of unfunded commitments to provide debt financing to its portfolio companies as of March 31, 2009 and September 30, 2008, respectively. Such commitments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet and are not reflected on the Company’s Consolidated Balance Sheet.

A summary of the composition of the unfunded commitments (consisting of revolvers and term loans) as of March 31, 2009 and September 30, 2008 is shown in the table below:


	March 31, 2009		September 30, 2008
MK Network, LLC	$	—	$	2,000,000
Fitness Edge, LLC		1,500,000		1,500,000
Rose Tarlow, Inc.		—		2,650,000
Western Emulsions, Inc.		2,000,000		2,000,000
Storyteller Theaters Corporation		4,000,000		4,000,000
HealthDrive Corporation		1,000,000		1,500,000
Martini Park, LLC		—		11,000,000
IZI Medical Products, Inc.		2,500,000		—

Total	$	11,000,000	$	24,650,000

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 31,2009				September 30, 2008
Cost:
First lien debt	$	143,062,526	44.94	%	$	108,716,148	37.41	%
Second lien debt		165,160,692	51.88	%		172,547,862	59.38	%
Purchased equity		4,120,368	1.29	%		4,120,368	1.42	%
Equity grants		5,992,250	1.89	%		5,200,607	1.79	%

Total	$	318,335,836	100.00	%	$	290,584,985	100.00	%


	March 31,2009				September 30, 2008
Fair value:
First lien debt	$	133,105,761	45.78	%	$	108,247,033	39.54	%
Second lien debt		154,371,979	53.09	%		160,907,915	58.78	%
Purchased equity		701,306	0.24	%		2,001,213	0.73	%
Equity grants		2,598,253	0.89	%		2,602,993	0.95	%

Total	$	290,777,299	100.00	%	$	273,759,154	100.00	%

The Company 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.


	March 31, 2009				September 30, 2008
Cost:
Northeast	$	105,254,740	33.06	%	$	89,699,936	30.87	%
West		98,089,123	30.81	%		81,813,016	28.15	%
Southeast		42,689,689	13.41	%		42,847,370	14.75	%
Midwest		22,755,252	7.15	%		22,438,998	7.72	%
Southwest		49,547,032	15.57	%		53,785,665	18.51	%

Total	$	318,335,836	100.00	%	$	290,584,985	100.00	%


	March 31, 2009				September 30, 2008
*Fair value:*
Northeast	$	87,996,123	30.26	%	$	73,921,159	27.00	%
West		92,062,050	31.66	%		80,530,516	29.42	%
Southeast		42,541,684	14.63	%		42,950,840	15.69	%
Midwest		23,189,832	7.98	%		22,575,695	8.25	%
Southwest		44,987,610	15.47	%		53,780,944	19.64	%

Total	$	290,777,299	100.00	%	$	273,759,154	100.00	%

Set forth below are tables showing the composition of the Company’s portfolio by industry at cost and fair value as of March 31, 2009 and September 30, 2008:


	March 31, 2009				September 30, 2008
Cost:
Healthcare technology	$	37,119,838	11.66	%	$	9,688,834	3.33	%
Healthcare services		33,607,000	10.56	%		23,274,321	8.01	%
Footwear and apparel		21,886,322	6.88	%		18,035,269	6.21	%
Restaurants		19,914,912	6.26	%		19,311,810	6.65	%
Construction and engineering		19,058,539	5.99	%		18,753,268	6.45	%
Healthcare facilities		18,669,599	5.86	%		18,222,690	6.27	%
Trailer leasing services		17,065,410	5.36	%		16,986,613	5.85	%
Manufacturing — mechanical products		15,579,195	4.89	%		15,494,737	5.33	%
Data processing and outsourced services		13,663,473	4.29	%		13,850,146	4.77	%
Media — Advertising		13,089,380	4.11	%		12,781,230	4.40	%
Merchandise display		12,954,164	4.07	%		12,799,999	4.40	%
Home furnishing retail		12,710,861	3.99	%		11,419,981	3.93	%
Food distributors		12,008,090	3.77	%		11,994,788	4.13	%
Housewares & specialties		11,208,803	3.52	%		11,419,317	3.93	%
Capital goods		9,801,088	3.08	%		9,638,999	3.32	%
Emulsions manufacturing		9,610,219	3.02	%		9,523,464	3.28	%
Environmental & Facilities Services		8,984,801	2.82	%		8,954,807	3.08	%
Household products/ specialty chemicals		7,829,903	2.46	%		11,853,805	4.08	%
Leisure facilities		7,319,603	2.30	%		7,482,805	2.58	%
Entertainment — theaters		7,292,208	2.29	%		11,780,851	4.05	%
Building products		7,004,740	2.21	%		6,973,122	2.39	%
Lumber products		1,957,688	0.61	%		10,344,129	3.56	%

Total	$	318,335,836	100.00	%	$	290,584,985	100.00	%


	March 31, 2009				September 30, 2008
Fair value:
Healthcare technology	$	36,199,751	12.45	%	$	9,864,480	3.60	%
Healthcare services		34,040,899	11.71	%		23,377,791	8.54	%
Footwear and apparel		21,435,177	7.37	%		17,934,513	6.55	%
Construction and engineering		18,520,519	6.37	%		18,683,167	6.82	%
Restaurants		17,379,388	5.98	%		17,639,081	6.44	%
Healthcare facilities		17,189,033	5.91	%		18,222,690	6.66	%
Manufacturing — mechanical products		15,523,110	5.34	%		15,494,737	5.66	%
Data processing and outsourced services		13,369,069	4.60	%		13,697,302	5.00	%
Merchandise display		12,889,165	4.43	%		12,799,999	4.68	%
Trailer leasing services		12,418,047	4.27	%		16,985,473	6.20	%
Food distributors		11,887,135	4.09	%		11,994,788	4.38	%
Media — Advertising		11,275,567	3.88	%		12,516,696	4.57	%
Capital goods		10,300,667	3.54	%		9,775,696	3.57	%
Emulsions manufacturing		9,788,669	3.37	%		9,523,464	3.48	%
Home furnishing retail		9,252,095	3.18	%		10,723,527	3.92	%
Environmental & Facilities Services		8,087,949	2.78	%		8,859,477	3.24	%
Entertainment — theaters		7,257,784	2.50	%		11,777,270	4.30	%
Leisure facilities		7,107,403	2.44	%		7,494,930	2.74	%
Building products		7,019,950	2.41	%		6,975,311	2.55	%
Housewares & specialties		6,965,779	2.40	%		11,407,776	4.17	%
Household products/ specialty chemicals		1,953,743	0.67	%		3,626,497	1.33	%
Lumber products		916,400	0.31	%		4,384,489	1.60	%

Total	$	290,777,299	100.00	%	$	273,759,154	100.00	%

The Company’s investments are generally in small and mid-sized companies in a variety of industries. At March 31, 2009 and September 30, 2008, the Company had no investments that were greater than 10% of the total investment portfolio. Income, consisting of interest, dividends, fees, other investment income, and realization of gains or losses on equity interests, can fluctuate upon repayment of an investment or sale of an equity interest and in any given year can be highly concentrated among several investments. For the three months ended March 31, 2009, no individual investment produced income that exceeded 10% of investment income. For the three months ended March 31, 2008, the income from one investment exceeded 10% of investment income. This investment represented approximately 11.1% of the investment income for the three month period ended March 31, 2008.

Note 4. Unearned Fee Income—Debt Origination Fees

The Company capitalizes upfront debt origination fees received in connection with financings and the unearned income from such fees is accreted into fee income over the life of the financing in accordance with Statement of Financial Accounting Standards 91 “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” In accordance with SFAS 157, the net balance is reflected as unearned income in the cost and fair value of the respective investments.

Accumulated unearned fee income activity for the six months ended March 31, 2009 and March 31, 2008 was as follows:


	Six months			Six months
	ended March 31, 2009			ended March 31, 2008

Beginning accumulated unearned fee income balance	$	5,236,265		$	1,566,293
Net fees received		2,227,846			3,047,617
Unearned fee income recognized		(1,816,247	)		(698,554	)

Ending accumulated unearned fee income balance	$	5,647,864		$	3,915,356

Note 5. Share Data and Stockholders’ Equity

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 approximately $129.5 million net of investment banking commissions of approximately $9.9 million and offering costs of approximately $1.8 million.

The following table sets forth the weighted average shares outstanding for computing basic and diluted earnings per common share for the three months ended March 31, 2009 and March 31, 2008.


	Three months		Three months
	ended March 31, 2009		ended March 31, 2008

Weighted average common shares outstanding, basic and diluted		22,752,668		12,480,972

On December 13, 2007, the Company adopted a dividend reinvestment plan that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder elects to receive cash. As a result, if the Board of Directors authorizes, and the Company declares, a cash distribution, then its stockholders who have not “opted out” of the dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares of common stock, rather than receiving the cash distributions. On May 1, 2008, the Company declared a dividend of $0.30 per share to stockholders of record on May 19, 2008. On June 3, 2008, the Company paid a cash dividend of approximately $1.9 million and issued 133,317 common shares totaling approximately $1.9 million under the dividend reinvestment plan. On August 6, 2008, the Company declared a dividend of $0.31 per share to stockholders of record on September 10, 2008. On September 26, 2008, the Company paid a cash dividend of $5.1 million, and purchased and distributed a total of 196,786 shares ($1.9 million) of its common stock under the dividend reinvestment plan. On December 9, 2008, the Company declared a dividend of $0.32 per share to stockholders of record on December 19, 2008, and a $0.33 per share dividend to stockholders of record on December 30, 2008. On December 18, 2008, the Company declared a special dividend of $0.05 per share to stockholders of record on December 30, 2008. On December 29, 2008, the Company paid a cash dividend of approximately $6.4 million and issued 105,326 common shares totaling approximately $0.8 million under the dividend reinvestment plan. On January 29, 2009, the Company paid a cash dividend of approximately $7.6 million and issued 161,206 common shares totaling approximately $1.0 million under the dividend reinvestment plan.

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 may be made through open market at times and in such amounts as Company management deems appropriate. The stock repurchase program expires December 2009 and may be limited or terminated by the Board of Directors. In October 2008, the Company repurchased 78,000 shares of common stock on the open market as part of its share repurchase program.

Note 6. Line of Credit

On January 15, 2008, the Company entered into a $50 million secured revolving credit facility with the Bank of Montreal, at a rate of LIBOR plus 1.5%, with a one year maturity date. The credit facility is secured by the Company’s existing investments.

Under the credit facility, the Company must satisfy several financial covenants, including maintaining a minimum level of stockholders’ equity, a maximum level of leverage and a minimum asset coverage ratio and interest coverage ratio. In addition, the Company must comply with other general covenants, including with respect to indebtedness, liens, restricted payments and mergers and consolidations. At December 31, 2008, the Company was in compliance with these covenants.

On December 30, 2008, Bank of Montreal renewed the Company’s $50 million credit facility. The terms include a 50 basis points commitment fee, an interest rate of Libor +3.25% and a term of 364 days. As of March 31, 2009, the Company had $21.0 million of borrowings outstanding under this credit facility. At April 30, 2009, the Company had $17.0 million of borrowings outstanding under this credit facility.

Prior to the merger, the Partnership entered into a $50 million unsecured, revolving line of credit with Wachovia Bank, N.A. (“Loan Agreement”) which had a final maturity date of April 1, 2008. Borrowings under the Loan Agreement were at a variable interest rate of LIBOR plus 0.75% per annum. In connection with the Loan Agreement, the General Partner, former member of the Board of Directors of Fifth Street Finance Corp. and an officer of Fifth Street Finance Corp. (collectively “guarantors”), entered into a guaranty agreement (the “Guaranty”) with the Partnership. Under the terms of the Guaranty, the guarantors agreed to guarantee the Partnership’s obligations under the Loan Agreement. In consideration for the guaranty, the Partnership was obligated to pay a former member of the Board of Directors of Fifth Street Finance Corp. a fee of $41,667 per month so long as the Loan Agreement was in effect. For the period from October 1, 2007 to November 27, 2007, the Partnership paid $83,333 under this Guaranty. In October 2007, the Partnership drew $28.25 million under the loan agreement. These loans were paid back in full with interest in November 2007. As of November 27, 2007, the Partnership terminated the Loan Agreement and the Guaranty.

Interest expense for the three months ended March 31, 2009 and 2008, was $128,201 and $72,982, respectively. Interest expense for the six months ended March 31, 2009 and 2008, was $168,359 and $187,681, respectively.

Note 7. Interest and Dividend Income

Interest income is recorded on the 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 a payment-in-kind (“PIK”) interest provision. The PIK interest, computed at the contractual rate specified in each debt agreement, is added to the principal balance of the debt and is recorded as interest income. Thus, the actual collection of this interest generally occurs at the time of debt principal repayment. The Company’s policy is to stop accruing PIK interest when it is determined that PIK interest is no longer collectible.

Accumulated PIK interest activity for the six months ended March 31, 2009 and March 31, 2008 was as follows:


	Six months ended			Six months ended
	March 31, 2009			March 31, 2008
PIK balance at beginning of period	$	5,367,032		$	588,795
Gross PIK interest accrued		4,170,923			1,687,713
PIK income reversals		(453,436	)		—
PIK interest received in cash		(163,575	)		(15,638	)

PIK balance at end of period	$	8,920,944		$	2,260,870

As of March 31, 2009, the Company had stopped accruing PIK interest and OID on four investments, including two investments that had not paid their scheduled monthly cash interest payments or were otherwise on non-accrual status. The aggregate amount of this income non-accrual was approximately $1.0 million and $1.6 million for the three and six months ended March 31, 2009, respectively.

Income non-accrual amounts for the current year are as follows:


	Three months ended		Six months ended
	March 31, 2009		March 31, 2009
Cash interest income	$	632,071	$	902,578
PIK interest income		249,035		453,436
OID income		97,350		194,700

Total non-accrual of income	$	978,456	$	1,550,714

Note 8. Fee 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.

Note 9. Realized Gains or Losses from Investments and Net Change in Unrealized Appreciation or Depreciation from Investments

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. Net change in unrealized appreciation or depreciation from investments 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 on exited investments.

For the three and six months ended March 31, 2009, the Company recorded $12.4 million of realized losses on two of our portfolio company investments in connection with our determination that such investments were permanently impaired based on, among other things, our analysis of changes in each portfolio company’s business operations and prospects. For the three and six months ended March 31, 2008, the Company had no realized gains or losses.

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.

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 under the investment advisory agreement 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 pro rated.

Prior to the merger of the Partnership with and into the Company, which occurred on January 2, 2008, the Partnership paid the Investment Adviser a management fee (the “Management Fee”), subject to the adjustments as described in the Partnership Agreement, for investment advice equal to an annual rate of 2% of the aggregate capital commitments of all limited partners (other than affiliated limited partners) for each fiscal year (or portion thereof) provided, however, that commencing on the earlier of (1) the first day of the fiscal quarter immediately following the expiration of the commitment period, or (2) if a temporary suspension period became permanent in accordance with the Partnership Agreement, on the first day of the fiscal quarter immediately following the date of such permanent suspension, the Management Fee for each subsequent twelve month period was equal to 1.75% of the NAV of the Partnership (exclusive of the portion thereof attributable to the General Partner and the affiliated limited partners, based upon respective capital percentages).

For the three months ended March 31, 2009 and 2008, base management fees were approximately $1.5 million and $1.0 million, respectively. For the six months ended March 31, 2009 and 2008, base management fees were approximately $2.9 million and $1.8 million, respectively.

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 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.

	•		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 will be 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 will equal 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, provided that, the incentive fee determined as of September 30, 2008 will be 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.

For the three months ended March 31, 2009 and 2008, incentive fees were approximately $1.9 million and $1.0 million, respectively. For the six months ended March 31, 2009 and 2008, incentive fees were approximately $3.9 million and $1.0 million, respectively.

Transaction fees

Prior to the merger of the Partnership with and into the Company, which occurred on January 2, 2008, the Investment Adviser received 20% of transaction origination fees. For the six months ended March 31, 2008, payments for the transaction fees paid to the Investment Adviser amounted to approximately $0.2 million and were expensed as incurred.

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 Securities and Exchange Commission. 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 his staff. 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, 2009, the Company incurred administrative expenses of approximately $318,000 and $595,000, respectively. At March 31, 2009, approximately $381,000 was included in Due to FSC, Inc. in the Consolidated Balance Sheet.

Note 12. Financial Highlights (1)


	Three months			Three months			Six months			Six months
	ended March			ended March			ended March			ended March
	31, 2009			31, 2008			31, 2009			31, 2008 (2)
Per share data: (3)
Net asset value at beginning of period	$	11.86		$	13.92		$	13.02		$	—
Adjustment to net asset value for issuance of common stock		(0.04	)		—			(0.02	)		8.56

Capital contributions from partners		—			—			—			5.33
Capital withdrawals by partners		—			—			—			(0.23	)
Dividends declared and paid		—			—			(0.70	)		—

Repurchases of common stock		—			—			(0.02	)		—
Net investment income		0.33			0.33			0.69			0.62
Unrealized appreciation (depreciation) on investments		0.33			(0.13	)		(0.49	)		(0.16	)
Realized loss on investments		(0.54	)		—			(0.54	)		—

Net asset value at end of period	$	11.94		$	14.12		$	11.94		$	14.12


Stockholders’ equity at beginning of period	$	268,548,431		$	173,699,990		$	294,335,839		$	106,815,695
Stockholders’ equity at end of period	$	272,352,706		$	176,210,249		$	272,352,706		$	176,210,249
Average stockholders’ equity (4)	$	270,633,268		$	174,955,120		$	277,946,883		$	160,985,605
Ratio of total expenses, excluding interest and line of credit guarantee expenses, to average stockholders’ equity (5)		1.59	%		1.54	%		3.11	%		2.70	%
Ratio of total expenses to average stockholders’ equity (5)		1.64	%		1.59	%		3.17	%		2.81	%
Ratio of net increase in net assets resulting from operations to ending stockholders’ equity (5)		1.04	%		1.42	%		-2.73	%		3.24	%
Ratio of unrealized appreciation (depreciation) on investments to ending stockholders’ equity (5)		2.85	%		-0.89	%		-3.94	%		-1.16	%
Total return to stockholders based on average stockholders’ equity (5)		1.05	%		1.45	%		-2.67	%		3.36	%
Weighted average outstanding debt (6)	$	477,778		$	2,881,933		$	236,264		$	1,417,344


(1)		The amounts reflected in the financial highlights above represent net assets, income and expense ratios for all stockholders.

(2)		Per share data for the six months ended March 31, 2008 presumes the issuance of the 12,480,972 common shares at October 1, 2007 which were actually issued on January 2, 2008 in connection with the merger described above. There was no established public trading market for the stock for the period prior to October 1, 2007.

(3)		Based on actual shares outstanding at the end of the corresponding period or weighted average shares outstanding for the period, as appropriate.

(4)		Calculated based upon the daily weighted average stockholders’ equity for the period.

(5)		Interim periods are not annualized.

(6)		Calculated based upon the daily 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. The Company’s certificate of amendment was also approved by the holders of a majority of the shares of its outstanding common stock through a written consent first solicited on April 7, 2008. On April 24, 2008, the Company filed its certificate of amendment and on April 25, 2008, it sold 30,000 shares of Series A Preferred Stock to a company controlled by Bruce E. Toll, one of the Company’s directors at that time. For the three months ended June 30, 2008, the Company paid dividends of approximately $234,000 on the 30,000 shares of Series A Preferred Stock. The dividend payment is considered and included in interest expense for accounting purposes since the preferred stock has a mandatory redemption feature. On June 30, 2008, the Company redeemed 30,000 shares of Series A Preferred Stock at the mandatory redemption price of 101% of the liquidation preference or $15,150,000. The $150,000 is considered and included in interest expense for accounting purposes due to the stock’s mandatory redemption feature. No preferred stock is currently outstanding.

Note 14. Subsequent Events

On April 3, 2009 and May 4, 2009, the Company repaid $4.0 million and $3.0 million, respectively, of the balance on its secured revolving credit facility with the Bank of Montreal. As of May 6, 2009, the outstanding balance on the facility was $14.0 million.

On April 15, 2009, the Company declared a $0.25 per share dividend to its common stockholders of record as of May 26, 2009. The dividend is payable on June 25, 2009.

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

The information contained in this section should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this quarterly report on Form 10-Q.

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

	•		our future operating results;

	•		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 quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Risk Factors” in our annual report on Form 10-K for the year ended September 30, 2008 and elsewhere in this Form 10-Q. Other factors that could cause actual results to differ materially include:

	•		changes in the economy, including the current recession;

	•		continued instability in the financial markets;

	•		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 and RICs.

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

Overview

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

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

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

On June 17, 2008, we completed an initial public offering of 10,000,000 shares of our common stock at the offering price of $14.12 per share. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “FSC.”

Since approximately mid-2007, the financial markets and the economy have been volatile and generally declining. This has a wide impact on our business. It effects our investment origination, valuation, and pricing. It effects our portfolio companies’ ability to grow their business and service our debt. It effects our ability to raise capital.

To the extent these conditions continue or worsen, it could negatively impact our operating results and limit our ability to grow.

Critical Accounting Policies

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

Investment Valuation

We are required to report our investments that are not publicly traded or for which current market values are not readily available at fair value. The fair value is deemed to be the value at which an enterprise could be sold in a transaction between two willing parties other than through a forced or liquidation sale.

Under SFAS 157, which we adopted effective October 1, 2008, we perform detailed valuations of our debt and equity investments on an individual basis, using market based, income based, and bond yield approaches as appropriate.

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. 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. 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.

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. We also 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.

We also may, when conditions warrant, utilize an expected recovery model, whereby we use alternate procedures to determine value when the customary approaches are deemed to be not as relevant or reliable.

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 the deal team within our investment adviser responsible for the portfolio investment;

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

• Separately, an independent valuation firm engaged by the Board of Directors prepares preliminary valuations on a selected basis and submits a report to us;

• The deal team compares and contrasts their preliminary valuations to the report of the independent valuation firm and resolves any differences;

• The deal team prepares a final valuation report for the Board of Directors;

• The Valuation Committee of our Board of Directors reviews the preliminary valuations, and the deal team responds and supplements the preliminary valuations to reflect any comments provided by the Valuation Committee;

• The Valuation Committee makes a recommendation to the Board of Directors; and

• The Board of Directors discusses 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, 2009, and December 31, 2008, was determined by our Board of Directors.

Our Board of Directors has engaged an independent valuation firm to provide us with valuation assistance with respect to at least 90% of the cost basis of our investment portfolio in any given quarter. Upon completion of its process each quarter, the independent valuation firm provides 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 an independent valuation firm 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.

An independent valuation firm, Murray, Devine & Co., Inc., provided us with assistance in our determination of the fair value of 91.9% of our portfolio for the quarter ended December 31, 2007, 92.1% of our portfolio for the quarter ended March 31, 2008, 91.7% of our portfolio for the quarter ended June 30, 2008, 92.8% of our portfolio for the quarter ended September 30, 2008, 100% of our portfolio for the quarter ended December 31, 2008, and 88.7% of our portfolio for the quarter ended March 31, 2009 (or 96.0% of our portfolio excluding our investment in IZI Medical Products, Inc., which closed on March 31, 2009 and therefore was not part of the independent valuation process). The independent third party provides negative assurance with regard to the reasonableness of the valuations.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS 159 also requires entities to display the fair value of the selected assets and liabilities on the face of the Consolidated Balance Sheet. SFAS 159 does not eliminate disclosure requirements of other accounting standards, including fair value measurement disclosures in SFAS 157. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of Statement 157. While SFAS 159 became effective for our 2009 fiscal year, we did not elect the fair value measurement option for any of our financial assets or liabilities.

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.

Fee Income

We will receive a variety of fees in the ordinary course of our business, including origination fees. We will account for our fee income in accordance with Emerging Issues Task Force Issue 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 addresses certain aspects of a company’s accounting for arrangements containing multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (i.e., there are separate units of accounting). EITF 00-21 states that the total consideration received for the arrangement be allocated to each unit based upon each unit’s relative fair value. In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. The timing of revenue recognition for a given unit of accounting depends on the nature of the deliverable(s) in that accounting unit (and the corresponding revenue recognition model) and whether the general conditions for revenue recognition have been met. Fee income for which fair value cannot be reasonably ascertained is recognized using the interest method in accordance with Statement of Financial Accounting Standards No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,” (“SFAS No. 91”). We will recognize fee income in accordance with SFAS No. 91. In addition, we will capitalize and offset direct loan origination costs against the origination fees received and only defer the net fee.

Payment-in-Kind (PIK) Interest

Our loans typically contain a PIK interest provision. 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 the form of distributions, even though we have not yet collected the cash. We will stop accruing PIK interest when it is determined that PIK interest is no longer collectable. Accumulated PIK interest represented approximately $8.9 million or 3.1% of our portfolio of investments as of March 31, 2009 and approximately $5.4 million or 2.0% as of September 30, 2008. The net increase in loan balances as a result of contracted PIK arrangements are separately identified on our Consolidated Statements of Cash Flows.

Portfolio Composition

Our investments principally consist of loans, purchased equity investments and equity grants in privately-held companies. Our loans are typically secured by either a first or second lien on the assets of the portfolio company, generally have terms of up to six years (but an expected average life of between three and four years) and typically bear interest at fixed rates and to a lesser extent, at floating rates.

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


	March 31, 2009			September 30, 2008

Cost:
First lien debt		44.94	%		37.41	%
Second lien debt		51.88	%		59.38	%
Purchased equity		1.29	%		1.42	%
Equity grants		1.89	%		1.79	%

Total		100.00	%		100.00	%


	March 31, 2009			September 30, 2008

Fair value:
First lien debt		45.78	%		39.54	%
Second lien debt		53.09	%		58.78	%
Purchased equity		0.24	%		0.73	%
Equity grants		0.89	%		0.95	%

Total		100.00	%		100.00	%

Set forth below are tables showing the industry composition of our portfolio at cost and fair value as of March 31, 2009 and September 30, 2008:


	March 31, 2009			September 30, 2008
Cost:
Healthcare technology		11.66	%		3.33	%
Healthcare services		10.56	%		8.01	%
Footwear and apparel		6.88	%		6.21	%
Restaurants		6.26	%		6.65	%
Construction and engineering		5.99	%		6.45	%
Healthcare facilities		5.86	%		6.27	%
Trailer leasing services		5.36	%		5.85	%
Manufacturing — mechanical products		4.89	%		5.33	%
Data processing and outsourced services		4.29	%		4.77	%
Media — Advertising		4.11	%		4.40	%
Merchandise display		4.07	%		4.40	%
Home furnishing retail		3.99	%		3.93	%
Food distributors		3.77	%		4.13	%
Housewares & specialties		3.52	%		3.93	%
Capital goods		3.08	%		3.32	%
Emulsions manufacturing		3.02	%		3.28	%
Environmental & Facilities Services		2.82	%		3.08	%
Household products/ specialty chemicals		2.46	%		4.08	%
Leisure facilities		2.30	%		2.58	%
Entertainment — theaters		2.29	%		4.05	%
Building products		2.21	%		2.39	%
Lumber products		0.61	%		3.56	%

Total		100.00	%		100.00	%


	March 31, 2009			September 30, 2008
Fair value:
Healthcare technology		12.45	%		3.60	%
Healthcare services		11.71	%		8.54	%
Footwear and apparel		7.37	%		6.55	%
Construction and engineering		6.37	%		6.82	%
Restaurants		5.98	%		6.44	%
Healthcare facilities		5.91	%		6.66	%
Manufacturing — mechanical products		5.34	%		5.66	%
Data processing and outsourced services		4.60	%		5.00	%
Merchandise display		4.43	%		4.68	%
Trailer leasing services		4.27	%		6.20	%
Food distributors		4.09	%		4.38	%
Media — Advertising		3.88	%		4.57	%
Capital goods		3.54	%		3.57	%
Emulsions manufacturing		3.37	%		3.48	%
Home furnishing retail		3.18	%		3.92	%
Environmental & Facilities Services		2.78	%		3.24	%
Entertainment — theaters		2.50	%		4.30	%
Leisure facilities		2.44	%		2.74	%
Building products		2.41	%		2.55	%
Housewares & specialties		2.40	%		4.17	%
Household products/ specialty chemicals		0.67	%		1.33	%
Lumber products		0.31	%		1.60	%

Total		100.00	%		100.00	%

Portfolio Asset Quality

We employ a grading system to assess and monitor the credit risk of our loan portfolio. We rate all loans 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.

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

	•		Investment Rating 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 rated 2.

	•		Investment Rating 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 rating of 3 may be out of compliance with financial covenants.

	•		Investment Rating 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 Rating 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 rating 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 rating scale at fair value, as of March 31, 2009 and September 30, 2008:


	March 31, 2009								September 30, 2008
	Investment at Fair		Percentage of Total						Investment at		Percentage of Total
Investment Rating	Value		Portfolio			Leverage Ratio			Fair Value		Portfolio			Leverage Ratio
1.	$	9,788,669		3.37	%		2.88		$	7,578,261		2.77	%		4.05
2.		239,166,947		82.25	%		4.09			244,727,144		89.39	%		4.23
3.		29,758,091		10.23	%		6.47			17,069,260		6.24	%		5.86
4.		9,193,449		3.16	%		6.58			4,384,489		1.60	%		9.80
5.		2,870,143		0.99	%		NM	¹		—		0.00	%		—

Total	$	290,777,299		100.00	%		4.38		$	273,759,154		100.00	%		4.42


¹		Due to operating performance this ratio is not measurable.

As a result of current economic conditions and their impact on certain of our portfolio companies, we have agreed to modify the terms of our investments in nine of our portfolio companies. Such modified terms include increased payment-in-kind interest provisions and reduced interest rates. These modifications, and any future modifications to our loan agreements as a result of the current 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. See footnote 9 to the Consolidated Schedule of Investments as of March 31, 2009 in our consolidated financial statements included herein.

In addition, as the United States economy continues to remain in a recession, the financial results of small- to mid-sized companies, like those in which we invest, have begun to 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 performance of certain of our portfolio companies has 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 affect distributable income.

Loans and Debt Securities on Non-Accrual Status

As of March 31, 2009, we had stopped accruing PIK interest and OID on four investments, including two investments that had not paid their scheduled monthly cash interest payments or were otherwise on non-accrual status. The aggregate amount of this income non-accrual was approximately $1.0 million and $1.6 million for the three and six months ended March 31, 2009, respectively.

Income non-accrual amounts for the current year are as follows:


	Three months ended		Six months ended
	March 31, 2009		March 31, 2009
Cash interest income	$	632,071	$	902,578
PIK interest income		249,035		453,436
OID income		97,350		194,700

Total non-accrual of income	$	978,456	$	1,550,714

Results of Operations

The principal measure of our financial performance is the net income (loss) 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 cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

Comparison for the three and six months ended March 31, 2009 and 2008

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, annual administrative fees, unused fees, prepayment fees, amendment fees, equity structuring fees and waiver fees. Other investment income consists primarily of the accelerated recognition of deferred financing fees received from our portfolio companies on the repayment of the outstanding investment, the sale of the investment or reduction of available credit, and interest on cash and cash equivalents on deposit with financial institutions.

Total investment income for the three months ended March 31, 2009 and March 31, 2008 was approximately $11.9 million and $6.9 million, respectively. For the three months ended March 31, 2009, this amount primarily consisted of approximately $11.2 million of interest income from portfolio investments (which included approximately $1.9 million of payment-in-kind or PIK interest), and $753,000 of fee income. For the three months ended March 31, 2008, this amount primarily consisted of approximately $6.2 million of interest income from portfolio investments (which included approximately $959,000 of payment-in-kind or PIK interest), and $425,000 of fee income.

Total investment income for the six months ended March 31, 2009 and March 31, 2008 was approximately $24.5 million and $12.3 million, respectively. For the six months ended March 31, 2009, this amount primarily consisted of approximately $22.6 million of interest income from portfolio investments (which included approximately $3.7 million of payment-in-kind or PIK interest), and $1.8 million of fee income. For the six months ended March 31, 2008, this amount primarily consisted of approximately $11.2 million of interest income from portfolio investments (which included approximately $1.7 million of payment-in-kind or PIK interest), and $699,000 of fee income.

The increase in our total investment income for the three and six months ended March 31, 2009 as compared to the three and six months ended March 31, 2008 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to an increase of seven debt investments in our portfolio in the year-over-year period, partially offset by debt repayments received during the same periods.

Expenses

Expenses for the three months ended March 31, 2009 and 2008 were approximately $4.4 million and $2.8 million, respectively. Expenses increased for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 by approximately $1.6 million, primarily as a result of increases in base management fees, incentive fees and legal fees related primarily to our formation of and application to license a Small Business Investment Company subsidiary and other deal related matters.

Expenses for the six months ended March 31, 2009 and 2008 were approximately $8.8 million and $4.5 million, respectively. Expenses increased for the six months ended March 31, 2009 as compared to the six months ended March 31, 2008 by approximately $4.3 million, primarily as a result of increases in base management fees, incentive fees, legal fees related primarily to our formation of and application to license a Small Business Investment Company subsidiary and other deal related matters, and other general and administrative expenses.

The increase in base management fees resulted from an increase in our total assets as reflected in the growth of the investment portfolio. Incentive fees were implemented effective January 2, 2008 when Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp., and reflect the growth of our net investment income before such fees.

Net Investment Income

As a result of the $5.0 million increase in total investment income as compared to the $1.6 million increase in total expenses, net investment income for the three months ended March 31, 2009 reflected a $3.4 million, or 83.5%, increase compared to the three months ended March 31, 2008.

As a result of the $12.2 million increase in total investment income as compared to the $4.3 million increase in total expenses, net investment income for the six months ended March 31, 2009 reflected a $7.9 million, or 102.5%, increase compared to the six months ended March 31, 2008.

Realized Gain (Loss) on Sale of Investments

Net realized gain (loss) on the sale of investments is the difference between the proceeds received from dispositions of portfolio investments and their stated cost. During the three and six months ended March 31, 2009, we recorded $12.4 million of realized losses on two of our portfolio company investments in connection with our determination that such investments were permanently impaired based on, among other things, our analysis of changes in each portfolio company’s business operations and prospects. During the three and six months ended March 31, 2008, we sold no investments and reported no realized gains or losses.

Net Change in Unrealized Appreciation or Depreciation on Investments

We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized in our Consolidated Statement of Operations. Value, as defined in Section 2 (a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the board of directors pursuant to our valuation policy and a consistently applied valuation process. At March 31, 2009, and September 30, 2008, portfolio investments recorded at fair value represented 97.7% and 91.5%, respectively, of our total assets. Because of the inherent uncertainty of estimating the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the board of directors 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.

There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. We specifically value each individual investment on a quarterly basis. We record unrealized depreciation on investments when we believe that an investment has depreciated in value including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment, or when the bond yield models concludes that the debt investment has depreciated. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has also appreciated in value or the bond yield models concludes that the debt investment has appreciated in value. Changes in fair value are recorded in the Consolidated Statement of Operations as net change in unrealized appreciation or depreciation.

Net unrealized appreciation or depreciation on investments is the net change in the fair value of our investment portfolio 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, 2009, we recorded net unrealized appreciation of $7.7 million. This consisted of $12.4 million of reclassifications to realized losses (i.e., we reversed previously recorded unrealized depreciation on two of our portfolio company investments in connection with the recognition of the realized losses described above), $4.4 million of unrealized depreciation on debt investments and $0.3 million of unrealized depreciation on equity investments. During the three months ended March 31, 2008, we recorded net unrealized depreciation of $1.6 million. This consisted entirely of unrealized depreciation on equity investments.

During the six months ended March 31, 2009, we recorded net unrealized depreciation of $10.7 million. This consisted of $12.4 million of reclassification to realized losses, $21.0 million of net unrealized depreciation on debt investments and $2.1 million of net unrealized depreciation on equity investments. During the six months ended March 31, 2008, we recorded net unrealized depreciation of $2.0 million. This consisted entirely of unrealized depreciation on equity investments.

Financial Condition, Liquidity and Capital Resources

For the six months ended March 31, 2009, we experienced a net decrease in cash and equivalents of $19.2 million. During that period, we used $25.4 million of cash in operating activities, primarily for the funding of $47.9 million of investments, partially offset by $11.2 million of principal payments received and $15.7 million of net investment income. In addition, in October 2008 we repurchased 78,000 shares of our common stock totaling approximately $462,000 pursuant to our open market share repurchase program, on December 29, 2008 we paid a cash dividend of $6.4 million to our common stockholders and issued 105,326 common shares totaling approximately $763,000 to those common stockholders that opted to reinvest the dividend under our dividend reinvestment plan, and on January 29, 2009 we paid a cash dividend of $7.6 million to our common stockholders and issued 161,206 common shares totaling approximately $1.0 million under the dividend reinvestment plan. On January 29, 2009, we borrowed $1.0 million under our secured revolving credit facility with Bank of Montreal. This amount was repaid in full on January 30, 2009. Also, we borrowed $21.0 million under the facility on March 30, 2009. $17.0 million of this amount remained outstanding at April 30, 2009. We intend to fund our future distribution obligations through operating cash flow or with funds obtained through our credit line, as we deem appropriate.

As of March 31, 2009, we had $3.7 million in cash, portfolio investments (at fair value) of $290.8 million, $2.8 million of interest receivable, $21.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million. At April 30, 2009, we had $1.8 million in cash, $2.2 million of interest receivable, $5.7 million of dividends payable, $17.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million.

For the six months ended March 31, 2008, we experienced a net decrease in cash and equivalents of $15.2 million. During that period, we used $92.5 million of cash in operating activities, primarily for the funding of $102.3 million of investments partially offset by $7.8 million of net investment income. $77.3 million of cash was provided by financing activities, due primarily to net capital contributions from partners of $66.5 million and net borrowings of $14.4 million.

Below are the significant capital transactions that occurred from Inception through March 31, 2009:

On March 30, 2007, we closed on approximately $78 million in capital commitments from the sale of limited partnership interests of Fifth Street Mezzanine Partners III, L.P. As of September 30, 2007, we had closed on additional capital commitments, bringing the total amount of capital commitments to $165 million. We then closed on capital commitments from the sale of additional limited partnership interests of Fifth Street Mezzanine Partners III, L.P., bringing the total amount of capital commitments to $169.4 million as of November 28, 2007.

On 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 of Fifth Street Finance Corp.

On January 15, 2008, we entered into a $50 million secured revolving credit facility with the Bank of Montreal, at a rate of LIBOR plus 1.5%, with a one year maturity date. The credit facility is secured by our existing investments.

On April 25, 2008, we sold 30,000 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”) at a price of $500 per share to a company controlled by Bruce E. Toll, one of our directors at that time, for total proceeds of $15 million. For the three months ended June 30, 2008, we paid dividends of approximately $234,000 on the 30,000 shares of Series A Preferred Stock. The dividend payment is considered and included in interest expense for accounting purposes since the preferred stock has a mandatory redemption feature. On June 30, 2008, we redeemed 30,000 shares outstanding of our Series A Preferred Stock at the mandatory redemption price of 101% of the liquidation preference, or $15,150,000. The $150,000 is considered and all included in interest expense for accounting purposes due to the stock’s mandatory redemption feature.

On May 1, 2008, our Board of Directors declared a dividend of $0.30 per share of common stock, paid on June 3, 2008 to shareholders of record as of May 19, 2008.

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 and received net proceeds of approximately $129.5 million. Our shares are currently listed on the New York Stock Exchange under the symbol “FSC.”

On August 6, 2008, our Board of Directors declared a dividend of $0.31 per share of common stock, paid on September 26, 2008 to shareholders of record as of September 10, 2008.

In October 2008, we repurchased 78,000 shares of our common stock on the open market as part of our share repurchase program following its announcement on October 15, 2008.

On December 9, 2008, our Board of Directors declared a dividend of $0.32 per share of common stock, paid on December 29, 2008 to shareholders of record as of December 19, 2008, and a dividend of $0.33 per share of common stock, payable on January 29, 2009 to shareholders of record as of December 30, 2008.

On December 18, 2008, our Board of Directors declared a special dividend of $0.05 per share of common stock, payable on January 29, 2009 to shareholders of record as of December 30, 2008.

On January 29, 2009, we borrowed $1.0 million from our secured revolving credit facility with Bank of Montreal. This amount was repaid in full on January 30, 2009. Also, we borrowed $21.0 million from the facility on March 30, 2009. This amount remained outstanding at March 31, 2009.

We intend to continue to generate cash primarily from cash flows from operations, including interest earned from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less, 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, we cannot assure you that our plans to raise capital will be successful. In this regard, because our common stock has traded at a price below our current net asset value per share over the last several months and we are limited in our ability to sell our common stock at a price below net asset value per share, we have been and may continue to be limited in our ability to raise equity capital. See “Risk Factors - Risks Relating to Our Business and Structure — Regulations governing our operation as a business development company will affect our ability to, and the way in which we, raise additional capital” and “- Because we intend to distribute substantially all 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 our Form 10-K for the year ended September 30, 2008 for a discussion of the provisions of the 1940 Act that limit our ability to sell our common stock at a price below net asset value per share.

In addition, we intend to distribute to our stockholders substantially all of our taxable income in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. See “Regulated Investment Company Status and Dividends” below. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings under our $50 million secured revolving credit facility, which matures on December 29, 2009. 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. As of March 31, 2009, we had $3.7 million in cash, portfolio investments (at fair value) of $290.8 million, $2.8 million of interest receivable, $21.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million. At April 30, 2009, we had $1.8 million in cash, $2.2 million of interest receivable, $5.7 million of dividends payable, $17.0 million of borrowings outstanding under our secured revolving credit facility and unfunded commitments of $11.0 million.

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, 2009, we were in compliance with this requirement. 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, in light of the recent worsening of the conditions in the financial markets and the U.S. economy overall, we are considering other measures to help ensure adequate liquidity, including the formation of and application to license a Small Business Investment Company subsidiary. We cannot provide any assurance that these measures will provide sufficient sources of liquidity to support our operations and growth given the unprecedented instability in the financial markets and the weak U.S. economy.

Borrowings

On January 15, 2008, we entered into a $50 million secured revolving credit facility with the Bank of Montreal, at a rate of LIBOR plus 1.5%, with a one year maturity date. The secured revolving credit facility is secured by our existing investments.

On December 30, 2008, Bank of Montreal renewed our $50 million credit facility. The terms include a 50 basis points commitment fee, an interest rate of Libor +3.25% and a term of 364 days. As of March 31, 2009, we had $21.0 million of borrowings outstanding under this credit facility. At April 30, 2009, we had $17.0 million of borrowings outstanding under this credit facility.

Under the secured revolving credit facility we must satisfy several financial covenants, including maintaining a minimum level of stockholders’ equity, a maximum level of leverage and a minimum asset coverage ratio and interest coverage ratio. In addition, we must comply with other general covenants, including with respect to indebtedness, liens, restricted payments and mergers and consolidations. At March 31, 2009, we were in compliance with these covenants.

Since our inception we have had funds available under the following agreements which we repaid or terminated prior to our election to be regulated as a business development company:

Note Agreements.

We received loans of $10 million on March 31, 2007 and $5 million on March 30, 2007 from Bruce E. Toll, a former member of our Board of Directors, on each occasion for the purpose of funding our investments in portfolio companies. These note agreements accrued interest at 12% per annum. On April 3, 2007, we repaid all outstanding borrowings under these note agreements.

Loan Agreements.

On April 2, 2007, we entered into a $50 million loan agreement with Wachovia Bank, N.A., which was available for funding investments. The borrowings under the loan agreement accrued interest at LIBOR (London Inter Bank Offered Rate) plus 0.75% per annum and had a maturity date in April 2008. In order to obtain such favorable rates, Mr. Toll, a former member of our Board of Directors, Mr. Tannenbaum, our president and chief executive officer, and FSMPIII GP, LLC, the general partner of our predecessor fund, each guaranteed our repayment of the $50 million loan. We paid Mr. Toll a fee of 1% per annum of the $50 million loan for such guarantee, which was paid quarterly or monthly at our election. Mr. Tannenbaum and FSMPIII GP received no compensation for their respective guarantees. As of November 27, 2007, we repaid and terminated this loan with Wachovia Bank, N.A.

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, 2009, our only off-balance sheet arrangements consisted of $11.0 million of unfunded commitments to provide debt financing to certain of our portfolio companies. Such commitments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet and are not reflected on our Consolidated Balance Sheet.

Contractual Obligations

A summary of the composition of unfunded commitments (consisting of revolvers and term loans) as of March 31, 2009 and September 30, 2008 is shown in the table below:


	March 31, 2009		September 30, 2008
MK Network, LLC	$	—	$	2,000,000
Fitness Edge, LLC		1,500,000		1,500,000
Rose Tarlow, Inc.		—		2,650,000
Western Emulsions, Inc.		2,000,000		2,000,000
Storyteller Theaters Corporation		4,000,000		4,000,000
HealthDrive Corporation		1,000,000		1,500,000
Martini Park, LLC		—		11,000,000
IZI Medical Products, Inc.		2,500,000		—

Total	$	11,000,000	$	24,650,000

We have entered into two contracts under which we have material future commitments, the investment advisory agreement, pursuant to which Fifth Street Management LLC has agreed to serve as our investment adviser, and the administration agreement, pursuant to which FSC, Inc. has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations.

As discussed above, we have also entered into a $50 million secured revolving credit facility with Bank of Montreal, at a rate of LIBOR plus 3.25%, with a one year maturity date. This credit facility is secured by our existing investments. As of March 31, 2009, we had $21.0 million of borrowings outstanding under this credit facility. At April 30, 2009, we had $17.0 million of borrowings outstanding under this credit facility.

Regulated Investment Company Status and Dividends

Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp., which has elected to be treated as a business development company under the 1940 Act. We intend to elect, 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 taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distributive requirements of our taxable income on a calendar year basis (i.e., calendar year 2009). We anticipate timely distribution of our taxable income within the tax rules, however, we may incur a U.S. federal excise tax for the calendar year 2009. We intend to make distributions to our stockholders on a quarterly basis of between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). 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 facility. 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.

Pursuant to a recent revenue procedure issued by the Internal Revenue Service (“IRS”) (Revenue Procedure 2009-15) (the “Revenue Procedure”), 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 shareholder have a right to elect to receive its entire distribution in cash. If too many shareholders elect to receive cash, each shareholder electing to receive cash must receive a proportionate share of the cash to be distributed (although no shareholder electing to receive cash may receive less than 10% of such shareholder’s distribution in cash). This revenue procedure applies to distributions made with respect to taxable years ending prior to January 1, 2010.

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 our president and chief executive officer. Pursuant to the investment advisory agreement, payments 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 (b) an incentive fee based on our performance.

Pursuant to the administration agreement with FSC, Inc., FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will pay FSC, Inc. our allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and chief compliance officer, and their respective staffs. Each of these contracts may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other.

Mr. Toll, a former member of our Board of Directors and the father-in-law of Mr. Tannenbaum, our president and chief executive officer and the managing partner of our investment adviser, was one of the three guarantors under a $50 million loan agreement between Fifth Street Mezzanine Partners III, L.P., our predecessor fund, from Wachovia Bank, N.A. Fifth Street Mezzanine Partners III, L.P. paid Mr. Toll a fee of 1% per annum of the $50 million loan for such guarantee, which was paid quarterly or monthly at our election. Mr. Tannenbaum, our president and chief executive officer, and FSMPIII GP, LLC, the general partner of our predecessor fund, were each also guarantors under the loan, although they received no compensation for their respective guarantees. As of November 27, 2007, we terminated this loan with Wachovia Bank, N.A.

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.” Fifth Street Capital LLC is controlled by Mr. Tannenbaum, its managing member. 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.

As mentioned previously, on April 4, 2008 our Board of Directors approved a certificate of amendment to our restated certificate of incorporation reclassifying 200,000 shares of our 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. Our certificate of amendment was also approved by the holders of a majority of the shares of our outstanding common stock through a written consent first solicited on April 7, 2008. On April 24, 2008 we filed our certificate of amendment and on April 25, 2008, we sold 30,000 shares of Series A Preferred Stock to a company controlled by Bruce E. Toll, one of our directors at that time. For the three months ended June 30, 2008, we paid dividends of approximately $234,000 on the 30,000 shares of Series A Preferred Stock. On June 30, 2008, we redeemed 30,000 shares of Series A Preferred Stock at the mandatory redemption price of 101% of the liquidation preference or $15,150,000.

Recent Developments

On April 3, 2009 and May 4, 2009, we repaid $4.0 million and $3.0 million, respectively, of the balance on our secured revolving credit facility with the Bank of Montreal. As of May 6, 2009, the outstanding balance on the facility was $14.0 million.

On April 15, 2009, we declared a $0.25 per share dividend to our common stockholders of record as of May 26, 2009. The dividend is payable on June 25, 2009.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent any of our debt investments include floating interest rates. The significant majority of our debt investments are made with fixed interest rates for the term of the investment. However, as of March 31, 2009, approximately 6.0% of our debt investment portfolio (at fair value) and 5.8% of our debt investment portfolio (at cost) bore interest at floating rates. As of March 31, 2009, we had not entered into any interest rate hedging arrangements. At March 31, 2009, based on our applicable levels of floating-rate debt investments, a 1.0% change in interest rates would not have a material effect on our level of interest income from debt investments.

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective in timely alerting them of material information relating to us that is required to be disclosed in the reports we file or submit under the Securities and Exchange Act of 1934. There have been no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Changes in Internal Controls

Our independent auditor has informed us that they believe we have a significant deficiency in internal control over financial reporting related to the research and application of accounting principles generally accepted in the United States of America (“GAAP”). As a result, we have engaged outside advisors to consult with, on an as needed basis, in connection with the application of GAAP.

Other than the foregoing, there have been no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. 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, we are currently not a party to any pending material legal proceedings.

Item 1A. Risk Factors.

There were no material changes from the risk factors as previously disclosed in our Form 10-K for the year ended September 30, 2008.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

While we did not engage in unregistered sales of equity securities during the three months ended March 31, 2009, we issued a total of 161,206 shares of common stock under our dividend reinvestment plan. This issuance was not subject to the registration requirements of the Securities Act of 1933. The aggregate price for the shares of common stock issued under the dividend reinvestment plan was approximately $1.0 million.

Use of Proceeds from Initial Public Offering

On June 11, 2008, our registration statement on Form N-2 (SEC File No. 333-146743), for the initial public offering of 10,000,000 shares of our common stock, became effective. 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. The net proceeds totaled approximately $129.4 million net of investment banking commissions of approximately $9.9 million and offering costs of approximately $1.9 million.

At March 31, 2009, the net proceeds of $129.4 million have been used as follows: (1) approximately $15.2 million to redeem all 30,000 shares outstanding of our preferred stock, (2) $26.9 million to pay down in June 2008 our outstanding borrowings under our secured revolving credit facility with Bank of Montreal, and (3) $87.3 to invest in portfolio companies.

Item 4. Submission of Matters to Vote of Security Holders

Our Annual Meeting of Stockholders was held on February 4, 2009, for the purpose of:

	•		Proposal No. 1 — Election of three directors, each to serve until the 2012 Annual Meeting of Stockholders or until their successors are duly elected and qualified; and

	•		Proposal No. 2 — Ratification of the appointment of Grant Thornton LLP as our independent registered public accounting firm for the fiscal year ending September 30, 2009.

There were no broker non-votes for either proposal. Both matters were approved.

The nominees for directors for a three-year term as listed in our 2009 proxy statement were elected by the following vote:


	For		Abstain
Bernard D. Berman		20,531,139		10,500


	For		Abstain
Adam C. Berkman		20,606,646		13,406


	For		Abstain
Leonard M. Tannenbaum		20,679,684		10,500

The recommendation to ratify the appointment of Grant Thornton LLP as our independent registered public accounting firm for the fiscal year ending September 30, 2009 was approved by the following vote:


For	Against		Abstain
20,361,600		451,383		8,500

Item 6. Exhibits.


Exhibit Number		Description of Exhibit
31.1*		Certification of Chairman, President, and Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1*		Certification of Chairman, President, and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).

32.2*		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).


*		Submitted herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Fifth Street Finance Corp.
Date: May 6, 2009	/s/ Leonard M. Tannenbaum
	Leonard M. Tannenbaum
	Chairman, President and Chief Executive Officer


Date: May 6, 2009	/s/ William H. Craig
	William H. Craig
	Chief Financial Officer

EXHIBIT INDEX


Exhibit Number		Description of Exhibit
31.1*		Certification of Chairman, President, and Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1*		Certification of Chairman, President, and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).

32.2*		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).


*		Submitted herewith.